The Economy and the Crash: A Press Account Jude Wanniski and Alan Reynolds December 7, 1987

Executive Summary: The story of the Crash of 1987 is a story of politics and economics that has its beginnings in the earliest days of the Reagan Revolution, when the foundations of the great bull market were put in place. In retrospect, we see the counter revolution taking hold for the first time in early November 1986, with the Democrats winning control of the U.S. Senate and the revelations of U.S. arms sales to Iran weakening the President himself in a major way. This paper, which will be published soon as part of the 1988 MediaGuide, traces the story of the U.S. and world economy, the linkages with key political events, and connections with the financial markets. It does so through narrative that stitches together a series of important news articles and commentaries that appeared in the major print media during the year. The exercise, we think, is worth the trouble, even for those of you who have followed our line of thinking through this critical period, who will recognize the milestones and signals that appeared as the year unfolded. As 1988 approaches, the central forces and players that bear upon this continuing story suggest a colossal denouement that will set the course of the world economy for the rest of the century.

The Economy and the Crash: A Press Account

The most cataclysmic economic event of the century was the Wall Street stock market crash of 1929 and the market slide that continued in 1932, ushering in the global economic contraction we call the Great Depression, and ultimately, World War II. The Wall Street crash of October 19, 1987, Black Monday, was of an equal magnitude with the initial market decline in October, 1929. It was, of course, the most important story of the year as it resonated volcanically in markets around the world, but signaling what? A dramatic decline in the prospects for the world economy, we can say for sure, but from a very optimistic level to begin with. The story of the Crash and how it was reported by the press is a story of the unfolding world political economy in 1987, a seamless story of taxes and trade, money, debt and exchange rates, and the relative decline of the Reagan Administration.

At the outset of 1987 the central facts of the economy were these. A revolutionary tax reform had been enacted in 1986 and would take effect in stages, bringing the top marginal tax rate on income in the U.S. to 28% by 1988, the lowest in the industrial world. With the rest of the world holding on to high rates of taxation, global capital was flowing in to the United States, resulting in an enormous trade deficit as the U.S imported goods and exported stocks, bonds and other productive assets. As in 1929, following a similar experience with U.S. tax rates declining throughout the 1920s, trade protectionist forces grew more politically vociferous. They pressed the Administration and the Congress to block the flow of imports through restrictive legislative barriers or through a devaluation of the dollar. The latter approach, which according to the prevailing economic theory, would make foreign goods more expensive and lead to fewer imports. The first important news account of the year was "Officials Say U.S. Seeks Bigger Drop for Weak Dollar," 1-25, by Peter T. Kilborn in The New York Times. The story became the first of many signaling the ambivalence of Treasury Secretary James Baker III on the dollar question as he heard arguments for and against devaluation.

The other central facts were these. The President was already seen to be in a weakened position because of the November 1986 revelations of arms sales to Iran and the diversion of proceeds to the Nicaraguan contras. The Democrats had regained control of the U.S. Senate in 1986 and were marshalling their forces against the "twin deficits," having taken over the traditional GOP role of trade protection and balanced budgets. The U.S. budget deficit had exceeded $220 billion in 1986 and was projected to come down, but not enough to meet the Gramm-Rudman targets legislated by Congress.

Forecasts at the outset of 1987 were for a weak economy with few surprises. Tax reform was supposed to hurt housing and business investment, inflation was supposed to stay tame, the falling dollar was expected to fix the trade deficit, and almost everyone had grown tired of crying wolf about the budget deficit. As late as July 20, Alfred Malabre Jr. of The Wall Street Journal was writing about "just more of the same, slow persistent dull growth that has become so boringly familiar of late" in his "In Its Unexciting Way, Expansion Nears Mark." The business press was hungry for something to write about.

