Ed:

Are the Scenarios realistic?

I don't know if I completely buy into your scenarios. A serious Y2K problem is not going to be like a recession or a depression. Y2K will be an inflationary event, not a deflationary event. When the flow of goods is disrupted, the price of those goods will soar.

The depression, on the other hand, was a deflationary event. Prices fell and companies could not make money. There was too much productive capacity, not too little.

The US has seldom experienced an episode such as this. It will be more akin to a famine, a war or a revolution than to a depression. Probably the only example in US history is the South during the Civil War.

Let us assume that oil is in short supply. Producers who are compliant and have productive assets will experience enormous profits. They will work vigorously to increase production and will plow profits back into buying non-compliant oil companies and making them compliant. This will then add to profits.

Nothing like this went on between 1929 and 1941. Am I missing something?

-- Dick Patton (patton@ra.msstate.edu), August 15, 1999

Answers

Dick,

It doesn't have to be "either-or" with respect to inflation/deflation; I think it's possible to have both. If the supply of "necessary" items shrinks, then prices will rise as consumers compete for the privilege of acquiring those few items.

On the other hand, much of what is produced and consumed in society today is non-essential, at least in the North American marketplace. If, say, Nike managed to muddle through Y2K and continue producing high-priced jogging shoes, but nobody can afford to buy them, then we have a deflationary situation.

Also, it's worth noting that we're on the verge of a deflationary crunch already, without Y2K -- i.e., because of over-capacity of factories in Asia.

Ed

-- Ed Yourdon (HumptyDumptyY2K@yourdon.com), August 17, 1999.

I think that Dick is right. I am also anticipating that inflation, rather than deflation, is the more likely outcome of Y2K. We will certainly have price inflation on a wide range of goods due to supply chain disruptions and shortages. Furthermore, if it turns out to be anything less than a 10 (and something in the 5 - 8 range seems to me to be the most probable outcome), then the FedGov't will be motivated to do anything -- ANYTHING -- to keep at least the big money center banks up and running. If the bank runs, cascading cross-defaults, and the rest of the deflationary spiral starts to unfold, then there will only be one way to stop it, and that is by countering it with a massive increase of the money supply -- HYPERINFLATION. If you don't know what that means, go back in read the history of Germany in the early 1920s. Oh, and make sure that you own a wheelbarrow -- you might soon find your billfold to lack sufficient storage capacity for cash!

Remember, also, that the politicians are counting on running surpluses as far out as the eye can see. What are they going to do when the Y2K recession wipes their surplus out? Most governments have found the temptation to inflate the money supply when times were difficult to be almost impossible to resist. Does our current government give you the impression that they possess the strength of character to resist doing the wrong thing, regardless of the consequences?

-- Stefan Stackhouse (stefans@mindspring.com), August 16, 1999.

There's no point in wiping out the creditors of the economy with hyperinflation, in an attempt to save the debtors. After the creditors are bankrupt, there's no one to hire or lend to the debtors. They end up just as badly as if there had been deflation. Can you point to a case of hyperinflation that helped? Plus, rich people make policy, and have more to lose.

Better to just let bankruptcies take their course, and tax the well off to support the very poor. Let the economy shrink until demand hits bottom. Then it can start growing again.

My impression is that Japan has not been willing to go this route. They've tried to avoid massive bankruptcies, and have chewed through $100 billion+ in the attempt. If you believe they've eaten most of the postal savings accounts, then the totals are even larger. This will just make the eventual contraction even more painful.

Shortages could drive up prices temporarily, but soon businesses are closing and purchases drop dramatically. I don't think a shortage of luxury cars would be a problem for long, for example! Food variety might go down, but if quantity is severely affected, we're not just talking depression.

-- Michael Goodfellow (mgoodfel@best.com), August 16, 1999.

My 0.02 is that as long as there is some kind of centralized banking control over the economy--something like the Fed setting the Prime rate and controlling the money supply--there will be a tendency towards deflation. The big wig bankers will simply opt to tighten the money supply so tautly that it will be impossible for anyone but the hardiest to stay in business. Since there will be so many poor people who can't spend their money, the problem is mediated so that there is a shortage of demand, not a shortage of supply. If this means sending every man, woman, and child to the poorhouse and sending unemployment over 30%, so be it.

If there is no central financial authority in place to put the brakes on the economy, there will be shortages of supply at first, not demand. Prices go into runaway, hyperinfination. This stagnates the economy and likewise sends us into a depression. In this scenario, prices are HIGH and everyone's out of work. In the other scenario, prices are lower and everyone's out of work.

I guess if we get a 1930's style depression with the central banks remaining battered but intact, we can count on deflation. If worse, we can count on wheelbarrows o cash.

-- coprolith (coprolith@rocketship.com), August 16, 1999.

