Black Monday and Financial Deregulation

In the previous episode, we saw the postwar Japanese market that rose from the ashes spreading to the masses together with investment trusts. It was the story of an era when the market became ‘something for everyone.’ But around that time, the world’s markets had also begun moving in another direction. Across national borders, they were trying to link up with one another.

In the 1980s, the advanced nations vied to loosen their financial regulations. They freed up commissions, opened their doors to foreign participants, and moved trading from paper and human hands to electronic screens. Markets that had until then been partitioned country by country were now linked by lines and woven into a single vast apparatus.

Deregulation meant that more funds could move faster and farther. It was full of the foretaste of prosperity. But at the same time, it had also created a circuit through which the tremor of one market could be transmitted to the entire globe in an instant. On October 19, 1987, that circuit operated in the worst possible way.

Markets That Loosened Their Rules and Began to Connect

First, let us look at the tectonic shift of this era.

A symbolic event was the major reform of the securities market carried out in Britain in October 1986 — the so-called ‘Big Bang.’ Trading commissions were deregulated, banks were permitted to enter the securities field, and trading shifted to on-screen dealing. Through this reform, London sharply raised its standing as an international financial center.

The same wave spread to each nation. The markets of each country competed to become more open, faster, and lower-cost. It has been pointed out that this very competition between systems was the force that drove the financial globalization of the 1980s. In Japan too, the deregulation of interest rates advanced in stages, and products linked to market rates began to appear.

A connected market brings efficiency and prosperity in peacetime. But once a shock runs through it, that connection can turn into a conduit that amplifies fear and carries it around the world. In the autumn of 1987, several anxieties were already smoldering in the market — America’s trade deficit and fiscal deficit, the so-called twin deficits, and concern over rising interest rates. And then a certain Monday came.

The Monday When Twenty Percent Vanished in a Day

Monday, October 19, 1987. New York’s Dow Jones average fell 508 dollars in that single day. The rate of decline was about 22.6 percent. As a single day’s drop, it is regarded to this day as one of the largest on record.

The weight of this figure becomes clear when compared with the past. Even the crash of October 24, 1929, which triggered the Great Depression, is said to have had a decline rate of a little over ten percent. Black Monday brought about a collapse far exceeding that, in just one day.

Why did such a collapse occur? In fact, its root cause is said to remain not completely explained even today. Anxiety over the twin deficits and rising interest rates, among others, have been pointed to, but none is easy to call the decisive blow. What can be said for certain is that market participants fell into a panic and rushed all at once to sell.

There is, however, something often singled out as a factor that deepened this crash all at once: automatic buying and selling by computer — program trading. Following conditions built in beforehand, when prices fall to a certain level, machines issue sell orders without waiting for human judgment. That selling drove prices down further, and the lowered prices called forth the next automatic selling. A vicious cycle in which decline begets decline is said to have been coldly accelerated by computers.

The Connected Fear of a Connected Market

New York’s collapse spread to the world that same day and into the next. The market, bound into one by deregulation, would now come to share its fear.

The next day, the 20th, Tokyo’s stock prices too collapsed sharply. Japan’s stock prices are said to have recorded one of the largest decline rates of the postwar era. London too, Hong Kong too — markets in each region were sold off simultaneously. A crash that occurred in one time zone struck the morning of each market one after another, following the rotation of the earth. The world was made to realize that markets linked by electronic lines instantly share not only prosperity but also collapse.

This lesson changed the shape of the market a little. Following the report of the Brady Commission, which investigated the crash, a mechanism called the ‘circuit breaker’ — which halts trading once for a time when prices plunge — was proposed and introduced at exchanges in America and other nations. When a market begins to run wild, it is forced to stop and people are given time to regain their composure — an attempt to sever the chain of machines with a different rule.

Black Monday did not lead directly to a long recession like the Great Depression. The market is said to have regained its calm relatively quickly. But this is not a story of reassurance. Rather, it was an event that clearly engraved how fragile an over-connected market can be, and how the interaction of humans and computers can generate collapses that are hard to predict. The protagonists of the market began to include not only people but machines — there was, in this single day, a sure sign of that.

And the heat of deregulation and globalization did not cool even after this crash. Above all, on an island nation to the west of the Pacific, a frenzy over land and stocks was about to swell to a scale no one in the world had ever seen. In the next chapter, we will step into the story of that unprecedented bubble and its unavoidable collapse.