investigating a debt channel for the smoot-hawley tariffs: evidence from the sovereign bond market

Economic History Association

Investigating a Debt Channel for the Smoot-Hawley Tariffs: Evidence from the SovereignBond MarketAuthor(s): Kevin CareySource: The Journal of Economic History, Vol. 59, No. 3 (Sep., 1999), pp. 748-761Published by: Cambridge University Press on behalf of the Economic History AssociationStable URL: http://www.jstor.org/stable/2566323 .

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Investigating a Debt Channelfor the Smoot -Hawley Tariffs. Evidence from the

Sovereign Bond Market KEVIN CAREY

I examine the change in prices of foreign sovereign dollar bonds over several weeks in 1930 that marked major legislative progress for the Smoot-Hawley tariffs. If the market was preoccupied by anticipated debt-repayment problems arising from the tariffs, this should be visible in the cross-country pattern of bond prices. The bond price data are compared to indicators of country sensitivity to the tariffs and debt service. A significant relationship is found for bond price changes in June 1930, but the size of the effect is very small. Analysis at the regional and individual country level reveals some puzzling cases.

r he conventional wisdom in economics has been that the Smoot-Hawley tariffs of 1930 do not have a major role in explaining the severity of the

Great Depression. Even though the tariffs were assigned an important role in contemporary discussions of the Depression, Charles Kindleberger, amongst many others, notes that the primary effect of tariffs is to redirect aggregate demand from foreign to home products; while there are losses due to lower gains from trade, there are also gains in aggregate demand.1 The argument applies with special force for the United States and Europe, because exports and imports were a relatively small proportion of U.S. Gross Domestic Product to begin with, and Europe traded relatively little with the United States. Thus although Douglas Irwin finds that the tariffs can explain 40 percent of the decline in imports during the Depression, it is still difficult to view this shock as having a major macroeconomic impact in the United States.2

Kindleberger prefers to view the tariffs as an indication of lack of con- structive leadership at the global level: the signing of the bill by Hoover "made clear that in the world economy no one was in charge."3 Nevertheless, there have been occasional aftempts to affach more than symbolic impor- tance to the tariffs. Mario Crucini and James Kahn have used a combined stochastic growth and computable general equilibrium approach to argue

The Journal of Economic History, Vol. 59, No. 3 (Sept. 1999). C The Economic History Association. All rights reserved. ISSN 0022-0507.

Kevin Carey is Assistant Professor, American University, Department of Economics, 4400 Massa- chusetts Ave., NW, Washington, DC 20016-8029. E-mail [email protected].

I thank Ben Bemanke, Mike Connolly, John Devereux, seminar participants at American University, and the referees for hielpful comments, and Lingfeng Li for excellent research assistance.

I Kindleberger, World, chap. 6. 2 Irwin, "Quantitative Assessment." 3 Kindleberger, World, p. 126.

748



A Debt Channelfor Smoot-Hawley 749

that the macroeconomic impact of the tariffs has been understated.4 In their benchmark scenario, they find that the tariffs could have reduced U.S. output by 2 percent (relative to trend) between 1929 and 1932. This is a large effect given the small trade shares of the time, but still small relative to the overall output decline of the period. The key mechanism in their model is to view the tariffs as taxes on intermediate inputs, which has the effect of converting them into distortionary taxes on labor supply and capital accumulation. Their benchmark scenario requires elastic responses of consumption and labor supply to the tariffs. However the magnitude of these elasticities is subject to considerable debate; to take one example, many economists believe that the elasticity of labor supply is close to zero.

An alternative route by which the tariffs might have operated is suggested by Philip Friedman's discussion of the impact of the trade wars on European output. He notes that European dependence on trade with the United States was low, and argues that the tariffs were:

perhaps... an indication of America's unwillingness to support Europe in the future. The implications of this for capital markets . . . probably operated through some unspecifiable expectations mechanism.5

This can be generalized to the view that the tariffs operated by disrupting the international financial arrangements of the time. In particular, trade surpluses are the means by which foreign debts are serviced. By imposing tariffs, the United States was attempting to reduce its imports from the rest of the world and improve its trade balance. However, the United States had been a net lender to the rest of the world from the end of World War I, and the repayment of these debts required that the debtor countries run substantial trade surpluses with the United States. Yet throughout the 1920s the United States ran large trade and current account surpluses, and the Smoot-Hawley tariff carried with it the implied goal of continuing this state of affairs.