Four things have driven the 90's economy. Low crude oil prices, low interest rates, a housing boom, and increased business efficiency through just in time delivery (The IT Age). As of today 8-16-99, crude oil prices are way up from the first of the year, lumber prices are the highest they've been in three years, and mortgage rates just went north of 8% (more to come). Anything that knocks the pins out of any of these four things has a negative impact on the rest. Put Y2K in the mix, (who knows what's going to happen? Nobody, but something will happen) and there has to be a negative impact on the economy. Then, I read about a month ago that 2% of GDP was stocks leveraged on margin! I'm curious, am I missing something here, or does anybody else see a setup for a major change? It ain't going to be the end of the world, but it might seem so for the generation or two that belives they're entitled to a 20% return in the stock market, and a 6% home loan. (By they way, if you have an Adjustable Rate Mortgage, it's going to adjust.)

-- Curious in Oregon (Danlg@aol.com), August 16, 1999.

If we have a 8-10 severity, then very few will have cash to buy anything.The electronic money will disappear. Most people will not have cash or gold to buy anything. The ones with goods for sale will demand whatever the traffic will bear. They will have no assurance of re-stocking, since it is J.I.T. warehousing now.We are interdependant. The dominoes will fall.It will take years to regain some semblance of our present efficiency. Meanwhile, many will die. Jube

-- Jubilation T. Cor npone (logic@nd reason.com), August 16, 1999.

Although inflation and deflation are useful descriptors of an economy, for historical or regional comparison, we should also consider that y2k may cause changes that are so dramatic that they are difficult to understand by "classic" methods.

My reply to Dick, who started this thread, is that he should spend some time over at garynorth.com. Dr. North may not be right about all things (he doesn't really want to "waste time" with discussing any scenario better than 10) but he does spend a lot of words on the issues of money supply.

One of the points that often get missed in the discussion is that spending is not only determined by money supply. It is also a factor of a mysterious thing called money velocity. What really made the depression severe was that the destabilizing effects of deflation could not be countered by the government increasing the money supply because people were not willing to borrow the money and spend it (i.e. create velocity). In the end, the government had to dream up large public works projects to spend the money into circulation.

Stephan warns of the potential of a repeat of Hyperinflation caused by the German Gov't printing cash. This is almost an impossibilty today if you are talking about cash. In Germany at that time, a large number of transactions were done in cash, and the Government used newly printed money to purchase goods to supply the army. They contributed heavily to the pool of cash while at the same time removing goods from a limited production base.

The modern problem is much different. The US money supply is about $7 billion and is primarily "digital" (numbers in computers which are printed on bank statements). There is about $350-500 billion actual cash dollars on hand. So only about 5-7% of the total money supply is green cash. Up to 60% of this is believed to be overseas where it serves as legitimate reserve money as well as "grey-market" currency. The safe bet is that most of the small bills are in America and most of overseas cash is in 50s and 100s.

Most Americans pay the larger bills by bank transfer, check, or credit/debit cards. The small bills are used for the small things. 80-90% of the money that changes hands each day is between businesses, which is almost 100% digital transfers (i.e. ATT does not send $2 million in green cash to Dell Computer when they buy 1500 new PCs.) The rather small "amount" of physical cash is actually out there being used a lot. This means that for green cash, there is a high velocity.

Now here comes the first effect of y2k. There is a "danger" that enough banks will have trouble accurately managing their "digital" accounts such that the entire banking system begins to slow down or even almost stop. At this point, almost 90% of the money supply could be either frozen or moving like cold maple syrup. Any money which is locked out is a reduction in the money supply. Any slow down lowers the velocity. When people begin to understand that green cash is "more valuable" than a bank statement, they will decide to "hold on to it" and this dramatically reduces the velocity of cash.

If cash is the "only means of payment" available (other than trade or barter) because all the bank balances are frozen, then prices (even for the most essential items) could fall because cash is still rarer than food.

Now comes the next problem. If lots of families and businesses have gone bankrupt because even though they had deposits, they lost access to them for too long, then huge amounts of debt may never be repaid. Eventually the banks will find ways to make the money of depositors available but this will also put a lot of pressure on debtors. In this scenario, with a significant amount of losses made, excess money will be used to pay debt, not to buy goods. There will be a lot of pressure for people who have money to pay their debts. Thus, there will be a relatively small number of people who have enough spare cash to bid up the value of many things.

The third threat (or maybe its a blessing) is that a large amount of the economy will be driven to bartering systems or newly created local money methods. For example, you might pay the doctor in some form of local currency but have to use dollars to buy gasoline.

The fourth threat is that the lack of accurate information makes it impossible for the "government" to gather "accurate" information about the economy. In the lesser scenarios of 4,5,6, where the government is still fairly intact, there will be announcements made about the GDP or price inflation but how do we prove it is accurate?

