The threat from nationalistic policies to investors

Nationalistic policies can seriously affect investment returns – it’s time we learnt the lessons from America’s Great Depression, says Jonathan Compton.


If you're depressed now, wait to see what protectionism will do for you
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It would horrify many, especially those who consider themselves laissez-faire and liberal, to learn that most of President Trump's core economic policies are in fact very similar to those of President Obama and politicians on the left and right in many nations: Theresa May and Jeremy Corbyn in the UK; Germany's left wing red-red-green opposition; Italy's populist Beppe Grillo; even Russia's Vladimir Putin.

All are economic revanchists, seeking tighter control over everything from immigration to foreign investment and takeovers, while campaigning for domestic manufacturing to replace imports and for multinationals to pay more tax. Since 2008, such nationalistic messages have appealed increasingly to domestic voters. And it's true that many individuals, trades, sectors and large geographical areas have lost out to globalisation. But the answers do not lie in blaming foreign elements for domestic problems. History shows that taking our current direction is barking mad, and could affect investment returns.

The Great Insanity

Today, Reed Smoot and Willis C. Hawley are all but forgotten. Yet they were key players in ensuring that, despite the best intentions, the recession following the 1929 Wall Street crash turned into the Great Depression. By the late 1920s, the US economy had made huge strides in productivity. One consequence was a giant surplus in farm produce and timber. Agriculture was then a major employer.

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The Republican Senator Smoot, shortly joined by Senator Hawley (also a Republican), championed a huge hike in tariffs on foreign agricultural imports following a relatively mild rise in 1922. The proposed legislation grew to include many other products and was passed in July 1930. The main tariff rate was set at 60% on 3,200 imported products and came to encompass another 20,000 at the same, or lower, levels.

Even before it was passed there were fears about the potential impact. In May 1930, more than 1,000 economists for once on the right side of history petitioned President Hoover to veto the legislation. Earlier still, by September 1929, the administration had received pleas not to proceed from 23 trading partners, including Britain, France and Canada. Yet in the end, nationalistic populism and a widespread belief that foreigners were taking advantage of the US crushed the logic of these objections. It would labour the point to draw further similarities between politics then and now.

Initially but briefly, Smoot-Hawley seemed to work. Pay, construction and industrial production all increased sharply. Yet the banking sector, weakened by the Wall Street crash and poor practices, was reducing credit. Perhaps more importantly, many affected countries enacted tit-for-tat measures and set up new agreements in realigned trading blocs. The consequences were dire. Over three years, US imports fell by 66%, and exports by 61%. Gross national product (GNP) fell from $103bn in 1929 to $56bn in 1933.

World trade collapsed by two-thirds. As regards its core intention, the Act failed even more spectacularly. Agricultural unemployment quadrupled and nationwide it rose from 8% in 1930 to 25% in 1933. More than five decades later, Charles Kindleberger, an economic historian and senior US Treasury official, produced his terrifying graphic of the downward spiral in world trade in just over three years from 1929.

The Great Depression's trade death spiral


It is a peculiar quality of both stockmarkets and economies that recoveries take far longer than crashes (I reckon three to six times longer). Although Franklin Roosevelt was elected in 1932 largely on his promises of a "New Deal" and in 1934 began unwinding protectionism via the Reciprocal Trade Agreement Act, the impact was muted and it took many years and World War II for the US economy to recover to its pre-Smoot-Hawley level; so too for most other major countries.

Structural reform proved effective

From the late 1940s right up until the turn of the century, there were many well-intentioned and effective international efforts to avoid previous errors, from the creation of the United Nations for peace, through to international credit bodies such as the World Bank and the International Monetary Fund; and also to ensure that if trade wars and protectionism could not be stopped altogether, at least they could be rolled back.

The first significant event was the General Agreement on Tariffs and Trade (GATT) in 1948, followed by the UN Conference on Trade and Development in 1964, and the World Trade Organisation (WTO) in 1995. There were many rounds of talks under GATT, which often covered arcane topics and occasionally produced perverse agreements. But for all the politicking and weaknesses of these groups, the direction of travel in reducing both direct tariffs and "non-tariff" barriers (restrictions such as quotas and sanctions) proved highly successful.

World trade boomed, growing by more than 7% a year from 1960, about twice the growth rate in world GDP. Poor countries were able to export to richer ones. As their economies matured, domestic consumption accelerated, providing new export markets for these richer nations. The standard of living for both increased considerably.

Goods and services became cheaper and more widely available. The reverse also applied. The more restrictions a country imposed on trade, the further down the league tables it fell, while those that retreated from opening up to trade also suffered a slowdown. Even America was not immune; when in 1971 President Nixon introduced an across-the-board import surcharge of 10%, the decline in America's rust belt, unemployment and economic growth continued unabated. The surcharge was soon abandoned.

The failure to learn from history

Growth in world trade has been slowing for the last five years and has now stalled. In 2016 it recorded its lowest growth since the financial crash, at 1.7%. Forecasts for 2017 suggest it might even turn negative. Part of the slowdown is understandable weaker economic growth in Europe and parts of Asia; lower commodity prices and demand; and some countries such as China gradually shifting from an export-based model to one focusing on greater domestic consumption. None of these are a cause for alarm.

However, at the same time, restrictive trade measures have been increasing. According to the WTO, since 2008 the G20 (richer) nations have introduced 1,583 new trade-restrictive measures and removed only 387. In 1930, capital flows (foreign direct investment FDI) were small relative to trade. Now they are at least as important. For example, many advanced countries (including the US and the UK) fund their budget deficits by attracting savings from developing economies.

Here there should be real concern (unless you want higher taxes and a lower standard of living) as FDI flows are also slowing. Again some reasons for this such as sluggish growth and overcapacity, especially in emerging markets are simply cyclical, but often the cause is new barriers on FDI. No economy has ever thrived when FDI has reversed.

Despite ongoing spats even now between economists over the precise causes of the Great Depression or the benefits of freer global trade, the relationship between expanding trade and FDI, and higher living standards, greater efficiency, lower prices and even improving human rights, is simply too close to be coincidental. The concerns over the two-generation decline in manufacturing simply mirror the collapse in agricultural employment over the previous four. Businesses change.

The solution is not an attempted return to self-reliance, because all such centrally planned economic experiments have failed; it is that policy makers must invest in and encourage new businesses (especially in services), to replace the old. The current mood in many countries bombastic, introspective and nationalistic is the greatest single threat to investors, wherever they may live.

Jonathan Compton was MD at Bedlam Asset Management and has spent 30 years in fund management, stockbroking and corporate finance.