Alleged Currency Manipulations and Retaliatory Tariffs. Some lessons from the 1930s

Thilo Albers is PhD student in Economic History
at London School of Economics (LSE)
How forceful can retaliations to alleged currency manipulations be? What are the effects on trade? The following research seeks answers to these questions in the interwar period.

The evidence for China still deliberately undervaluing her currency is at best weak (see Cheung et al 2016). Yet, with the new US president in office, import surcharges for alleged currency manipulation against her and other countries have become more likely. Indeed, even before he had come into office, important public figures across the political spectrum had called for an import surcharge (e.g. Krugman 2010). At the heart of such debates is the argument that the country undervaluing her currency significantly gains at the expense of others. A lower real exchange rate stimulates exports, which in turn creates current account problems abroad (Goldstein and Lardy, 2006). It is frequently invoked that a retaliatory tariff could be used to force the alleged currency manipulator to re-align her currency. According to the standard narrative (e.g. Krugman 2010), this worked smoothly towards the end of Bretton Woods, when the United States forced other countries to re-align their currencies with an import surcharge. However, this was a very particular case in a very particular setting and the final realignment might have well been reached without the surcharge (Irwin 2013). Neither does this case answer the most important question. What are the potential political and economic costs of retaliatory tariff policies?

The 1930s provide a blueprint to assess such costs. Some countries had left the gold standard and floated their currencies. Other countries alleged them of deliberately undervaluing their currencies and imposed retaliatory tariffs. In a new study focusing on French commercial policy (Albers 2017), I show that moving towards discretionary tariff policies can have high political and economic costs. The study is a first attempt to quantify the relative importance of retaliatory as opposed to general tariff increases for this commercial policy episode. The retaliatory motive for French protectionism turns out to have been at least as important as factors driving the general tariff level. The effects of retaliation on trade were comparable to those of modern trade treaties – just with the opposite sign. The analysis of historical newspapers demonstrates that leniency vanished from the public discourse and nationalist agitation took over.

Alleged currency manipulation back then

When Britain had unilaterally left the gold standard in the autumn of 1931 and other countries followed suit soon after, policymakers in these countries did not intended to manipulate their currencies. The imminent threat of further deflation and the drain of gold reserves had effectively pushed countries off the gold standard, especially Great Britain (Accominotti 2012). However, many policymakers abroad perceived this devaluation as currency manipulation. At the forefront of them, the French government retaliated by raising tariffs and introducing quotas specifically aimed at those countries that had left the gold standard.

From the villain to the victim of exchange rate policies

It is not without irony that French commercial policymakers perceived their country (and other countries on the gold standard) as the victim of currency depreciations abroad. When France stabilised her currency at 20 % of its pre-war value in 1928 while many countries such as Britain returned to their pre-war parities, this led to a massive gold influx in France. Some have argued that this played a part in causing the Great Depression, because it led to further deflation abroad (Johnson 1997, Irwin 2010). The paper shows that contemporary commentators abroad likewise argued that the Franc was undervalued. In this sense, France was the villain of exchange rate policies in the late 1920s.
After the first wave of currency depreciations had hit in the autumn of 1931, tables turned. The real value of the Franc doubled against the pound in the following two years. French policymakers now felt victimised by exchange rate policies abroad. A qualitative analysis of contemporary newspapers focusing on the Anglo-French commercial policy relationship suggests that the rhetoric shifted from leniency before the devaluations to agitation afterwards. Numbers can indeed mirror this debate as Figure 1 shows. It plots the number of articles in the Guardian per year containing keywords that identify protectionism and tariffs in general and those that contain additional references to tariff wars or retaliation. The retaliatory sentiment first peaked in 1930, when the discussion about the Smoot-Hawley tariff in the United States got heated. This local peak was far exceeded by the discussions about the devaluations two years later. These numbers and the discussion of the articles behind them lead to the conclusion that the political costs of the devaluations and the following retaliation were indeed high.
Figure 1: The Rhetoric of Retaliation

