Published in Business Spectator (Melbourne), 14 October 2010

http://www.businessspectator.com.au/bs.nsf/Article/depression-government-economy-currency-market-pd20101012-A67FD?OpenDocument

This week, and for the first time in its history, the Mont Pelerin Society (MPS) is holding its General Meeting in Sydney. Founded by a group of liberal intellectuals around Friedrich August von Hayek and Milton Friedman in 1947, the society’s main goal has been to keep the basic idea of liberty alive through establishing contacts between like-minded individuals.

When the first MPS meeting took place at Switzerland’s Mont Pelerin, the world was still recovering from a sequence of catastrophes that had culminated in the Second World War and the Holocaust. It was also facing the threat of Soviet communism. But none of these events would have been possible without the preceding economic catastrophe of the Great Depression.

The early MPS members knew that a free and stable global economic order was not just vital for creating prosperity. It is also a necessary condition for peace. In today’s environment of intensifying currency wars, this is a history lesson well worth remembering.

More than any other event in the 20th century, perhaps with the exception of the First World War, the Great Depression shaped the further course of history. The most obvious result was the surge of the Nazi party in Germany. It was the rise of unemployment to more than six million towards the end of the Weimar Republic, which made it possible for Adolf Hitler to present himself as the ‘saviour’ of the Fatherland.

The international disruptions caused by the Great Depression go far beyond this, however. What started with the stock market crash of 1929 became a decades-long crisis mainly because of the political reactions to it.

In America, the infamous Smoot Hawley tariff established the most protectionist trade regime in the history of the United States. It also set a negative example that other countries soon followed. The trade distortions so created were amplified by a series of competitive devaluations and currency controls.

All of those measures had the effect of curbing international trade. It took well into the 1950s until real world trade had recovered from the obstacles that politicians and regulators had put into the way of global commerce as a response to the economic crisis.

One of the reasons of the strong global performance of the economy in the 1950s and 1960s, apart from the results of post-War reconstruction, was the return of international trade. Though still incomplete, freedom to trade was restored from where the measures originating in the Great Depression had left it.

The lesson that freedom to trade is an essential component for economic growth was learnt once again. It was not a new lesson, to be sure. Since Adam Smith and David Ricardo, the benefits of the international division of labour had been well researched and well documented.

It is a tragedy of economics not so much that its basic teachings get refuted but that they are simply forgotten. The global financial crisis, sadly, was no exception.

Although initially world leaders solemnly declared that they had not forgotten how disastrous the consequences of the protectionist policies had been in the 1930s, their words soon started to sound hollow.

In many countries, most notably in the US and France, parts of the stimulus packages were linked to national industries to the exclusion of trade. Thus President Sarkozy had threatened to block support to French carmakers if they kept producing cars in Eastern Europe. Such blunt protectionism was widely criticised, not least by other governments within the European Union still wishing to play by the rules of the common market.

But since these first steps towards protectionism, we have witnessed the emergence of competitive devaluations. They are not always easy to identify as such. Was the Bank of England’s policy of quantitative easing a legitimate extension of monetary policy or was it a deliberate weakening of Sterling?

However, the longer such policies continue the harder it is to ignore the protectionist thrust to them.

In the beginning of the financial crisis, with all its G8, IMF and G20 meetings, there was a glimmer of hope that it would not lead to a replay of the distortions of the Great Depression. In hindsight, this was too optimistic.

Frederic Bastiat, the great French economic writer of the 19th century,once warned that when goods were no longer allowed to cross borders, soldiers would cross them instead. His prediction sadly came true in the 20th century.

It is now up to the remaining defenders of free trade in the 21st century to help avoid history repeating. At this week’s MPS conference, there is a sombre mood among the delegates. The Society’s members had long and successfully articulated the case for free trade and freedom of commerce over the past decades. But have all these lessons been forgotten in this crisis? Or is there still a chance to avoid a replay of the consequences of the Great Depression?