At this point the capital markets story must be careful not to rely on pure distribution effects, such as tariffs redistributing aggregate demand (as pre- viously noted), or the mere occurrence of defaults (which are losses to creditors but gains to debtors). The most promising route is that the tariffs contributed to some monetary or financial disruption by raising the expectation of defaults by debtors unable to generate funds to make debt repayments. The increased possibility of default could have arisen either because the contraction in aggregate demand within debtor nations that was required for continued debt servicing (in the absence of new flows from the United States) was bound to be politically infeasible at least for some countries, or because the ability of the United States to use the threat of trade sanctions to

4 Crucini and Kahn, "Tariffs." 5 Friedman, Impact, pp. 20-21.



750 Carey

enforce sovereign debt repayment was diminished because the tariffs and the associated retaliation were reducing the openness of the world economy.

If the tariffs contributed to fears of a major default on international loans, a disruptive "flight to quality" could have ensued. This could have been a contributing factor to the "scramble for gold" described by Barry Eichen- green.' Ben Bernanke considers the possibility that the tariffs played a role in triggering the Central European financial collapse in 1931 by leading to a sudden withdrawal of short-term funds from Germany and Austria.7 He finds it difficult to assign an important role to the tariffs, given the presence of many other plausible influences on the foreign funds withdrawal from Austria and Germany such as the poor state of bank balance sheets in both countries and the rise of Hitler. Furthermore, Germany was not experiencing any serious trade difficulties at the time. Bernanke then notes that it could be that expectations of future trade difficulties sparked the financial crisis. It is precisely this potential role for expectations that make asset prices the most promising place to look for the debt effect.

The idea of this article is that because this story about the tariffs relies on a rising possibility of defaults, this should be visible in the prices of foreign sovereign dollar bonds at the time. A large number of sovereign and quasi- sovereign (state-backed corporate) dollar bonds were traded on the New York bond market, and there is every reason to expect that prices of these bonds reflected investors' assessment of the likelihood that the bonds would continue to be serviced. If a debt channel was at work, then the revised assessment of the ability to repay debts as a result of the tariffs should be related to the dependence of the country in question on trade with the United States. Countries more dependent on U.S. trade suffer greater shocks to their ability to repay debts as a result of the tariffs. Countries with larger debt service are also more affected by the tariffs, ceteris paribus.

The methodology of this article is related to a series of papers in the international trade field that also use asset prices to understand the effects of trade policy.8 However, it should be emphasized that this article is not seek- ing to measure the total impact of the tariffs though the impact on bond prices on particular dates; that is, this is not a full event study. In fact, the obstacles to an event study are considerable. The key problem is that there is no one date that we can identify on which the prospect of tariffs represented true news to financial markets. The question of tariff increases had arisen in the 1928 presidential election and had been under consideration by Congress at various points before the bill became law on 17 June 1930.

6Eichengreen, Golden Fetters. 7Bernanke, "Review." 8 See Thompson, "Trade Liberalization," for an application to the Canada-United States Free Trade

Agreement and additional references.




The issue explored here is whether the bond market viewed the tariffs as bad news for foreign debts, and the test is whether, looking across bonds of different countries, bond prices react to tariff news in a manner that would be consistent with the likely impact of the tariffs on the debt service ability of each country.

DATA

Detailed sovereign bond data are available from the Bond Record of the New York Stock Exchange report in the Commercial and Financial Chroni- cle, a weekly publication. For each listed bond, the record reports the bid and ask prices for the Friday of that week, the number of bonds sold that week, and the high-low range for that week and since I January of that year. The case of Argentina is a good example of the type of information available. Ten national government bonds are listed with some description of type and purpose (for example, sinking fund, public works). There are also several subnational (but sovereign) bonds, including bonds for Buenos Aires city and province.

From well over 200 listed foreign government securities, the sample was reduced to 152 distinct bonds, mostly by eliminating some bonds that would have added little new information (for example, where there were several bonds of the same type and maturity for a given country). Some bonds were also omitted because quotes were not available throughout the year, but the sample remains quite broad, containing 37 countries. The bonds include central and local government bonds as well as those of state-backed corpora- tions. In general, the bid price on the Friday of each week was used as the price of the bond. Where bid prices were not available, the mid-point of the week's range was used as the price. Any potential biases introduced by this procedure are likely to be small relative to the true week-to-week movements in the prices.

