'Y2K Economics 101
Jennifer Yourdon's Response to Mitch Ratcliffe's Rebuttal of my Y2K Outlook
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Introduction and Background
A few weeks ago, I wrote an essay entitled "My Y2K Outlook: A Year of Disruptions, A Decade of Depression." It apprently struck such a chord on the part of Ziff-Davis journalist Mitch Ratcliffe that he wrote a two-part rebuttal; part 1 is entitled "Economics 1010100010010011 ..." and the other is entitled "Daily Fix: How might Y2K bit the economy". I'm not sure how much this dialogue is actually adding to our mutual understanding of the Y2K situation, but since numerous people have emailed me to ask my opinion of Mr. Ratcliffe's commentary, I responded in a separate essay which I'll be uploading shortly. But since the entire argument revolves around the impact of Y2K on the economy, I asked my daughter, Jennifer Yourdon, to offer her thoughts and opinions on the matter.
Before you read Jennifer's response, you should probably read my original essay and both of Mr. Ratcliffe's articles.
Ed Yourdon
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Y2K Economics 101
By Jennifer Yourdon, Co-Author, Time Bomb 2000
Dear Mr. Ratcliffe,
Though I spend much of my free time at lunch scanning through the Year 2000 websites I have bookmarked in order to keep current on news and opinions, I typically do not participate in any of the on-line Internet debates on Y2K -- primarily because I don't have the time to spend my workday on non-work related activities. My full-time, non-Y2K related career keep me occupied enough.
I feel compelled, however, to respond to your recent essay. I understand you've have written some previous Y2K commentaries, which I have not seen, nor have I had the opportunity review and critique the second part of your essay. The current topic you've written about is an area in which I feel quite comfortable: I have a Bachelor's Degree in economics from Trinity College, and have taken both PhD and Masters level classes in economics and mathematics at NYU. I have worked on Wall Street since 1993, doing economic research for foreign exchange proprietary desks, building econometric models to forecast and trade foreign exchange, equity indices and interest rates at a hedge fund, and finally analyzing hedge funds and constructing hedge fund portfolios using portfolio optimization techniques, correlation studies, sensitivity analyses and risk/return research.
I won't comment extensively on your nitpicking of my father's Y2K essay except to say that his expertise in various areas of technology (which have changed and developed over time with the industry), not only Y2K, is generally undisputed. As he has admitted, and you pointed out, he is not a trained economist. I am. Are you?
For simplicity, I have put quotes from your essay in bold italic.
I am sure my father used the term "thoughtful people" to differentiate between those who have taken the time to think about/ research Y2K, and those who casually dismiss it, and wait for others to tell them what to do. I am sure my father would also label individuals as "thoughtful people" if they took the time to research their own risks and decided to do nothing -- he just wouldn't agree with them. I honestly do not think "Ed wants you to spend now, on supplies, and to change jobs, redistribute assets..."; he has always made it very clear that all he can hope for is that people do enough research on their own. In fact, I am sure my father has enough to do and isn't particularly concerned with what your plans are.
For the remainder of my comments, I'll focus on the section of your essay entitled "The Economic Argument", and will allow my father to rebut the statements made about his beliefs and opinions.
The economic argument
I agree that my father's analogy of throwing the monkey wrenches into the engine of the global economy is not one you would find in a classic economics text book. It is however, illustrative and self-explanatory. Anyone can understand the scenario that he was envisaging: no one Y2K-induced problem would be enough to spark a slowdown in the global economy, but several at the same time might be quite harmful. Indeed, I challenge you to build an econometric model forecasting the likelihood and severity of a Y2K-induced recession, when there are no data with which to do this. That is a key point: the Year 2000 problem has never happened before, nor has there been a similar economic event that we can use as a model. Finally, the 0.3% dip forecasted by some economists (not all as you imply) only takes into account unproductive spending being undertaken to remediate the Year 2000 problem. It does not take into account possible disruptions in business, credit tightening, business failures, layoffs, increased trade imbalances, power outages, oil shortages, or a decline in the stock market.
Actually, my father did discuss further his vision of an economic decline as severe in length and magnitude as the Great Depression. He specifically discusses Japan, which has been in recession (depression) since 1990. In Japan, the government deficit has risen to almost 10% of GDP, the stock market has declined by almost 75% from its peak, and unemployment has surged. His argument was that whether you call it a depression, or an extended recession, this is not an event relegated to the 1920s: Japan, once the economic powerhouse of the world (much like the US is now) has fallen sharply, and this could happen again in a developed country. You dismiss his arguments, which are that big companies are behind, small companies are behind, governments are behind, foreign companies and governments are behind. The likelihood of them all finishing and testing on time, at this late stage, is low. In addition, it is "yadda yadda" not "yada yada" ...you are obviously not from New York.
Your argument that there have historically been different rates of failure in different industries, and that where the failures occur is important, makes sense. I am sure my father would "recognize" this point also. In fact, I think that any person of average intelligence understands that business failures at certain levels in certain industries have a larger economic impact than failures in others. I question using 1992 business census data for corporate bankruptcies, though I understand these are the most recent census data available. However, I examined more recent payroll employment data, and found the manufacturing sector has been adding very few jobs, while the service sector has been adding four times as many jobs. In fact, in 1998 there were approximately 300,000 (seasonally adjusted) manufacturing jobs created, and approximately 1,200,000 (seasonally adjusted) service jobs (Source: Bureau of Labor Statistics). In fact, in 1991 (the year before your census figures), there were approximately 1,000,000 (seasonally adjusted) service jobs created, or a full 20% fewer than in 1998. Meanwhile, in 1991 there were approximately 285,000 (seasonally adjusted) manufacturing jobs created, or just 5% fewer than in 1998. These figures show that the growth in service-related jobs (and presumably the health of the service industry) has increased quite nicely, while there has been a rather paltry increase in the number of manufacturing jobs created every year. I would argue that this trend would suggest that the Internet and technology inspired economy of the past seven years has caused a shift in the general health of the service and manufacturing industries, and possibly in their bankruptcy rates as well.