An unexpected sharp upturn in the stock market provided some relief from the boredom, but it just didn't fit with the "consensus" forecast of a feeble economy. Leonard Silk of The New York Times, decided the forecasters were right and the markets were wrong, in "Fury in the Markets," 1-25. "Is this really a time for euphoria, as much of Wall Street believes," asked Silk, "or a time for desperation, as much of American industry and agriculture fears?" Silk concluded that the market simply rose because the dollar fell, not because the economy was picking up. The dollar couldn't keep falling without causing inflation, he reasoned, so the bull market could not continue. David Pauly and Rich Thomas of Newsweek took the cue, "Is The Fed Behind The Stock Boom," 1-26, and argued that "Easy money may lead to bloated share prices." But Silk's colleague Robert Hershey had a prescient hunch, 2-13, about the upcoming "Louvre Accord" in Paris. The five major countries, said Hershey, "appear to be edging toward agreement on stabilizing their currencies." If stocks had merely risen because of a falling dollar, as Silk had argued, wouldn't stopping the dollar's fall now mean an end to the bull market?

The Louvre Accord of late February did indeed stop the dollar from falling. "New Dollar Accord an Encouraging Step," the WSJ's Art Pine wrote, 3-9. While monetarists were also insisting money was too tight, stocks roared ahead. In February, the long campaign to drive chief of staff Donald Regan from the White House finally succeeded and former Sen. Howard Baker, Jr., not only a supporter of higher taxes to balance the budget, but also less committed to free trade, took over March 1. (Evans & Novak's column of 3-2 is aptly titled "Reagan's Surrender.") As the first consequence, in early April, the Administration slapped trade sanctions against the Japanese semiconductor industry, to show Congress it was getting tough. The dollar began to dip once again, and the Federal Reserve, ignoring the Louvre Accord, fed dollars into the system even as their value fell. The prices of stocks and bonds fell, too.

Next, the accounts were that a falling dollar was no longer good for the stock market, but was instead a disaster. Newsweek led off with "A Case of the Jitters," 5-4, in which Bill Powell and Rich Thomas complained that "the sinking dollar fans inflationary fears, driving up interest rates." The same issue also worried about "a Great Crash, a Depression, some kind of collapse...There's not much debate about the remedy. Nearly all economists agree that Washington should take steps to cut the budget deficit...pull in the national belt a bit." BusinessWeek immediately ran with this, even titling its lead story "Jitters," 5-11, and suggesting "the economy seems poised either to slide into recession or undergo a new round of inflation." As with Newsweek, there could be no middle ground between depression and inflation, and, as always, "not much debate." But the Louvre Accord was reaffirmed around new rates and the Federal Reserve complied, "Real Support for the Dollar, Finally," 5-4, by Randall W. Forsyth of Barron's.

On June 1, though, Fed Chairman Paul Volcker, a defender of stable exchange rates, submitted his resignation to the President. Alan Greenspan, a defender of floating exchange rates, was named his successor. BusinessWeek's Blanca Riemer wrote in "What's in Store at the Fed," 6-15: "The Greenspan appointment marks the triumph of the OOP's old guard. With Howard Baker, Jr. heading the White House staff, James A. Baker III ensconced at the Treasury, and Greenspan on deck at the Fed, the Reagan Administration's revolutionary fervor has been supplanted by a cautious conservatism." The stock market hit its peak on August 25. The front page of the NYT of 8-23 reported "Reagan's Advisors See Shift in Focus," news that the Howard Baker team had decided to seek "compromise with Congress on several important domestic bills, such as...trade." Colin Millham warned in the Financial Times, "Dollar Set on Downward Trend Out of the Chaos," 8-24, that "the market is waiting to hear" a statement on dollar policy from Greenspan, who "will be very concerned not to send the currency into free fall with a few ill chosen words." Millham made the connection with trade policy, that with the U.S. trade numbers worsening, "the Democrat-led assembly now has further justification for overriding the veto," and "Japan may find further acceptance of a further depreciation of the dollar against the yen, as the lesser of two evils."