Before moving to the analysis, it is worth establishing that the New York market is the right place to look for the market assessments of ability to pay. Table 1 reports an estimate of the percentage of dollar bonds held by Ameri- cans in 1935. As the source notes, this likely understates American holdings in 1929 or 1930, because matny of the bonds were sold to foreigners following the defaults. Even in 1935, however, American holdings were substantial, amounting to at least 50 per cent of the outstanding debt for well over half the countries in. my sample. It thus seems reasonable to assume that changes in desired holdings of these bonds would be reflected in New York bond prices.

Another concern is that thin markets may mean that quoted prices do not appear to move because no transactions took place. The Commercial and



752 Carey

TABLE 1 AMERICAN HOLDINGS OF FOREIGN GOVERNMENT BONDS AT NOMINAL VALUE, 1935

(millions of dollars)

County Total Country Total

Colombia 117.3 Yugoslavia 31.8 Japan 147.4 Argentina 196.4 Brazil 286.8 Hungary 28.5 Cuba 111.5 Poland 59.5 Mexico 88.7 Bolivia 49.3 Peru 63.9 Finland 24.6 Czechoslovakia 8.1 UK N/A Chile 261.8 Panama 11.2 Uruguay 41.8 France 20.3 Germany 532.2 China 5.5 Haiti 8.9 Belgium 49.1 El Salvador 6.9 Italy 109.0 Australia 102.0 Ireland 10.1 Dominica 14.7 Netherlands 17.5 Canada 1,306.7 Greece 13.5 Denmark 104.1 Norway 102.7 Estonia 32.3 Austria 9.6 Costa Rica 7.5 Bulgaria 11.0 Switzerland N/A Sweden 65.0

Source: Foreign Bondholders Protective Council, taken from Madden et al., America's Experience, appendix 6.

Financial Chronicle does provide information on the number of bonds traded each week, and a cursory examination of these data shows that most bonds were actively traded most weeks of the year, although volumes were often quite small. It is worth noting, however, that the bond market does display a rapid and strong response to political problems in October 1930, indicating that prices could respond to events that were perceived as important (see also the discussion of Figure 1 in the next section).

DATA ANALYSIS

For preliminary analysis, the countries were grouped into six regional categories: Central and Eastern Europe, Western Europe, South America, Central America and Caribbean, Pacific (including East Asia and Australia), and Canada. It quickly became clear that a useful portrayal ofthe data would require an additional category for bonds already in default during the same period. Bonds from Mexico and China fall into this category, and not sur- prisingly these bonds traded at far below par value, which makes it unwise to average them with other bonds. Figure 1 presents the data for the entire year for these groups; and from a legislative standpoint, the period of interest is the second quarter. An ongoing decline in bond prices is evident from the




1 10 - Western Europe - Central anu Eastern Europe Ea South Amexica

-s Central America Canada : - Pacific (Australia and Japan)

100

90 'e _so

70

6 0 .. . . . . . . . ..- 01/03 02/07 03/14 04/18 05/23 06/27 08/01 09/05 10/10 1/14 12/19

24

22 ]

'~20

16

_ Previous Dlefiulters (Mexico and China)

14 01/03 02/07 03/14 04/18 05/23 06/27 08/01 09/05 10/10 11/14 12/19

FIGURE 1

END OF WEEK SOVEREIGN BOND PRICES, 1930

Sources: Commercial and Financial Chronicle; and author's calculations.

figure, but it is equally noteworthy that the price movements around June are small when compared with the clear collapse in October 1930, which is attributable to political problems in Europe and Latin America.

