There Was Never a 'Greenspan Put'

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When people traditionally think about stock market crashes, images of the Great Depression immediately spring to mind. Stocks and the economy have become intertwined in that manner without ever pressing the equation. The reason the Wall Street crash in 1929 was so damaging was that it was directly linked into the actual monetary resources of the domestic (and foreign) banking system. Through the call money market, the correspondent system had plunged an unbelievable proportion of "reserves" into NYC and thus stocks; meaning that it was not just asset prices at risk, it was the currency system itself.

Not all stock market conditions are so linked to the monetary system; there is always some fashion of relationship, but the nature of it is not in any way static. There was the Crash of 1987, which troubled Alan Greenspan in his first months on the job, but it was largely isolated, providing little opportunity for far greater economic distress. There was also a crash in 1962 that appeared similarly disengaged from an economy that was recovering steadily from the double dip recession in 1960-61. Called the "Kennedy Slide", stocks peaked in late 1961 and then sank about 23% through May 1962.

The drop was punctuated on May 29, 1962, with what was then called the "flash crash." For some reason May has been the target of such episodes, with most wrongly believing that the May 2010 repeat was the first. Some of the most dependable Blue Chip stocks were devastated in a matter of minutes. This Wall Street Journal article written in the aftermath of "our" flash crash spills the details of five decades prior.

"Around 2:48 p.m., International Business Machines Corp. crashed like a boulder pushed from a cliff. IBM, which had closed the day before at $398.50, fell from $375 to $365 on four sickening downticks within two minutes, hit $360 six minutes later and bottomed at $355 at 3:17 p.m. The shares had fallen 5.3% in 19 minutes. Less than six months earlier, IBM had traded at $607."

Though the country's attention would soon turn to geopolitical crisis that fall, for a time there was great consternation though the trouble seemed so isolated into just equity markets. The economy bore no ill-effects afterward and even credit markets seemed little impressed by the drama. If there was trouble, it lay elsewhere.

The day after 1962's "flash crash" the FOMC met in its regular policy format, but the discussion was dominated by Canada - yes, Canada. While stocks were hit in liquidations, so, too, were foreign exchange and gold markets (the Bank of England had been forced to sell some gold to once again defend $35.08). The Canadian dollar had become an object of worry, so much that European banks were pulling out of Canadian markets. However, convertibility being somewhat tenuous in volume as well as transaction, it wasn't as simple as a European bank turning over its Canadian dollars to the Bank of Canada and receiving its home currency (or repatriating Canadian dollars via the home central bank through official channels). Instead, banks exiting the Canadian mess would convert Canadian dollars to US dollars and then further exchange from there.

That meant the US dollar had strengthened against the looney but was at or near its floor against all the major European currencies save the Deutsche mark. Under the exchange system of Bretton Woods, which was, despite popular conception, only loosely based on gold, once a currency reached a floor that triggered central bank activity - and usually a flurry of it.

On June 21, 1962, the FOMC held an emergency conference call to essentially "bailout" the Canadian dollar. With "outflows" in US dollars, the Bank of Canada was rapidly reaching the liquidity edge. Without some US aid in terms of dollars, the Canadian dollar would have to be greatly revalued, an outcome nobody wanted to see in Canada, the US or Europe precarious as the global system seemed by then. The FOMC had discussed a swap arrangement with the Bank of Canada at its regular policy meeting two days earlier, but voted instead for abeyance on the swap in the hopes that short-term fluctuations would be proven as that. They were not.

The Bank of Canada was expecting to draw $160 million in liquidity assistance immediately; while not appearing to be much from today's debased perspective, for a country like Canada in 1962 that was enormous, and enormously destabilizing. But that wasn't the end of the call, however, as it was expected that another $300 million should be necessary in the immediate future. The Fed was asked to provide a $250 million swap line, with provision for forward cover (and important distinction), while the Bank of England would commit a $100 million line and the US Export-Import Bank $350 to $400 million on a standby basis.

