Things That Make You Go Hmmm...

Mon, Jul 9, 2012 - 12:30pm

The following is an excerpt of Grant Williams' free weekly newsletter "Things That Make You Go Hmmm..." Click HERE to subscribe.

panic buttonThey say it’s always darkest before the dawn but in the financial world we seem to repeatedly go beyond ‘dark’ into pitch blackness when the periodic stumbles that are part and parcel of an ever-growing world come along.

Inevitably, when these meltdowns take place they are assigned the rather unimaginative adjective ‘Black’ in order to convey just how gloomy they are. Indeed, in a world such as finance, that thrives and grows in large part to hyperbole, one would think that perhaps a more evocative description could be used, but no. ‘Black’ it is.

In fact, one can live through a very ‘Black Week’ indeed just by examining the pages of history, and reliving the various episodes that have befallen the world in just the last century alone.

Such a week would begin, of course, with ‘Black Monday’.

There are many still involved in the financial industry who remember vividly the events of that day when, on October 19 1987, the stock markets of the world crashed as a toxic combination of overvaluation, conflict amongst G-7 nations, problems in bond markets and the failure of portfolio insurance overwhelmed the world’s bourses and led to a stunning (though ultimately short-lived) collapse in markets across the globe.

‘Black Tuesday’ occurred on October 29, 1929 when some 16 million shares traded on the New York Stock Exchange (a record that would stand for 40 years) as panic gripped the world. The Dow lost 12% in a day which only added to the previous day’s 13% fall (a day which, funnily enough, had been called, you guessed it, ‘Black Monday’). In fact, this ‘Black Two-Day’ saw the Dow Jones Industrial Average plummet from 298.97 to 230.07—a fall of some 23%. The following day, when the Dow bounced 12% remains sadly bereft of a snappy monicker but such is the nature of these things.

‘Black Wednesday’ took place on 16 September 1992 when the UK’s Conservative government was forced to withdraw the Pound Sterling from the European Exchange Rate Mechanism (ERM) after their promise to keep the currency above its agreed-upon lower limit was broken—an event that famously bagged George Soros a $1bln profit— a colossal amount of money in 1992 or, as it’s known today, $43 million less than the box office takings of Pirates of The Caribbean: On Stranger Tides.

‘Black Thursday’? Well for that we need to return to the Wall Street Crash of 1929, specifically Thursday October 24th when, seemingly without warning (except for those issued by a few Cassandras who went unheeded) and despite the intervention of some very serious names from the financial world, panic could not be averted:

(Wikipedia): On October 24 (“Black Thursday”), the market lost 11% of its value at the opening bell on very heavy trading. Several leading Wall Street bankers met to find a solution to the panic and chaos on the trading floor. The meeting included Thomas W. Lamont, acting head of Morgan Bank; Albert Wiggin, head of the Chase National Bank; and Charles E. Mitchell, president of the National City Bank of New York. They chose Richard Whitney, vice president of the Exchange, to act on their behalf. With the bankers’ financial resources behind him, Whitney placed a bid to purchase a large block of shares in U.S. Steel at a price well above the current market. As traders watched, Whitney then placed similar bids on other “blue chip” stocks. This tactic was similar to one that ended the Panic of 1907. It succeeded in halting the slide. The Dow Jones Industrial Average recovered, closing with it down only 6.38 points for the day; however, unlike 1907, the respite was only temporary.

And so we come to ‘Black Friday’.

Now, one could reasonably expect Fridays to have the potential to be the Blackest of all days in financial circles, what with traders desperate to square away positions ahead of an uncertain weekend, but, whilst the previous four days of our Black Week all involve stock markets— gripped by fear—falling precipitously, our ‘Black Friday’ took place on September 24, 1869 and the resultant market dislocation was due to something altogether different. Something that is uppermost in the collective psyche right now; market manipulation.

Incidentally, as we wend our way through the dog days of July, into August and towards September and October, it’s worth bearing in mind that our ‘Black Week’ is constituted of two days in September and three in October. I’m just saying...

But back to ‘Black Friday’.

Unlike the other ‘Black Days’, this one had nothing to do with stock markets, but was, in fact, the result of an attempt by two leading financiers of the day - Jay Gould and James Fisk - to corner the gold market.