Refining the approach required determining appropriate dates for analysis. The tariffs were signed into law by President Hoover on Tuesday, 17 June. The key assumption is that the two week period in the run-up to enactment led people to revise their assessments that the bill would eventually become law. The final bill passed in the Senate on Friday, 13 June by only two votes. Irwin and Kroszner describe a complicated horse-trading process that char- acterized the passage of the bill through Congress.9 This surely created a

9 Irwin and Kroszner, "Log Rolling."



754 Carey

TABLE 2 AVERAGE PERCENTAGE CHANGE IN BOND PRICES, VARIOUS REGIONS

Week Ending Week Ending Week Ending Region March 28 June 13 June 20

Western Europe 0.31 -0.18 -0.06 Central and Eastern Europe -0.21 0.05 -1.43 South America -0.68 -0.58 -2.41 Central America -0.41 -0.95 0.89 Canada -0.25 -0.04 -0.16 Pacific 0.06 -0.02 -0.68 Defaulted 0.50 -0.07 -22.05

Source: Commercial and Financial Chronicle and author's calculations. The defaulted group refers to bonds already in default in the first half of 1930, those of Mexico and China. They are excluded from their respective regions in these calculations.

great deal of uncertainty of what the final act would look like, as well as to whether it would pass at all. In addition, President Hoover came under great pressure not to sign the bill. Therefore the progress of the conference com- mittee version of the bill through the Senate, the House (14 June), and the actual signing of the bill plausibly represented news to financial markets. Because the final legislative progress of the bill encompassed two weeks (and thus two Fridays), I look at the change in bond prices for the week ending 13 June and the week ending 20 June. (See Table 2.)

The possibility remains that the impact of the tariffs may be reflected in bond prices at an earlier date. Because the tariff revision was proposed as early as 1928, there are in fact a wide variety of potential dates one might identify.'0 To avoid the exercise becoming vacuous, this study concentrates on one specific date when it is arguable that new information was revealed: Monday, 24 March 1930, when the bill passed the Senate. As Irwin and Kroszner explain, the rules of the Senate and the House made it likely that any substantial revision to the bill was likely to take place in the Senate; therefore the emergence of the bill from the Senate likely provided a good indication of what the final bill would look like. Following the same logic as above, I look at bond price changes for the week 21 March to 28 March (that is, the Friday to Friday change).

The next consideration is whether there is any relationship between the bond price movements over these periods and the likely impact of the tariffs on the rest of the world's ability to pay its debts. Three measures of the impact of the tariffs on debt service ability are used. These are based on country characteristics in 1929; besides being known to market participants, the assumption is that these patterns were not distorted by the prospect of the tariff and provide some indication of the structural trade patterns between countries. Trade data were obtained from Brian Mitchell's European Histor-

0 See Irwin and Kroszner, "Log Rolling," for a chronology.




ical Statistics and International Historical Statistics, and the annual renorts of the Foreign Bondholders Protective Council, a negotiating group for creditors formed following the 1930s defaults."

The simplest relationship one might imagine is that countries with a high proportion of exports going to the United States should have been seen as particularly harmed by restrictions on trade. Therefore it might be expected that we should see a negative relationship between the share of exports going to the United States (PXUS) and the movement in bond prices over the relevant window. Another variable is motivated by the observation that it is not exports per se that underlie changes in a country's net wealth, but current account balances. Because external debt in the aggregate is essentially the claim to future current account surpluses, likely reductions in the stream of surpluses should be associated with a decline in value of the debt. For each country, I calculate the trade-balance share, which is the trade balance of that country with the United States, expressed as a percentage of total exports (PTBUS). A negative relationship is expected since positive values of the trade-balance-share variable indicate countries for whom the United States is an important source of foreign exchange earnings.

The final variable considered is a constructed debt-service burden variable. For each country, I obtained data on the total nominal value of outstanding foreign bonds in 1935 from the same source as in Table 1. Since most countries made few repayments in the depression years, this is a good approximation to debt levels entering the Depression. A coupon rate of 7 percent is assumed on this debt, which was close to the average coupon rate for the bonds, and the service on the bonds was calculated as 7 percent of the outstanding value. In taking an average coupon rate for all countries, the assumption is that differences in risk would be reflected in the initial price of the bond and not its nominal interest payments. The debt-service burden is then constructed as the calculated interest payments expressed as a ratio to total exports (DVSP). We expect a negative relationship since countries already carrying a heavy debt burden might have been perceived as suffering more from the tariffs.

All three variables are included in a regression with the price change as the dependent variable. The regressions were run for four time periods: the week in March, the two separate weeks in June, and combining the two weeks in June. Each regression was run for two samples: a sample of 37 countries that excludes only Panama from the data shown in Figure 1, and a sample of 35 countries that also excludes the previous defaulters (Mexico and China). Panama is excluded because its trade statistics are dominated by trans-shipment trade and create huge outliers in the regressions. This gives rise to eight regressions in all, reported in Table 3.

