Revisiting The '87 Crash

By, Chris Rossini
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25 years ago today, the U.S. stock market experienced the largest one-day percentage decline in U.S. market history.

You'll surely hear about all of the non-reasons of why the '87 crash occured. Excuses like:

• Treasury Sec. Baker made a statement in a TV interview that the dollar should slip further, publicly criticizing the German government for nudging up short-term interest rates.
• The U.S. attack on an Iranian offshore platform the week before the crash.
• Everyone's favorite excuse: Program trading.

And if another crash were to happen again today, you can count on hearing excuses similar to the following:

• Bob Pisani would be on the case checking everyone's hand for a "fat finger".
• Neocons would point their fat fingers at a foreign nation for creating a "cyber-attack" and call for a military invasion somewhere in the world.
• Robert Reich would proclaim that there just isn't enough regulation on Wall Street. That "high-frequency traders" are the enemy of mankind and should be banned forever.
• Bill Clinton would say that the crash occured because of the cowboy "you're on your own" attitude of the U.S.
• Neil Barofsky would write a book on how we need to "reform the system".
• Ben Bernanke would proclaim that The Fed needs more power, so as to avoid another crash in the future.

But here at EPJ, we cut through all the nonsense, and focus on the culprit that is universally ignored by the talking heads: The Fed.

The Crash of 1987 can be attributed the The Federal Reserve, and specifically Paul Volcker, since he was Chairman during the run up to the crash.

Volcker became Chairman of the Fed in 1979. Prior to his appointment, he had been an executive at the Chase Manhattan Bank, was a Director of the Council of Foreign Relations, and a trustee of the Rockefeller Foundation. His job was to come in as Fed Chairman, and apply the dreaded medicine of higher interest rates to stop the high inflation of the 1970's. And he did.

A year later, in 1980, a key act was passed called The Monetary Control Act. This Act gave the Federal Reserve the power to purchase the debt of any institution in the world. In other words, if another central bank, say in Mexico, gets into trouble, they can create a bond which the Fed could then purchase with dollars that it creates out of thin air.

Reagan took office in 1981, and by 1982, the inflation that Volcker came in to get under control had run its course. Gold dropped from a high of $850/oz in 1980 to $290/oz in 1982.

Mission Accomplished for Volcker. He saved the Fed!

And that's where the story ends when it comes to the media. Volcker is a hero...case closed. That's all you need to know about him.

Well, that's not where the story ends. That Monetary Control Act that was passed in the U.S. in 1980 would come in handy a mere 2 years later. In 1982, Mexico declared that it could not repay its foreign debt of over $800 billion. Back in 1982, that was a lot of money!

In response, Volcker, in coordination with other western central banks, promised the magic potion called "liquidity" and loan renegotiations for Mexico.

This "liquidity" marked the reversal of Volker's tight money stance and the beginning of the stock market boom that would ultimately end in the year 2000. 

Please don't be fooled in thinking that the stock market boom of the 1980's was caused by Reagan. He wasn't the small-government, deregulating champion that the Kudlow's of the world portray him to be. Read this by Murray Rothbard to get the truth about Reagan.

The key is to pay attention to the Fed. Volcker put the Fed into inflation mode, and big-spending Reagan only helped the inflationary cause throughout the 80's.

Fast forward to 1987, and in comes "The Maestro" Alan Greenspan as Fed Chairman. Within weeks of his taking over, the Greenspan Fed began tightening credit to stem the Volcker inflation that began with the Mexican bailout in 1982.

Now, those who understand the Austrian Business Cycle Theory, know what happens once interest rates start to rise after a long period of double-digit monetary expansion. All of the malinvestments become exposed. In other words, once interest rates rise sharply, a stock market crash is inevitable.

In 1987 it was a steep decline.

After the crash, The Maestro issued the following statement: 

“The Federal Reserve, consistent with its responsibilities as the nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.” 

The Maestro would print...and print...and print...taking us all the way to the the Nasdaq mania in 2000.

But we'll stop there, since this post is about the 1987 crash.

The key is understanding the Volcker Fed. It is politically correct for the media to hail him as a hero for stopping the inflation of the 1970's. But his actions afterward are met with the sound of crickets.

Beginning in 1982, Volcker set the U.S. markets on the path to the 1987 crash. Every other excuse that you read about is nothing but a diversion to take focus off of The Great Counterfeiter known as The Federal Reserve.