Economic backdrop eerily similar to 1987 crash

By Burton Frierson

NEW YORK (Reuters) - Economists who believe history tends to repeat itself can be forgiven for approaching the 20th anniversary of the 1987 stock market crash with a sense of trepidation.

Leading up to the "Black Monday" rout on Wall Street, a massive budget shortfall, falling dollar and burgeoning trade deficit clouded the horizon for the U.S. economy, even as the Dow hit a string of record highs.

Sound familiar?

Since the start of this decade, the U.S. budget has swung from surplus to deficit, the dollar has slid to record lows and a huge hole remains in the trade balance -- only now it's nearly twice as big compared to the overall economy.

Transcripts from the Federal Reserve's meeting a month before the 1987 crash show similar issues were on the minds of policy makers.

Investors were also concerned, particularly after a bond market rout in the wake of a precipitous drop in the dollar during the two years leading up to the October 19, 1987, crash.

"Eventually the dollar broke and that crushed the bond market," said William O'Donnell, head of U.S. interest rate strategy and research with UBS in Stamford, Connecticut.

"Part of that was weakness in the dollar caused a flight of foreign investors and eventually what that did, the combination of higher rates, just eventually crushed the stock market."

FOREIGN CURES

Then, as now, the U.S. looked abroad for cures to the economy's maladies. Officials pressed West Germany and Japan, which had large trade surpluses, to stimulate their domestic economies so their imports of U.S. goods would rise.

Today, they decry a global "savings glut" as the culprit behind the huge U.S. trade deficit, a shortfall that also weighs on the withering dollar.

The greenback has tanked against a host of other currencies, raising concerns it may spark U.S. inflation, scare off foreign investors and undermine Europe's economy.

In recent years the U.S. has also embarked on a campaign of jawboning and cajoling the Chinese into allowing their currency to rise against the greenback to close the trade gap.

Which brings us back to 1987, when aggressive U.S. efforts to get Germany to help support the dollar were blamed for contributing to the stock market tailspin

In a survey of overseas officials and economists after the 1987 crash, Reuters reported: "Most of those interviewed said a basic reason for the selloff was the imbalances in the world financial system created by the failure of the Reagan Administration to reduce its budget and trade deficits."