" Foreign Bondholders Protective Council, Annual Reports.



756 Carey

TABLE 3 EXPLAINING CHANGES IN BOND PRICES OVER VARIOUS WEEKS IN 1930

Week Ended Week Ended Week Ended June 13 June 20 June Cumulative March 28

All All All All Obser- Excluding Obser- Excluding Obser- Excluding Obser- Excluding

Variable vations Defaults vations Defaults vations Defaults vations Defaults

DVSP T.0.21 -0.04 0.18 -0.28 -0.03 -0.31 -0.05 -0.04 (0.17) (0.09) (0.41) (0.14) (0.36) (0.13) (0.06) (0.06)

PXUS -0.02 -0.01 -0.03 0.04 -0.04 0.04 -0.01 -0.01 (0.03) (0.02) (0.07) (0.03) (0.07) (0.02) (0.01) (0.01)

PTBUS 0.00 0.02 -0.05 -0.07 -0.04 -0.05 0.00 0.00 (0.03) (0.02) (0.07) (0.02) (0.07) (0.02) (0.01) (0.01)

Notes: The dependent variable is Percentage Change in Bond Prices. The prediction is for negative relationships in all cases. All estimation is by Ordinary Least Squares. DVSP is the estimated annual nominal debt service, expressed as a percentage of total exports. PXUS is the percentage of country exports going to the United States. PTBUS is the trade balance (plus or minus) with the United States, expressed as a percentage of total exports. Standard errors are in parentheses. Panama is excluded from all regressions. The Excluding Defaults columns show the results when Mexico and China (whose bonds were already in default) are excluded from the regressions. Results when they are included are shown in the All Observations column.

For the first June week, none of the trade or debt variables do a good job of explaining the pattern of bond price changes. The first sign of some ex- planatory power comes in the regression for the second June week, with the previous defaulters excluded. All variables are significant at 10 percent or better, but the export-share variable has the wrong sign. The trade-balance variable does best in terms of significance, but the magnitudes of the effects of the debt-service and trade-balance variables are small: each additional I percent share of exports going to debt service is associated with a decline in bond prices of just over one-quarter of 1 percent; each 1 percent incre- ment in the trade balance as a share of exports is associated with a decline in bond prices of less than one-tenth of 1 percent. Combining the two weeks in June slightly strengthens the effect of the debt service variable (up to about one-third of 1 percent) and weakens the trade-balance variable but does not change the qualitative nature of the results. Finally, the March results are the weakest of all, with the effect of all three variables small in economic and statistical terms.

Since the regressions involve asset price data, there is a legitimate concern that the use of the usual standard errors might not be appropriate for infer- ence. To alleviate this problem, significance tests using standard errors robust to heteroscedasticity were performed.12 (Autocorrelation is not a

12 The correction is what is commonly referred to as the White estimator of the variance-covariance matrix, implemented by the "robusterrors" option in RATS.




TABLE 4 COUNTRY GROUPS BASED ON 1929 TRADE PATTERNS

Group Countries

Trade Surplus with United States Cuba, Colombia, Brazil, Peru, Chile, Japan, and Czechoslovakia

High Export Dependency (above 20 percent of Cuba, Colombia, Brazil, Japan, Canada, Peru, exports are to the United States) Costa Rica, Chile, and Dominica

Notes: Groups are based on 1929 trade statistics. China, Mexico (both already defaulted), and Panama (most trade being trans-shipment) are excluded from all calculations based on these groups.

concern in this case, since all regressions are in cross-section). Not suipris- ingly, the results were even weaker with only the trade-balance variable significant at the 5 percent level for the second June week and the June weeks combined, in the sample that excludes the previous defaulters. Of course because the regression coefficients are identical, the economic inmpor- tance of the trade-balance effect remains extremely small.

