The fragile economic recovery would crumble. Nearly $8 trillion of wealth would disappear. Retirement plans would collapse and unemployment would soar. And it could happen with a keystroke.
Just like Target—which was a sitting duck for hackers on Black Friday, when 100 million customers were compromised—the stock market is shockingly vulnerable to a flash crash that could erase 6500 points from the Dow Jones Industrial Average. This isn’t an outlandish forecast. In fact, it is something we should be expecting.
No one knows what will trigger the crash, but it’s prudent to prepare for it, especially now. My investing mentor, Sir John Templeton, taught me in 1987 that “every bull market is followed by a bear market.” When I asked him what that meant, he pointed to the Dow and predicted a 40% drop. At the time, the Dow stood at 2700, up 250% over the preceding five years. A 40% decline would bring the index under 1700. A crash, Templeton told me, could occur within two months. Two months later, on October 19, 1987—Black Monday—the Dow crashed just as he had warned.
Now, let’s compare today’s situation with that of October 1987. We are five years out from a terrible recession, and the market has seen enormous gains—it’s up 150% from the lows of early 2009. There have been substantial political changes under Obama, just as there were under Reagan.
Unfortunately, there are also some important differences. In 1987 the economy was humming and employment was booming. The unemployment rate, with much higher workforce participation, had fallen from 9.7% to 6.2% and was headed lower still. Today’s recovery is anemic, and unemployment is a real problem. From 1982 to 1987, the economy grew about 70%, more than twice the growth we’ve had over the past five years.
Yes, the unemployment rate has fallen from 9.3% to 6.7%, but much of that decline represents people giving up and dropping out of the labor force. From 1982 to 1987, the labor force participation rate rose from 63.7% to 65.7% and was destined for further gains. Over the past five years, the participation rate has fallen from 65.7% to 62.8%, a 35-year low. Our economy is much weaker today than in 1987 and therefore even more vulnerable.
But wait, it gets worse. While technology played a role in the crash of 1987, its effect today will be far more severe. We’ve already experienced “flash crashes” caused by technical glitches. They strike individual stocks almost daily. Last April the Syrian Electronic Army hacked the Associated Press Twitter feed and sparked an instant 1% drop in the entire market. But what happens if a serious, coordinated electronic attack hits a stock exchange already overdue for a correction? A market bloodbath. A drop of 6,500 points, about 40%, to the 10,000 level would just be the start. The resulting chaos would be even greater.
No one can predict with certainty the timing of a natural market correction let alone a cyber-economic attack. But we know that enemies of the United States have been planning a cyber attack on our economy for quite some time. And we are more vulnerable than ever before. Official Chinese military publications identify a “man-made stock market crash” as an appealing financial weapon for a new era. The deputy chief of the general staff of the Chinese army has said, “In the information era, seizing and maintaining superiority in cyberspace is more important than seizing command of the sea and air in World War II.” He’s right and he’s not alone in this knowledge.
Documents obtained by the Pakistani journalist Fouad Hussein indicate that al Qaeda’s long-term plan includes “economic warfare” against the United States, including electronic attacks on our critical infrastructure. Our enemies appreciate our markets’ vulnerability and are recruiting henchmen to pull off a “hack and crash.” Most Americans don’t know what to do in the event of a cyber-economic attack and are vulnerable to personal economic devastation.
In 2014, we face the imminent danger of a cyber-economic market crash that could wipe out $8 trillion or more of American wealth with a keystroke. It will make 1987’s Black Monday look like a picnic.
Kevin D. Freeman, CFA, is the author of Game Plan: How to Protect Yourself from the Coming Cyber-Economic Attack.
