In American politics, the Democratic Party embodies a great dichotomy. Its ideological leaders reside on the left, holding world views that favor an energetic government role in social and economic affairs to lift the prospects of common people. The party’s voting support comes primarily from those among low-income individuals, minority groups and the disadvantaged who can be persuaded they will benefit from active government.

But economic policies championed by the Democratic Party are mercantilist - designed to provide advantage to moneyed interests that are anathema to many party activists. The case for the point is not at all far-fetched, although it is unlikely you have seen it made before.

Tenets of Mercantilism

Three tenets of mercantilist economic policy are: (1) high tariffs (to keep foreign competitors out of domestic markets); (2) high marginal tax rates (to provide social safety net entitlements to those unemployed due to high tariffs); and (3) controlled domestic interest rates (to subsidize domestic production). These have been policy objectives of mercantilism since the 15th Century. They sound familiar because, in the 21st Century, they are central planks in the Democratic Party platform.

Call them populist, protectionist or Keynesian – these policies comprise the contemporary face of ancient mercantilism. They find broad political support among Democrats led by Senator Charles Schumer (D-NY) and occasional Republicans such as Senator Lindsey Graham (R-SC). For the past three years, these senators have threatened to impose a 27.5% tariff against Chinese products unless China’s central bank discontinues a more than decade-old peg of its currency’s value to the dollar.

Only two weeks ago, America’s new best friend in Europe, President Sarkozy of France, solemnly advised the U. S. Congress that the Fed’s severe weakening of the dollar threatens a global trade war. Sarkozy’s message is all too true, and reveals that currency devaluation is simply the other side of the protective tariff coin.

China’s Peg to the Dollar

Ordinarily, a foreign central bank’s decision to peg its currency to the dollar is the highest compliment (short of dollarization) that can be paid the Fed. A dollar peg means that foreign central bank is ceding its monetary policy to the Fed. Responding to the U. S. tariff threat in 2005, China dropped its dollar peg and began a process of allowing the dollar to devalue slowly against the yuan. While the yuan-dollar peg endured, it provided China currency stability with its largest market – the U. S. – an entirely rational motive inconsistent with “manipulation.” At the same time, America received a reliable source of goods at stable prices. The Treasury Department of the Bush administration professes free trade policy, but pressures China to accept dollar devaluation so as to avoid instabilities in global trade that might precipitate from Schumer’s China tariff.

Mercantilism’s Political Home

Tariffs and high tax rates did not always find political support in the Democratic Party. Mercantilism achieved its American resurgence during the one term of President Herbert Hoover. When Hoover allowed tariff protection for farmers to be placed in the 1928 Republican platform, Democrats were the party of farmers and free trade.

Republicans passed the Smoot-Hawley Tariff Act in the U. S. Senate by a two-vote margin, with only four votes provided by Democrats, producing the Great Crash of 1929 and 25% unemployment by 1932. Hoover then asked for increases in tax rates to balance the severe federal budget deficit Smoot-Hawley had produced. Democrats and Republicans in Congress obliged with a quadrupled lowest bracket and trebled highest bracket retroactive to January 1, 1932.

After Hoover’s two historically tragic errors, Franklin D. Roosevelt was elected president in a landslide and both houses of Congress went strongly Democratic in 1932. Inexplicably, rather than reverse Hoover’s wrongs, Roosevelt kept the tariffs, added excise taxes on imports, and raised tax rates every year except 1939 during his four terms as president.

From the inception of the Republican Party until 1932, mercantilism’s political home was there. From 1932 to the present, mercantilism has reached its greatest influence through the Democratic Party. Building on Roosevelt’s business relationships with Wall Street during his earlier career there, mercantilism found its new home among Democrats, where it remains today.

Keynes’ Assist to Mercantilism

In 2007, the Democratic Party remains devoted to Keynesian economic theory and rhetoric, despite obvious detriments to Democrat constituencies. Most egregious of all is outright Democratic support for Federal Reserve monetary policy designed to manipulate domestic interest rates.

In The General Theory of Employment, Money and Interest (1936), Cambridge University professor of classical economics John Maynard Keynes wrote that he had been misled in his youth to have no appreciation for the merits of mercantilism. Keynes undertook to fill an intellectual void by providing a theoretical model capable of advancing mercantilist objectives. He advised that governments should be preoccupied with achieving a positive balance of trade and controlling domestic interest rates. The latter objective could aid the former, Keynes opined, by subsidizing employment while protecting workers from “bankers’ whims.”

Mercantilism Rules the Federal Reserve

Riding Keynes’ advice while turning it on its head, mercantilists persuaded a Republican president, Richard M. Nixon, to place control of domestic interest rates in the hands of bankers at the Federal Reserve System. Nixon voided by executive order the money rule in effect under the Bretton Woods Protocol that had required the dollar’s value to be kept stable relative to gold. The dollar’s value henceforth would “float” in the market so the Fed could manage domestic interest rates.

Since that fateful decision, the dollar’s value relative to gold has dropped 96%. Intermittently (1980-1982 and 1996-2001), the dollar has soared to deflationary peaks, causing damage at least as bad as inflation by means even more difficult to detect. No one suffers more at the hands of Federal Reserve Keynesianism than traditional Democrats: the common people.

Fruits of Mercantilism

During periods of inflation, the Fed raises the funds rate to cause greater unemployment so workers will not have bargaining power to insist on higher wages to maintain their standard of living. Workers and the unemployed are most likely to own only cash rather than hard assets (such as real estate, equipment, etc.) that rise in price with inflation. Thus, inflation produced by interest rate manipulation hurts middle and lower income groups worse than those with greater capital and hard assets.

Deflation treats Democratic constituencies even more harshly than inflation. Deflation means the dollar’s value is increasing. This requires prices of products and services to be reduced, thus reducing revenues and profits. Lower profits mean less capital to invest in hiring workers and buying equipment that increases productivity (and wages) of workers. Marginal (sub-prime) workers are the first fired during deflation, just as they are the first fired during inflation when the Fed hikes interest rates.

Why the Fed Manipulates Interest Rates

With these economic scenarios so readily discernible, why does the Fed persist in its cyclical routines of hiking and cutting its “funds rate target,” while attempting explanations in only the most abstract and obtuse terms? There is no alternative answer: mercantilist influence.

Mercantilists benefit from the Fed’s manipulation of the funds rate in two primary ways. First, the funds rate “target” serves as a benchmark for all commercial banks by which they adjust interest rates charged on loans to their customers. This greatly relieves bank executives of the stress and strain of doing the same thing by a private arrangement in violation of anti-trust (price-fixing) laws.

Second, and importantly to investment banks and hedge funds, predictable moves of interest rates provide cyclical investment opportunities for those with closest knowledge of the Fed’s operations. As interest rates are ratcheted up, asset prices decline and collapse (the “buy low” opportunity). Then interest rates are cut, usually sharply, and asset prices rise (the “sell high” opportunity). Sitting on the boards that select Federal Reserve regional bank presidents, who meet with and sometimes vote on the Federal Open Market Committee, has its prerogatives.

Whence from here?

More difficult to fathom is how long Democratic Party faithful will continue their devotion to mercantilist objectives or, as it is contemporarily known, Keynesian economic policy. The common people benefit from jobs and an honest dollar, not from buying and selling opportunities. ~