The fact that the size of the effect is small does not mean we can eliminate the prospect of the tariffs as a major influence on bond prices. Asset prices often contain a lot of unexplained variation and information about the tariffs had been around for a long time. It is also possible that a linear regression framework obscures sharp effects for certain groups of countries. To address these concerns, the countries were classified into various groups and bond price changes for the groups were compared. The groupings are trade surplus countries versus trade deficit countries, and U.S. export-dependent countries versus non-U.S. export-dependent countries. Countries with more than 20 percent of their exports going to the United States are classified as U.S. export dependent. The members of the U.S. export-dependent groups are shown in Table 4. However, one major point already emerges from these classifications: virtually all European countries were not major trading part- ners of the United States, and so their ability to finance their external dlebts could not have been significantly affected by the tariff. Europe as a whole was experiencing chronic trade deficits with the United States, which is precisely what made the international financial structure of the interwar period so precarious.13 Given this, the Smoot-Hawley tariffs certainly appear perverse (tariffmeasures usually being associated with the imposing country running trade deficits, not surpluses), but the most they can have done from a European perspective was to make an already bad situation worse.

Table 5 reports the average change in bond prices over the two-wieek window for the various groups described above. The group results are another reflection ofthe weak link between the trade variables and bond prices. Even when the differential between the groups is as we would expect (a bigger fall in bond prices for the trade surplus or high deficit countries), the

13 See the standard arguments on this point in Eichengreen, Golden Fetters.



758 Carey

TABLE 5 CHANGE IN BOND PRICES FOR VARIOUS COUNTRY GROUPS

Week Ended Week Ended Week Ended Group March 28 June 13 June 20 June Sum

Trade Surplus with United States -0.68 -0.02 - 1.17 -1.19 Trade Deficit with United States -0.06 -0.40 -0.66 -1.06 High U.S. Exports -0.48 -0.04 -1.10 -1.14 Low U.S. Exports -0.08 -0.42 -0.63 -1.05

Source: Commercial and Financial Chronicle; Foreign Bondholders Protective Council, Annual Reports; and Mitchell, European Historical Statistics and International Historical Statistics.

size of the differential is small-about one-half of 1 percent. Indeed, it is interesting to compare Table 5 with Table 2, the breakdown of bond price changes by region. Table 2 makes clear that the biggest declines in bond prices over the relevant periods were for South America and Central and Eastern Europe. The trade-based analysis cannot explain this, because the Eastern European countries were no more integrated with the United States than Western Europe (which saw a mild decline in bond prices), whereas the South American countries were no more integrated with the United States than Central America or Canada (which also saw milder declines in bond prices). Some interesting individual cases, shown in Table 6, highlight this apparent puzzle.

For Brazil, the effects seem very much as we would expect; a sizable trade surplus with the United States and heavy export dependence, and a fall in bond prices of just over 2 percent. The other cases are all in some respect more surprising. Argentinian bonds fell by 1.5 percent. But as the figures indicate, there was nothing in Argentina's trade structure in this period that made it particularly dependent on trade with the United States. It was running a small deficit with the United States, and exported a very small share of exports to the United States and from a trade perspective looked more like a European country.

Another major puzzle is presented by Cuba. It is very surprising that Cuba's ability to repay its debts was not seen as adversely affected by the tariffs. Cuba exported one commodity, sugar, to one country, the United States, and the tariff on sugar was increased substantially (from $1.75 to $2.00 per ton) in the Smoot-Hawley Act. Though discerning the impact of the tariff on Cuba is difficult because of other events, the tariff was followed by a collapse in the Cuban sugar industry. Sugar production in the United States expanded rapidly in response to the protection, contributing to a steep decline in the world price of sugar. Indeed the quota system was introduced in 1934 partly in, response to the belief that the tariff increase had been counterproductive for the United States and Cuba. Despite this perhaps predictable subsequent history, the price of Cuban bonds hardly changed in response to the tariffs.




TABLE 6 INDIVIDUAL COUNTRY CASES

Trade Balance with Change in Bond Prices: United States Share of Exports to June 6-20

Country (percentage of exports) United States (percentages)

Argentina -6.6 4.3 -1.52 Brazil 14.7 42.2 -2.09 Canada -25.0 37.5 -0.20 Cuba 30.0 76.6 0.80

Sources: See Table 5.

