'The Money Panic' —a guide for survival in six parts

Part 4: The bust

Condensed from the book by Martin D. Weiss

Note: Parts 4 and 5, with the exception of certain past statistics, are entirely fictional — written in the summer of 1974, from the perspective of a mythical twenty-first century historian looking back on the hectic days of the mid-1970s. The reader should bear in mind that the names have not been changed but any action or statement attributed to them is entirely a product of my own imagination. Some of the events predicted have already occurred. Some may never occur. Many, however, could very well be upon us, in one form or another, within the next twelve months.

As the top-heavy American economy teetered momentarily on the tightrope between rapid acceleration and rapid deceleration, and as the world tried to make up its mind whether it wanted inflation or depression, the bust began. Unlike the 1929 crash, it didn't begin on the floor of the New York Stock Exchange. Nor did it begin in London or Tokyo. The bust began in the New York money market — in the nooks and crannies of Wall Street, behind the closed doors of the phone-cluttered, smoke-filled trading rooms of banks and brokerage houses.

Many people confessed their ignorance of the "highly sophisticated money-market transactions." Yet the New York money market was the biggest of all markets in the world and rapidly replaced the stock market as the central axis of the crash. In 1974, it had an average daily turnover of $8 to $10 billion — more in dollar volume than all the New York and regional stock markets put together, several times more than the world's most active corn-lido:1*y markets of Chicago and New-Yo-r-k-,and at times equal to, or larger than, all the currency and gold exchanges in London, Zurich, and New York. It later became the core of the money panic, the nucleus, the power house that transmitted the shock waves to the four corners of the so-called "civilised world."

Perhaps one of the difficulties in understanding the money market was the fact that it was so amorphous, so scattered, so difficult to see, let alone control or regulate — managed by small groups of specialists that operated out of "money-market trading rooms" attached to firms like Salomon Brothers, Merrill Lynch, First Boston, Eastman Dillon, Bache, Morgan Guaranty, Chase Manhattan, Chemical, Manufacturers Hanover Trust, Bank of America, First National City.

In the days before the bust, the money market went dead and volume slowed to a trickle. It seemed as if the earth had frozen in orbit. Then disaster struck. Rumours of the collapse of an electrical giant came over the wires and burst into the trading rooms like a spark in a tank of natural gas. As if by some prearranged signal, all the phones began buzzing at once. At Merrill Lynch, specialists in Government securities, traders winced as big institutional customers shouted over the phones, demanding immediate action on the sale of big blocks of Treasury bills, notes and long-term bonds. But the traders were having enough trouble liquidating their own inventories of government securities.

At Garvin Bantel, a few blocks away, a middle-aged woman and two trading assistants, specialists in federal funds, were buying and selling excess bank reserves at the dizzying pace of manymillions of dollars a minute.

But soon, while one trading assistant was on the wire trying to get cash reserves from First Chicago, First Chicago was, already talking to his colleague on the other line, trying to get cash reserves for itself. In the meantime the list of pending requests for federal funds had mushroomed.

First bankruptcies

The rumours were true; one of the major electrical companies was in deep trouble. In the earlier 1970 money squeeze it was Chrysler that had gone through this kind of a crisis — a surprise to most analysts because they had forgotten to consider the liquidity positions of Chrysler's captive finance affiliate. Even when the company was on the brink of collapse they still thought that Chrysler's liquidity was relatively good. This time, the analysts made the same mistake: they paid little attention to the finance affiliates of the electrical equipment companies.

The mother corporation, which had been counting on big business from the utility companies, was being flooded with order cancellations.

The sequence of events was quite simple:

Commercial paper owners decided not to renew and switched their money elsewhere. The standby credit at the banks, which was supposed to back up this commercial paper, could not be implemented. Attempts to borrow money from employees' pension funds were blocked by the unions. Production cuts and layoffs were ordered, but there were rio immediate savings because of the severancepay provisions in the new labour contracts. A financial vice-president jetted across the —.Atlanticto raisemoney in the Eurodollar market, but returned empty handed. An einergency meeting called between a group of bankers and congressmen, which was expected to result in a Penn Central-type rescue proposal, resulted instead in one collective and unanimous shoulder-shrugging session. The lawyers were called in. The books were laid out on the table and it was like Nixon's last farewell to his cabinet — a brief discussion followed by an even briefer sob session, after which the lawyers simply snapped their briefcases shut and walked off to the bankruptcy courts!

