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 wasovervalued 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 tellingFortune 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.

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