When markets move suddenly, we look for a causal explanation. Many times this is a silly and vexing exercise. Why are traders — whether the robots following algorithms or humans seeking to filter the news of the day through their own models of asset prices — acting the way they do? In most cases, we just don’t know, but the human urge to attach narratives to those uncertainties is often too great to resist.
But sometimes the causal narrative is appropriate and incontrovertible. Headlines around Congress’s stalled bailout talks in September 2008 forced stocks lower. Or, more recently, the markets tanked as the breadth and depth of the coronavirus pandemic became more apparent.
And there’s another example, one that many of us may have forgotten: when Henry Kaufman, a widely quoted and illustrious economic forecaster who served as head of research for Salomon Brothers, predicted in 1982 that interest rates would fall, sparking a then-record market surge.
Kaufman, joined by the gifted business historian David Sicilia as co-author, gives readers a remarkable glimpse into the weeks (and months, and years) surrounding “The Day the Markets Roared” in reaction to Kaufman’s change in forecast.
Does a book on this subject by these authors seem dry, almost self-indulgent? Perhaps. Kaufman wrote a memoir in 2000 and another quasi-memoir in 2017, so one can be forgiven for thinking the territory has been covered before. And an entire book dedicated to a memo on interest rates and a market jump that few remember does not seem like fertile ground for extended meditation.
But this delightful, slim volume is neither dry nor self-indulgent; rather, it is a micro-history of a pivotal point in an extraordinarily important period in financial history, and the connections Kaufman and Sicilia make have enormous implications for money and banking in 2021 and beyond.
We are today engaged in a robust debate about inflation — whether sudden price rises are transitory, whether the Fed’s monetary policy regime is defensible, whether the government is spending too much, whether banks are lending enough.
That makes the context for “The Day the Markets Roared” that much more poignant: Following a half-decade of doldrums in collapsing real wages, high inflation and low productivity, Ronald Reagan rode a wave of discontent to the White House in 1981. His supply-side economics — that rising tides would lift all boats as we slashed taxes and put money back in the hands of high earners, deficits be damned — was not working to restore vitality to credit and securities markets. Meanwhile, the Paul Volcker-led Fed had launched a monetary revolution all its own beginning in October 1979, sending interest rates soaring in an effort to tame inflation. Recession followed.
Kaufman had long noted that these above-mentioned trends, focusing on inflation in particular, were a drag on economic and productivity growth. This gave him the moniker Dr. Doom in the press, but his more-often-correct-than-wrong predictions had also given him significant credibility. And Kaufman remained skeptical of Reaganomics well into the president’s first term, continuing to point to the consequences for interest rates of the president’s soaring deficits.
Then, in August 1982, Kaufman changed his mind. He penned a memo that said the recession had no end in sight, unemployment was stuck at 9% and the prospect of a “smart business recovery” in the face of these pressures was unlikely. These factors, and many others, put significant downward pressure on interest rates, he said, likely compelling the Fed to bring them from their stratospheric highs somewhere closer to earth.
Markets promptly went berserk. Kaufman’s revised outlook and the prospect for a less-crippling interest rate environment marked the beginning of the end of this curious period of financial history when politicians, bankers and businesses obsessed over the direction of interest rates. Sound familiar?
This book is essential reading for financial historians, market participants, and policymakers interested in how markets react to which information and why. For those of us who refer to financial history to debate financial policy — including, I imagine, most readers of American Banker, myself included — Kaufman and Sicilia make a compelling case that cause and effect in markets are rarely as easy to discern as we like to think, even in instances as clear cut as August 1982.
Kaufman and Sicilia also give us good reason to pause when we recount our own tales of market heroes and villains. The authors give the Volcker Fed great credit in creating the macroeconomic conditions for sustained economic growth in the 1980s — something politicians of the era were unable to do on their own. But it also gives us reason to rethink the conventional wisdom that Volcker was the hero who defeated stagflation.
In one of the most charming excerpts of the book, Kaufman and Sicilia quote a journalist writing about the strange 1982 rally in an imagined dialogue between father and son:
SON: Hey Dad, I hate to bug you again, but you’ve got to tell me what happened in the stock market last week. I hear prices went through the roof one day, and the next day, the market traded 132 million shares.
DAD: It’s very simple, son. Two of Wall Street’s big name economists — a fellow named Henry Kaufman of Salomon Brothers and another guy with a really big name, Albert Wojnilower of First Boston [who wrote a similar report a day later] — said business was lousier than they expected it to be and the chances of a good recovery were getting dimmer.
There is an important depth to this satirical exchange. The monetary revolution launched by Volcker was not bloodless. The day the market roared was indeed a response to Kaufman’s (mistaken, it turned out) prediction that the recession was far from over and that there was little banks could do to provide more credit support to Main Street. The prediction that the Fed would have to relent was very good news for investors, but was it good news for everyone else?
I expect we will debate that point with renewed vigor in the months and years to come. Fortunately, because of “The Day the Markets Roared,”we will do so with better insights about how these vital dynamics have played out before.