After the US Civil War, in March, 1869, Ulysses S. Grant assumed the presidency of a United States in complete disarray and with an economy on the brink of implosion. Federal debt was out of control after the conflict and hundreds of millions of dollars of ‘greenbacks’ had forced gold coins out of circulation. The credit rating of the country was akin to that of today’s PIIGS.

Grant’s very first act as President was to sign a law which promised that payment of US bonds would be made in ‘gold or its equivalent’ and that redemption of ‘greenbacks’ would be made as soon as was practicable.

The signing of this law sent the price of gold tumbling to $130 an ounce - a low not seen since Congress suspended payments in gold and silver in 1862.

Grant’s Treasury Secretary, George Boutwell, rather ingeniously began selling the Treasury’s surplus gold to retire ‘greenbacks’ and then used those very same ‘greenbacks’ to buy back government bonds. The strategy worked like a charm. The gold price remained low, the money supply stayed even and the National Debt was reduced (yes, folks, it is NOT a one-way ride) to $50 million - or, as we like to call it today, 25% of the payroll of the New York Yankees.

At the time, the gold market was tiny in size; $15 million in turnover, and this made it simple for the government to (in those days, overtly) set the price simply by selling varying amounts of gold. Gould and Fisk realized that by getting their hands on inside information as to the governments plans for gold sales, they could trade ahead of the government and make a ridiculous sum of money. Easy.

The NY Times takes up the story:

(NY Times): Gould convinced a brother-in-law of President Grant, Abel Corbin, to join him and Fisk in their gold-market investments. It is not certain, however, whether Corbin actually knew the real plot or was just a pawn in the high-finance game. Gould then approached the assistant treasurer in New York, Daniel Butterfield, who was in charge of gold sales. The financier gave Butterfield $10,000 (his annual salary was $8000), which the federal agent later claimed was a no-interest loan. Furthermore, Gould offered twice to invest $500,000 in gold for Grant’s personal secretary, Horace Porter, who refused. Finally, Gould brazenly offered to give Grant’s wife, Julia, half-interest in $250,000 worth of bonds, but she, too, declined.

When Grant visited New York on several occasions, Corbin arranged for Gould and Fisk to be present, and the conspirators tried to persuade the president that a higher gold price (from reduced Treasury sales) would benefit the nation. As he usually did, Grant listened without comment. When Gould pointedly asked for a hint at the government’s actions, the president resolutely refused. However, the financiers’ visible access to Grant and those close to him enhanced the influence of Gould and Fisk in financial circles. They began buying millions of dollars worth of gold in early September 1869, initiating a rise in the market.

So this insider trading scheme was actually a pretty poor attempt when push came to shove as the conspirators failed to actually gain any real inside information. But that didn’t deter them from pressing on, undoubtedly in the assumption that, financial types being what they were, it would be assumed that, simply by the level of their association with the White House, that they HAD inside information and were using it.

There’s none so blind as those that won’t see.

But back to our story, and in the midst of the denouement, we see just how important correct spelling and punctuation really are:

(NY Times): After conferring with leading bankers in New York, Treasury Secretary Boutwell realized what the speculators were up to, and that the federal government should increase its gold sales to stabilize the market, or risk devaluing greenbacks, government bonds, and American credit. Boutwell refused to see Corbin, who then alerted Gould that something was afoot and wrote a lengthy letter to Grant urgently requesting the president to stop his treasury secretary. Grant did not reply, but the telegram to Gould stating, “Letter delivered all right,” was mistranslated at the New York telegraph office as “Letter delivered. All right.” Gould intensified his gold buying spree, and the price continued climbing.

However, the suspicious letter and Porter’ sad mission of Gould’s bribery attempt made Grant realize that he had been used as cover for the financiers to corner the gold market. The president warned Corbin to cut his ties with Gould, and allowed Boutwell to proceed with his plans to increase the government’s gold sales. Corbin, though, tipped off Gould, who began selling his gold without informing Fisk. The two-week frenzy on the gold market had virtually halted the country’s foreign trade, which relied on gold as the medium of exchange, and threatened to broaden into an economic panic.

On Friday, September 24, 1869, the price of gold reached between $160 and $162, and Fisk, still buying, boasted that he would push it to $200. After a brief discussion with the president, Boutwell sent a telegram to Butterfield directing him to sell $4,000,000 in gold and buy the same amount in bonds. When the news reached the Gold Room, the price of the precious metal fell to $133 within a few minutes.

And with that, ‘Black Friday’ was born.

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