The Crash: Panic Grips The Globe

A crisis spotlights Washington's failures

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Frank Korth, senior vice president of Shearson Lehman, explains the mechanism by which market cracks get translated into slowdowns or recessions: "If you lose $4,000 in the stock market, you don't go out and spend $1,200 on a new color TV or $4,000 on a new motorboat. As a result, the man on the street whose job is in the boat plant is out of a job because there is no market for his company's product. Boatbuilders don't want to build inventory, so they close down their plants. Everybody loses: the plant workers, the suppliers, the corner grocer, the shoe store."

This is, of course, a highly simplified scheme, and there is nothing inevitable about it; it could be averted by Government action that would restore confidence. But what kind of action? An answer must begin with an analysis of what triggered the market crash.

Superficially, the bust might seem, to put it bluntly, insane. By no rational calculation could the asset value and earning power of American corporations be 22.6% less on Monday night than they had been the previous Friday. But that statement assumes that their values on Friday were realistic, and in hindsight there is widespread agreement that they were not. In other words, the crash to some extent really was -- oh, all right -- a correction, though one on a scale to make that word seem ludicrously inadequate.

Says Korth of Shearson Lehman: "The market should not have reached 2700 ((on the Dow Jones average)) in the first place. We probably should have been trading around 1900 or 2100; maybe 2000 would have been the right number based on interest rates, corporate earnings and other fundamentals. We were 700 points ahead on sheer greed." As early as August, when the American bull market celebrated its fifth birthday, some investing pros were noting apprehensively that stock prices were getting out of line with expected corporate earnings, and dividend yields had fallen well below the interest return on bonds, making the fixed-income securities potentially a better investment. But the general feeling then was that the Dow might go as high as 3000, on pure momentum if nothing else, so why not stick around for the end of the ride? A similar psychology ruled overseas, according to Nils Lundgren, chief economist of Sweden's PKbanken. Says he: "The market was really overspeculated, with people saying to themselves, 'I won't get out now, but as soon as stocks start to fall, I will sell.' When you have that mentality operating, you are ready for a big fall."

When markets get into such a state, almost anything can start a smashup. In the event, last week's explosion did not lack for triggers. Interest rates were pushing higher: the yield on U.S. Treasury bonds rocketed briefly above 10%. That seemed likely to pull money out of stocks into the bond market. In fact, something of the sort seems to have happened. While the stock market suffered through its collapse Monday, the bond market began a brisk rally, presumably propelled by money fleeing the stock exchanges and looking for a safe haven. The biggest immediate blow of all was a report two weeks ago showing that the monthly U.S. trade deficit in August had declined only slightly, to $15.7 billion. Investors who had been hoping for a large reduction took that as a sign that U.S. finances were out of control and that the Reagan Administration did not know how to fix them. They began dumping stocks.

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