The stock market, which had rallied considerably after the big 1974 drop, was suddenly knocked for a loop. IBM, one of the market's favourites, fell close to one hundred points. General Motors ten points, duPont thirty points, Eastman Kodak twenty points. They were all hit with big selling pressure; the glamours, the blue chips, the gold stocks. There were no exceptions. Nevertheless the great bulk of businessmen and bankers still clung to the belief that, if presented with the cold facts, the White House would save the day; that it was their "moral responsibility" to send a delegation of influential business leaders to meet with the President and his economic advisers and convince them to take immediate action.

Rescue attempt

A previously-scheduled session with.. Simon, Greenspan, and Burns was expanded to include a well-known consumer pollster as well as business leaders from General Motors, Citicorp, Exxon and Sears. The Secretary of the Treasury opened the meeting.

Simon: Gentlemen, we have come to a crossroads here; The recovery is faltering and

many of you are feeling the pinch. I want you all to understand that we here in the Administration are well aware of that. You want the recession ended. We understand that also. Right from the outset let me assure you, gentlemen, that this Administration is doing and will continue to do all it can to maintain a stable business environment. But the question we have to answer today is: Is this the proper time to give up the battle against inflation?

(The Secretary paused and looked around the table for a response. All he got was blank stares, and so he continued.)

I am convinced that this is not the right time, that it would be premature and rash. I am convinced that if we let up on the battle against inflation now it will be far worse than the last time. So if you are here today to ask for a sizable government rescue operation, for an expansionary thrust — which by the way, would really be an inflationary thrust — well — I'm sorry, but — that's a price we can't afford to pay.

(The businessmen let out murmurs, and shook their heads. An expansionary thrust was precisely what they had come to ask for.)

Citicorp: But Mr Secretary, this isn't your run-of-the-mill inflation-recession crossroads. Simon: What is it then?

GM: It's a tunnel straight to hell. That's what it is. We don't have the luxury of time. We are almost beyond the point of no return. Either the Congress and the Fed go out there today or tomorrow and initiate strong action, right-now action, or we're headed for a first-class depression.

Greenspan: So what do you have in mind? Expansionary fiscal policy? Expansionary monetary policy? Expansionary legislative policy?

GM: Yes! The answer is yes. Three times yes. You think the electrical equipment industry is the' only one. Well, let me skip the details and lay down all my cards right from the beginning. If nothing is done to stop the bust, we — will — run — out — of — cash — in — a few — days. Today's Monday. So by Friday we'll have to get an emergency loan or else — Citicorp: We have to forget the "whatcould-happen-if" arguments for the moment and sit back to examine the immediate situation at hand. If nothing is done to remedy this situation, we won't have to wait around for some hypothetical hyperinflation down the road. The banks could be wiped out right here and now. We've all got GM loans, you know. If nothing is done to save GM now, we will have a banking collapse the likes of which you have never seen.

Simon: The trouble with your appraisal is you've been listening to the gloom-and-doom boys on Wall Street. Those bears blow the bad news out of proportion.

President: Exactly! I'm sick and tired of this damned-if-we-do-damned-if-we-don't talk. Can't we steer a middle course? '

Burns: But, Mr President, we have been steering a middle course. These gentlemen all seem to imply that we have been following a tight-money policy. The fact is we've been expanding the money supply quite rapidly.

GM: With all due respect, sir, I'd be very grateful if you could tell me where that money supply is, or how I can get access to it. The fact of the matter is, from a practical business standpoint, there is no supply. There is no MI, M2, M3 or whatever it's called. It's all gone. Don't ask me where. All I know is, it's gone.

President: So what do you suggest we do?

Citicorp: There's only one thing you can do.

President: What's that?

Citicorp: Gold! Raise the official price to $150. Call an emergency international monetary conference!

Greenspan: I'm afraid fiddling with the price of gold will get us nowhere. How is it going to solve the problems of the corporation? How is it going to affect debts? How is it going to reduce layoffs or increase car sales? Do car salesmen get paid in nuggets of gold? No, of course not. You gentlemen seem to forget that gold is only an international mechanism, which can't really solve our domestic problems, which can't affect here-and-now problems like recession and deflation.

