THE GREAT DEPRESSION OF 1990
Ravi Batra
New York: Simon & Schuster, 1987
235 pp., $17.95
Ever since the stock market crash of 1929, there have been best-selling books every few years exploiting fears of another crash. Several such books are on the market today, just as there were around 1975 and 1979. Ravi Batra's The Great Depression of 1990 is scarcely unique, but it does make the most extreme claims so far, predicting "the worst economic turmoil in history."
To the average person, stock prices seem to rise and fall for no reason, as though investors--even the skilled staffs of major financial institutions--were simply foolish. The authors of doomsday books can easily exploit the fears that come from such ignorance by arguing that stock prices have to fall simply because they went up. Yet previous peaks in stock market prices, such as December 1961 or January 1966, were usually followed by prosperity, not depression. In 1961, for example, the stock of IBM sold for eighty times its profits per share, while even at the market peak in August 1987, IBM stock was only about twenty times its earnings, and most other stocks were not even that high. Yet 1961 was hardly a year that people remember as an insane speculative binge or a prelude to disaster, even though stock prices in real terms (adjusted for inflation) were even higher in 1961 than they were at the peak of September 3, 1929. Stock prices once again tripled from the summer of 1982 to the fall of 1987, but this was not irrational. Instead, the stock market rally reflected a huge increase in actual and expected profits and production, as well as a much lower level of interest rates, tax rates, and inflation.
In mid-October, when stock prices "crashed," they merely dropped back to the highest levels of 1986--still twice as high as the 1970s' highest levels. The alleged trillion-dollar loss incorrectly assumes that everyone bought at the top of the market and sold at the bottom. It also ignores October gains from rising bond prices. Most of the panic sales of stock around October 19 were at a profit, not a loss. The image of a "crash" suggests much more than smaller-than-expected gains or slipping back to the high stock prices of a year earlier. From 1929 to 1932, stock prices fell by over 85 percent--the equivalent today of the Dow-Jones index of stock prices dropping from 2,700 to 400! Politicians who never worried when the Dow-Jones stock average was below 1,000 throughout the 1970s are suddenly terrified if it now slips below 2,000.
The evidence is overwhelming that the stock market is very "efficient," in the sense that stock prices accurately and immediately reflect the best available information. Only serious and unexpected bad news can cause the whole stock market to drop substantially. Such major surprises are usually political, such as the Senate's expansion of the Smoot-Hawley Tariff in October 1929 or the Hoover administration's successful campaign in 1931-32 to more than double the income tax rates. Around October 14, 1987, the market had similar scares about the direction of U.S. and foreign tax, trade, and monetary policies. The House Ways and Means Committee proposed a variety of anti-wealth taxes, including a tax on takeovers; an unexpectedly large trade deficit appeared to make another Smoot-Hawley-Gephardt trade bill more likely; and the breakdown of cooperation between major countries
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