-- Thom Gilligan (thomgill@eznet.net), August 17, 1999.

Think stagflation, like an oil shock, and large changes in relative prices.

-- nothere nothere (notherethere@hotmail.com), August 17, 1999.

A couple of comments.

First, Thom, I am very familiar with Gary North's opinions.

Second, while I think that all of the comments have merit, they all miss what I was trying to get at. I've had a couple of days to think it over. Here goes.

What I am missing is attitude. Emotion. Uncertainty. Depressions, which include loss of money velocity and the other things Thom alluded to, come from self-doubt. Economics is ultimately about how we feel about things.

Think of it this way. If you are a Japanese investor unfortunate enough to invest at the top of the bubble, you lost money and TRUST. You have uncertainty - why did this happen?

Question: Are you going to lose trust in your banker because some geeks were too lazy to use 4 digits? Y2K isn't going to have that kind of ripple effect. It's one thing when bankers screw up, and an entirely different thing when technologists screw up. Y2K will give an image of bankers as honest, but clueless.

So I think perceptions are as important as reality, in fact they are part of reality. If a Y2K disaster hits, people are going to be

1) hopping mad at the geeks 2) filled with energy to fix the problem and get on with their lives 3) demanding of the politicians to fix the problem

I could see a Manhattan-type project in which technical people are drafted to serve their country. I can visualize a government moratorium on debt repayment during the crisis. I can't visualize despair, because this is the type of problem that can be fixed. That's why I don't like the scenarios - they all seem to refer to experiences in the past when no one really knew what was wrong, even though everyone had an opinion. When confronting a problem, knowing what's wrong makes a big difference in the speed and determination with which the problem is attacked. That may not make a big difference in the first year, but as the technical problem gets fixed, I can't see the aftereffects lingering for a decade. The despair just isn't there.

-- Dick Patton (patton@ra.msstate.edu), August 17, 1999.

I'd like to speak to the original post, and then some of the responses. First, I'd say that the prices of necessities will quite possibly go up. How much is dependent on the severity of shortages AND the perception as to that severity. Secondly, I'd say that the prices of "frou-frou" items will decline. I think most people's focus will change away from the high percentage of time spent in some variant of pleasure, and more on "making it through".

Insofar as money's velocity, consider the example of my local bank. They have fixed five computers which were obviously non-compliant. As near as they can tell, all's well, internally. Everything is backed up on both floppy and paper. Then, they plan on no inter-bank computerized communications for the first day or two of 2000. Their first i-b-c-c after that will be via one stand-alone computer to see if there is contamination from outside. I have to believe that other banks have made that sort of plan.

Any comments?

Regards, Desertrat

-- Desertrat (arthur@surfsouth.com), August 18, 1999.

.....my compliments on the debate point and counter-point, but I have come to the following conclusion:

Our society, as a whole, in ALL it's diversities, tangents, and common threads, is as a great square of cultural cloth, each side under Extreme, but equal, pressure, and each side committed to keep the equilibrium, either by chance, purposeful design, or governed force.

Put a small hole in that fabric, and there lies within the rest of the whole the strength to hold the cloth together, thus preserving it's integrity.

Blast it through with thousands upon thousands of those same small holes, and under the very same pressure of yesterday, the integrity of the whole is compromised, and the remnants that seperate and fling themselves away from every other fragment become scattered, soon to become of so little worth in a new age, with the possible exception of becoming the words to be placed among the literal writings of future historians as they struggle to make some sense of what should have been a very controllable situation.

Personally, I resent being placed in a situation of threat by those who have been elected or are in positions of influence, where 'they' should have had the moral backbone to stand up and face the future, whatever it might hold. There is so much cowardice around us.

Now, after thousands of hours of sleep-hungry research, personal professional experience, and careful reflection (because I can think for myself), the actions I feel forced to take to insure the safety and well being of my loved ones, to what I have concluded to be a viable threat, are called 'extremist' and 'unnecessary'.

Why?

I am intelligent, college educated, and a professional.

I have endeavored to share the logic behind my decision to others only to be summarily dismissed as a 'nut case', when my only interest has been the responsibility I believe I should have for the welfare of my fellow man and the preservation of a hopeful future for my children.

We want so much to dot the i's and cross the t's and find validity in our viewpoints in the careful reflections of others, but there MUST come a time when we abandon all speculation, gather our courage, choose 'That' path and vigourously set down it's course.

I just hope that the course's we all choose independently will be the best course for us all.

-- mike mercado (cinderelaman@lds.net), August 29, 1999.

From: Y2K, ` la Carte by Dancr near Monterey, California

much of what is produced and consumed in society today is non-essential, at least in the North American marketplace. If, say, Nike managed to muddle through Y2K and continue producing high-priced jogging shoes, but nobody can afford to buy them, then we have a deflationary situation.

