Both major political parties in the United States seem to have abandoned the idea of free trade. As with free immigration in the United States and the whole world, the theory and policy has hit the rocks and regimes around the world are looking for other answers. This represents a dramatic turning against 70-plus years of efforts to lower trade barriers and increase globalization.
Let us try to understand why.
As with so much else, the real problem may trace not to the practice of the pure idea but its implementation and the marketing of the corruptions of the idea. We’ve seen this in medicine, law, government, media, technology, and so much more: a poor deployment turns out over time to discredit the whole.
In the 20th century, the dedication to free trade began in the mid-1930s, mostly as a behind-the-scenes answer to the perception that the trade barriers erected in 1932 had made the Great Depression worse and not better. As war broke out in Europe and then the United States joined the effort, a consensus developed in diplomatic circles that as the war ended, new efforts would be pushed for peace through trade, on the belief that nations that trade don’t go to war.
After the war, the victors settled on the General Agreement on Tariffs and Trade (GATT). It was a fallback position. What they really wanted was a Global Trade Organization but that was seen as a threat to national sovereignty. Getting that would have to wait half a century. And yet, GATT was politicized from the beginning. Not everyone could join. It was a club, governed by Most Favored Nation status. Enemies of the dominant power, the United States, suffered.
Still, global tariffs fell and fell.
In the 1990s, the United States took a strange turn toward solidifying its regional trade bloc with the North American Free Trade Agreement or NAFTA. It was not free trade but still pitched as such. Running tens of thousands of pages, it was packed with subsidies, carve-outs, non-tariff pushes and pulls, plus intellectual property enforcements.
It was the same a few years later with the World Trade Organization (WTO). All these new globalist institutions were marketed as the embodiment of free trade rather than the extension of bureaucratic control that they were in fact.
Since the 1990s, and especially with the rise of China, the manufacturing base of the United States underwent a huge upheaval as textiles and then steel left U.S. shores, gutting cities and towns of industries that were not not easily converted to other purposes, leaving carcasses of facilities to remind residents of a time gone by.
Market defenders have long said that this is just what happens when half the world that was previously closed opens up, China in particular. The division of labor expands globally, and there is nothing to be gained by taxing citizens to preserve manufacturing that can take place more efficiently elsewhere. Consumers benefited greatly. Adjustment among the production sector was inevitable, unless you want to pretend like the rest of the world doesn’t exist.
But along with that, there were other problems brewing. Free-floating exchange rates with a global dollar standard based on fiat gave the strong impression that the United States was actually exporting its economic base as the world’s central bank accumulated dollars as assets, without the natural corrections that would have happened under a gold standard.
China is the classic case. It accumulated vast “assets” consisting of U.S. debt instruments which were used as collateral on which to build a vast financial empire. These new funds were poured into producer infrastructure in China, which created new consumer products for the world, and undermined local production in the United States.
Again U.S. consumers benefited but it was all deeply suspect. China’s expansion was being fueled by fake money built upon U.S. debt finance which ultimately came out of the hide of the American public. After all, someone would eventually be left to pay this bill. The earliest payments came in the form of producer upheaval. The most recent payments have come in the form of a dramatic loss of purchasing power at home.
Keep in mind that this system had nothing to do with the world of David Hume, Adam Smith, David Ricardo, and Frédéric Bastiat. Their defense of free trade presumed sound money based in gold. In the 18th and 19th centuries, all currencies in the increasingly industrialized world were just different names for the same thing.
There were money trades of course but permanently free-floating rates, and a financial empire to back them, were not even conceptually on the table at all. Instead, trade was governed by what Hume described as the price-specie flow mechanism. In countries with a positive balance of trade, gold would flow into the country in the amount that the value of exports exceeds the value of imports. The same was true in reverse: with a negative balance, gold would flow out.
This affected both prices and bank lending. With gold declining, prices would fall and banks would restrict lending. With gold incoming prices would rise and banks would expand. The mechanism was self-governing. This principle was a foundation of all classical economic theory.
In countries with a positive trade balance, higher prices would cause exports to decrease and imports to increase. In countries with a negative balance of trade, the lower prices would cause exports to increase and imports to decrease, which neutralized the imbalance. These adjustments in the balance of trade will continue until, in the long run, the balance of trade would fall to zero, and so too with wages and profits (the long-run equilibrium).
Again, this observation became a kind of orthodoxy built from real-world experience. But remember the premise: all world monies were different names for the same specie grounding in gold. This and nothing else was money. And sure enough, the account balance for nations reflected this over a very long period of time. The United States ran no long-run “trade deficits” at all under the gold standard.
This whole system was blown up in 1971 as the Bretton Woods gold standard fell apart. The Hume-era mechanisms were disabled. There were no more limits on credit expansion. Central banks could print all the money they wanted to fund debt expansion by governments.
“The destruction of Bretton Woods allowed domestic monetary policies to escape the financial discipline that automatically resulted from reserve asset movements. The old regime of monetary discipline happened because trade deficits caused a loss of gold, which tended to shrink domestic bank credit, thereby deflating domestic demand, wages, prices, costs and net imports. At the same time, the prolonged accumulation of reserve assets owing to persistent current account surpluses tended to generate the opposite effects—domestic credit expansion, price and wage inflation, and an eventual reduction of trade surpluses.”
In the fiat world of the late 20th century, accounts were never settled. All the benefits flowed to elites of major nations (United States and China) and away from the people. This wild distortion in the way trade works metastasized from freedom into a machinery of industrial upheaval, driving wages down in the industrialized world and creating forever opportunities for global industrialists to draw on dirt-cheap labor the world over that would never adjust.
The discipline in the system and its capacity for self-management were gone forever. It was one thing to lose the watch industry of the late 19th century and the piano industry of the first half of the century. It was something else to lose textiles, steel, and even automotives, and watch as a century of skill, capital, and marketing nearly vanished, leaving a nation of aging sick people nursed by pharma and the most expensive and expansive medical system in the world.
It certainly seemed like something was wrong but the problems are so complicated and traced to such an obscure source that few could figure out what was going on. Even as this took place at home, business creation became ever more difficult at home with high taxes and intensifying regulatory controls that made enterprise ever less functional.
The problems were not due to “free trade” as such. In fact, the idea of “free trade” was unnecessarily scapegoated throughout. Huge trade agreements like NAFTA, the EU, and the WTO were sold as free trade but they were actually heavily bureaucratized and managed trade with corporatist substance. Their failure was blamed on something they were not and never intended to be.
Adding to that is the dollar-based fiat money system of the world that exports U.S. debt expansion all over the world to enable vampiric industrial expansions in foreign countries that would otherwise be unsustainable. These days, people look around and know for sure that there was and is a problem but have nothing to blame but the freedom to trade itself.
That’s where tariffs come in. This is understandable. The balance of payments looks awful on paper but the numbers are by and large meaningless, the collection of which is a relic of times gone by. And yet, there they are, giving the strong impression that the United States loses money with every import and gains money with every export.
Tariffs are not a viable answer. They operate as a tax on domestic production and consumption. They are tolerable as tools of revenue but as instruments of economic planning more generally, they are a blunt instrument that feeds conflict and the breakdown of diplomacy. In observing that, however, it is wrong to default to a pure defense of what has been wrongly marketed as “free trade.”
We need all forms of freedom, including the freedom to trade, but that belongs to business and their customers, not governments, much less central banks. This system can be fixed but it won’t be easy. The core of the issue is the quality of the money itself and the locus of its control. It needs to be taken back for the people.