Altogether, the rescue of the Canadian dollar in just liquidity might be as much as $1 billion. The IMF was part of the discussions, but could only commit limited resources as its rules in immediate circumstances only permitted liquidity equal to the gold amount paid into the fund. The Bank of Canada was suggesting to all its central bank and supranational counterparties that its "reserves" were a little more than $1 billion. For this reason and others, the FOMC was somewhat reluctant - Charles Coombs, the Open Market Account Manager, was bombarded with questions as to the Fed's ultimate risk.

Because of the glaring scale of the liquidity problem, the FOMC was only going to go ahead with the swap line so long as it was just a part of the larger package that was being developed externally in dollar liquidity, but also paired internally with Canadian government fiscal and monetary concessions (the austerity that accompanies these kinds of things). As it was, liquidity draws upon any standby from the Ex-Im Bank or should the Bank of Canada be forced to borrow heavily in private money markets in NYC would only exacerbate the US' balance-of-payments imbalance.

The US had been in a position of "outflows" for some time, which was really the genesis of this Canadian drama. Not only had American reserves been drained of gold, massive in its run, in the late 1950's, that still continued as the world tried to come to terms with what was a transitional phase of global monetary mechanics. To truly appreciate its form and possibility, you have to fully incorporate what these central banks were doing ostensibly under a "gold exchange standard."

The Canadian dollar crisis did not abate the larger dollar inequity across the globe, primarily Europe. Far from it; by the middle of July 1962, the Swiss National Bank had been intervening heavily as the franc was visited by an enormous buying binge, forcing the SNB to buy dollars to save the exchange mechanism. It was so heavy, that Swiss dollar holdings had come to be $210 million in excess of their informal $175 million dollar ceiling; that limit suggested to the Swiss central bank to convert their dollar holdings so as not to accumulate too much dollar "liquidity" in favor of gold. To circumvent this gold exchange mechanism, the FOMC proposed on July 10, 1962:

"In the light of this situation my negotiations with President Schwegler and Dr. Ikle of the Swiss National Bank over the past weekend resulted in agreement on their side to a stand-by swap operation of $200 million incorporating most of the provisions in our swap arrangements with other central banks. Schwegler and Ikle suggested, however, that it would be preferable from their point of view if the swap arrangement were broken into two parts: first a $100 million stand-by swap directly between the Federal [Reserve] and the Swiss National Bank, and second, another $100 million stand-by swap between the Federal [Reserve] and the Bank for International Settlements. In both cases we would swap dollars against Swiss francs, with the BIS obtaining Swiss francs through a third swap arrangement of its own with the Swiss National Bank. Our swap with both the Swiss National Bank and BIS would be initiated on a stand-by basis with the prospect, however, of an immediate drawing of $50 million under each one for purposes of mopping up $100 million of the present surplus dollars held by the Swiss National Bank. Both swaps would carry an identical interest rate on both sides based upon the U. S. Treasury bill rate; in both cases we would be offered time deposit facilities at the BIS for investment of any Swiss franc balances we might hold. The swap arrangement would be for three months but the Swiss have requested a special provision for liquidation of the swap on two days' notice at the initiation of either party; this request apparently arises from the insistence of their lawyers that the Swiss National Bank must be covered against the contingency of an outbreak of war."

As I wrote above, you truly have to read through that tangled mess of central bank liabilities and exchange liabilities to appreciate not only what was taking place in terms of global payments and the reckoning of imbalances but also how gold was already by then totally overcome by the rule of bankers. What should have been another gold outflow from the US was instead (partially) "sterilized" by a split swap arrangement that included the BIS, forming the basis of a third in purely francs, with any franc balances ended up at the US in time deposit format with the BIS. Why such a mess? Accounting.

In January 1962, the Fed reported a, "rapid outflow of foreign funds from the Fed into the market during the first week of January" that instead of being placed in official channels (which would then convert to gold) found itself in private but offshore dollar trading. Unlike years past, the US current account deficit in early 1962 was not a result of trade balance; it was instead "short-term capital outflows" of the kind the Fed in the middle of 1962 was trying to avoid to any great length.

