History: Currently Rhyming and Repeating Itself

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Before there was BP's Deepwater Horizon oil spill in the Gulf of Mexico, there was Pemex's Ixtoc I leak in Mexico's Gulf of Campeche. It dumped a total of about 3.5 million barrels of oil 290 days in 1979, compared with the current spill's estimated 1.9 million barrels over the past 85 days.

Ironically, the same techniques that failed to stop the Ixtoc leak (junk shot, top hat and top kill) were again used to try to halt the Deepwater Horizon leak. They failed to work this time, too. The inability to stop the current oil spill quickly is a failure to learn from history or to plan for a disaster. But oil company executives aren't the only ones who don't learn from the past. It seems that economic planners are about to commit the same error.

Traditional economic theory suggests that negative real interest rates (interest rates minus inflation rate, see chart courtesy of thechartstore.com, click to enlarge) are supposed to spur economic activity. Conventional wisdom suggests that the Great Depression was solved by New Deal spending and massive “money printing” after the U.S. government took the dollar off of the gold standard. But the period from 1937-1942 shows that negative real interest rates, the New Deal and removal of the gold standard had no lasting impact as the S&P 500 fell 60% and the economy languished. Let’s review the actions that government took to kick-start the economy back then, because they are eerily similar to today’s.

March 1933: President Roosevelt is inaugurated and institutes New Deal I.

April 1933: Roosevelt issues Executive Order 6102 confiscating all U.S. citizens’ gold and removing the domestic gold standard. (Today’s less dramatic equivalent is quantitative easing). Also, the FDIC is created to stop bank runs. (Today’s equivalent is TARP).

1934-1936: New Deal II commences.

1937: Negative real interest rates fail to prevent another round of economic contraction. (Today's equivalent is still unfolding.)

Just as in the late 1930s, we are dealing with massive debt deflation that has not run its course. We say this because as the June 18 Weekly Insight wrote, consumers simply are not interested in more credit, no matter how cheap. Just like 1937-1942, we are about to bear witness again to markets and economies being more powerful than any attempts to control them. Try not to make the investing equivalent of BP’s mistake. Learn from history, and be prepared for disaster in case it happens.

Disclosure: I am currently short EUR/USD.