1987 vs. 2023
At this point, I hope I’m sounding like a parrot reiterating how the pattern of US market crashes correlate to each other. If you’ve been keeping up with the market crash comparisons, then you’ll have noticed they follow a 6-step program:
1. Interest rate shenanigans by the Federal Reserve and their international central bank counterparts.
2. Political negligence towards markets followed by a clumsy presidential reaction effort to remediate.
3. The lower and middle classes getting screwed in the aftermath through inflation, unemployment, and a debasement of their rights as citizens.
4. A new financial product that promises the world to investors and traders alike, only to be the undoing of the entire speculative frenzy.
5. A military conflict that in turn bolsters production to help ease the pain of an economic downturn or induce a growth spurt.
6. Emerging technology makes the process happen faster than the prior crisis.
Instead of patronizing you with a chronological order of events, I’ll “parrotize” them by their corresponding numbered steps from above. So without further ado, Black Monday of 1987:
1. Interest rates were jacked up to ~18% by the end of 1982. Inflation was a major issue in the 70s as the global unit of account left the gold standard for good and the rest of the world had followed suit.
2. “Morning in America” meant Reagan was going to cut corporate taxes and kick off the money printing machine. Democrats in turn demanded increases in taxes on the raiders of hostile corporate takeovers, like T. Boone Pickens and Carl Icahn. When the markets went south, “the White House was standing by to do whatever was needed”. They didn’t call whatever was needed Too Big To Fail or Bank Term Funding Program, but I’m sure those catchphrases were on the tips of their tongues.
3. Unemployment became widespread among high inflation and low economic growth, creating the term stagflation. It should sound familiar, as it’s what the Fed is intending the country experiences if the rate hikes continue today (don’t hold your breath for a soft landing if you still are). The goal is to put people out of work to slow down inflation by charging more to access credit.
Quite an easily forgotten pattern by an anxious proletariat when the government wants to, say, hand out social safety nets in a global economic depression or stimulus checks in a global pandemic. Also, easily accepted by the ruling class when interest free money is accessible to grow their business, yet a hard pill to swallow for everyone but the C-Suite when laying off workers is the solution. By the time everyone else is about to riot, it becomes necessary to start the employment and Up Only market party again by cutting interest rates overnight to zero.
By the early 90s, the US would be in a recession again, but would close out the decade with low interest rates and a budget surplus. It is worth noting that the low interest rates at the end of the millennium are roughly the same as today's rates, yet are now considered high interest rates due to the massive amounts of liquidity pumped into the system between the financial crises and the pandemic response, as well as the aggressiveness at which they’ve been raised over the course of roughly a year.
4. Portfolio insurance is a hedging strategy developed to limit the losses an investor might face from a declining index of stocks without having to sell the stocks themselves. The technique was pioneered by Hayne Leland and Mark Rubinstein in 1976. Since its inception, the portfolio insurance strategy has been marketed as a product (similar to an insurance policy). However, this is a misnomer as it is not a policy and there is no insurer of last resort (beside the taxpayer when the government subsidizes the loss on to them, of course.)
This strategy involves selling futures of a stock index during periods of price declines. The proceeds from the sale of the futures help to offset paper losses of the owned portfolio. This is similar to buying a put option in that it allows an investor to preserve upside gains but limits downside risk. Portfolio insurance is most commonly used by institutional investors when the market direction is uncertain or volatile.
The concept sounds great until every person and computer program wants to sell at once, and that’s exactly what happened when…
5. On Black Monday, October 19, 1987, Iran and the United States started attacking each other with missiles, first with one missile from the Iranian held Fao Peninsula hitting a US tanker carrying 300,000 barrels of gas, and then the US response of firing hundreds of missiles in Operation Nimble Archer. While this conflict didn’t turn into the military industrial complex dream of an instant budget increase, it didn’t take long for the Gulf War to bolster the aforementioned early 90s recessionary markets.
6. In practice, a portfolio insurance strategy uses computer-based models to analyze an optimal level of stock-to-cash ratios in various stock market conditions. Though the number of owned shares could stay the same, the total portfolio value changes with the market. As the market drops, a portfolio insurer would increase cash levels by selling index futures, maintaining the target ratio. Conversely, the same portfolio insurer might buy index futures when stock values rise. This combination of buying and selling of index futures is done in an effort to maintain the proper stock-to-cash ratio demanded by the portfolio insurance model or strategy.
When everyone wanted to sell at once as it seemed like the US was at war with Iran overnight, there were no buyers and the market kept crashing. The market stopped crashing when a little known index similar to the S&P 500, the Major Market Index or MMI, suddenly (and tin foil hat conspiracy style) started catching a spike in bids. Confidence was restored as the market started to surge upwards again and quickly recovered in the following year, back to new highs by 1989.
If we can determine by reading a few books from the library how this pattern unfolds, then cypherpunks on the ground floor of the information age and dawn of the internet in the late 80s and early 90s could too. The next time the markets would crash in 2008, emerging technology was ready to answer with a solution that would start small and grow into an elephant in the Oval Office that it is today. I won’t try and fool you that we’re going to directly talk about the 2008 subprime crisis next, as if you’ve been following along, you in turn have figured out the pattern of these articles.
So, next up, with the Republicans and Democrats meeting in the Oval Office today to determine if the US is able to raise the debt ceiling or keep this tribal game of chicken going, we’ll review their outcome with notes before 2008 vs. 2023 (let’s hope the financial world hasn’t fallen apart by then).