Economics Without The B.S.**:
[** Double entendre intended.]
With the international stock markets in mass retreat this past week, for the two days after President Trump announced his newly revised tariff trade policies, I am wondering if there are similarities to the stock market crash in 1987. I am old enough to remember those days and I did have a lot of money in the stock market then, as I do now. And I am also old enough to have parents and been educated from kindergarten through my college years, including grad school, with folks who directly experienced and came through the Great Depression years of the 1930s – the so-called “Greatest Generation”. They did not name themselves; and they are not called “The Perfect Generation”. So let’s look back to the events of 1987 and see if there are parallels to today.
On Monday October 19th 1987, the Dow Jones Industrial Average dropped over 22% that day; the panic selling started right from the get go of the opening bell, following similar losses in the international markets in both Asia and Europe before the New York markets opened. This was preceded by the previous week that saw the market decline by approximately 10%. And it was followed by the next day that saw the market continuing to decline by another 10%, before things stabilized with a variety of actions taken by the Fed and others.
Various reasons are given for the crash:
(1) The precipitous decline of the dollar and the failure of international leadership in stabilizing currency valuations.
(2) Persistent U.S. trade and budget deficits
(3) Rising U.S. interest rates, from the Fed (under the new Chairman, Alan Greenspan) and international markets, with concerns about inflation creeping back in to the economy after the Fed, under Chairman Paul Volcker, had tamed inflationary expectations.
(4) Program trading by big money managers
(5) Portfolio insurance hedging by big money managers
(6) Over enthusiastic speculative buying in the stock market (e.g, P/E Ratios too high) earlier in the year that could not sustain itself given the performance of the real economy. The Dow was up over 40% during the year.
In my opinion, I attribute “The Crash” on that particular Monday to (1), the uncertainty and disruptiveness in the currency markets with respect to the Dollar vis-à-vis the DM (Deutsche Mark) and Japanese Yen. The other items I feel contribute to “The Crash” but do not explain why “The Crash” happened on that particular Monday and not the week before, two weeks before, or a month before, where all these other conditions were still present.
So let me explain. But first a little background. President Reagan was in office when this stock market crash took place and the various causes were going on. One very interesting thing that took place was his change in Treasury Secretaries while he was in office; and this change took place in the beginning of 1985 as President Reagan’s second term was about to begin. His first Secretary of the Treasury was Donald Regan. James Baker was President Reagan’s Chief of Staff. At the start of President Reagan’s second term these two men switched positions, on their own accord, and notified President Reagan for approval, which they both got.
This change however would involve more than a switch in personnel, it was a switch in President Reagan’s economic policies. During President Reagan’s first term, the Fed under Chairman Paul Volcker was continuing its policy of combating high inflation and the concomitant built-in high inflation expectations with prohibitive very high interest rates approaching 20%, which resulted in the most serious recession for the United States since World War II. But as the nation was recovering, and the economy was improving by 1983, the Fed was bringing down the high interest rates, but very slowly because of uncertainty in the banking sector. [Notably the failure of Continental Illinois Bank in 1984, viewed at the time as a systemic problem, and some instability with the Savings and Loan Sector of the banking sector.]
So the high interest rates along with the improving American economy in 1984, 1985 made the value of the dollar very high in comparison to its trading competitors – Japan, which was doing extraordinarily well, and West Germany. The high value of the dollar vis-à-vis with the DM and Yen, two manufacturing economies that were very competitive with the U.S., made it difficult for U.S. manufacturers who operated both domestically and internationally, resulting in large trade deficits for the U.S. vis-à-vis large surplus countries like Germany and Japan.
Of course, when there is a deficit in the Current Account (of the Balance of Payments method of accounting) due to trade, those dollars that go overseas must come back into the U.S. This is accounted for in the Balance of Payments by the Capital Account which tracks capital flows from country to country. So the U.S. was experiencing capital flows back into the U.S. If you recall in the 1980s, Japanese investors were buying up large commercial real estate projects, to include Rockefeller Center in New York City. Foreign investors also bought U.S. treasuries and bonds, helping to finance the huge government budget deficits the Reagan Administration was running up.
Treasury Secretary Regan, a Wall Street veteran, looked upon this exchange favorably. When James Baker replaced him as Treasury Secretary, he did not share this outlook, and was able to convince President Reagan that it was detrimental to the U.S. manufacturing sector of the economy; and, it would cost the Republicans votes and possibly their majority in the Senate.
After taking office, Baker will negotiate his way with our other major trading partners and arrive at the Plaza Accord later in 1985. This is to stabilize the major currencies – depreciate the dollar while getting our other major partners to raise the value of their currencies. And the dollar did depreciate by 20% up to Black Monday, while there was some improvement in the federal budget deficit. But both Japan and West Germany, their Central Banks, were trying to keep their currencies on a favorable level with the depreciating U.S. dollar. This annoyed Secretary Baker.
