The 1987 Crash
The 1987 Crash also became known as Black Monday referring to Monday October 19th, 1987. It was a fateful day when the US stock market crashed, creating a wave of confusion as capital and government failed to grasp the real underpinnings of currency. The 1987 Crash came precisely to the day on our Economic Confidence Model 1987.8 (365 x .8 = 292 days = October 19th, 1987). The dominos were set up by Paul Volcker who raised interest rates to stop inflation going into 1981. However, raising the discount rate to 14% dramatically increased the amount of money the US paid on its national debt. This indeed caused capital to shift from investment to government debt. People were selling everything including shifting to long-term CDs at banks. What actually happened, the immediate inflation seen in commodity prices was shifted forward to the debt markets. The national debt rose from $907.7 billion in 1980 to $3.2 trillion in 1990. The interest expenditure was $1.8 trillion while the spending deficit for this period was $922 billion. The effort to reduce inflation actually propelled the debt substantially higher. It also attracted foreign capital to the dollar to gain interest rates at about 17%+. This rise in interest rates to absurd levels set in motion the dollar rally, which is necessary to contract asset values.
The dramatic rise in the dollar between 1980 and 1985 then prompted government interaction with the idea of forming a group of 5 major countries to combat the currency markets. The idea that emerged centered on coordinated manipulation/intervention to compel the decline in the dollar. Government listened only to exporters and saw the rise in the dollar as causing jobs to leave the USA. It was the idea of James Baker to create the Group of 5 (G5). This famous meeting took place on September 22nd, 1985 at the Plaza Hotel in New York City whereby they reached an agreement affirming that the dollar was overvalued and, therefore, the yen undervalued, and announced they “wanted” to see the dollar fall by 40%.
This agreement thereby began a reckless attempt to alter international trade with no consideration whatsoever about capital and investment flows. By lowering the value of the dollar, they failed to understand that the Japanese, who had purchase about one-third of the US National Debt to ease trade friction, US shares, and trophy real estate like Rockefeller Center, would then suffer a 40% loss and would sell those assets. It would not be just wigets that became cheaper, but everything.
The new G5 set out to deliberately shift supply and demand by pressuring in the markets to do as they desired. This was not only the same position taken by Karl Marx insofar as saying he did not like the way society functioned and thus the answer was to seize all assets and place them in the hands of government creating Communism. In both cases, this is the equivalent of saying you want it to be bright and sunny everyday so you devise a machine the sucks upon all clouds to ensure it will not rain.
Clearly, those in government rely far too much upon intervention assuming they have the power and knowledge to alter the course of nature. They disagreed with the “free market” assuming they could create a coordinated attack to achieve the desired effect. This intervention led to a rapid rise in the value of the yen and a drop in the dollar. From its average of ¥243 per US$1 in 1985, the yen rose to a peak of ¥121.25 in December 1987. The consequences of this intervention were devastating to the world economy in no less a profound manner than communism itself.
The investment capital shifted internationally moving out of the dollar. This trend set in motion by the G5, created the 1987 Crash for foreign investors sold shares not because of earnings, interest rates hikes, decline in GDP, or any normal domestic fundamental news. They sold simply because they felt the dollar would decline another 40%. The yen was rising as the Japanese were selling US assets returning their money to Japan. As that trend unfolded, the rising currency and Nikkei share index attracted foreign capital as well. Domestic Japanese capital was pouring into local real estate as international capital poured into shares and the Japanese Bubble was created.
When we look at the capital flows for this period, we can see the wild and crazy swings that became the hallmark of the 1987 Crash. The swings in capital returning to Japan clearly contributed to creating the 1987 Crash, which was then followed by the capital concentration in Japan manifesting in the Bubble there for December 1989 also in line with our Economic Confidence Model target 1989.95.
The evidence of the 1987 Crash being driven by currency was evident by the fact the single piece of news that began selling in overseas markets concerned the US trade deficit, which widened even though the G5 reduced the value of the dollar by almost 40%. What they failed to understand was that what they call the “trade deficit” is really the Current Account, which includes ALL cash movement and that means interest and dividends paid to foreign holders. The trade deficit expanded dramatically because of the exceptionally high interest paid on government debt because of Volcker’s insane hike in interest rates into 1981. Lowering the dollar to sell more widgets failed to produce any effect because the bulk was not trade, but vast amounts of interest payments thanks to the high rates. At 8:30 am Eastern Time, the government announced that the so-called “merchandise trade deficit” for August was $15.7 billion, approximately $1.5 billion above the figure expected by the financial markets. Within seconds, traders in the foreign exchange markets sold dollars in the belief that the value of the dollar would have to fall further before the deficit could narrow given the G5 posture. The German Deutschemark and the Japanese-yen rose dramatically in value. Treasury bond traders, fearing that a weakening dollar could both discourage international investment in U.S. securities and stimulate domestic inflation, sold on the London market and on the U.S. bond market, when it opened. The Dow Jones Industrial Average (DJIA) dropped by 508 points to 1738.74 (22.61%). Domestically, investors called their brokers asking what was going on. Failing to understand currency, they did not realize why foreign investors were selling based on their belief that the dollar would have to fall much further. This had nothing to do with domestic economic statistics.
