Generational Dynamics: Forecasting America's Destiny Generational
 Forecasting America's Destiny ... and the World's


Generational Dynamics Web Log for 19-Oct-07
Investors commemorate the False Panic of Monday, October 19, 1987

Web Log - October, 2007

Investors commemorate the False Panic of Monday, October 19, 1987

The Dow Industrials fell 22% in a single day, the largest one-day drop in history.

But the collapse wasn't sustained. By the end of 1987, the market was rising robustly again, and it recovered completely within 1½ years.

That wasn't true in 1929. On Black Monday in that year, October 28, 1929, the market fell "only" 13%.

The difference, though, was that the market kept falling, and falling, and falling -- for four years! Bit by bit, the market kept falling, until it had tumbled to just 10% of its 1929 peak.

That's how you can tell that the 1987 crash was a "false panic" -- recovery was rapid, as opposed to the "generational panic" of 1929.

It's not surprising that the stock market recovered quickly after the Panic of 1987. The stock market was underpriced in 1987, while today the stock market is overpriced by a factor of 250%, same as in 1929.

John Kenneth Galbraith's 1954 book The Great Crash - 1929, contrasted the 1929 with previous panics:

"A common feature of all these earlier troubles [previous panics] was that having happened they were over. The worst was reasonably recognizable as such. The singular feature of the great crash of 1929 was that the worst continued to worsen. What looked one day like the end proved on the next day to have been only the beginning. Nothing could have been more ingeniously designed to maximize the suffering, and also to insure that as few as possible escaped the common misfortune." (p. 108)

That's the situation we're in today. One of the reasons that almost no one is concerned about a possible crash today is because there is general belief that once it happens, the troubles will be over. However, from the point of view of Generational Dynamics, we're now overdue for a new generational crash, and it will be very long-lasting, like the crash of 1929.

If you examine the articles that are being written about the Panic of 1987, you'll see that nobody has any idea why the Panic of 1987 occurred, and why it occurred then instead of, say in 1980 or 1990.

This is a similar problem to the question of why the 1990s dot-com bubble occurred at the time it did. You can look at all the macroeconomics research and you'll discover that no one has a clue. It's as if it occurred by magic. From the point of view of Generational Dynamics, and from the point of view of ordinary common sense, it's perfectly obvious why the bubble began in the mid-1990s. It began in the 1990s because that's exactly the time when the people from the generation who survived the Great Depression all disappeared (retired or died), all at once, leaving behind the Boomers and the Xers who were debauched in using debt and credit.

Generational change after 58 years

The Panic of 1987 occurred at that time for a related reason. 1987 was 58 years past the crash of 1929, and generational research has found a number of examples where a huge disaster occurs, and a "false panic" occurs 58 years later.

Anyone who was 4 years old or older in 1929 had some personal memory of the panic of 1929. Thus, in 1987, people who were 62 years old or older are the only ones now remembering anything about the 1929 panic. (Paragraph corrected on 22-Oct)

Thus, the 1987 panic appears to have occurred at a time of a significant generational change. Whatever latent fears that still existed about a recurrence of the 1929 panic were focused on this moment, as those who remembered the 1929 were quickly disappearing, and were replaced by those who didn't remember it.

Another example was the "swine flu" panic in 1976. The public became hysterical over the possibility of a new flu pandemic. Responding to public demands, the government prepared millions of doses of swine flu vaccine. The pandemic amounted to nothing, and the whole thing was a political fiasco.

This was a false panic that occurred exactly 58 years after the Spanish Flu epidemic of 1918. It appears to be the same kind of thing as the false panic on Wall Street in 1987. Up to that point, people were afraid of a recurrence of the 1918 epidemic. The 1976 panic was a political fiasco that reversed the public mood, and left the public with no further fear of a flu epidemic. That's why the public today has no fear of a bird flu pandemic.

The Panic of 1914

The Panic of 1914 was another "false panic," and it has many similarities to the Panic of 1987. In particular, it occurred 58 years after the previous generational crash, the Panic of 1857 (also known as the Hamburg crisis of 1857).

The Dow Industrials actually fell 24.39% on November 11, 1914, but it's not counted as a one-day fall because the market had just reopened after a hiatus caused by the outbreak of the Great War (World War I).