President: What about the petrodollar flow? As I recall money was coming in from the Arabs to buy our bonds to the tune of $10 billion. Why can't we set more of that?

Exxon: Excuse me, I've been waiting for this opportunity to bring up some news on the petroleum corporations. I think it will come as quite a surprise to you, as it did to me, but I am dutybound to tell it as it is with no punches pulled: We don't need to import much more Mideast oil.

Simon: I don't understand. Just yesterday — Exxon: All of this is new information. It is so new that most people in Exxon are not fully aware of it yet. Simon: Hell! What is it?

Exxon: A glut! A huge, long lasting energy glut! This may be premature on my part, but from what I can see now, it looks like all our Projections were upside down.

Simon: Come now. Capacity wasn't increased that fast.

Exxon: It's not capacity. It's demand. From one day to the next our big petrochemical customers, without warning, simply cancelled their orders. All of a sudden they decided they've got enough in their tanks to tide them over for the next several months. The problem is there's nothing we can do now to stop the tankers at sea. The oil is coming and we don't know what in the hell we're going to do with it! The new exploration, all the new drilling — I Shudder to think what we could lose on project independence. It could ruin us. Simon: I think you are being too negative. If What you are saying is true, it could be a blessing in disguise. It could be the big break We've been looking for. Excuse me. I don't Mean that a fall in profits is blessing. I mean that a substantial cut in the price of oil can deal a mean blow to the inflationary spiral and benefit us all.

Greenspan: Yes, I see what you mean. With the back of inflation broken, we could shift our focus to the problems that were brought up here today. We could all go out to the public and say in unison: Look! Inflation is no longer Public enemy number one. Now our first priority IS to get rolling again, get the economy back on its feet.

(Until this point no one in the room had bothered to ask for the opinion of the consumer Pollster, who was sitting there quietly. When he finally did speak gloom enveloped the meeting).

Consumer Pollster: You have been talking about the money markets. You have been talking about business conditions. You have begun to come up with proposals for countering the growth in corporate bankruptcies and for solving the problems of the international economy. Gentlemen, you'll have to forgive my bluntness, but I think they will inevitably fail.

In My opinion, it matters little how much

Rioney you pump into the banking system, or now well you patch up the corporations. Unless You can somehow get the consumer back into the marketplace, unless you do something to Maly the American people, the whole rescue Operation will be a flop. This is one of the greatest consumer rebellions I have ever seen. The confidence level is at the lowest point since I began making these surveys and it continues to drop almost daily. It looks as if the consumer is in a panic. Greenspan: Isn't that what you told us in 'JUly?

Consumer Pollster: No! Now consumer fears ?re being converted into real action. That, more ;-han anything else, is what's behind the Dusiness decline, the withdrawals, the bankr'!1, ptcies. If you don't prepare now, gentlemen, t, hen the next time we meet, I'm afraid you will De in a panic yourselves!

(There was a long silence after he finished. No one commented. The Secretary of the Treasury finally broke the silence.) Simon: Last time the Arabs had us over a barrel because we needed the oil so badly, but this time, if there really is a glut, it's going to be our turn to make the demands. If they don't give in, just cancel the orders. If they do give in, well then we'll decide what to do with the orders. Let me add this. If there is one point, one principle we all agree upon, it is that the Government can function only when and if it gets co-operation. We can rescue GM. We can stop inflation. We can prevent a recession. We can create a strong recovery. We have the know-how. We have the tools and the power. So let's get to it.

Bear market rally

The Middle East oil price cut came through two weeks later. It wasn't the pressure from Simon or from the industrial nations. The oil producers were swayed by an impartial report, which predicted that if prices were not lowered, Europeans and Americans would abandon their cars: Japanese steel tycoons would feed petroleum order forms into shredding machines; and the entire Western world would cut down the demand for oil by ov.er 50 per cent.

The stock market, which had dropped .sharply, soared again and another bear-market rally was under way! Within a matter of a few short weeks it was up almost 150 points. Short-term interest rates made a hasty retreat, and commodity prices were bouncing all over the place, mostly up. A wave of euphoria burst out of Wall Street like a cloud of white pigeons. "Let's buy them to kingdom come," said the money mangers. "They'll break through the 1,000 level this time for sure," declared an ecstatic specialist.

