For anyone around at the time, 1987 seemed to be a year much like any other. Margaret Thatcher won her third election victory. The Rugby World Cup started. The first outing of The Simpsons was shown on TV. But for the financial markets, it was a major turning point. 1987 was the year that saw the creation of the "Greenspan put" shorthand for a policy among central bankers, that if the stockmarket collapsed, they would automatically ride to its rescue.
Birth of the put
It came in the wake of Black Monday. Share prices cratered on Wall Street, and across Europe. The then-Federal Reserve chairman Alan Greenspan acted to bail them out. In the wake of the collapse, Greenspan flooded the markets with liquidity to stop the plunge in equity prices from hitting the real economy. It worked in the short-term anyway. There was no fall-out of any great significance from the crash, and very soon the real economy was humming along nicely again. Meanwhile, investors recouped their losses very quickly, and anyone who bought on the dip did very well.
That was the first time, but far from the last. Over the next 30 years, the central bank would always step in during a crisis to rescue investors, making equities essentially a one-way bet. They stepped in after the US Savings and Loan crisis; after the Russian and Asian financial crisis; after the bursting of the dotcom bubble in 2000; and, of course, in the most dramatic way possible, after the crash of 2008. Each time the Fed and other central banks did what they could to get the markets back up again. The techniques varied: from verbal intervention to interest rate cuts to quantitative easing (QE). But there was always something. It became part of the psychology of the markets. If there was trouble, the central bank had your back.
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And the "put" is still alive and well. We have seen that confirmed in the last month. After the dramatic collapse in Chinese equity prices started to impact on the rest of the world, there was immediately talk of the Fed postponing its planned rise in interest rates, while the European Central Bank (ECB) promised to support the markets with more QE if necessary. China has taken the policy to new extremes. Selling shares now practically merits a bullet to the back of the head, or at least a decade or two in a re-education camp the "Xi put", to coin a phrase, is more extreme than the Greenspan one ever was.
The case for intervention
Approve of it or not, you can see what Greenspan was up to in 1987. Central bankers had been taught on their economics courses that the 1929 crash had been the trigger for the Great Depression of the 1930s, and that the Fed had not done enough to prevent that. No one wants to see a re-run of that miserable decade. If the central bank propped up the markets in a crisis, ran the theory, it would prevent a depression from taking hold. It would make financing cheaper for companies, because equities would be easier to issue, and the wealth created for investors would trickle down into the real economy. So it made sense to bail the markets out.
A boom and bust accelerator
There is a problem, however, and it is hardly a minor one. The costs of the "put" now clearly outweigh the benefits. Sure, from 1987 to 2000, it created what was arguably the greatest bull market in history. From 1990 to 2000, shares rose for 119 months a longer run even than the bull market from 1921 to 1929. And there should have been no great surprise about that. After all, if the central bank has promised to rescue you in a crash, what's the downside? It is heads, you win and tails, the central bank loses.
But from 2000-2015, the "put" has only served to create a cycle of ever more volatile booms and crashes. The longest bull market in history has been replaced by an even longer bear market, now stretching to 15 years, with little end in sight. Central banks have pumped up the markets ever more furiously, but the returns have been diminishing for a long time, to the extent that they are virtually nonexistent. All they have achieved is an ever more volatile boom and bust cycle.
Whatever benefits there might have been from higher equity prices have long since evaporated and in several markets equity prices are not any higher than they were in 2000 anyway. Companies are drifting away from a stockmarket listing, in part because the volatility puts them off. Investors are deterred by the wild swings in prices. There is not much of a trickle-down effect, because no one is really making any money, and the few that do are such a small minority that they can't boost consumption much no matter how many yachts they buy.
Almost three decades on, the Greenspan put is well past its sell-by date. Central banks if they are to exist at all should ignore the stockmarket and stick to controlling inflation, and letting the market do whatever it wants. They can't prevent crashes, and they are not helping the economy. The Rugby World Cup is still in robust health. The Simpsons even more so. But the "Greenspan put" should be consigned to the history books.
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Matthew Lynn is a columnist for Bloomberg, and writes weekly commentary syndicated in papers such as the Daily Telegraph, Die Welt, the Sydney Morning Herald, the South China Morning Post and the Miami Herald. He is also an associate editor of Spectator Business, and a regular contributor to The Spectator. Before that, he worked for the business section of the Sunday Times for ten years.
He has written books on finance and financial topics, including Bust: Greece, The Euro and The Sovereign Debt Crisis and The Long Depression: The Slump of 2008 to 2031. Matthew is also the author of the Death Force series of military thrillers and the founder of Lume Books, an independent publisher.
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