The Panic of 1914 was important in United States history, because it transformed the US into the major monetary superpower in the world.

Here's how it's described by William L. Silber in When Washington Shut Down Wall Street: The Great Financial Crisis of 1914 and the Origins of America's Monetary Supremacy:

"The Great War threatened the United States with financial disaster. During the last week of July 1914, Europeans began to liquidate their Wall Street investments and transfer gold to Europe to pay for the war. Foreign investors owned more than 20 percent of American railroad securities, the largest category of securities traded on the New York Stock Exchange. Under the gold standard, they could demand the precious metal in exchange for the proceeds of their stock sales. The biggest gold outflow in a generation imperiled America’s ability to repay its debts abroad. Fear that the United States would abandon the gold standard pushed the dollar to unprecedented depths on world markets.

The European assault on American finance brought danger and opportunity. In 1914 the United States was a debtor nation with a history of financial crises. Failure to meet its foreign obligations could sink American dreams of world monetary leadership. If it passed the test, however, the United States could jump to the head of the class.

Less than three weeks after the outbreak of the European conflict, Woodrow Wilson reviewed a road map for America’s march to world financial supremacy. Henry Lee Higginson, an investment banker in Boston, wrote to the president on August 20, 1914, that "England has been the exchange place of the world, because of living up to every engagement, and because the power grew with the business. Today we can take this place if we choose; but courage, willingness to part with what we don’t need at once, real character, and the living up to all our debts promptly will give us this power; and nothing else will. I repeat that it is our chance to take first place." Wilson sent Higginson’s letter to Treasury Secretary William G. McAdoo with the following covering message: “Here is a letter which is no doubt worth your reading whether you think the suggestions are practicable or not." ...

How did the summer of 1914 change history?

A suspension of the gold standard in 1914 would have been a setback to American dreams of international financial leadership. The Panic of 1907 had already damaged U.S. credibility. A panic in 1914 would have been the second act in an American financial tragedy. Alexander Noyes, the contemporary business editor of the New York Times, appropriately highlighted the drama: "It is not too much to say that as a matter of financial history, the United States stood during those two or three weeks of August at the parting of the ways." Suspending the gold standard would have relegated the dollar to second-class status, and sterling would have remained the undisputed money of choice for international finance. ...

[Treasury Secretary William G.] McAdoo succeeded in August 1914 because he did not hesitate to bludgeon the crisis with a sledgehammer. He wielded powerful weapons— suspending stock trading for four months and flooding the country with emergency currency—that could have injured America. His exit plan, stimulating agricultural exports with the Bureau of War Risk Insurance, avoided lasting damage to the economy. McAdoo could apply massive force because he had implemented a plan to restore normal functions. Failure to include a strategy for withdrawal either promotes toothless emergency weapons, like a placebo to treat a serious disease, or imposes unnecessary costs. ...

McAdoo’s imprint—decisive leadership combined with a road map for crisis control—turned a potential financial disaster into a monetary triumph."

This description illustrates another major parallel between the two false panics (1914 and 1987): Treasury Secretary William G. McAdoo established his reputation as major financial leader in 1914, just as Alan Greenspan established a similar reputation in 1987, as I described in "System Dynamics and the Failure of Macroeconomics Theory."

As quoted above, John Kenneth Galbraith wrote, "A common feature of all these earlier troubles [previous panics] was that having happened they were over. The worst was reasonably recognizable as such."

This is a very significant statement because it hints at the process that occurs, leading from one generational crash to the next, from 1857 to 1929, and from 1929 to today.

The Panics of 1914 and 1987 served the same purpose: They occur 58 years after the preceding crash, at a time of significant generational change from the last people who have any personal memory of the previous crash. And they serve to convince the younger generations that there's nothing to fear, that the economic and policy problems that caused the previous crash have all been solved, and that there's nothing left to fear.

From the point of view of Generational Dynamics, the False Panics of 1914 and 1987 are important events. In particular, the False Panic of 1987 has led to the debauched use of debt and credit that we've been seeing for the last few years, and that will lead to the coming generational crash and new 1930s style Great Depression. (19-Oct-07) Permanent Link
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