The first mention of such outflows was made as far back as May 1960 when FOMC Vice Chairman Hayes submitted in his written report, "Having just returned from Europe, I can't help giving some weight to the consideration that any reduction in our discount rate could tend to accentuate the flow of short-term capital to Europe--a flow which is already raising difficult problems for some of the European central banks." In October 1960, the staff economists reported likewise, "It is equally clear, on the basis of other information at our disposal, that a major cause of the ‘deterioration' has been an increase in short-term capital outflow, which in turn has been significantly affected by the differences in the level of interest rates here and abroad."

The staff in October 1960 made it plain the scale of the dollar dismissal. The combined gold and dollar "outflow", the latter made in accounting terms as reported foreign holdings of dollars, had averaged $500 million per month in July and August that year, up from a $280 million average May and June. As the economists noted, these numbers "will be such as to invite widespread comments on what will undoubtedly be generally characterized as a [sic] deterioration in our balance-of-payments position."

In all of the 17 FOMC meetings in 1960, totaling 941 pages of discussion that year, despite this great concern over balance-of-payments and the mysterious "short-term capital outflows", there is not one mention of the eurodollar. The next year, 1961, the word "Euro-dollar" (as it would come into convention) was cited exactly once the whole year, in October, but it was an extremely important reference:

"As a result there was a spread of 34 basis points in favor of British bills on a covered basis yesterday, compared with a spread of only 2 basis points at the time of the last meeting. I should point out that too much emphasis may be placed on the British bill rate in this connection, and that the Euro-dollar rate is perhaps more important than the British bill rate."

That suggests there was awareness at some levels of the nascent eurodollar system, likely in the operational corridors of the Open Market System (which is why Charles Coombs was more and more prominent as these discussions took on their increasing proportions). The next year's balance of FOMC meetings, 1962, saw 15 Euro-dollar mentions for the whole year, including, finally, documented appreciation for where all this was going (from March 1962):

"On a covered basis, the interest-rate differential between these places, as measured by the difference in Treasury bill rates minus the forward discount of the pound sterling, has been in favor of New York for quite some time. Recently the differential has reached three-eighths of one per cent, which might be thought sufficient to cause some flows to New York.

"Actually, however, comparison based on Treasury bill rates can be misleading because the London money market offers higher rates on certain investments that are, rightly or wrongly, considered by some investors the equivalent of prime investments in New York, especially deposits with local authorities and with finance companies. On a covered basis, these rates still show an advantage of nearly one per cent over investments in the New York money market. Euro-dollar rates in London also are still quoted at 3-1/2 per cent, at least 1/2 per cent higher than returns on prime money market paper in New York."

The eurodollar market even by 1962 had become a full-fledged money market even if it wasn't clear to the rest of the world, and especially US policymakers, what or why. In fact, it would take years before just minimal comprehension, even though foreign central banks had become some of the most prominent agents in eurodollars all throughout the 1960's. As I detailed here, by late 1968 and early 1969, eurodollars had become central to try to resolve the tangled mess that was left by these efforts in the earlier part of the decade. If the eurodollar wasn't mentioned at all in 1960 and only once in 1961, it was mentioned 28 times at the December 1968 meeting alone; 41 times in March 1969; and 61 and 62 times in April and February 1969, respectively.

The specific problem of the later 1960's was that when central banks were trying to resolve these latent tensions of gold exchange and fixed currency floors and ceilings, they were no longer contracting swaps with the Fed or each other but rather more so just acting with and at the eurodollar market as it attained global payment status. From that, as economists like Milton Friedman supposed, the problem was the system of fixed exchange itself; removing that and allowing currencies to float was supposed to resolve these tensions. It was a sentiment that gained wide favor among economists because economists would act the former role of gold or foreign exchange (and who doesn't like being told they are the most important elements in the world's financial regime?).

The "flash crash" in 1962 was thus far different than the events of 1929 and 1930, and not just in terms of magnitude. Stocks at that time were being subjected to liquidity differentials not as a fatal withdrawal but in the uncertain nature of the transition from gold to eurodollar. As gold was allowed (and, as noted above, encouraged) to at best a sideline role throughout the 1960's, there was this offshore and in many ways separate dollar market to fill the void - though it caused intermittent difficulties via the natural tension of being applied with the old system still somewhat in place. By the later 1960's, those efforts toward tradition simply withered.

