1929 and Its Bear Trap Jude Wanniski October 28, 1998

Gretchen Morgenson, the new “Marketwatch” columnist for The New York Times, has been producing some of the best market commentary in recent months. Formerly a Forbes reporter who served as Steve Forbes’s press secretary in his 1996 run for the GOP presidential nomination, Morgenson this morning wonders if the 1000-point advance of the Dow Jones Industrial Average since its August 31 low of 7,539.07 has been setting a “bear trap” for investors. Which is to say, a seductive rally within a secular bear market, soon to be overtaken by another deep decline. As a reminder, we agreed with Barton Biggs of Morgan Stanley on July 28, 1998 that we were in a cyclical bear market that would end when the market had declined enough to satisfy Alan Greenspan’s distaste for market exuberance. At the market bottom cited by Morgenson as August 31, we said we believed the 500-point decline, “A Kick in the Pants,” September 1, surely was enough to satisfy the Fed Chairman and that we’d hit bottom. We still think August 31 was the bottom of the bear, yet we could lose a bunch of the 1000 points gained since while waiting for Greenspan to figure out how to get the price of gold up. The outcome of the November 3 elections also will be critical to the near-term movements of financial assets, not so much as for how many Democrats and Republicans win, but how the outcome is interpreted. The outcome of the 1996 election was bullish, we thought at the time, because the politicians agreed the voters wanted a bipartisan budget deal that would include supply-side tax cuts.

What struck me in reading Morgenson’s “bear-trap” hypothesis this morning was her citation of the 1930 rally after the 1929 Crash as the Mother of all Bear Traps: “[T]he biggest ‘gotcha’ of all was in 1930 -- when stocks recovered from the broad decline of 1929 that took the Dow average down almost 48 percent. In early 1930, stocks rose almost 50 percent, then crashed, losing 83 percent of their value in the next two years.” The account was a reminder that The New York Times has never once acknowledged that the 1929 Crash was caused by the Smoot-Hawley Tariff Act of 1930. The Wall Street Journal carried a full account of my analysis in October 1977 and many times since has alluded to the connection between the tariff legislation and the Crash. When The Way the World Works was published in April 1978, with its precise details on the Crash, the Times was not publishing because its printing unions were on strike. For 21 years, the Times’ economic and financial writers have ignored this direct connection. This is the equivalent in the physical sciences of hiding from Albert Einstein’s law of relativity -- which overturned Euclidean geometry.

Tying the Smoot-Hawley tariff to the 1929 crash was so critical because it brought back from the dead Jean Baptiste Say’s Law of Markets, perhaps the most important economic theorem of the 19th century and the cornerstone of supply-side economics. John Maynard Keynes opened his General Theory of 1936 by driving a stake through the heart of Say’s Law, arguing that no longer does supply create its own demand. In this new, modern world, said Keynes, demand creates its own supply. Instead of the producer, the individual supplier of goods, being the most important actor in the economy, it is the consumer -- the collective, aggregate demander of goods. The upshot of this Keynesian revolution was to denigrate the efficiency of mass markets and to elevate the wisdom of the elites. According to John Kenneth Galbraith and Milton Friedman, two of the most important demand-side economists of the century, the 1929 Crash represented the bursting of an irrational bubble. If markets are so irrational as to expand by frenzied buying of equities by a herd of bulls, only to contract when confronted by bearish reality, then wise governments must replace dumb markets.

For the Keynesians, money must be taxed away from those who have it and refuse to spend it and spent by governments or given to people who will spend it. As long as spending occurs, the market will supply the goods. For the Monetarists, it was the gold standard that caused the Crash, by preventing the government from printing money with which to force aggregate spending. In the classical world of Say’s Law, the gold standard gives each individual in the market the power to determine whether there is too much liquidity or too little and thereby fix the unit of account. In the demand model of Keynes and Friedman, the small groups of independent men and women, who are trained in the mysteries of money, meet in secret every six weeks to determine money’s values.

Was the 1930 rally on Wall Street a bear trap? Of course it was, if you did not know that the 1929 Crash was the result of a shocking change of heart from free markets to protectionism in the U.S. Senate. As explained on pages 148-149 of TWTWW, the DJIA had fallen from a high of 381 on September 3, 1929, to 230 at the end of Black Tuesday, October 29, then to 198 on December 28, 1929. It climbed back to 294 in April 1930 as free traders mounted a counter-attack aimed at persuading President Herbert Hoover to veto the bill and as world leaders threatened retaliation if it were signed. “The stock market began a slow slide again in April as such protests brought no new word from the White House.” When the Senate voted June 13, 1930, to send the finished legislation to the White House by a 44-to-42 vote, the DJIA fell to 230, exactly where it was at the end of Black Tuesday. On Sunday June 15, Hoover announced he would sign the bill. After the market reaction on Monday June 16, the NYTimes front page of June 17 reported the following: DEMOCRATS TURN TARIFF FIRE ON HOOVER AS SENATE SENDS BILL TO THE WHITE HOUSE; BREAK IN STOCK AND COMMODITY PRICES.  Selling Swamps Exchange   Leading Issues Tumble   Wall Street Assails the New Tariff   Many Margins Wiped Out   Much of the Liquidation Due to Brokers Calling in Vain for Further Deposits.

If you read these accounts, you must ask why would it take until 1977 before anyone would connect the Crash of 1929 with the tariff, when it now seems so obvious. Why do Keynesians continue to cite Galbraith’s bubble theory as the cause of the Crash? Why does Friedman continue to insist that it was Fed policy, not Smoot-Hawley, that broke the ’29 bubble? Just as Einstein’s discovery led to the atomic bomb, this insight blew up the rationale for the entire demand-side intellectual universe. It was because of this discovery that I could predict in 1977, long before anyone else did, that the Cold War soon would be over. If Say’s Law were alive, communism only could be dead.

During the 1929 Crash, supporters of the tariff were arguing that the market was crashing because of fears it would not pass. In 1930, when it passed, only the relatively small decline of June 16 was connected with the tariff. The elites of corporate America continued to celebrate. As I wrote in 1977: “The National Association of Manufacturers...predicted that the new tariff, when it became law, would bring ‘a breath of relief to all industry and all business.’ Organized labor also approved. Big business, big labor, and big government were in agreement.” The DJIA continued its decline as Hoover raised income tax rates and as foreign governments followed through on threats of retaliation. Then came Depression, which produced World War II and then the Cold War.

So is this a bear trap? Will there be a bigger Crash, another recession, markets falling all over the world, billions unemployed, unspeakable acts of terrorism, nuclear accidents, the end of the world at Y2K? Reading Gretchen Morgenson this morning, these thoughts floated through my head and I concluded: Probably not. But, as always, we will be keeping  a weather eye out on your behalf for all bears, cyclical and secular.