The U.S. economy nonetheless continued to perform well. Economic growth averaged 3.7 percent over the first three quarters, although BusinessWeek, in "The Economy Isn't Sailing, It's Snailing," 8-17, by William B. Franklin and James C. Cooper, was still writing that the economy's "pace is decidedly slow — and chances are it will stay that way." The stock market rose from 2200 in late April to more than 2700 by late August. The periodic doomsday stories, and even the slow-growth forecasts, had to be put back on the shelf. Instead, a monster on the cover of The Economist, "Inflation's Return," 8-1, now proclaimed Han inflationary boom." In place of last year's stories about "losing jobs" to foreigners, or about all those low-paid "service jobs" on Wall Street, we now began to read about a "labor shortage" -- too many jobs. A BusinessWeek cover story, 8-10, covered "The Coming Labor Shortage," while a 9-14 Wall Street Journal story on "Workers Wanted" said good jobs were already going begging. The New York Times, 9-20, noted "the unemployment rate has already pierced the 6 percent threshold that for a decade was judged the flashpoint of rising inflation. At that moment, the government often tries to cool the economy by such means as raising taxes...or by raising interest rates."

The economy that the financial media consensus had agreed was on the verge of depression in May, and sluggish in August, was now said to be facing an overheated, inflationary boom by September. Both the depression stories and the boom stories were based almost entirely on some mixture of theories and opinions, with a bare minimum of factual information. One notable example was the widely hailed piece by Peter Peterson, a leader of the GOP "old guard," in Atlantic, 10-87. "The Morning After," simply asserted that the U.S. had "seven catastrophic years for U.S. manufacturers...and pink slips for one to two million domestic manufacturing workers each year." Manufacturing output was up 5.5% in the year ending in September, and a rousing 37% higher than in 1982. Employment in manufacturing was also up, not down, and productivity gains in that sector had averaged 4% a year since 1981, compared with 2.5% in Japan.

August marked the anniversary of the five year bull market in stocks, with the Dow Jones index having more than tripled, to more than 2700 from 780. Yet as the economic expansion lengthened to a peacetime record, the financial press almost uniformly looked the other way. Behind the drive for "protection" of the strongest economy in the world came the work of two unabashedly socialist economists, Barry Bluestone and Bennett Harrison, "proving" that the expansion had mainly been in low-skilled and low-paying "McJobs." Their constantly massaged numbers were given magnification by Senator Lloyd Bentsen, chairman of the Joint Economic Committee, sponsor of the protectionist trade bill being urged by the AFL-CIO and parts of corporate America. By and large the press corps swallowed his hoax and perpetuated it throughout the year, an embarrassing blot. Only Robert J. Samuelson, writing in Newsweek, "The American Job Machine," 2-23, and Warren Brookes, writing in The Washington Times, "Sorry, Wrong Numbers on Jobs," 4-20, questioned the hoax and ridiculed it. In an incredible front-page leader, even the WSJ joined this parade, presenting the additional notion that the bull market itself was meaningless for most people, "Some of Rich Gained the Most While Millions Lost Jobs," 8-10, by Tim Metz. The stock market was no longer a meaningful indicator of anything, simply a product of the "Casino Society," to use BusinessWeek's snappy phrase.

U.S.News & World Report, on the other hand, was uniquely accurate before the crash, with a cover story, "The Bull Market: Time To Get Out?" 8-31, written at the very peak of the Dow. "Stocks don't seem like much of deal any more," wrote Jack Egan and Daniel Wiener, and "given the worldwide and historic dimensions of this bull market, it's likelier to end with a bang than with a whimper." Indeed, the falling stock market suddenly restored the respectability of stock markets as a very meaningful indicator. The news in September and early October was mixed. Economic growth had brought the federal deficit down by $73 billion in the fiscal year ending September 30 compared to the previous year. Treasury Secretary Baker proposed at the IMF meeting in Washington a commodity-price indicator, including gold, to guide international exchange-rate policy, and the Louvre Accord still held together. But both West Germany and Japan resisted Treasury Secretary Baker's calls for economic expansion, the only positive way of cutting the U.S. trade deficit. But the Financial Times' Andrew Fisher, in "Lambsdorff Attacks U.S. Over West German Economy," 9-29, reported that Otto Lambsdorff, economic spokesman for the junior partner of the Bonn coalition, was criticizing the U.S. "for not putting enough pressure on the West German Government to stimulate the economy." Soon thereafter the Bonn government announced it would raise withholding taxes on securities! At the same time, the Administration, which had two spending bill vetoes overridden in the summer, looked woefully weak as the President's Supreme Court nominee, Judge Bork, was rejected decisively by the Senate. The Wall Street slide in stocks and bonds continued. Fortune's cover story, "Why Greenspan is Bullish,11 10-26, appeared Monday, 10-12, noting that the Fed chief believes the U.S. dollar might have to fall by 3% a year indefinitely, which seemed to put him at odds with the Treasury and the Louvre Accord.