That is why the economy never faltered despite the very real fears (at that time Kennedy's Slide was the first real reversal in stock prices since the Depression). The money supply of eurodollars was ever-expanding, and greatly so - it was in short order the beginning of the Great Inflation, after all. This process also answers the crash in 1987 despite the S&L crisis; though at that time it was more of a second wave of eurodollar/wholesale banking reaching the full measure of its crescendo. By the time the S&L crisis had fully abated, in the early 1990's, all that was left were commercial banks of the "shadow" variety set in motion toward qualitative monetary expansion rather than purely quantitative.

The stock market crash in the dot-coms likewise falls under those monetary circumstances; the eurodollar by the 2000's was just reaching its full bloom, cushioning so much the great stock withdrawal the economy barely noticed. It was a disaster, of course, but it answers why the crash in 2008 both started on August 9, 2007 and why it was so devastating in the same ways as 1929 (for banking but not true "deflation"). And it further explains why the re-flaring of the same difficulties in 2011 was likewise so upsetting to the permanent order, if on a much, much slower pace than the usual economic and financial slide. Like the 1960's, only backwards, central banks have been studiously attempting to reframe contemporary conditions within their traditional settings (tradition in 1962 being gold but more so fixed; tradition in 2008 and 2011 being whatever it was that banks were doing before). In very general terms, the Fed, ECB and all the rest thought they were going to easily rebuild the financial system and its financialized economy just as it had existed before August 2007.

The events of 2011 proved, at least to deeper monetary agents in funding markets, it was not possible. So, like the 1960's dragged out slowly into eventual monetary regime shifting, the 2010's are performing the same but in the other direction. What's utterly fascinating, in a terrifying sort of way, is that the eurodollar is at the center of both; coming and now going. Unlike August 1971 when Nixon "closed the gold window" for good, there is no parallel monetary system in place to take up the function of global financial and really exchange payment system. Then, the eurodollar had already been ceded most of the exchange function; all that was left was official acknowledgement. It was a terrible prospect in that economists really had no idea how to control an "offshore" dollar; and indeed, they never have.

This is different in that there is nothing but a yawning void at its end. As I write persistently, the end of the eurodollar would be cause for great and deserved celebration all over the world, bringing up the actual prospects for true prosperity and sustainable growth (debt nowhere near the center) if it were being done with a replacement not just in mind but likely already in place and with parallel function already begun. Instead, I am writing constantly about fifty-year old history that still hasn't been recognized for what it was; policymakers still have no idea about the eurodollar in its full agency, and economists in general still think money is something the Fed does.

What does that mean as the eurodollar fades in increasing intensity? I have no idea, but I think it increasingly evident we are seeing now beyond the contours of it that have been clear for the past few years (rising "dollar" and all that). At best, it seems something of a crossroads; if Janet Yellen is allowed to interfere yet again, as Bernanke did before her, we will no doubt be captured witnesses to only more and repeated absurdity - like just last month when the Fed declared both recovery and recession on the same exact day, only with the recovery proclamation not even lasting to the next policy meeting. We become Japan, stuck in an economic world of zombification, which is really nothing more than zombified dead money. That much we already recognize in far too close proximity of financial markets where curves and time value have little left to be drained (with the US not so far behind Europe as some would have it).

The other option is likely more violent, but only in the short run. We figure out a true and sustainable monetary system that doesn't depend upon the will and whims of economists who actually exert far less control than they think. If that wasn't apparent enough after the Great Inflation, or the Panic of 2008, and it really should have been, it will be at least one more time. Unfortunately, it's a little late in the game to just be starting the planning phase. There never was a Greenspan put; there isn't even "money" in monetary policy, nor currency in "currency elasticity." What substituted as all that was unnecessary complexity that simply made it seem like central bankers knew something about something worth doing. That is why when called on it, as markets are to do on occasion, they come up literally short. It's more than an uncomfortable prospect as even stocks now start the engine of worry all over again.


Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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