Thinking about Markets and Y2K Jude Wanniski December 9, 1999

At our NYC client dinner Tuesday, I asked for a show of hands of those who had made investment decisions in which the Y2K computer bug WAS a factor. None did. I noted that one client not present had begun to accumulate some gold shares, but had lost ground on these thus far. I made the point that when gold leaped from $252 in September to as high as $330, I surmised that the first jump to $290 or $300 may have been due to a decline in liquidity demand when the GOP dropped all plans for a tax cut. The further increase, I suggested, might have been early Y2K speculation. This was no doubt an error on my part, as it cut against my year-long assumption that if anything there would be an increased demand for liquidity as we approached Y2K, which would mean a weakening of the dollar/gold price. It would not be until rollover that there would be a decrease in demand for dollar liquidity, and therefore gold would not begin to climb until the first of the year. The underlying assumption was that the Federal Reserve would not react to the surplus liquidity in the system by draining with open-market purchases of bonds. If real economic actors began to see more trouble in the domestic and world economy than they could see before rollover, there would be a reversal in employment trends, with pressure on the Fed to add even more liquidity to rescue the economy with monetary policy.

Senator Bob Bennett [R-UT], chairman of the Senate Select Y2K Committee, was our guest speaker, and the evening was totally devoted to the topic. Those who came worried about Y2K seem to have left reassured things might not be so bad. Those who came thinking things would not be so bad seem to have left more anxious. He was clear on one point, though, saying he expects zero GDP growth in the first quarter of 2000 and that we won't know the full effects until late March or April. The scenario gets much worse, he indicated, if there are systemic failures elsewhere in the world that feed back into our financial markets. His gloomiest prospect was for the countries that comprised the old Soviet Union, where he believes there will be greatest incidence of failure because the great majority of computers in use were pirated versions of old IBM machines that are the most vulnerable to failure. When asked why it would take so long to know the extent of the clean-up the world will face, he gave a theoretical example of an Italian power plant that goes down but is backed up by a diesel plant, but in two weeks runs out of diesel fuel and can't scrounge any more. A critical Italian supplier of SUV parts then has to inform General Motors that production will have to stop. Bennett also expressed worries about Japan's readiness.

On the domestic front, he expects the power grids to be functioning, where he wasn't so sure several months ago. He said the fact it is winter is a blessing, because there is surplus power in the system compared with summertime. One caveat involves the nuclear power plants, here and around the world. They supply 40% of the power in the northeast and 20% of the power for the country as a whole. A recent experience at one of the Indian Point plants in Westchester was troubling, when in the process of remediation, files critical to the running of the plant were destroyed and it took several days to rewrite them. It is a comfort to him that rollover begins in New Zealand and we will have 15 hours to assess the first effects. He personally will be in Utah at one of the two Y2K command centers, the other being in Washington. He readily acknowledges that the federal government has given the public a rosier sense of where things stand than is warranted -- on the theory that the public might panic if it were given a more sober assessment. Bennett will be the guest on CNN's "Evans&Novak" this weekend, and I assume he will shake things up a bit. I have been urging Bob Novak to get him on the show and he said it took weeks before the producers agreed, making the argument that because everyone knows there will be no Y2K problem, it will be a waste of time. Bennett says he hopes that in January everyone blames him for wasting our time. He did say he would have no fear flying the domestic airlines on domestic routes, but would not fly others on foreign routes. His greatest concern on the domestic front is with municipalities that are heavily computerized in their operations and are not as ready as they should be. He specifically expressed anxieties about Baltimore, San Francisco, and Washington, D.C., noting possible problems in dispensing food stamps and welfare checks.

It was when Bennett left to catch the DC shuttle that I asked for the show of hands on how many clients in the room had made decisions factoring Y2K. I reminded them about my "jelly bean" story, which I'd heard first from Jack Treynor, former editor of the Financial Analysts Journal. He would demonstrate the efficiency of the financial market by passing a jar of beans around and having each one in his audience guess the number and write it on a slip of paper. By adding up the total number of beans guessed and dividing by the number of guessers, invariably the audience would come within a few percentage points of the right number. In this case, I said, Y2K is making a demand on the market that is unprecedented. It is asking that we collectively guess the number of beans in a dark room, though we aren't even told how big the room is, nor where the beans are kept, and in how many jars. I'm more bearish than the market, I said, because Bennett two years ago urged me to start worrying about the problem with him, and Polyconomics has spent serious time going into that dark room and blindly feeling around. My greatest concern is of systemic failures in global finance, unless the Federal Reserve at the last minute takes the advice of Nobel Laureate Bob Mundell (who gives his Nobel lecture in Stockholm tomorrow) and fixes the dollar/gold rate and gets the euro and yen to also link. I wrote an op-ed outlining the idea for The Wall Street Journal, but it was rejected on the grounds that it wouldn't be adopted and would be like firing a "blank round." Instead, the editorial page Wednesday ran an op-ed, "Apocalypse Not," more happy talk from our political establishment, for which the WSJ now speaks.

If you haven't noticed, the equity markets have been acting funny. Records are being broken almost daily, but in the last month the advance/decline line steadily has been getting worse. There have been 7 advance days and 15 decline days on the NYSE but the aggregate tells a more troubling story, a total of 8222 decliners over advancers in the 30 days ending yesterday as the NYSE increased by 1%. The NASDAQ advance/decline ratio over the same period is even at 11 days, and the composite is up 15.6%. But the advance-decline aggregate is a trivial +118. In other words, take the 4500 NASDAQ stocks, add the total advanced and subtract the total declined, and the mountain of trading activity begat a mouse. The population hears day after day about the strength of the stock market, which invariably means good times ahead. It is of course the Internet stocks that look way, way ahead, past Y2K problems, which are causing all the excitement. The broader market is looking into that darkened room and getting nervous. When rollover arrives, it will be nice to have that long weekend to look around as the lights begin to come on, before the opening bell sounds on Wall Street. As Senator Bennett reminded us, the most serious mechanical problems might be addressed in the first 72 hours, but there will be dark corners that won't be lit up for a really confident assessment of the financial markets for at least another several weeks.