By George P. Brockway, originally published November 30, 1987
ONE LISTENS with astonishment to the explanations of the Great Crash of 1987. With unprecedented unanimity, pundits and brokers and bankers and public officials call the budget deficit and the foreign trade deficit to blame.
In his post-crash press conference, President Reagan seemed not to understand. He was being pushed into what the press called a summit conference with Congressional leaders to see about reducing the budget deficit, but his heart plainly wasn’t in it. Look, he protested, the budget has been Gramm-Rudmaning down and will go down some more, even without a conference. He couldn’t see what is so bad about that trend, although he was ready to blame the Democrats for anything anyone happened to think bad about it.
It’s not hard to share the President’s bewilderment. If the budget deficit is a problem, it is in fact being reduced. A few hardliners may be upset that the reductions are not greater and faster; yet most people (including Ronald Reagan) have absorbed enough from Keynes (whom the President gracelessly and ignorantly disparaged) to know that doing too much too fast with the deficit would be a pretty sure prescription for a recession. Keynes himself might well have thought the reductions an utter mistake at this time. But he is dead (as we all are in the long run), and what is actually being done is what the pundits say Wall Street wants. If Wall Street is really upset by the deficit, it should have broken two years ago, when the deficit was higher, or five years ago, when the deficits (and the market itself) started their dramatic climb.
No, the deficit story is a fairy tale. It is implausible on its face, and its implausibility can readily be tested. We had a pretty good market crash in 1929. What happened then? Well, one thing is sure: The 1929 crash wasn’t caused by a budget deficit, for the budget was in surplus that year to the tune of $700 million, which was a lot of money back then. Either the crashes of 1929 and 1987 are totally different breeds of animal, or deficits had nothing to do with either of them.
The two crashes did, without question, have one thing in common. Both were preceded by prolonged and steep run-ups of the stock markets. That in itself is no surprise, since you have to have attained a certain height to be able to make an attention-getting fall. But what it signifies is that both climbs were speculative: Business didn’t improve all that much. Though in both years all persons of prominence assured us that the economy was fundamentally sound (there seem to be no other words to express this meaningless thought), in neither year was there a justification for the heights the market reached.
Speculation, however, doesn’t need a justification; it merely needs an occasion. The necessary occasion is a very simple one: Some people have to have more money than they know what to do with. Literally.
We have been satisfying this requirement. As the recently announced figures from the Census Bureau show, the number of people with large incomes has increased in the decade and a half from Richard M. Nixon through Ronald Reagan. The top 20 per cent of American families had an average income of $126,415 last year and together engrossed 46.1 per cent of all personal income. More important, they have improved and are improving their position at the expense of the middle class and the poor.
Now, it is practically impossible to spend a million a year on living well (although some 57 professional baseball players are having a go at it), and it is perfectly possible to be pretty comfortable, even in a high-priced city like New York, on as little as a hundred thousand. You can, of course, spend pots of money collecting lead soldiers or used postage stamps or post impressionist masters. The trouble with such collections is that, even at a moderate rate of inflation, they increase in value very rapidly and so add to rather than deplete your wealth. So lots of people-and not merely ball players have lots of money.
The supply-side theory, to which the President pledged continued devotion the other night, contemplates that the rich, thwarted in their struggle to consume their income, will invest it. But when 20 per cent or more of the economy’s productive capacity is lying unused, the possibilities of prudent new investment are severely limited. What to do? Nothing for it but to take a flyer in the market. At the same time, the rich of the rest of the world have the same problem-and the same solution. Add to all this the mutual funds, the pension plans, the educational and charitable endowments, the insurance reserves, and the unabashed speculations, and you have a lot of money chasing a limited number of shares of stock.
Ingenious men have worked very hard to increase the number and kinds of paper to buy and sell. Two ways have especially recommended themselves: the development of the stock futures markets, and the computerization of Wall Street. The first created new products (as the brokers call them) out of nothing but the eagerness to speculate; the second, by enabling an increased velocity of trading, increased the opportunities to speculate, just as an increase in the velocity of money in effect increases the money supply.
There was also a partially contrary movement. Takeovers and buyouts, which generally substituted debt for equity, reduced the number of shares of some stocks available for speculation while simultaneously greatly enhancing the taste for speculating.
THE MOST elementary fact about a bull market is that it absolutely and unceasingly depends on sucking more money into it. If there are 100 shares of stock, and $100 available for investment, the price of each share will fluctuate narrowly around a dollar, no matter what incantations are uttered by market analysts and government officials. If the number of available shares is reduced, or the number of available dollars increased, the price will rise proportionately. But all who anticipate a further increase in available funds will become more eager in their bids, in the expectation of quickly and profitably selling what they buy to the holders of the new money. Thus Holland’s Tulipmania was sustained, and thus the Great Bull Market of the ’20s, and thus the Reagan-Thatcher-Nakasone market that has now crashed.
Because one way or another the number of pieces of paper to speculate in has greatly increased, the number of dollars to sustain the recent bull market had to be increased still more, and this has been done in two ways: the shift of trust and endowment funds out of the bond market and into the stock market, and the supply-side tax cuts for the wealthy. The former was substantially effected a couple of years ago, and the latter has gone about as far as it can go with the new tax law’s reduction of the top rate to 28 per cent. There is still a fantastic amount of money around, but it is no longer being increased rapidly. The kissing had to stop.
The trade deficit is said to have joined with the budget deficit in scaring foreigners out of our market. This explanation of the crash overlooks what is ordinarily insisted on: the global interdependence of financial markets. It wasn’t Wall Street alone that laid an egg. Eggs were laid in Tokyo and Hong Kong and Sydney and London before the New York market opened on Black Monday. You might say that all over the world bull markets that had known no boundaries were suddenly fenced in.
Just as the reason for the crash is grievously misunderstood, the policies proposed for dealing with it are grievously misconceived. Since what happened was caused by a large number of people having more money than they knew what to do with, it follows that it is counterproductive to resist taxing some of that money and applying it to public purposes, not excluding deficit reduction. The supply-side tax cuts were a disaster. Since the wealthy couldn’t find enough new productive investments for their surplus funds, it follows that there hasn’t been enough effectual demand (as Adam Smith would have said) to keep our existing productive capacity busy; so the enthusiasm devoted to union busting, entitlement shaving, welfare restricting, and real-wage reducing-all of which reduce effectual demand-has been disastrously misdirected.
Our pundits seem able to behold the mote in German and Japanese eyes but not to consider the beam that is in ours. If the world economy would be strengthened by increased consumption in those lands (and it would), it can scarcely make sense to decrease consumption in ours. Over the past 15 years the income share of the poorest 20 per cent of our families- those who have to spend their incomes-has fallen 10.8 per cent. An economy that reduces its aggregate demand in that way-and seems determined to do more-is not fundamentally sound.
The New Leader