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Y2K

Do I demand the libertarian principle as an individual to indulge my pursuits even if I end up looking like a fool? You bet I do.

I was tempted to confess something akin to an Alcoholics Anonymous introduction session – “Hi, I am Roland and I am a Y2Kaholic”. But, you know, my bruised ego demanded I place myself in the more neutral position between “pollyanna” and “doomster”.

Thus, such millenarian thoughts went through my head as I recently took a couple of bags of basmati rice to the local dump along with some other food that I had stored but which were now well past their sell by date. The operator of those scary machines that pulp and cube everything cast into them took a look at the bags of rice and refused them entry into a final, congealed mass grave. In his broad East Edinburgh accent, he said, “Ah’ll feed them tae the burds!" I guess his machine was not Y2K-compliant in a broader sense of the word, but at least the food was being put to some use.

When I made my own degree of risk-assessment regarding Y2K back in 1999, I bought a few shopping cartloads of food and stored them in the attic. With the anonymity gleaned from participation on various Y2K Internet discussion forums, I told no one lest the hungry hordes came banging at the door looking for my hoard! Furthermore, I assured myself this was an investment akin to a house insurance premium but with the added bonus that I could eat it come what may.

That sounded like a win-win situation until I decided that the hot pies and deliciously filled sandwiches which private enterprise continued to supply in the year 2000 always won out over boring cans of tuna and processed ham. I reckon over half the food supplies did not get eaten and ended up being dumped but the tuna still has a sell-by date well into 2003. Perhaps those Edinburgh birds still have a treat ahead of them.

I suppose it was not just intellectual vanity that made my ego stop short of the label of Y2K doomster. By profession, I am a software engineer who works with embedded software that runs direct on chips. It was this class of device that was mooted as being the death-knell of Y2K remediation as there were too many of them and too inaccessible.

No one denied there were millions of these mission critical chips deep inside oil refineries, nuclear power stations and pipelines. But, as such a class of engineer, my simple question was “Why does such an inaccessible device need to know what year it is?"

Users of the UNIX operating system may be familiar with the concept of year ignorance; the internals of that system simply count ticks since January 1st 1970. It doesn’t care what year it is and it leaves such niceties to the applications which interface with the biological devices that do have an interest with such a concept – us. (As an aside, UNIX will have it own problems with this tick technique in about 36 years when most of us would have shuffled this mortal coil.).

Meanwhile, Leviathan was optimistic of the outcome and assured all that Y2K would come and go with minimal disruption. They were right, I was wrong and that is a rare admission for me to make. With hindsight, though, I should have expected the State to have said nothing else. When the State does wield its pretended omniscience as regards man-made or natural disasters, it quickly realises that it is sometimes no more prescient than a Babylonian Statist looking at animal entrails cast upon an altar to Merodach. It is very much a “fix-on-failure” policy when it comes to disasters as September the 11th has shown and that was the line to be taken as regards Y2K. They won with the latter but not the former as these implicit gambles go.

I say they were right and I was not, but my worry was with the lesser-developed countries and the knock-on effects that any trouble in their infrastructure entailed. This ripple effect, I deduced, could have economic implications for the better-prepared West. So, I moved my investments from equities to cash and waited and watched. The London stock market continued its bull surge right up to the very last hours of December 31st 1999 as it struck almost 7000 and then with an eeriness of precision proceeded to spend the first 22 months of this millennium drifting down to 70% of its peak value. The New York stock exchange followed suit a few weeks later as the DJIA hit its all time high and then began its meandering course downwards. What happened to the NASDAQ needs no further comment.

There was no obvious impact of Y2K in the world outside and yet the markets began a bear market in January 2000 that suggested Y2K but offered no evidence of it. As I recently pondered this uncanny timing, I was mindful of a prediction made by a christian that seven years of fat would be followed by seven years of lean in the economic West.

Then again, it did not take the divine to see that a bear market was overdue when one considered the implications of the Austrian Trade Cycle Theory on that period of credit bingeing. My thesis would then be that the period of Y2K spending was the final straw that broke the back of an excessive period of easy credit.

One important fact to consider was the total cost worldwide of remediating Y2K-vulnerable software and hardware. This either involved fixing the old equipment or replacing the whole system with an up to date configuration. One estimate I have seen was between $300 to $600 billion worldwide. Another study concludes a mid-sized company of 8,000 computers may have spent about $4 million on remediation costs. Indeed, it suggested that only the costs of environmental and asbestos litigation and compliance might have ever exceeded Y2K costs for companies.

This estimate has more relevance when compared against corporate profits made worldwide over the heaviest remediation period from 1998 to 1999. According to the WSJ, the top 100 largest public companies made a combined profit of just over $300 billion in 1999. Add the lesser profits for these companies in 1998 and we get a number approaching the upper limit of Y2K remediation costs. Of course, total worldwide profits of all companies with a critical investment in computer technology will boost the numbers even more, but it is obvious that remediation could be a significant hit on profits (or debt if the company was not doing well).

