Would a Market Meltdown Spur Protectionism?

A stock market slump could have consequences for the protectionist push in Congress.

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"If we get a recession, then all bets are off," is how David Smick, who provides political analysis to hedge funds, described to me the chances of the new Congress passing harsh protectionist legislation targeting China. He predicted more jawing than action unless there was some external macro event as a catalyst.

Now this was back at the start of the year, and the protectionist push has since gained considerable momentum on Capitol Hill. But this week's stock market decline has me wondering if a continued stock slump might accomplish the same thing as an economic downturn. One could possibly link the dropping Dow to market disappointment over the Federal Reserve's reluctance to cut interest rates.

And why is the Fed reluctant to cut rates despite recessions in the housing and auto sectors? You could argue that with rates rising elsewhere in the world–the European Central Bank just hiked rates to a six-year high–and U.S. inflation numbers still a bit dodgy, Bernanke and company can't trim rates here without sparking a huge rout in the dollar. And the greenback wouldn't be in such fragile shape if not for the huge trade imbalances America runs with the rest of the world—especially, you guessed it, with China. One could argue this. Congressional protectionists—or "economic nationalists," if you prefer—have already built up a head of steam, and this week's market decline may be putting a few more coal nuggets in the boiler.

By the way, I think a more likely explanation for the market's tumble is the fact that stronger-than-expected U.S. economic growth has shocked growth-hating bond market bulls, pushing yields higher and playing havoc with market valuation models. Both Goldman Sachs and the House of Doom—Merrill Lynch—for instance, have ditched their market predictions of a Fed easing anytime soon.