By the end of October, the damage from the 1987 Crash was widespread with stock markets in Hong Kong had fallen 45.5%, Australia 41.8%, Spain 31%, the United Kingdom 26.45%, the United States 22.68%, and Canada 22.5%. New Zealand’s market was hit especially hard, falling about 60% from its 1987 peak, and taking several years to ever recover.It took about 5 months before the market began to fill the gap it left between Friday and Monday. The interesting thing is clear from the pattern. The market also NEVER retested the low but began to build a sideways base indicating the low was in place and it was preparing to resume its rally.
Now compare this pattern to 1929. Here we see a spike collapse thrusting down for the first 3 months. Then there is a 5 month Counter-trend Reaction into early 1931. This was a normal trading pattern. But then came the second crisis – Sovereign Debt Crisis. Within 10 months news lows were being made again. We do not have that pattern in 1987 where there was a thrust downward that moves in total 31.4 days down from the major high August 25th with one Counter-trend 8 day rally.The pattern in 1929 was continual liquidation whereas that was not the case in 1987. The bull market that peaked in 1929 began in 1921. Here, the 1987 high came just 2 years from the last low. It was not a fully developed mature bull market.
The terms Black Monday and Black Tuesday are also applied to October 28 and 29, 1929 when the Dow fell 12.82% in a day, which occurred after Black Thursday on October 24, which started the Stock Market Crash of 1929. In Australia and New Zealand the 1987 Crash is also referred to as Black Tuesday because of the time zone difference. The Black Monday decline was the largest one-day percentage decline in history. In the Dow Jones World War I Crash December 12, 1914 of 24.39% was created retroactively after the DJIA in 1916 was revised.
Following the 1987 Crash, 99% of the analysts were predicting a Great Depression. A group of 33 eminent economists from various nations met in Washington, D.C. in December 1987, and concluded “the next few years could be the most troubled since the 1930s”, as reported by the New York Times; “Group of 7, Meet the Group of 33” (12/26/1987). Nonetheless, because this was currency driven, it was clearly not a domestic event as most analysts and economists predicted. That proved to be the actual low and from there the market based, then began to rise to new highs.
There were those who were blaming computers. Others blamed the futures markets which just began trading the S&P 500 in 1985. Economists claimed the internal reasons included innovations with index futures, hedging using portfolio insurance, and program trading. But many of the computers were correct and said sell. The portfolio managers however did not sell assuming there had to be a rebound. Clearly, the selling began overseas and that contradicts the argument that program trading was to blame as was the evidence that surfaced from interviews. Even during the Great Depression, there was an assumption the market went down because of short-selling. They hauled everyone before the Senate and interrogated them. They never found that mythical short seller. Likewise, they never found any program trading strategies that were used primarily in the United States that set anything in motion. This boiled down to the simple fact that when everyone is long, scare them and you flip the herd into a stampede of all sellers with no bid.
The 1987 Crash was caused by Government trying to manipulate the free markets without any understanding of what they were doing.
The following in the formal request to supply our research into international capital flows from The Presidential Task Force on Market mechanisms otherwise known as the “Brady Commission.” Our efforts were designed to demonstrate that the high volatility of the 1987 Crash was caused by international currency concerns, and was not the result of domestic economic events nor was it driven by manipulative speculation. There was also no evidence whatsoever that this was ABNORMAL being driven by computer trading that has begun to emerge.
The 1987 Crash was simply caused by the G5 public announcements that they “wanted” to see the US dollar lower by 40% to effect trade thereby reducing the trade deficit and in theory create jobs. Such artificial intervention is HIGHLY dangerous, and warns above that government should address the issues directly that are increasing the trade deficit – taxes. By taxing corporations at excessive levels and labor, the cost of production in the United States is rising far more rapidly than other nations. Capital can always leave or hoard in times of uncertainty, but labor can do neither, as President Cleveland once commented. The numerous layers of taxation are increasing the international cost of labor and eliminating any hope of global competitiveness.
Copyright 1988 for the PEI Annual Economic Conference