There was another meeting of the major trading partners, this time was the Louvre Accord in early 1987. The same thing, Secretary Baker trying to stabilize the dollar against the other major currency, wanting the exporting nations – namely Japan and West Germany – to do more to stimulate their economies so Americans goods would have more of a market. While there was “agreement” there was still reluctance to find parity. The dollar continued to depreciate, but was still not competitive, to the annoyance of Baker.
Also in mid-1987, President Reagan will announce the appointment of Alan Greenspan as the new Chairman of the Federal Reserve. He will take that position in July. He will work with the Administration, but he, like Volcker before him, has the economy and the banking situation to deal with. Inflation is starting to pick up, so Greenspan, like Volcker, is continuing to increase interest rates, which normally would raise the value of the dollar. But the dollar while still dropping and too high for Secretary Baker.
So, with that background, let’s lead up to Black Monday with the action going on the week before. During this week the dollar is precipitously dropping, and it is a big news item. Will the U.S. intervene in the markets to support the dollar? The U.S. stock market, as well as other markets, are showing strains and in a degree of turmoil. Secretary Baker finds the West Germans in particular indifferent. In mid-week when he is asked if the U.S. will support the dollar, he replies [something to the effect] “If the markets want to drop the dollar, so be it!” And the rest of the week, that is what the dollar does, continue sharply dropping – now along with stock prices. And that is how we head into the weekend.
Now I am not sure which day it is, but I believe it was Saturday when one of the West German ministers – the Finance Minister I believe – makes a statement about the situation and says West Germany will lower its interest rate because they see slower growth coming on with the possibility of a recession. This would mean the DM will have a more favorable standing vis-à-vis the dollar, the exact opposite of what Secretary Baker wants the West Germans to do. He is infuriated by the West German’s remark, and says over the weekend, he will let the dollar depreciate even more.
This is a talking point on the Sunday news shows in the U.S. Now I’m out in California, on West Coast time on Sunday. But Sunday afternoon and evening, West Coast time, is Monday business hours in Asia. And the Asian markets are taking this news in and it doesn’t take much to digest it. There is panic selling in all the Asian markets.
And I did not stay up past midnight, West Coast time, to follow the European markets opening Monday morning, but the rout on the markets continued. In fact the London market – the FTSE – was down by a bigger percentage than the New York markets at the end of the day.
So my feelings are it was those remarks over the weekend that set off the panic selling, because the New York market dropped precipitously as soon as it opened. Program trading did not even kick in at the opening bell. The panic selling started in Asia, continued in Europe, and went right into the U.S. markets.
The devices traders used in the U.S. markets accelerated the selling panic, but they did not cause the panic, they were only responding to the panic that was already there. The Asian markets and European markets did not have the accelerants, like program trading, to the degree the American markets had; and they still had their markets collapsing that day. So anyway, that is my take on “Black Monday”.
Now what is going to happen this weekend with the response to Trump’s tariffs. Because since Trump announced his stance on the tariffs in midweek, all the markets – in the U.S., Asia, and Europe – each day have lost at least 3% to 5%. That is a Big Deal! And Sunday West Coast time in the afternoon and evening is what???...the Asian markets are open.
We have already seen Canada’s Liberal Party leader, Mark Carney, who may win the upcoming election, firmly but diplomatically denounce President Trump’s actions. He said, “Our relationship with the United States is over.” And said it needs to be re-negotiated.
So as of Saturday afternoon, West Coast time, as I write this I have not heard much news on the response by foreign countries to Trump’s tariffs; only a small news item that Trump still intends to keep the tariffs on.
And I will remind you, like I have reminded others going back to when Trump first decided to run for president in 2015, that this guy has had six business bankruptcies during his career; and that was his main business – construction and casino/hotel operations – not including side ventures like Trump Champagne, Trump Steaks, Trump Airline, and Trump University. The last one was in 2009, when he refused to make a $50 million loan payment and wanted to renegotiate it with the lender. He argued with his Board of Directors. They reduced his stake in the company and fired him as the CEO. And the company went through the process of selling off its assets. Now the irony is that at that time in 2009, Mr. Trump was still doing ‘The Apprentice’ show where he was showing his make-believe business acumen and firing people.
I do not know what the outcome of all this will be. I am not making any predictions. I do think there are some interesting parallels with 1987. Trump seems to dig into situations without resolution, and without a willingness to change, passing the blame off to others. The markets have dropped almost 10% in the two days since his tariff announcement. Whether it will continue with an orderly retreat, a massive sell-off in a panic like “Black Monday”, or maybe even reverse course and recover sanity, remains to be seen.
Stay tuned for Sunday; it could be a prelude to the next step. And we will see what happens.