Y2K at the Forefront Jude Wanniski November 5, 1999

You may wonder how I can be so nervous about Y2K when hardly any one else seems to be. Barron's this week found that only 13% of asset managers believe Y2K will bring significant economic disruptions. Bulls outnumber bears on Wall Street by 3-to-1. Why am I bearish, when I have been a bull from the first client letter I wrote for Polyconomics in 1978? It is because I force myself to think for myself, to come to conclusions that flow from my basic assumptions about the way the world works. I'm not always right -- and in this instance I pray that I am wrong, and that Y2K will be ho-hum. Still, the flow of information that comes to my attention tells me the world economy is probably in for rougher going than the pacific tone of Y2K news now suggests. For the most part, I think, Wall Street is accepting this story because the two men at the top of the global Y2K pyramid, Fed Chairman Alan Greenspan and Treasury Secretary Lawrence Summers, are telling those below that all is okay.

Group dynamics is easy enough to analyze in a group of six or twelve men and women. When group dynamics involve the 6 billion people on the planet -- which is what Y2K is all about -- my tendency is to assume that everyone in the world is more or less looking to the top for guidance. Greenspan and Summers, at the tippy-top, are proceeding with their fingers crossed, hoping the general mass of the global population will be able to cope with the "glitches" that appear, and that Y2K soon will be a memory to the financial markets. Which is to say that the adventure into the unknown is an unknown for everyone on earth, but we have been assured by our group leaders -- Greenspan and Summers -- that it will be bumpy, but not painful.

In my Polyconomics conference call Wednesday, I talked about my concerns that the world's seaports will throw Y2K curves at global commerce. I worry most about Japan, which is naked when it comes to dependence on unfettered, trans-oceanic commerce. Even so, I expect that computer problems involving the seaports will be resolved by manual operations and that Japan will get sufficient energy supplies to cope, even if it means temporary rationing. In this realm, I don't have any special expertise, so I am willing to go along with those who tell me the physical problems associated with Y2K will be dealt with in timely fashion. There may be power outages and telephone glitches and airline and seaport delays -- while the folks on the ground patch-together fixes in the good-old, can-do American way. It is the area of digital money that causes me the greatest concern. I've been hoping that my anxieties were baseless, which would enable me to join the chorus of full-speed-ahead bulls in the market, but our new Nobel Laureate, Robert Mundell, agrees with me that there could be a systemic problem. He continues to give interviews making this point, but in almost each and every case, the reporters dismiss his Y2K concerns because they are so far outside the box.

A relevant question was posed in the conference call regarding Mundell's suggestion that President Clinton call together the appropriate Euro and Brit and Japanese officials to discuss a temporary linkage of the dollar/gold/Euro/yen exchange rates. The client wondered if adding gold into the present confluence of monetary policies in our world of floating currencies simply would make matters more complex, leading to more turbulence. I do not know if I satisfied him with my answer, but decided that if my clients still wonder how this prescription would help, it must be that I have not done a very good job of presenting my concerns. Here they are:

1. Y2K could see an abrupt shift in the demand for dollar liquidity, with the market preferring gold and other commodities to the dollar and other currencies. This is because the demand for the dollar as a circulating medium will shift to a demand for the dollar as a store of value; the dollar then will seem more risky than gold. The dollar/gold price will rise. The more serious the disruptions, the greater will be the shift to gold from the dollar. The market will prefer preservation of assets to liquidity. The work of our David Gitlitz in examining the debt markets solidly supports this thesis. In the futures spreads, there is now "time preference" for liquidity which drops sharply at Y2K.

2. If the dollar/gold price is stable, all the currencies of the world that use the dollar as a guidepost for monetary policy will be stable. Individual economic actors in the U.S. will not have to puzzle over whether the dollar will rise or fall relative to gold, and similar actors elsewhere in the world will not have to worry that their accounting units will rise or fall because of Y2K externalities. When the dollar and gold are linked by executive order, with Fed compliance, the question of which is the "safe haven" does not arise. They are equal -- which takes that enormous risk of dramatic currency volatility out of the world economy.

3. The administration position, as expressed in the President's letter to Jack Kemp in August, was that gold would tie the Fed's hands in an emergency. Mundell's work for the past 40 years points to the greater importance of maintaining the stability of the unit of account than to use monetary policy to manage the real economy. The correct instruments for dealing with the real economy are fiscal and regulatory policy. If there will be a serious Y2K problem in the realm of global commerce and the financing of transactions in more than 160 currencies, there is much more to be gained by having the common unit of account anchored to gold than to have 160 central banks trying to figure out what to do in the midst of the storm.

4. The single gold-anchored unit of account for the major currencies deals directly with the Y2K computer bug through the sheer simplicity of having digitized money relieved of having to transfer debits and credits through the world banking system in ever-changing currency values. This goes to the argument that it would be impossible to have the kind of managed currency system we now have if it were not for powerful mainframe computers. Adding gold to the system removes the most serious element of complexity in the inter-connected world economy and sharply reduces the risk of what Greenspan calls "systemic failure."

The Asian crisis that resulted from the Asian currencies' link to a moderately deflating dollar should have provided a major warning to Greenspan and Summers and to the world's central bankers about the risks of Y2K monetary instability. But because Greenspan remains in denial about his role in bringing about that crisis, the lesson has not been learned. Conventional wisdom still holds that "hot capital flows" produced bubbles in Bangkok, which in turn spread through the other regional economies, and somehow even leaped across oceans to South America. We would normally expect the WSJournal editorial page to have been on top of this, making sure the lesson was learned, but it seems to be in bed with Greenspan on Y2K, staying mum on Mundell's recommendation just as it did on Kemp's exchange of letters with the President. The Political Establishment -- which controls the two wings of the same bird -- has decided to do nothing that might alarm the masses. Naturally, any problems that emerge next year will be blamed on the private sector for not being Y2K compliant, or individual Cabinet members for not having their agencies Y2K compliant. The President, Larry Summers, and Alan Greenspan all have their backsides covered.