[Reprinted with permission from Alan Reynolds, “What Do We Know about the Great Crash?” National Review, November 9, 1979]
Many scholars have long agreed that the Smoot-Hawley tariff had disastrous economic effects, but most of them have felt that it could not have caused the stock market collapse of October 1929, since the tariff was not signed into law until the following June. Today we know that market participants do not wait for a major law to pass, but instead try to anticipate whether or not it will pass and what its effects will be.
Consider the following sequence of events:
The Smoot-Hawley tariff passes the House on May 28, 1929. Stock prices in New York (1926=100) drop from 196 in March to 191 in June. On June 19, Republicans on the Senate Finance Committee meet to rewrite the bill. Hoping for improvement, the market rallies, but industrial production ( 1967 = 100) peaks in July, and dips very slightly through September. Stocks rise to 216 by September, hitting their peak on the third of the month. The full Senate Finance Committee goes to work on the tariff the following day, moving it to the Senate floor later in the month.
On October 21, the Senate rejects, 64 to 10, a move to limit tariff increases to agriculture. "A weakening of the Democratic-Progressive Coalition was evidenced on October 23," notes the Commercial and Financial Chronicle. In this first test vote, 16 members of the anti-tariff coalition switch sides and vote to double the tariff on calcium carbide from Canada. Stocks collapse in the last hour of trading; the following morning is christened Black Thursday. On October 28, a delegation of senators appeals to President Hoover to help push a tariff bill through quickly (which he does on the 31st). The Chronicle headlines news about broker loans on the same day: "Recall of Foreign Money Grows Heavier-All Europe Withdrawing Capital." The following day is stalemate. Stocks begin to rally after November 14, rising steadily from 145 in November to 171 in April. Industrial production stops falling and hovers around the December level through March.
On March 24, 1930, the Senate passes the Smoot-Hawley tariff, 222 to 153. Debate now centers on whether or not President Hoover will veto. Still, stocks drop 11 points, to 160, in May. On June 17, 1930, despite the vigorous protests of a thousand economists, Hoover signs the bill into law, noting that it fulfills a campaign promise he had made, and stocks drop to 140 in July.
The Commercial and Financial Chronicle dated June 21, 1930 led off with the major events of the week –"the signing by the President of the Smoot-Hawley tariff bill" and "a renewed violent collapse of the stock market." Without ever quite linking the two events, the Chronicle did observe that "if the foreigner cannot sell his goods to us he cannot obtain the wherewithal to buy our goods." Other sections noted that international stocks were particularly hard hit, that 35 nations had vigorously protested the tariff and threatened retaliation, and that Canada and other nations had already hiked their own tariffs "in view of the likelihood of such legislation in the United States."
It may be hard to realize how international trade could have so much impact on the domestic economy. For years, in explaining income movements in the Thirties, attention has instead been focused on federal spending and deficits. Yet on the face of it, trade was far more important: exports fell from $7 billion in 1929 to $2.5 billion in 1932; federal spending was only $2.6 billion in 1929 and $3.2 billion in 1932. In 1929, exports accounted for nearly seven percent of our national production, and a much larger share of the production of goods (as opposed to services). Trade also accounted for 15 to 17 percent of farm income in 1926-29, and farm exports were slashed to a third of their 1929 level by 1933.
Even these numbers, however, understate the significance of trade. Critical portions of the U.S. production process can be crippled by a high tax on imported materials. Other key industries are heavily dependent on exports. Disruptions in trade patterns then ripple throughout the economy. A tariff on linseed oil hurt the U.S. paint industry, a tariff on tungsten hurt steel, a tariff on casein hurt paper, a tariff on mica hurt electrical equipment, and so on. Over eight hundred things used in making automobiles were taxed by Smoot-Hawley. There were five hundred U.S. plants employing sixty thousand people to make cheap clothing out of imported wool rags; the tariff on wool rags rose by 140 per cent.
Foreign countries were flattened by higher U.S. tariffs on things like olive oil (Italy), sugar and cigars (Cuba), silk (Japan), wheat and butter (Canada). The impoverishment of foreign producers reduced their purchases of, say, U.S. cotton, thus bankrupting both farmers and the farmers’ banks.