Identifying the retaliatory motive in commercial policy

Tariffs had been increasing across all countries during this episode, and mostly so in countries adhering to the gold standard (Eichengreen and Irwin 2010). The new retaliatory protectionism, however, had a new quality and severe political economy implications. Retaliation was directed at certain trading partners and thus different from the previous general increases in tariffs to either balance trade and budgets or protect the home industries. Irwin (1993) coined this bilateralism “pernicious,” but so far, we know little about its magnitude relative to the general increase of protectionism and its effects on trade.
While most studies on protectionism make use of aggregate tariff data, this study employs a novel dataset of bilateral tariff rates of France against her trading partners. This so-far widely neglected dimension of tariff data allows me to separate general tariff increases from those with a retaliatory motive by using a difference-in-differences setup. Figure 1 shows that the “tariff treatment” for those leaving the gold standard was indeed very large.
Figure 2: The “tariff treatment” for leaving the gold standard
The most conservative estimate suggests that, while the general increase (against all trading partners) amounted to 5 %, the retaliatory component of the increase in French protectionism amounted to about 7.5 %. This is very close to the average tariff reduction reached by NAFTA (Burfisher et al. 2001). Hence, retaliation was important for the increase of French protectionism, but did it matter for trade, too? A back-of-the-envelope calculation and an econometric estimate suggest that the reduction in trade implied by these tariff increases was about 20 %. This magnitude, albeit being a bit smaller, is comparable to the one of trade-creating effects of Regional Trade Agreements (see median estimate by Head and Mayer 2014). In sum, the economic costs of retaliation were large.

What do we learn?

It is almost needless to say that French policymakers did not change minds abroad with their actions, especially as the abandonment of the gold standard abroad was clearly a prerequisite for recovery (Eichengreen 2013). The chaotic manner and the absence of any coordination of the devaluations, however, led to more protectionism in those countries that decided to stay on the gold standard. The quality of this protectionism was markedly different as it targeted certain trading partners. This discretion could thus lead to tit-for-tat tariff escalations, for which the interwar period has become so infamous for. The political and economic costs of retaliatory tariffs were large by modern standards.
We should be skeptical when commentators refer to the successful case of 1971, in which the United States had employed an import surcharge to force countries to re-align their currencies. There is no guarantee for retaliatory tariffs to solve currency disputes. On the contrary, the attempt to use them as a bargaining chip might fail and instead provoke ever more protectionism. After all economic policy cooperation appears to be the best recipe to avoid disaster. 
This blog post was written by Thilo Albers, PhD candidate at the Deparment of Economic History at LSE. 
The working paper can be downloaded here:


Accominotti, Olivier (2012): “London Merchant Banks, the Central European Panic and the Sterling Crisis of 1931,” The Journal of Economic History, Vol. 72, pp. 1–43. 
Albers, Thilo (2017): “Currency Valuations, Retaliation and Trade Conflicts Evidence from Interwar France,” LSE Economic History Working Paper, No. 258/2017
Burfisher, Mary E., Sherman Robinson, and Karen Thierfelder (2001): “The Impact of NAFTA on the United States,” The Journal of Economic Perspectives, Vol. 15, pp. 125–144.

Cheung, Yin-Wong, Chinn, Menzie and Xin Nong (2016): “Estimating currency misalignment using the Penn effect: It’s not as simple as it looks.” NBER Working Paper, No. 22539
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Johnson, H. Clark (1997): Gold, France, and the Great Depression, 1919–1932: Yale University Press.

Goldstein, Morris and Nicholas Lardy (2006): “China’s Exchange Rate Policy Dilemma,” The American Economic Review, Vol. 96, pp. 422–426. 
Head, Keith and Thierry Mayer (2014) “Gravity Equations: Workhorse,Toolkit, and Cookbook,” in Elhanan Helpman Gita Gopinath and Kenneth Rogoff eds. Handbook of International Economics, Vol. 4, Chap. 3, pp. 131 – 195. 
Irwin, Douglas A (1993): “Multilateral and Bilateral Trade Policies in the World Trading System: An Historical Perspective,” in Jaime De Melo and Arvind Panagariya eds. New Dimensions in Regional Integration, Vol. 5: Centre for Economic Policy Research, Cambridge University Press, pp. 90–119. 
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Irwin, Douglas A. (2013): The Nixon shock after forty years: the import surcharge revisited. World Trade Review, 12(1), 29-56.
Krugman, Paul (2010): “Taking on China,” New York Times, March 14, 2010
Mankiw, Gregory N. (2009): “It’s no Time for Protectionism”, New York Times, February 7, 2009