BERNANKE TO REPLAY 
GREENSPAN'S 1987 ROLE?
by I. M. Vronsky
Editor & Partner, Gold-Eagle,com
August 17, 2007

The Fed's dramatically increasing liquidity last Friday and this week "ain't" going to cut the mustard..IMHO. It is merely stopgap measures whose effectiveness has already waned, subsequently requiring a preemptive market rescuing bail out cut by Bernanke in the Fed Funds rate with a view to preventing an irreversible TOTAL meltdown in the stocks and credit markets.

A market saving slash in the Fed Funds rate could probably be on order of 50 to 60 basis points (the latter executed by Fed chairman Greenspan on November 1, 1987 to stave off the imminent collapse of the New Stock market).

To be sure, such a draconian action portends monumental ramifications for real estate, stocks, the US dollar, gold, the XAU and HUI.

Today's evolving market debacle reminds me of 1987.

An Overview of the brief but substantial 1987 correction

Black Monday (1987)
From Wikipedia, the free encyclopedia

DJIA (19 July 1987 through 19 January 1988)

FTSE 100 Index (19 July 1987 through 19 January 1988).

Black Monday is the name given to Monday, October 19, 1987, when the Dow Jones Industrial Average (DJIA) fell dramatically, and on which similar enormous drops occurred across the world. By the end of October, stock markets in Hong Kong had fallen 45.8%, Australia 41.8%, the United Kingdom 26.4%, the United States 22.68%, and Canada 22.5%. (The terms Black Monday and Black Tuesday are also applied to October 28 and 29, 1929, which occurred after Black Thursday on October 24, which started the Stock Market Crash of 1929.)

The Black Monday decline was the second largest one-day percentage decline in stock market history. The largest one occurred on Saturday, December 12, 1914, when the DJIA fell 24.39%. However, in that case, the New York market had been closed since July due to the outbreak of the First World War. The greatest point loss in DJIA history was on Monday, September 17, 2001, 684.81 points, six days after the September 11, 2001 attacks and the first day after which the market was open.

A certain degree of mystery is associated with the 1987 crash. Many have noted that no major news or events occurred prior to the Monday of the crash, the decline seeming to have come from nowhere. Important assumptions concerning human rationality, the efficient market hypothesis, and economic equilibrium were brought into question by the event. Debate as to the cause of the crash still continues many years after the event, with no firm conclusions reached.

In the wake of the crash, markets around the world were put on restricted trading primarily because sorting out the orders that had come in was beyond the computer technology of the time. This also gave the Federal Reserve and other central banks time to pump liquidity into the system to prevent a further downdraft. While pessimism reigned, the market bottomed on October 20, leading some to label Black Monday a "selling climax", where the excess value was squeezed out of the system.

Greenspan to the rescue

When he became Fed chairman in August 1987 (a mere four weeks before the 1987 crash), core inflation ran at about 3.7 percent, and the Fed Funds rate was more than 7 percent.

Then came the infamous Black Tuesday (October 21, 1987), when the Dow crashed 23% that day. With financial Armageddon facing global markets, Fed Chairman Greenspan implemented a draconian measure with the objective of preventing a return of the 1929 Crash. Greenspan slashed the Fed Funds rate by an unprecedented 60 basis points.

1987-10-01 7.29
1987-11-01 6.69

Effectiveness of Greenspan's Draconian Rate Cut

The Fed Chairman's hugh rate cut effectively told the world the FRB was ready and willing to supply enough liquidity in order to stabilize the financial markets. The 1987 charts below clearly demonstrate how immediately effective the rate cut was in reversing and stabilizing key indices (ie DOW and SP500).

DOW

Source: Stock Charts

S&P500

Source: Stock Charts

Other ramifications of Greenspan's Draconian Rate Cut

The unprecedented Fed Fund rate cut had similar dramatic impact in the XAU, Gold, and the US dollar (but in an inverse manner with the greenback). The 1987 charts

XAU

Source: Stock Charts

GOLD

Source: Stock Charts

US Dollar

Source: Stock Charts

Greenspan slashes Fed Funds rate by 60 basis points (bp) on November 1, 1987 from 7.29% to 6.69%. As a result the Dow stopped falling, but the XAU & Gold rose as the greenback went into a relentless decline to yearend.

Subsequent to the 60 basis point rate cut: the XAU soared 52% from 84 to 128 in the next three weeks; gold rose over 10%, and; the greenback plummeted nearly 9% by yearend.

It's time for Fed Chairman Bernanke to come to the rescue

Assuming a déjà vu, where Bernanke cuts the Fed Funds rate by only 50 basis points (soon), it seems logical the greenback might immediately decline by 7.5% (falling to about 76), and consequently the XAU theoretically could rise by 43% (rising to about 180), while gold might increase 8.3% (to about $700). Estimates are calculated on a 50 bp cut, proportional to the 60 bp cut in 1987.

Accordingly, HUI projects to about 420 if the above scenario plays out….IF BERNANKE STEPS UP TO THE PLATE. AND CUTS FED FUNDS BY 50 BASIS POINTS.

Dr Bernanke, you are up to bat!

Summary

Stock market action worldwide will be determined by the US Fed's next critical action, which has weighty political overviews that must be addressed. For this reason I believe the Fed will indeed begin to lower the Fed Funds rate…and sooner rather than later. A by-product of a rate cut(s) will be to fuel precious metal equities to much higher levels.

Even though a rate cut is demanded by present market conditions and history, we should remember the sage wisdom of John Steinbeck:

"The study of history, while it does not endow with prophecy, may indicate lines of probability."

              - John Steinbeck