It certainly is the case that Cuba might have been perceived as within the American "sphere of influence" at this time. There was a history of U.S. interventions in the Caribbean to protect its interests, and this might have been perceived as supporting the value of the bonds. Finally, con- sider perhaps the most striking case in the sample: Canada. Canada was a major trading partner of the United States and also the largest sovereign debtor (with Americans holding $1.3 billion worth of Canadian bonds in 1935); however its bonds were barely affected. Markets were perhaps confident that either capital flows would continue or that Canada would be able to earn foreign exchange from other sources (most likely Com- monwealth trade).

As an alternative to picking specific dates and examining bond prices around those dates, one might also use the change in bond prices to identify dates of interest, a strategy used by Kristen Willard, Timothy Guinnane, and Harvey Rosen.14 Looking over all two-week periods in 1930, the period over which most countries experience their steepest price declines of the year is the period ended 10 October. The apparent impor- tance of this date is not confined to Latin America, and reflects increased political instability in Latin America and Europe as 1930 progressed. Spe- cific events that contributed to this instability include the deepening polar- ization of German politics evident in the elections of September 1930 in which the Communists and National Socialists both did well, and political turmoil in Argentina, Brazil (which was close to civil war), and Bolivia. It is plausible to view these events as reflecting long-running political tensions and economic difficulties. The latter include declining commodity prices in the case of Latin America, and financial instability in the case of Germany, both documented in great detail by Kindleberger. This in turn points to a complex range of problems, many building throughout the 1 920s, rather than the tariffs per se as playing the biggest role in the debt crises of the 1930s.

14 Willard et al., "Turning Points."



760 Carey

CONCLUSION

My basic finding is that the sovereign bond market did seem to react to the tariffs in a manner that suggests a mild concern with the tariffs' impact on debt repayments, but that this appears to be a small part of the overall explanation of bond price movements in 1930. It is possible that the tariffs were perceived as important by financial markets, but that this is reflected in a slow cumulative decline in the bonds rather than a single sharp response at any one date. This of course is difficult to test because the sharpness of the event study methodology is not available in this context. It is also possible that financial market imperfections prevent the tariff event from being reflected in bond prices immediately. Subjecting these alternative explanations of my results to closer scrutiny is deferred to future research.

A final possibility is that the chain of events precipitated by the tariffs was too complex to be clearly reflected in bond prices. Although many of the bonds in the sample did subsequently default, settlements were reached in many cases, albeit over an extended period of time. On government-backed dollar bonds issued in the 1920s, Eichengreen and Richard Portes estimate an internal rate of return of 3.25 percent; as they note, the most striking thing about this number is simply that it is positive.15 It is therefore possible that bond prices did not move that much in response to the tariffs because such a process of default followed by settlement was anticipated by markets. Of course, the internal rate of return displays great variation between countries so the fact that, on average, dollar bonds ultimately yielded positive returns does not explain why we observe weak correlation between price changes and trade or debt variables at the time of the tariffs.

The overall conclusion of the article is that the marginal contribution of the tariffs to the Great Depression appears to be quite small, reaffirming the conventional wisdom in economics. This of course is not to downplay the political impact of the tariffs, which at the very least led to a change in the way that American trade policy was conducted.16 The results leave us in- clined to attribute the severity of the Depression to the poor macroeconomic models and policies of the time (such as the supposed benefits of deflation, the malfunctioning Gold Standard, and vulnerable financial sectors in many countries) and to place less blame on "beggar-thy-neighbor" trade policies.

15 Eichengreen and Portes, "Debt." 16 Irwin ("From Smoot-Hawley") discusses the switch to bilateral bargaining by the United States

in the form of the Reciprocal Trade Agreements Act of 1934.

REFERENCES

Bemanke, Ben S. "Review of The Great Depression, 1929-38: Lessons for the 1980s by Christian Saint-Etienne." Jouirnal of Political Economy 93, no. 4 (1985): 831-35.




Crucini, Mario J., and James Kahn. "Tariffs and Aggregate Economic Activity: Lessons from the Great Depression." Jouirnal of Monetary Economics 38, no. 3 (1996) 427-67.

Eichengreen, Barry. Golden Fetters: The Gold Standard and the Great Depression, 1919- 1939. New York: Oxford University Press, 1995.

Eichengreen, Barry, and Richard Portes. "Debt and Default in the 1930s: Causes and Consequences." Euiropean Economic Review 30, no. 3 (1986): 599-640.

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investigating a debt channel for the smoot-hawley tariffs: evidence from the sovereign bond market

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