Conditions Today Were Last Seen in 1929 When Smoot-Hawley Tariffs Coincided with the End of a Long Phase of Credit Expansion

Germany, whose fastest growing market was China, has been driven into recession, with last Monday’s purchasing managers’ index headlined as “simply awful”. With Germany being the locomotive pulling along all the other Eurozone members, this is already leading to deepening concerns for the Eurozone’s outlook and a resumption of asset purchases by the ECB (quantitative easing) is now due in November. It is also very bad news for Germany’s hard-pressed banking community, represented in New York by Deutsche Bank. . . . 

Clearly, the conflict between America and China has escalated well beyond just tariffs, making it difficult to visualize how the damage to global trade can be corrected. The economic outlook is therefore set to deteriorate further, with no end to it in sight. From a banker’s viewpoint, a global recession is the greatest threat to his business as a financial intermediary between failing borrowers and nervous depositors. He can only survive by taking anticipatory action to avoid potential losses.

Some bankers will have been clinging to the hope that the Fed, by reducing interest rates and if necessary, reintroducing quantitative easing, will rescue the US economy from outright recession and that economic growth will resume. Without doubt, this is the advice being given to management by in-house economists, unfamiliar with today’s destructive dynamics of tariffs combining with a failing late-stage credit cycle. These conditions were last seen in 1929, when Smoot-Hawley tariffs coincided with the end of a long phase of credit expansion. However, there is little statistical evidence so far that the US economy faces anything more than a pause in economic growth, which is why stock prices and other collateralized assets have held their values.

The reality is that a credit crisis cannot be avoided, only deferred. It is also hard to see how zero interest rates reduced from current levels can be enough to rescue markets that, on the evidence from the repo market, are beginning to price growing counterparty risk into interbank loans. Recent experience and central banking models suggest that dollar interest rates should be reduced by at least four or five per cent to stabilize the situation, putting them deep into negative territory. And as for negative rates, there is no development more likely to drive depositors into gold, silver and other media to escape from the taxation of negative rates on deposits.

—Alasdair Macleod, “The Ghosts of Failed Banks Have Returned,” in Anatomy of the Crash: The Financial Crisis of 2020, ed. Tho Bishop (Auburn, AL: Mises Institute, 2020), 63-65.