That is, of course, assuming that the corporate accountants allowed the cost of Y2K bug fixing to hit the profits just mentioned. If an old system had to be debugged, the costs have to appear in that year’s accounts. If the system is replaced with the latest and more distributed systems, then that is a new asset and the cost can be capitalised over several years. In other words, the fiscal profits above may not immediately reflect the true cost of remediation. Nevertheless, the cash still had to be found to pay for these compliance fixes.

Thus, the upshot for many would be that old mainframes with proprietary applications were tossed out in favour of more advanced and maintainable systems. It is even argued that this overhaul improved efficiency and productivity and hence profitability. That may well be, but what we saw was a spending frenzy on IT equipment in 1998-1999 which must have helped propel the NASDAQ to greater heights as well as the DJIA to a lesser degree.

The knock-on effect of this was three-fold.

Firstly, the blitz of spending in 1998-1999 must imply less spending in the subsequent years, as companies must live within their means and budgetary spikes have to be smoothed out. Unless, of course, debt is taken on to sustain budgets.

In other words, and secondly, debt must increase. By how much this debt increases is an interplay of cash revenues and credit facilities. If profitability is not good, then credit is needed. How much that credit can increase by depends on the interest rates set by the central banks. As we will see, the Fed and others had a part to play in the ultimate effects of Y2K.

Thirdly, we must ask what the money would have otherwise been spent on? It is a bit like the government telling us that spending a few billion dollars on rebuilding the World Trade Centre is good for jobs and the local economy. It certainly would be, but it sure would have been spent somewhere else anyway and probably more efficiently (though admittedly less high-profile than making such a symbolic statement against terrorism).

As stated earlier, upgrading the entire computer system may indeed improve internal efficiency in the long term, but it doesn’t really help the company make its products more efficient and attractive in the way that funnelling the money into R&D would achieve. The point, though, is a bit academic, since it was remediation or corporate death for many.

The obvious answers to where the money could otherwise go (assuming a profitable company) are shareholder dividends, debt repayment or reinvestment in the company’s product development through staff and specialised equipment.

So, if you lower the expected dividend, the share price can go down.

If you rein in spending on expansion, the order books and hence quarterly profits of other companies suffers. Ultimately, their share prices can again go down.

If you defer or even increase debt repayments because remediation costs were too high, this again eats into quarterly profits and the share price eventually suffers.

Many predicted a recession because of Y2K, something of that genre may have visited us, but for monetary reasons rather than infrastructure failures. But, in the final analysis, is this a criticism of capitalism and individual choice? By no means.

Progress is all about taking risks. Many fail in the risks they take and enter bankruptcy and obscurity, or, in my case, a visit to the local dump with unused food. In the case of Y2K, the risk taken by corporates was not to do nothing and take a chance but in the late timing of the start of remediation work and hence costs.

With hindsight, this made eminent sense as opposed to a centrally planned solution, which may have arbitrarily set milestones and deadlines.

Firstly, if a company on its own sets out to remediate its systems in 1979 or 1989 rather than 1999, then the hit on expansion plans would have given their competitors an edge. However, if everyone is busily remediating their systems, then each company can be confident that any loss of competitive advantage is cancelled out across the sector. To put it another way, survival of the fittest initially demands non-compliance.

Secondly, why should your typical company in 1989 assume they will be around ten later? Only invest the money when you are sure you will be around to enjoy the benefits of it.

Thirdly, the more money invested successfully in 1979 or 1989 on the company goods and services will reap greater potential rewards via compounding than if it was put into something with no immediate reward.

So, though, R&D may suffer short-term, the savings and investing of the intervening years of the eighties and nineties made up for that. The execution of the free-market assault on Y2K was timed to perfection, so perfect indeed, that many wondered if it was not too late. Never fear, laissez-faire is here.

To that it must be emphasised again that the current bear market is not the fault of Y2K per se. The increase in the money supply engineered by the Federal Reserve (and other countries) from 1996 to 1999 undoubtedly fuelled the level of Y2K debt. That time window of credit opportunity allowed an increased proportion of the upper remediation figure of $600 billion to be taken on as debt rather than prudent use of revenues and reserves.

The increase of debt burden created by Y2K on top of the mountain that already existed in conjunction with the withdrawal of future spending on other goods and services necessary to generate revenues to service debt was the tinderbox spark to a change of perceptions. When the central banks reversed the downward trend in interest rates in 1999, the tinderbox of debt exacerbation was fully dried.

So, I am still sitting on cash waiting for the opportunity to get back in and it is obvious to me that my risk assessment regarding equities in 1999 was partially correct and paid off. Timing the re-entry in may require a bit more wisdom.

I started this series of thoughts by claiming the libertarian right to take the risk of ending up looking like a fool. This was the case with cans of tuna but not equities. I now also claim the laissez-faire right to adapt and learn from my mistakes without any handholding from any Statist Department of Better Citizenship.

I'll just pick myself, dust myself down and start all over again!

November 18 , 2001

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