The public watched with growing enthusiasm. Once again they crowded the brokerage houses and were hypnotised by the ticker tape churning out new highs day after day. Once again the phones on the desks of registered representatives rang incessantly as their customers called for the latest price quotations. But there was one thing they didn't do — buy stocks.

It followed that the rally was just that and nothing more — a rally; one not-so-impressive bear-market rally, conceived by the Government, born and nurtured by the big pensions, trusts, insurance companies and professional traders.

The big unexpected event which ruined it all was an upsurge in short-term Treasury bills which literally broke through the roof, catching the entire nation by surprise, and the stockmarket rally went dead in its tracks. Now you see it Now you don't.

Everyone was disappointed. But it wasn't primarily the market's action that upset people so much. Nor was it the short-term interest rates. All that had happened before. What was downright disconcerting was the fact that the Government's promises of a recovery never came through.

Only thirty days earlier there had been headlines plastered all over the newspapers: SIMON HALLS BIG VICTORY; CONGRESS VOTES GM LOAN; BURNS PROMISES LOW INTEREST RATES; PRESIDENT DECLARES INFLATION LICKED. Now a long month later, these issues were all old hat. To say inflation was licked was beginning to sound like a corny joke because most prices were falling apart. Some retailers were already complaining that prices had gone down too far. In other areas, government officials were still getting statistics showing that prices were going up, when they were already on the way down. It was one big mess — the public still complaining about too much inflation, the retailers already complaining about too much deflation, and some people complaining about not enough inflation or not enough deflation.

Lower interest rates were another bad joke Sure, interest rates went down temporarily, but what good was it if there was little or no money around to be borrowed? Even triple-A manufacturers couldn't borrow money, let alone a small businessman or home buyer. In short, despite the Ford Administration's success in giving a psychological lift to the stock and bond markets, the Government had failed to do little more than postpone a business decline.

There were two reasons for this failure. First was the disappearance of consumer confidence in the economy, and the concomitant decline in business activity. Dun and Bradstreet released figures of weekly bank clearings showing that despite the stock-market rally, there had been absolutely no comeba( k in the volume of business transactions done in major urban centres. Instead the clearings fell from a yearly volume of $22 trillion to less than $16 trillion. No wonder the new moneys pumped in by the Federal Reserve never made it down to the consuming public. No wonder corporations were going bankrupt. After paying off old .obligations, there simply was no money left for generating new business, new purchases, new orders or new capital spending.

The second reason for the failure of the recovery . came from within the Government itself — the biggest consumer of all. The pollsters and analysts never bothered to include Uncle Sam in their computer-selected -random, stratified samples." If they had, they would have discovered that Uncle Sam was the consumer hardest hit by the bust. I can just imagine the questions they might have asked him:

"Do you intend to buy and big-ticket items within the next six months, Mr Sam?"

"How can you ask me about my spending plans?" he answers. "Look what's happened to my disposable income! Come hell or high water, I have to pay out a minimum of $200 billion in fixed expenses. They can't be cut, no matter how much I lop off from defence or welfare. Now look at my budget deficit. We thought it was going to be big even with tax revenues at peak boom levels. But when the recovery didn't materialise the deficit was bloated to over $100 billion."

"So what are you going to do?" queries the pollster, departing from the questionnaire.

"Going to do?" Uncle Sam asks. "All I can do now is react; make decisions on a day-to-day basis and the only definite decision I have made so far, if you can call it a decision, has been to sell $40 billion in Treasury bills. We have to raise the money regardless of the price."

In the end the Treasury Department had no choice but to borrow heavily for the funds in the New York money markets, send interest rates soaring, and ironically sabotage its own efforts to rescue the economy from the depths of a recession.

This series represents only about one tenth of The Money Panic. The unabridged book, containing 400 pages and 47 diagrams, as well as a six-chapter survival programme is availa ble by sending $15 (plus $2 for air mail) to Weiss Research, Inc, 542 West 112th Street, New York, NY 10025, USA. Interested British

publishers may contact Abner Stein, 39A Cyril Mansions, Price of Wales Drive, London, S W11 4HP (720-7910).