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Richmans' Trade and Taxes Blog
A Summary of Modern Economic History
After Spain discovered the New World and started to ship lots of gold back from it, it became the most powerful country in the world. It could pay for new weapons with gold. It could pay for new ships with gold. It could outfit military expeditions with gold. So the other countries of Europe decided that they wanted to get Spain's gold and in the 16th and 17th centuries they invented mercantilism, the strategy of maximizing exports and minimizing imports in order to obtain Spanish gold.
As a result of their trade surpluses, England, France and the Dutch got Spain's industries and became the dominant powers in Europe. In the meantime, because of its trade deficits Spain lost its industries and became a minor power. Toward the end of the 16th Century, the Spanish tried to invade England, but the "Spanish Armada" was defeated. It took just one century for England and France and the Dutch Republic to replace Spain as the world's leading economic powers.
In the early 17th century. England, France and the Dutch competed with each other to establish colonies around the world. Their idea was that colonies could supply the needed raw materials which they would trade with the mother country for finished products. In the middle of that century the Dutch Republic abandoned mercantilism and, instead experienced trade deficits. As a result, it lost its industries, its military power, its banks, its universities, and its colonies (including New Amsterdam, now called New York).
The wars fought between England and France for colonies continued until they bankrupted the royal treasuries of both countries. When their kings raised taxes to pay for the wars, they caused revolutions. The Revolution in the United States split most of Britain's American colonies from the mother country. The Revolution in France resulted in the royal family being guillotined.
In 1776, at the same time that the U.S. Revolution was getting started, Adam Smith published his monumental book The Wealth of Nations. Mercantilism had stopped working for England. It always stops working after a while because the countries that are running trade surpluses need other countries to run trade deficits. But trade deficits can't continue forever because countries running them eventually go broke. Mercantilism doesn't keep working forever because it destroys the economies of its customers.
So after Adam Smith's book, Great Britain saw that mercantilism was no longer working. Instead of continuing to place high tariffs on foreign products, it took down its tariffs. Meanwhile, the United States developed its economy behind high tariffs under the industrial policy set by Alexander Hamilton. Its weak federal government was financed almost entirely by tariffs. That worked well until World War I when Woodrow Wilson got an amendment passed so that the federal government could raise money through an income tax.
Under President Coolidge the United States tried out-and-out mercantilism. Starting in 1925, the Coolidge administration added a low exchange rate with gold for the dollar to the already high U.S. tariffs so that he could maximize U.S. exports and minimize U.S. imports in world markets. In this way, the U.S. stole Britain's industries and got Britain's gold. France did the same thing. By using mercantilism, France and the United States experienced the Roaring 20's while Britain lost its industries and experienced recession. According to John Maynard Keynes' calculations, by September 1931, the United States had accumulated half of the world's gold stock while France had accumulated almost a fourth.
But in the 1930s, mercantilism stopped working. In response to America raising its already high tariff schedule through the Smoot Hawley tariff, Germany and Britain started free trade zones with their allies, and they and their trading partners put high tariffs on American products. As a result, both trade deficit countries quickly exited the Great Depression. Trade deficit countries can get out of recessions, simply by balancing trade.
President Roosevelt was able to pry Canada out of the British Commonwealth's free trade alliance, and that led to the U.S. romance with free trade agreements. U.S. trade with Canada has remained balanced to this day. But trade with Canada was not enough to pull the U.S.out of the Great Depression. It took World War II to do that.
After World War II, the United States abandoned its tariffs. But still ran trade surpluses, due to loans to European countries, partly through the Marshall Plan. Lending money abroad gives you trade surpluses. Before World War II, trade surplus countries collected gold. After World War II, they gave out loans.
America's low tariff system worked great until Japan and Germany and then later many other countries, mostly in Asia, discovered the power of lending. Their government-owned banks, including their central banks, forced loans upon the United States by buying U.S. assets such as Treasury Bonds, so that the United States dollar would go up in exchange rate and their currencies would go down and they would run trade surpluses while the U.S. would run trade deficits. They also built export industries with government loans so that they could steal U.S. market share in world markets.
President Nixon fought this process when he saw that gold was flowing out of the United States to pay the U.S. trade deficits. At first he placed trade balancing tariffs upon foreign products. Then he gave up the gold standard and the U.S. stopped worrying about trade deficits.
Since 1973, the growing U.S. trade deficits have cost the U.S. most of its industries and a large part of its middle class. In return, it got lots of loans from abroad, so it started to live like a shopoholic, buying goods from abroad on credit.
The United States was not alone, Beginning in the 1990s, the Asian mercantilist forced loans on Great Britain, Canada, and Australia as well. Germany's government-owned banks mostly loaned to the United States and the Southern European countries. So Japan, China and Germany grew rapidly, while the English speaking countries and the Southern European countries shopped.
The low interest rates resulting from the loans from the mercantilist countries produced real estate price bubbles in almost all of the English speaking and Southern European countries. This could not go on forever. Mercantilism eventually destroys its victims' economies. After a while, like the Shopoholic girl in the movie, the English speaking countries and the Southern European countries could not keep up their increased borrowing to buy imports. The financial crisis of 2008 was our first taste of what was coming.
Since then, the trade deficit countries have received new loans from the mercantilist countries. The U.S. resumed its shopoholic ways in 2009. The Southern European countries resumed their shopoholic ways in 2014. This won't continue. Bubbles eventually pop. Eventually the U.S. and Southern Europe will become such bad credit risks that nobody will keep lending them money. Meanwhile, their growth has already slowed to a trickle. Mercantilism has stopped working, so Germany, Japan, China and the other mercantilist countries are no longer growing rapidly, and they are starting to realize that their loans will never be repaid. The crash is coming. We just don't know when.
In a commentary in the American Thinker in January 2011, my father, son and I recommended simultaneously balancing U.S. trade and the U.S. budget to ward off the crisis. Here's what we predicted will happen, eventually:
Unless the United States balances budgets and trade soon, a crash is coming. After the crash we will experience high inflation and a low standard of living. Trade will balance itself because we won't be able to borrow money from abroad. But we with face growth-stifling interest rates unless we slash our government budgets and start saving. We will be approximately in the same place that Greece is now. What we do then will determine whether we recover, or just stay poor. Greece elected a socialist government, so it will stay poor.
Comment by Larry Walker, Jr., 11/4/2015:
Thanks. I find economic history most fascinating.
Comment by Ron V, 11/7/2015:
Very Informative. When one looks at the big picture at present, we are indeed closer to a collapse than many can imagine. If we get another Demacrat as President, its game over period!!
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