In 10-14 The Wall Street Journal, Monica Langley gave us the ominous news that "Tax Boosts Aimed at Wall Street, Rich, Agreed to by Democrats on House Panel," as a move to meet Gramm-Rudman budget targets. A few observers later noticed that takeover stocks, only one target of the House bill, were immediately hard hit. Also on October 14 the trade deficit for August was announced, somewhat higher than had been expected, and the market sank that day. It again sank the following afternoon when Secretary Baker revealed a dispute with the Bundesbank over monetary policy, Baker asserting it was the German central bank's responsibility to ease. He hinted at a news conference that he might be prepared to see the dollar sink rather than have the U.S. defend its rate with the Deutsch Mark. The Dow nosedived Friday the 16th by 100 points. On the weekend, Kilborn of the NYT reported "U.S. Said to Allow Decline of Dollar Against the Mark: An Abrupt Policy Shift," 10-18, quoting an unidentified official "that the Administration and the Federal Reserve would not interfere if market pressures start pushing the dollar down somewhat against the mark. They also said a decline of the dollar against the mark could be expected to bring a decline against many other currencies as well." This was the straw that broke the camel's back. The Administration had caved again to the protectionist forces of dollar devaluation, on a theory that had not worked before to reduce the trade deficit and would likely not work again.

The mass magazine that had been the most sanguine about the bull market continuing at the moment it was peaking, BusinessWeek, "Why The Bull Is Such A Long-Distance Runner, 8-24, by Jeffrey M. Laderman, was also the most hysterical after stock prices fell. After the crash, Edwin Diamond of New York reported in "Crash Reporting," 11-9, that "in a matter of days, the vision had turned apocalyptic: We were peering into the abyss...The market movement was also a movement event, fed by reports of its own activity as well as by news of presidential statements, trade reports, rumors of war, and fragments of gossip."

Some newsmen somehow felt free to be rudely partisan. Walter Isaacson of Time, in "After The Fall," 11-2, described the President of the United States as follows: "As he shouted befuddled Hooverisms...or doddered precariously through his press conference, Reagan appeared embarrassingly irrelevant to a reality that he could scarcely comprehend." What was that reality? "Fortunes were conjured out of thin air," explains Isaacson, "by fresh-faced traders who created nothing more than paper gilded castles held aloft by red suspenders." "Panic Grips The Globe" by George Church, in the same issue, opined the market crashed because of "Reagan's long, obstinate resistance to tax increases." Again diverging from the pack, though, was Warren Brookes in The Washington Times, "Luring Securities Dealers Into Line?" 11-3: "One of the most remarkable aspects of the Great Crash episode is how quickly the 'conventional wisdom' developed that it was 'the budget deficit' that did it and the only way to stabilize the market was to raise taxes," arguing that securities lobbyists had been led to believe by "key Hill majority staffers that their own tax and regulatory future depends on how they support the Democrats tax-increase agenda."

Kilborn of The New York Times, 11-8, whose 10-18 report triggered the Crash, now declared "the Reagan revolution, if it ever really began, has come and gone" in "Where The Revolution Went Awry." Had the revolution ended because stock prices were then merely double what they had been when President Reagan took office? No, said Kilborn, it was because the economy's "performance is no better than under President Carter." He also argued that tax "collections...grew four times faster under President Carter than under President Reagan" — a curious measure of economic success, and one that is quite untrue. Adjusted for inflation, real tax revenues grew very rapidly in 1983-87, but that was from higher profits, payrolls and capital gains, not from pushing the middle class into a 50% tax bracket.

