Déjà vu All Over Again?

It has been said that those who fail to learn from history are destined to repeat it. Indeed, it is remarkable how often succeeding generations experience a similar circumstance to their forebears.

In part, this is due to human nature and the tendency to be overly optimistic or pessimistic according to the events confronting them. Nowhere is this more apparent than in the investment markets.

The four most dangerous words in investment are “This time it’s different”.

They are used to justify wilful ignorance of the lessons of history and often precede the rapid destruction of investor wealth. Some recent examples include the dot com bubble of the late 90s and the housing boom earlier this decade.

I now fear we are on the cusp of once again failing to learn the lessons of history in relation to the Global Financial Crisis (GFC).

The closest thing to the GFC was the Great Depression of the 1930s. It was precipitated by an unprecedented boom of the stock market which drove the economy, imprudent lending and asset value growth. Then came the bust.

In 1929, the US stock market fell 48 per cent from peak to trough before rallying 44 per cent in rapid time.

Economists, politicians and business leaders all praised the rapid recovery as signs that ‘the worst is over’ and claimed that the economy was set to grow again as a result of increased public works.

At least one banker thought differently though. Dr Benjamin Anderson of Chase National Bank declared that “cheap money is a stimulant, also an intoxicant”.

He went on to say that “if the dose is large enough a very substantial temporary effect can be brought about, but headaches will follow”. This was in April 1930 and Dr Anderson was right.

The US and the world shortly thereafter entered into a prolonged slump that saw the main stock market index fall to one sixth of its post crash rally. To put that in perspective it would be like the Australia’s All Ordinaries plunging a further 3800 points (to around 800) over the next two years!

Now jump ahead four score years.

Household debt is nearly twice as high as a percentage of Gross Domestic Product (GDP) as it was in 1929. Savings rates are virtually nil and the major asset for most people, the family home, can no longer be used as an ATM because it is no longer rising strongly in value.

In 2009, the US stock market has fallen 52 per cent from peak to trough before rallying 53 per cent in rapid time.

Economists and bankers are now saying the worst of the global recession is behind us thanks to massive fiscal and monetary stimulus from government.

In fact, the explosive growth of money supply has been unprecedented in the history of any modern economy. It is only natural that this will have some effect. The problem is, history shows that it will likely be of relatively short-term benefit and could potentially have long-term negative consequences.

Injecting hundreds of billions of dollars into an economy will naturally cushion the impact of any inherent economic slowdown, but what happens when the stimulus money runs out?

Should the government just print more to keep the good times rolling?

The result of such a policy would be rampant hyperinflation most recently seen in the dysfunctional Zimbabwe. Yet this is precisely the action we are seeing in the UK and the USA and, to a lesser extent, in Australia.

Trillions of dollars are flooding into the global economy propping up an otherwise unsustainable situation. The cash injection has fuelled the rally in the stock market that has an eerie parallel with what happened decades ago.

As the new found optimism takes hold, it might be time to take another look at what happened back then as a little reminder of the path that could lie ahead. After all, those who don’t learn from history are destined to repeat it.

P.S – those who insist on claiming ‘this time it’s different’ and maintain that markets cannot fall by 80 per cent or more should remind themselves that the US NASDAQ stock market index reached an all time high of 5132 points on 10 March 2000. It later fell to 1108 points (a 4000 plus point decline!) on 11 October 2002. Today, more than nine years later, it languishes at 2132 – exactly three thousand points below its all time high!

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