Many lessons from the great 1987 share crash: Robert Gottliebsen

Traders on the floor of the New York Stock Exchange. Picture: Angela Weiss/ AFP

Tuesday, October 18 is the 35th anniversary of the great 1987 share crash.

In Australia, we immediately relate that share crash to the demise of the great entrepreneurs of the 1980s led by Alan Bond, Robert Holmes a Court, Christopher Skase and John Spalvins.

In 1987 on TV, radio and print, I was in the thick of it, so naturally I am tempted to relate the remarkable stories of collapse and survival that made the 1987 crash one of our most memorable.

But, far more importantly, there are lessons in the 1987 disaster that have great relevance to today’s world central banks, governments and corporate leaders because it could happen again if we don’t learn from the past.

The October 18, 1987 crash in Australia came after we woke up that morning to discover that Wall Street had slumped 20 per cent.

The fall we experienced later in the day merely followed what was had taken place in the US.

As always, there were many complex forces that drove the American market down, including the usual suspects of forced selling, computer glitches and panic.

But in many ways, these were surface manifestations of a much bigger driving force that just happens to be repeating itself 35 years later, albeit in different circumstances.

Traders at the New York Stock Exchange. Picture: Angela Weiss/AFP

In the US of 1987, during the second and third quarters leading up to the crash, the Federal Reserve tightened monetary policy to halt the downward pressure on the dollar. As a result of this monetary contraction policy, growth in the U.S. money supply plummeted by more than 50 per cent from January to September, interest rates rose, and stock prices began to fall by the end of the third quarter, leading to the October crash.

Fast-forward to our era and the US Federal Reserve, to prevent a collapse in the wake of the pandemic, injected money into the community by buying bonds at an unprecedented rate. This accelerated a policy that started after the 2008 financial crisis.

Now in 2022 the Federal Reserve is also going in the reverse direction and is allowing the around $US9 trillion of US Treasuries and mortgage securities on its balance sheet to mature without replacing them. That’s a massive tightening of liquidity. Australia has a similar policy, albeit more restrained.

Not surprisingly, both the Federal Reserve and US Treasury are now suddenly encountering falling demand at US debt auctions, so like 1987, this adds extra impetus to interest rate rises.

The US bond market sets the tone for debt markets around the world, so when there is weakening demand, traders get very jittery when governments do what the traders don’t like.

Embattled UK Prime Minister Liz Truss and her first Chancellor (Treasurer) had no idea in that in times of declining global liquidity, market forces have far more power than elected governments.

So when she cut taxes, traders dumped her currency and bonds, forcing her to recant and sack her Chancellor. While that was happening, our “chancellor”, Treasurer Jim Chalmers, was actually in the US to observe these US generated market forces trash his opposite number in the UK.

He must now realise that the markets will not allow Australia to implement the crazy promises that were trotted out in the 2022 election campaign without cuts in other places and/or tax rises.

The same rules will apply to the enormous money hoses spraying promises in the current Victorian election. No matter who wins they will not be delivered without spending cuts and tax increases, although, as I described on Monday, Victoria’s vast reserves of low cost natural gas could save the state, but that would require a change of Premier.

What we learned in 1987 is that if there is severe sustained tightening of global money after a period of unlimited credit then, in the absence of some other event, it is highly likely to cause a share crash. In Australia in the years leading up to 1987 there was unlimited local and overseas credit for Australia, which was accelerated by Alan Bond’s victory in the 1983 America’s Cup.

In the years leading up to 2022 we also had unlimited credit, but much of it was directed towards housing, but there were other pockets where unlimited credit also sprayed money. In the aftermath of the October 1987 share crash, office blocks and other commercial properties were hit. The recent fall in the prices of listed property trusts is an alert that a number of superannuation funds could go into the red if the listed markets are not reversed.

The China boom saved Australia from the 2008 global financial crisis, but that is not likely to happen in 2022 so, like 1987 we are very exposed to world events and just how determined the Federal Reserve is in continuing to reduce global liquidity and therefore helping to push up interest rates.

Liz Truss is a beacon for all politicians showing that the game of unlimited money has ended and in turn that will impact markets. If the US Federal Reserve does not remember the mistakes it made in 1987 then our share markets will likely see history repeating itself.