Initial efforts to unravel the causes of the October crash were surprisingly thin. In The Wall Street Journal, George Melloan's "A Dollar Poker Game Aided the Market Plunge," 10-20, was written within hours of the Dow's 508-point collapse, and was the best instant analysis anywhere. The best wrap-up we saw was in The New York Times, "Events That Changed Wall Street," 10-26, by James Sterngold, a long piece that assembled most of the elements with logical coherence. But very few newsmen questioned the idea that investors woke up one morning in October and suddenly noticed that the U.S. had a budget deficit. "Nearly every analyst," wrote staff members at Newsweek, in "Averting A Crisis: What Can Be Done?" 11-9, "believes the perceived inability of U.S. policymakers to get the deficit down...contributed to the global financial panic." Yet markets turn on news, and the only news about the budget deficit was that it had just fallen by a third, to $148 billion, with tax revenues up $85 billion in a single year. Earlier in the year, Alfred Malabre, Jr., and Lindley Clark, Jr., of The Wall Street Journal, 2-2, had cited forecasts that the 1987 budget deficit would be $220 billion to $300 billion. Most of the financial press avoided asking how a federal deficit much smaller than expected could possibly have led to the Crash. The New York Times did give Robert Eisner of Northwestern University and Larry Kotlikoff of Boston University op-ed space to refute the notion that stock prices fell because of the budget, 11-15.

Fortune and Forbes, bi-weeklies, had time to reflect. Malcolm Forbes Jr. was among the few to make sense of the overworked 1929 analogy, 11-16, noting that "the possibilities of protectionism, tax increases, rising interest rates and a weaker greenback did to equities what a similar combination did 58 years ago." Fortune's Myron Magnet, "1987 Need Not Become 1929," 11-23, observed that those who make comparisons with 1929-32 "are clamoring to make similar mistakes," such as higher tariffs and taxes, quoting James Tobin of Yale: "A recession would not be confidence-building."

Other late reports on the crash also gained from the added reflection. Samuel Brittan, the distinguished columnist of the Financial Times, "Undoing Conventional Wisdom," 11-19, flatly declared that the budget deficit "did not trigger the crash," instead attributing the crash to the breakdown of efforts to support the dollar, and the widening gap between bond and equity yields. Robert Bartley, editor of The Wall Street Journal, wrote a masterful full-page article, 11-24, "1929 and All That," which convincingly blamed the crash on the House Ways and Means proposal to tax takeovers, the threat of a protectionist trade bill and the breakdown of international monetary cooperation, which raised the risk of a severe drop in the dollar. Robert Novak added a political dimension in "The Politics of the Crash," 11-20, in National Review.

But time for reflection did not help with "Behind Baker's Policy Shift," 11-8, as Hobart Rowen of The Washington Post asserts "with the benefit of hindsight, it becomes clear that the famous Louvre Accord designed to stabilize the dollar's exchange rate is a key cause of the crash of financial markets," never explaining why the crash came after Secretary Baker revealed he was prepared to cut loose from the Louvre Accord! One of the great puzzles of the year is how the devaluationists maintained their support of financial journalists like Rowen of the Post, Kilborn of the Times, and Murray and Mossberg of the WSJ. After two years of dollar devaluation, the trade deficit was as high as ever at year's end. We know of no effort in any corner of the financial press to rigorously examine the hypothesis, which was clearly at the center of the October cataclysm in one way or another. In that sense, the intramural debate on who did a better job of journalism in cleaning up after the Crash is of only minor interest.

All things considered, there were heroic efforts here and there in reporting on the rise and fall of the DJIA in 1987, but it was not a year that will go down as a high point of financial and economic journalism. We saw too much sensationalism and hysteria, emulation that led to sheep-like fads, minimal dissent from prevailing views, illogical and contradictory efforts to explain events, and the garbling or suppression of relevant facts and statistics. Will 1988 be any better? The central facts at the outset of the year are much the same as they were at 1987's start: A weakened President, a huge trade deficit, a protectionist trade bill waiting in the wings with powerful supporters in labor and business, and continued exhortations to devalue the dollar. We must hope the press can sufficiently untangle itself from the political forces at work here and communicate.

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