“The American System” Made America Great

Authored by James Rickards via DailyReckoning.com,

It’s hard to believe, but the presidential election is just days away. It’ll all come down to the key swing states of Pennsylvania, Michigan, Wisconsin, Georgia, North Carolina, Arizona and Nevada.

It’s a tight race, although it appears to be breaking for Trump.

The Democratic strategy is essentially to call Trump Hitler and a would-be dictator who would jail his political opponents (sound familiar?) and destroy democracy.

Though they focus much more on Trump the man than his actual policies, it’s important to understand Trump’s position on tariffs, for example, because it would impact millions of Americans.

Donald Trump recently did an interview with John Micklethwait, Bloomberg’s top editor and a former editor of The Economist.

Micklethwait made the tired point that Trump’s tariffs would raise prices and be bad for Americans.

The Argument for Free Trade

Most of us have been taught that free trade is good and that tariffs are bad.

And on the surface it certainly seems true. The theory of free trade based on comparative advantage was advocated by British economist David Ricardo in the early 19th century.

Ricardo’s theory said that trading nations are endowed with attributes that give them a relative advantage in producing certain goods versus others.

These attributes could consist of natural resources, climate, population, river systems, education, ports, financial capacity or any other factor of production. Nations should produce those goods as to which they have a natural advantage and trade with other nations for goods where the advantage was not so great.

Countries should specialize in what they do best, and let others also specialize in what they do best. Then countries could simply trade the goods they make for the goods made by others.

All sides would be better off because prices would be lower as a result of specialization in those goods where you have a natural advantage.

It’s a nice theory often summed up in the idea that Tom Brady shouldn’t mow his own lawn because it makes more sense to pay a landscaper while he practices football.

For example, if the U.K. had an advantage in textile production and Portugal had an advantage in wine production, then the U.K. and Portugal should trade wool for wine.

Is Free Trade Everything It’s Cracked up to Be?

But if the theory of comparative advantage were true, Japan would still be exporting tuna fish instead of cars, computers, TVs, steel and much more.

The same can be said of the globalists’ view that capital should flow freely across borders. That might be advantageous in theory but market manipulation by central banks and rogue actors like Goldman Sachs and big hedge funds make it a treacherous proposition.

The problem with this theory of comparative advantage is that the factors of production are not permanent and they are not immobile.

If labor moves from the countryside to the city in China, then suddenly China has a comparative advantage in cheap labor. If finance capital moves from New York banks to direct foreign investment in Chinese factories, then China has the comparative advantage in capital also.

Trump understands this, Micklethwait doesn’t. Trump didn’t just make polite conversation in the interview. He called out Micklethwait by saying, “It must be hard for you to spend 25 years talking about tariffs as being negative and then have somebody explain to you that you’re totally wrong.” Ouch!

Tariffs Are as American as Apple Pie

Micklethwait certainly isn’t alone. Listening to hysterical commentary from the mainstream media about Trump’s tariffs, one would think his policies were in violation of the U.S. Constitution.

Nothing could be further from the truth. By advocating tariffs, Trump actually wants to return to what made America great in the first place.

In fact, tariffs are as American as apple pie.

From 1790–1962, the United States pursued high tariff policies under a program known as the American System.

It was created by George Washington’s secretary of the Treasury, Alexander Hamilton, who drafted a report to Congress called the Report on Manufactures presented in 1791. Hamilton proposed that in order to have a strong country, America needed a strong manufacturing base with jobs that taught skills and offered income security.

To achieve this, Hamilton proposed subsidies to U.S. businesses so they could compete successfully against more established U.K. and European businesses.

These subsidies might include grants of government land or rights of way, purchase orders from the government itself or outright payments. This was a mercantilist system that encouraged a trade surplus and the accumulation of gold reserves.

175 Years of Prosperity

Hamilton’s plan was later proposed on a broader scale by Kentucky Sen. Henry Clay. This new plan began with the Tariff of 1816. Later on, Abraham Lincoln adopted the American System as his platform in the election of 1860, and it became a bedrock principle of the new Republican Party.

It was affirmed by William McKinley at the end of the 19th century and by Dwight Eisenhower in the 1950s. The 19th and early 20th centuries were a heyday of the American System. This period was characterized by enormous economic growth and population expansion by the U.S.

The American System was also accompanied mostly by low inflation or even deflation (which increases the purchasing power of everyday citizens) despite occasional financial panics and some inflation during the Civil War.

The key takeaway is that America grew rich and powerful from 1787–1962, a period of 175 years, using tariffs, subsidies and other barriers to trade to nurture domestic industry and protect high-paying manufacturing jobs.

The Triumph of Free Trade Doctrine

But under the neo-liberal, globalist international order that prevailed in the decades after World War II, free trade doctrine supplanted the American System.

Globalism requires free trade, open borders and free capital flows or as close as you can come. In theory, this allows for price discovery, lower costs and higher returns to capital.

In reality, it causes lost jobs, lost competitiveness and lower wages, especially for Americans. U.S. industry was stripped bare and U.S. jobs were lost by the millions, with China being the main beneficiary.

Globalists embrace what they call “encasement.” The idea is that national governments don’t matter. What does matter is that all global powers — democratic, communist, socialist, kleptocratic — play by the same supranational rules that encase the system of sovereigns.

Free trade is part of that system (in reality, it’s not free trade but managed trade).

Trump is rejecting the globalist playbook. He’s pursuing the same basic policies that predominated in the U.S. from George Washington through Dwight Eisenhower.

He simply wants to return to the American System that once made America great.