When my concerns about Y2K rose last year, I suggested we think of it as a storm that financial markets would have to discount. The markets know that storms come and go and for the most part can be ignored when assessing their risks to capital assets. Wars are a bit different, although Winston Churchill did title the first volume of his six-part history of WWII, The Gathering Storm. Recently, I happened to have an exchange with Ken Fisher, a West Coast asset manager who writes a column for Forbes. In his October 18 column, Fisher pooh-poohed Y2K, arguing Adolf Hitler and WWII was a greater threat to Wall Street, yet the S&P500 rose every year from 1942 through 1945. Sorry, Ken: The S&P 500 nosedived in 1939 when war broke out in Europe. With Pearl Harbor in December 1941, Germany following with a declaration of war against the U.S., the S&P 500 continued its decline until April 1942. The market then climbed, but it was not until June of 1944 that the S&P got back to where it was in 1939. It took Wall Street five months into 1942 before it could begin to discount a win over the Axis powers. Wars are not good for capital assets, but if you are going to war, you better win, or you will hold worthless paper, such as Confederate currency or Reichsmarks.
My chief concern about Y2K has been that it would be a systemic problem. Our Y2K analyst Paul Bond originally suggested the old-fashioned Christmas tree lights to express that concern: When one bulb went out, they all went out. Modern lights are set in parallel instead of in series. If most of the bulbs are "compliant," there will still be a well-lit tree when a number burn out. With this in mind, I read the two speeches Fed Chairman Alan Greenspan gave last week. The first, Thursday, was a routine lecture about how asset values change according to risks, which sent Wall Street into a swoon even though the theme would normally draw a yawn: "[I]nformation is critical to the evaluation of risk. The less that is known about the current state of a market or a venture, the less the ability to project future outcomes and, hence, the more those potential outcomes will be discounted."
On Friday, Greenspan gave a short speech that almost received no attention in the media, even though financial markets dropped steadily after he delivered it early in the afternoon. The speech sought to assure the markets that the Y2K computer bug was not going to be a problem, because the big companies have gotten on top of the problem. He expressed concern that consumers could cause the greatest problems if they panic. The speech was so low-key -- Greenspan never even mentioned Y2K, but referred to it as CDC (Century Date Change), which assured it would get less attention. He also is prepared to blame the markets (consumers) instead of the Fed or the government or the supposedly compliant big businesses. This key paragraph, though, got my attention: "There is nothing exactly like the Century Date Change in our historical annals from which we can infer its potential consequences. But as a standard for monitoring developments, it is simply unrealistic to expect our advanced technology to function any better on January 1, 2000, than it has on any other day of the year. Moreover, while systems may fail as they have in the past, these failures never have resulted in broader and persistent -- that is, systemic -- breakdowns in our economy. In the event of breakdowns short of systemic, history teaches us that businesses are remarkably adaptive."
If Y2K proves to be systemic, well that is another matter, one that Greenspan did not even touch upon. It may be that he believes the "CDC" will not be systemic, and the light bulbs will not go out all at once, but the way the speech was crafted strongly suggests to me that here too he is covering his behind. If the markets fall, it is because of irrational fear -- the opposite of exuberance -- by panicked consumers of stocks and bonds. If there is systemic failure and the world economy goes into a deep recession lasting who knows how long, Greenspan can say the consumers caused it, just as irrational exuberance led to the Wall Street Crash of 1929 and the Great Depression.Hurricane Floyd came along just in time to provide a useful metaphor. Floyd was a century-class event, one that could have torn the East Coast to ribbons if it had not swerved. When the most likely target was identified as Savannah, the million inhabitants were evacuated. What can you imagine the value of a $500,000 mansion, up for sale, would have been on the day before Floyd swerved, if it had to go at any price? It would attract buyers, but perhaps at prices no higher than the value of the real acreage beneath. In another 24 hours, the price would have bounced right back to $500K. That's the problem the markets have now as we approach a hurricane that may be systemic and may not be. Economist Ed Yardeni for two years has forecast a Y2K recession in 2000 that would be preceded by a market decline. The most intelligent of the doomsayers, Gary North, who is holed up in the Alabama woods with several years supply of stuff, has always based his pessimism on a conviction that Y2K would be a systemic failure of the first order. At www.garynorth.com, he continues to predict a market "Crash" before year's end. Our own Paul Bond, who had been writing increasingly hopeful reports as data improved, in his last report to our Y2K subscribers noted a general decline in optimism -- which has not been picked up by the mass media.
Two things impress me about North: First, he told me he instantly agreed with my analysis of the 1929 Crash when I wrote it in a 1977 WSJournal op-ed, even though it is ignored to this day. Second, and more importantly, is that for the two years I've been in touch with him, he has predicted that at Y2K there would not be a single port of the United States that would be Y2K compliant. Now, with a couple months left, the Inspector General of the Department of transportation has testified that we can't be sure that any of the 300 ports will be ready on time. If our ports are not ready to receive the exports of other countries, what does that say about the ability of other countries to export goods to begin with?
The testimony is chilling. Says North: "At 12 midnight on January 1, 2000 (a Saturday morning), most of the world's mainframe computers will either shut down or begin spewing out bad data. Most of the world's desktop computers will also start spewing out bad data. Tens of millions -- possibly hundreds of millions -- of pre-programmed computer chips will begin to shut down the systems they automatically control. This will create a nightmare for every area of life, in every region of the industrialized world."
We're not that concerned -- yet. My greatest concern, which I repeat for the umpteenth time, is that the mainframe computers that manage the floating exchange-rate system will not cooperate at Y2K. The port authorities should be able to handle Hurricane Y2K in a reasonable period of time, because of the ingenuity of the people on the ground. In every one of the ports, there will be people who know how to operate manually. This does not apply to the global banking and financial sector. If there is systemic failure there, we've got real problems, because so much of the economic universe and global living standards are made possible by modern finance -- which in turn is made possible by happy mainframe computers. This is why the dollar must be fixed to gold prior to Y2K or Greenspan's CDC, to reduce this gigantic problem by simplification. I'm doing all that I can to try to make this happen and am headed to DC tomorrow. It is a tough road.