If a discussion of selective deflation goes into the book, a better example of a luxury can probably be found. In a world of drastic oil shortage, and increased pedestrian traffic, a foreign made high quality durable and comfortable shoe should be in high demand. Many Furbys will probably go unadopted, though.

-- Dancr (addy.available@my.webpage), September 07, 1999.

Gotta get my $.02's N: I do agree with Mr. Ed Yourdon in that a Y2K-induced recession will likely be both inflational and deflational. I think it will be a mixed bag but ultimately will be more deflational more lasting, and more severe than what Mr. Greenspan, the PR Man, would have us believe. I think the intensity of any recession (including a severe recession or even depression) will directly correllate with the intensity of Y2K problems felt by the public and in relation to how well (or poorly) our communities, our leaders, governments, emergency response teams, military, and businesses respond to any crises.

I think we may see both an acute and chronic severe recession. The acute part may well spike in weeks following embedded systems failures that will mostly occur in the first few days of Jan. Then, the financial/corrupted data failures will start streaming and trickling in after the end of January.

Once we think we have a handle on embedded systems problems (that's IF we get a handle on them), we could then experience a second-wave of embedded problems on Feb. 29 which is the first century leap year in 400 years and has a different mathmatical formula than standard 4-year leap years.

If any of the embedded systems problems are wide-scale or catastrophic in nature in early 2000, and it would probably only take one major catastrophy to rock public confidence, the stock market will take an immediate dive,especially as the global markets are being rocked by Y2K. If embedded systems failures surface and cause true hardship or disaster to a population center, the public will react in a demanding, angry, and betrayed manner.

Then to compound a bad situation, we will enter the more complex, silent, and corrosive long-term aspects of Y2K. I also believe that international stock markets will crash or be rocked severely. When that happens, it will ripple through our economy and cause more instability. Yes, foreign investors may find a safe-haven in the US but that will likely happen pre-2000 than during the initial Y2K aftermath. When international stock exchanges collapse, our own system will falter, with or without our own domestic Y2K problems. We are a castle built on the sand. One wave may not wash us out but a series of waves or even smaller ripples, over time may take the castle down.

However, if embedded problems are contained early or are only minor in nature, we may temporarily avoid an immediate sharp downturn in the economy.

But, next will come the more silent yet corrosive aspect of Y2K. Once skewed financial data and corrupt data starts steadily trickling in from everywhere, and as more systems become contaminated, the real economic crisis will begin. This aspect will likely be chronic and difficult to climb out of.

During this turbulence, other nations experiencing severe hardships from embedded failures (if not our own), could be rioting and in states of varying degrees of chaos or emergency. Let's also remember that many of these countries, will hold the West responsible for their calamities, hardships, and downfalls since they relied on our wonderful technology and because we, as the world leader, failed to enlighten them earlier on. At the same time, all those trusting Americans will also be holding their politicians and governments accountable. It could be a real damn mess.

Economics is NOT a science and any economist who thinks they can accurately pinpoint turns in the economy, is only guessing based on what they hope is accurate information. Y2K has been noted for its lack of accurate information (in almost every aspect) so while I dismiss Mr. Greenspan's speculations, I'm give him credit for a tough public relations job he has in trying to create the illusion (delusion?) of future economic stability.

Economics is based on supply and demand but is founded on emotionalism and consumer confidence. Our stock market can crash and burn just like that. It really doesn't take a whole lot. That is why Mr. Greenspan (our PR Man) is so concerned about pre-2000 panic and wants to GUIDE you in your thinking and consumer behavior. He (the government) can't alter human-nature reactions to bad news. All they can do is alter or spin-doctor the news. People don't like to feel gullible and foolish, even doomers. So, how can they try to avert pre-panic? By launching a successful yet fairly silent media campaign to make those believing in preparedness appear foolish and gullible to the vast majority still riding the Y2K fence.

The irony is that it may well turn out to be the pollys (and all those riding the fence leaning towards pollyannaism) that end up causing any pre-2000 panic. Many of those now scoffing or in denial, will take the "just in case" mentality, as media attention heightens in the wake of New Years. They may fulfill the very bank-run and food/water hoarding self-fulfilling prophecy that Mr. Greenspan so adeptly warned them of. Those believing in preparedness will have already prepared and not be a part of this. A shame the government did not preach preparedness when there was a large window of opportunity to do so without causing public panic. That window is almost shut now. What a shame...

Attention All Pollys: There aren't gonna be many Mickey-Dee burgers moving after eating da "BAD CHILI." See recent Westerguard article. We may be passing more gas than the Venezuelan pipelines...WAKE UP AND SMELL DA COFFEE!!! GET YOUR HEAD OUT OF THE SAND, MAN!!!

-- L. Scott (Scottl@ttc.com), October 19, 1999.