As you note, some large manufacturers "have announced their intention to end business relationships with suppliers that cannot ensure deliveries in 2000." Have you seen any such event take place? Have you seen any large manufacturer publicly announce that they are now ceasing business with supplier ABC because it cannot ensure deliveries in 2000? Either it hasn't started happening yet, and/or large manufacturers are only saying that they will end some relationships to soothe/calm analysts who follow their stock. In addition, some manufacturers (General Motors comes to mind) have so many suppliers that they a) cannot realistically expect responses from all of them; b) probably have a few suppliers who are the sole producers of a few of the goods they require ("the only flange maker for diesel engines"); or c) work on a just-in-time inventory basis, so that an interruption in even one factory or plant can disrupt the whole manufacturing process, as happened in the GM strikes in 1998 and 1996.
It is correct that most economists refer to GDP, rather than GNP, when discussing the state of the economy, though you define both of them incorrectly. Gross Domestic Product (GDP) refers to the value of the goods and services produced within the boundaries of an economy during a given period of time, usually one year. GNP is the total market value of final goods and services produced by citizens and businesses of an economy in a given period, usually one year. Thus, if Coca-Cola produces bottled soda in Indonesia and sells them in Hong Kong, those figures would not be included in GDP, as the US economy doesn't directly benefit from this production. In addition, one term isn't "older" than the other. As economies have become more globalized, it has become more accurate to use GDP to describe the state of the US economy.
In fact, GDP is not one of the ten indicators that make up the Leading Economic Indicators (LEI) published by the Conference Board. The ten factors are: average workweek, jobless claims, factory orders- consumer goods pace of deliveries, contract and orders- plant and equipment, building permits, unfilled factory orders- durable goods, raw material prices, M2, stock prices, consumer expectations. This, by the way, is very easy to look up, I easily found it on my Bloomberg at work. It makes perfect sense that GDP is not included in the LEI because the GDP is not leading, it is old news. GDP is reported quarterly, and is reported approximately a month after the end of the quarter, so a full third of the data is from four or five months prior.
My last point on your GDP discussion: if a 1.0% decline in 5 of the 10 LEI indicators is a "strong recession signal", then why hasn't it been accurate in forecasting a recession? There obviously isn't a high correlation between the two events!!
There probably is no one "compelling driver of cyclical activity" at any one time. Certainly, the importance of any one factor changes over time as conditions change. To argue that stock prices are not important to the overall health of the economy is ludicrous. Stock prices become even more important to the health of the economy after a long bull market, where individuals wealth has been multiplied several times over. Perhaps you have never heard of the "wealth effect." This is the phenomenon of wealth being created or increased as the value of investments rise. If you make $100,000 in the stock market this year, you just might consider changing your spending plans. Similarly, if you lose your entire net worth in the stock market this year, you also might consider changing your spending plans. This is how the stock market affects the economy! So you'll know I am not alone in this opinion, I excerpted just a few key sentences out of Federal Reserve Chairman Alan Greenspan's recent Congressional speech:
"The outlook for spending continues to be obscured to some degree by uncertainties about the course of equity prices; a failure of these prices to match the outsized gains posted in recent years would contribute to some moderation in spending growth, especially by households.
Along with the numerous other uncertainties that attend the outlook, an additional uncertainty is present this year because of the approach of the year 2000 and the associated Y2K problem.
At the same time, the wealth of households recorded another year of substantial increase, bolstered in large part by the continued rise in equity prices.
The rise in net worth probably accounts for much of the decline in the personal saving rate over the past few years, to an annual average of « percent in 1998.
With wealth rising faster than income over the year and with consumer confidence remaining at historically high levels, households were willing to boost their indebtedness to finance increased spending.
Federal Reserve surveys indicate that banks responded to the turmoil in financial markets by tightening standards and terms on new loans and credit lines, especially loans to larger customers and those to finance commercial real estate ventures. The tightening reflected the less favorable or more uncertain economic outlook as well as a reduced tolerance for risk on the part of some banks."
Federal Reserve Chairman Alan Greenspan
Humphrey Hawkins Testimony February 23, 1999
Just to summarize a few salient points: 1) the outlook for the economy after an unprecedented run-up in equity prices is uncertain, as consumers have been adjusting their spending plans as the value of their portfolio rises; 2) the outlook for the economy is uncertain given the unknown impact of Y2K; 3) a substantial portion of individuals' increased wealth in 1998 was due to the increase in equity prices; 4) as wealth rises, consumers are willing to save less, and even borrow, to spend more; 5) when the financial crisis occurred in the late/summer and fall, not only did it impact consumers' wealth, but it impacted financial institutions' willingness to lend to consumers.
To make this as clear as possible: if there has been a big increase in wealth because of a bull market, if stock prices fall, individuals often want to spend less, banks are often less willing to lend to people (who want to buy cars and homes), sales tend to fall at corporations, and layoffs are possible. These are all key ingredients to a recession. Perhaps you would like to send your argument about this to Mr. Greenspan.
......
yourdon.com |