It should be obvious that an effective limit on imports also reduces exports. Without the dollars obtained by selling here, foreign countries could not afford to buy our goods (or to repay their debts). From 1929 to 1932, U.S. imports from Germany fell by $181 million; U.S. exports to Germany fell by $277 million. Americans also had little use for foreign currency, since foreign goods were subject to prohibitive tariffs, so the dollar was artificially costly in terms of other currencies. That too depressed our exports, which turned out to be particularly devastating to farmers-the group that was supposed to benefit from the tariffs.
There had already been some damage done (particularly to farm exports) by the tariff legislation of 1921 and 1922. As Princeton historian Arthur Link points out, however, "its only important changes were increased protection for aluminum, chemical products, and agricultural commodities." Smoot-Hawley broadened the list to include 3,218 items (including sauerkraut), and 887 tariffs were sharply increased, on everything from Brazil nuts to strychnine. Clocks had faced a tariff of 45 percent; Smoot-Hawley raised that to 55 percent, plus up to $4.50 apiece. Tariffs on corn, butter, and unimproved wools were roughly doubled. A shrinking list of tariff-free goods no longer included "junk," though leeches and skeletons were still exempt.
A crucial consideration is that many tariffs were a specific amount of money per unit rather than a percentage of the price. As prices of many traded goods fell by half (or more) from 1929 to 1933, the effective rate of tariff doubled. If imported felt hats sold for $5, including a tariff of $2.50, a fall in price to $2.50 would confiscate the entire revenue from selling in the U.S. market. Without the dollars from selling in the U.S. market, the foreign hat manufacturer couldn't buy anything here.
A number of seemingly separate explanations of the Great Crash fit together quite well once the importance of anticipated tariffs is acknowledged. Charles Kindleberger, in Manias, Panics, and Crashes, describes some structural collapse in the financial system: "Lending on import, for example, seems to have come to a complete stop." But refusal to finance imports makes perfect sense if lenders were correctly anticipating steep tariffs ahead. There were early cancellations of import orders in 1929 that likewise reflected rational expectations, and import prices were among the first to fall.
A lot of stock was being bought on margin-that is, the buyer put up 25 to 50 per cent of the price and his broker went to the bank to borrow enough to cover the rest temporarily. The chairman of the Federal Reserve Board had warned the banks to curb these broker or "call" loans as early as February 1929, and the Fed nearly doubled the discount rate from 1927 to August 1929, partly in the hope of curbing stock market "speculation." Most of the broker loans in 1928-29 were not from the banks themselves, how- ever, but were instead re-lent to brokers on behalf of domestic business and foreign banks, businesses, and individuals.
The massive withdrawal of foreign lenders from the broker-loan market in early October probably reflected the correctly anticipated decline in the value of the collateral for those loans (stocks), and the fear among foreign capitalists that they would have to liquidate such assets to stay solvent in a world of high tariffs. The process contributed to the crash as both cause and effect. There was a scramble for liquidity by both the lenders and the owners of stocks. As stock prices fell, brokers required that their customers put up more money to meet the margin requirement. If stockholders couldn't come up with the cash, brokers could sell the securities to raise the money. Either way, owners and brokers were pressed to unload stocks, thus perhaps accelerating (but not causing) the stock market decline.
The market suffered continual policy assaults after 1930. In early April of 1932, the Commercial and Financial Chronicle reports "the market fell into a complete collapse . . . owing to the approval by the House of Representatives of an increased tax on stock sales." The Dow bottomed on July 8, when (as the Chronicle of the following day reported) there had been some good news –the Tariff Commission had trimmed 18 tariffs, and a House subcommittee was looking into ways to cut taxes by eliminating duplication with states. On Tuesday, September 19, candidate Roosevelt called the tariff "the road to ruin" and pledged to negotiate reductions in tariffs as soon as he took office. The following Saturday, the Chronicle was astounded that the "market again sharply reversed its course, and on Wednesday prices suddenly surged upward in a most sensational fashion."