Busch: Will G7 Repeat History?

The G7 meets today in Rome amidst a world economy that is in tatters and a rise in overt/covert protectionism.

India's recent decision to ban all Chinese toy imports shows how far and how fast the threat has risen. More disconcerting, Congressional negotiators have agreed to keep a "Buy American" provision as part of a $789 billion economic stimulus bill that requires public works projects funded by the plan to use only U.S.-made goods according to CNBC. The EU announced a series of meeting yesterday to address the rise in protectionism from its own members.

The covert protectionism ranges the entire gamut of government assistance to the private sector. China has just completed a plan to boost the country's information technology sector will focus on stimulating domestic demand for domestically produced goods. India's Labor Minister Oscar Fernandes said they are concerned about job losses in the civil aviation, textile, and gem and jewellery sectors and will take steps to retain jobs in the affected sectors. "We will give everything to the industry that is required to carry on." Lastly, the EU is expected to also take the UK to task over allowing its currency to depreciate rapidly with no signal of a change in policy to assist the currency.

Programming Alert: CNBC's Steve Liesman Reports Live From Rome

All of these example are disturbing, but we should have all expected countries to react this way. Why? Whether it's global warfare or financial turmoil, political leaders always turn inward when the environment turns dangerous. Many people point to the 1930s for a paradigm to view today's events. There are other parallels.

The 1914 collapse of the global equity markets started a shift in international trade and capital flows that lasted 6 decades. Yes, that's right 60 years. It wasn't until the US went off the gold standard and capital flows were free to move that things changed. Prior to World War I, the global economy and global capital flows surged during a golden era of growth and rapid technological changes such as communications. Interest rates were relatively low and emerging market spreads narrowed dramatically. Does this sound familiar?

To show that blind spots are not a recent phenomenon (sorry Black Swanners), UK Labour Party member and author Henry Noel Braisford wrote at the time, "In Europe the epoch of conquest is over and save in the Balkans and perhaps on the fringes of the Austrian and Russian empires, it is as certain as anything in politics that the frontiers of our national states are finally drawn. My own belief is that there will be no more wars among the six great powers." This was the prevailing belief throughout the world prior to the assassination of Archduke Franz Ferdinand according to Niall Ferguson in his book, "The Ascent of Money."

During the crisis, the world equity markets were shut down for up to 5 months due to do a massive liquidity crisis that forced banks, companies, and countries to raise capital. Structures that seemed to assist in creating a stable financial environment and reduction of risk turned out to be chimerical. The gold standard did it in 1914 and the packaging of risk into complex financial structures based on mortgages sold around the globe has done it today.

As we now know, the 1930s kept the ball rolling with, "Currency crises, defaults, arguments about reparations and war debts and then the onset of the Depression led more and more countries to impose exchange and capital controls as well as protectionist tariffs and other trade restrictions, in a vain bid to preserve national wealth as the expense of international exchange." (Ferguson) The world turned inward for a long time with the United States enacting the Interest Equalization Act in 1963 to discourage Americans from investing overseas.

This is what is at stake now in the world. This is why the US needs to be a leader in keeping global finance and trade open. This is why the "Buy American" is such a disappointment. Let's hope we don't spend another 60 years figuring it out

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Andrew Busch
Andrew Busch

Andrew B. Busch is Global FX Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him here. </</p>