Memo on the Margin
November 15, 2000
The Crash of 1987
Memo To: Bob Woodward, Washington Post
From: Jude Wanniski
Re: Alan Greenspan, the Maestro
Gee, Bob, now I learn you have written a book all about
how we all have Alan Greenspan to thank for the wonderful shape of the
U.S. economy, Maestro:
Greenspan’s Fed and the American Boom. While I’m happy
to see you did not write a book about how the boom is the result of
President Bill Clinton’s 1993 tax increase, I’m surprised
you did not call me for my comments on what Greenspan gave the economy
and what he subtracted from it. Then again, if you wanted to give Greenspan
nothing but credit for being the Maestro of the Universe, it
was probably wise of you to leave me out of it, as I think you and I
discussed his role in bringing about the Crash of 1987 after only two
months as Fed Chairman. In the second
installment of your book in the Saturday Washington
Post you put together an account of the ‘87 Crash
in which Greenspan plays a heroic role by writing a single sentence
that said he would supply all the liquidity the banking system needed
to stay afloat. If you would have called me, Bob, I would have told
you that is all a bunch of malarkey. There was no liquidity problem
in the banking system, which is why all the liquidity Greenspan provided
simply piled up on the bank ledgers and sat there for a few days until
the Fed called it back.
I hate to tell you this, old buddy, but Greenspan actually
caused the Crash of ‘87!!! That is correct. I kid you not.
He had been Fed chairman only a few months and did not know what he
was doing, a bull in a China shop. When he was appointed by President
Ronald Reagan, I was the only human being on the planet who openly opposed
the nomination, on the grounds that Greenspan thought that inflation
was caused by too much economic growth, and that recessions were necessary
to bring down prices. I’d engaged him in discussions about this
topic three or four years running at the annual conferences hosted by
Autranet, a division of Donaldson, Lufkin & Jenrette, hosted by
the late Jack Bober. Former President Gerald Ford also was in attendance
-- as he had a nearby residence at the conference site, a ski resort
at Beaver Creek, Colorado. As I recall, Greenspan was appointed Fed
chairman in June or July and was confirmed in early August. The previous
February, both Greenspan and George Perry of the Brookings Institution
sat shoulder to shoulder at the Beaver Creek conference, agreeing that
a recession would be necessary to bring inflation under control.
If you think back, Bob, the 1986 Tax Act the previous
year sharply lowered marginal tax rates, but also raised the capital
gains tax to 28% from 20% and left capital gains without the protection
against inflated gains that indexing would have provided. In February
1987, though, Treasury Secretary Jim Baker III -- the same fellow who
is representing George W. Bush in the Florida recount escapades -- signed
an agreement with our major trading partners to keep the dollar/D-mark/yen
rates stable. It all happened in Paris, so it was called the Louvre
Accord. If we were going to keep currencies stable, there would
be much less chance for inflation, so it would be no big deal that dollar
capital gains were not protected against inflation. In case you don’t
know, there is no worse combination than a high capital gains tax and
inflation. Even Alan Greenspan would tell you that, if you bothered
to ask. That’s because it takes some years for most investments
to produce a capital gain, and if the tax rate is 28% on the gain, and
most of the gain is nominal or just a monetary inflation of the
original investment, the government essentially confiscates the capital.
Knowing that’s what happens, investors don’t invest, and in
fact sell equities.
Greenspan had only been chairman for a few months when
Sylvia Nasar, then of Fortune magazine, asked him for an interview,
and Greenspan agreed. (It was the last interview he has given to an
individual publication for direct quotes.) In it, the Fed chairman stated
his belief that the dollar was overvalued and would have to be
devalued at the rate of 2% a year for some years until it got where
he wanted it to be. Did he know he was telling Fortune readers
that he either did not know about the Louvre Accord or did not care
about it? My guess is that he was just as naive as former Texas Senator
Lloyd Bentsen was when appointed Treasury Secretary by President Clinton
in 1993. Remember when Bentsen said at an open mike that maybe the dollar
was overvalued compared to the Japanese yen, and the currency markets
shook for two days? A meek Bentsen promised never to do that again.
In any case, the Fortune interview began appearing in Wall Street
mail boxes at the end of the week before the Monday Crash.
I’m not saying that Jim Baker did not help cause
the Crash. I’d met with him the Wednesday of that pre-Crash week,
with a message from Robert Mundell, last
year’s Nobel Prize winner. Mundell could see the Louvre Accord
under attack and advised me to advise Baker to do everything he could
to protect the dollar/gold price, including the sale of gold from Fort
Knox if necessary. I spent an hour and a half in JBIII’s office
with him and his secretary, who took notes, and left thinking I had
done my bit. But by Friday, it looked like other folks had gotten to
JBIII, arguing that the damned Germans were causing the problem. If
you call former Fed Governor Wayne Angell, who is now the chief economist
at Bear Stearns, he will confirm that he and I talked that Friday about
JBIII’s threats to the Germans and he, Angell, told me: "He
is playing with fire."
In the years since, here and there Baker has gotten
some of the blame for the Crash, because there was a Sunday NYTimes
story by Peter Kilborn, the Times Treasury reporter, citing "Treasury
sources" about how the Germans were the bad guys in keeping the
dollar/Deutschemark in line -- even though the DM gold price was steady
and the dollar gold price on the rise. It has been my contention, though,
that when the financial community read that the man in charge of the
dollar, the new Fed chairman, talked of the need to devalue the dollar,
that was the only match needed to light the Treasury fire.
See what I mean? All that baloney about how the wisdom
of Alan Greenspan saved western civilization has gotten further entrenched
because of your book. History, though, will show that it was Greenspan
who made the mess to begin with. He and JBIII dynamited the Louvre Accord
and thus signaled the markets that the dollar would remain volatile,
putting capital and capital gains at serious risk. Before you write
your next book, please give me a call.
* * * * *
Dr. Jude Wanniski
4 December 2000
Reprint Permission courtesy of http://www.polyconomics.com
*******************************
Jude Wanniski, president of Polyconomics, Inc., Morristown, New Jersey,
is one of the leading political economists in the United States. A prolific
writer and profound thinker, it was Mr. Wanniski who, as Associate Editor
of The Wall Street Journal from 1972 to 1978, repopularized the classical
theories of supply-side economics. His book, The Way the World Works,
published in 1978 to critical acclaim, and which brings a passion and
eloquence to the supply-side model of political economy, became a
foundation of the global economic transformation launched by the
Administration of President Ronald Reagan.
