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<nettime> Roberto Verzola's latest Y2K analysis
Patrice Riemens on Thu, 26 Aug 1999 19:38:57 +0200 (CEST)

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<nettime> Roberto Verzola's latest Y2K analysis

----- Forwarded message from Roberto Verzola -----
----- fwd from the interdoc-y2k list ----

Date: 24 Aug 99  14:32:54

Y2K: The Homestretch
by Roberto Verzola

     As Y2K preparations reach their homestretch, fund movements caused by
the Y2K problem's differential effect on the perception of financial risk
associated with various countries, markets and firms will become a major

     This concern should be especially intense in Asia. It is here where
fund movements in 1997 caused a currency crisis that triggered
bankruptcies, recessions and devaluations in vulnerable countries that
eventually included Russia and Brazil. 

State of Y2K readiness

     Last July 22, Inspector General Jacquelyn Williams-Bridgers of the
U.S. Department of State testified before a U.S. Senate Special Committee
on the Y2K Problem, where she reviewed Y2K-readiness worldwide: 

     * "Approximately half of the 161 countries assessed are reported to
be at medium-to-high risk of having Y2K-related failures in their
telecommunications, energy, and/or transportation sectors. The situation
is noticeably better in the finance and water/wastewater sectors, where
around two-thirds of the world's countries are reported to have a low
probability of experiencing Y2K-related failures"; 

     * "Industrialized countries were generally found to be at low risk of
having Y2K-related infrastructure failures, particularly in the finance
sector. Still, nearly a third of these countries (11 out of 39) were
reported to be at medium risk of failure in the transportation sector, and
almost one-fourth (9 out of 39) were reported to be at a medium or high
risk of failure in the telecommunications, energy or water sectors"; 

     * "Anywhere from 52 to 68 developing countries out of 98 were
assessed as having a medium or high risk of Y2K-related failure in the
telecommunications, transportation, and/or energy sectors. Still, the
relatively low level of computerization in key sectors of the developing
world may reduce the risk of prolonged infrastructure failures"; and

     * Key sectors in Eastern Europe and the former USSR are "a concern
because of the relatively high probability of Y2K-related failures". 

Failures in every sector, region and level

     Bridgers did not report how much of her assessment was based on
self-reported progress, and how much was based on independently-audited
reports. Since many Y2K progress reports are not audited and therefore
tend to be too optimistic, the situation could actually be more serious
than reported. One also wonders how the financial sector can be at a low
risk while sectors it totally depends on like energy and
telecommunications are at high-to-medium risk. 

     Bridgers concludes: "the global community is likely to experience
varying degrees of Y2K-related failures in every sector, in every region,
and at every economic level. As such, the risk of disruption will likely
extend to the international trade arena, where a breakdown in any part of
the global supply chain would have a serious impact on the U.S. and world

     As actual reports/rumors of Y2K failures come in, the perceived risks
per firm, sector, and country will change. And as these perceived risks
change, fund managers and depositors will keep moving their funds away
from high-risk areas towards low-risk areas. 

     This is simply rational economic behavior, part of the cold logic of
finance and investment. This is exactly how fund managers behaved, when
they withdrew their funds from Asia in 1997 to move them into areas of
lower risk. 

     These sudden fund flows bear watching. 

     Most well-informed fund managers would have access to similar
information and will therefore tend to move in similar directions.  Those
who lack information will tend to follow the placement decisions of the
better-informed. This leads to "herd behavior," a follow-the-leader or
follow-the-crowd strategy which tends to magnify small changes and cause
huge impacts. 

Beware of herd behavior and positive feedback

     With feedback, the situation is worse. If the resulting effects in
turn intensify the causes, this leads to even greater effects, which then
further feed back into the causes. This positive feedback loop is a
formula for rapid change, explosive growth, and extreme instability. By
removing barriers to capital flows, financial liberalization increased the
possibility of such positive feedback loops. When foreign speculators in
1997, for instance, rushed to sell their Thai baht for US dollars in fear
of a baht depreciation, the sudden demand for dollars caused the baht to
depreciate. This further fuelled the baht-to-dollar panic and eventually
triggered the global financial crisis whose repercussions we still feel,
two years later. 

     If Y2K problems change risk perceptions, which then trigger fund
movements that lead to herd behavior, the resulting rush can break the
weakest links in the system. Failures in the weakest links can then lead
to a bigger rush, which can overstress other links and cause even worse
failures, if not panic and collapse. 

     Globalization has made economies tightly interconnected. So, failures
in vulnerable countries and firms can propagate to others, including
countries and firms that are fully Y2K-compliant and those that are not
even automated. 

Avoiding collapse: options

     Governments will presumably do everything to control the situation
and ensure a "business as usual" post-Y2K scenario. They can either: 1)
dampen changes in the risk perceptions, so that risk-avoidance becomes
unnecessary, 2) dampen fund movements, to minimize herd behavior, or 3)
improve the system's capacity to absorb the stresses of herd behavior. 

     Unfortunately, it is too late for the first option to be effective. 

     Because of late conversion efforts, Y2K failures will surely occur.
The Bridgers report makes this clear. As failures occur, are confirmed or
even simply rumored, risk perceptions per firm will fluctuate, triggering
all kinds of risk-avoiding fund flows.  Ironically, even Y2K conversion
successes and failure-free claims can encourage their own fund flows, as
investors seek low-risk shelters for their funds. 

Dampening fund movements

     Critics of financial liberalization had long advocated the second
option. The proposed Tobin tax, China's highly regulated stock and
currency markets, and Malaysia's fixed exchange rate are variations of
this theme. 

     However, neo-liberal economists and the IMF have invariably resisted
these proposals to restrain gain-maximizing capital. They can hardly be
expected to restrict capital that is minimizing its risk and even trying
to preserve itself. To impose such restrictions as bank holidays and
withdrawal ceilings today would also simply erode the public confidence
and trust upon which the whole system stands.  Surely, the banking system
cannot survive the loss of confidence by the owners of even just 10% of
its deposits. 

Raising reserve requirements

     The third option is to improve the financial system's capacity to
absorb the stresses of huge fund movements and herd behavior, if that is
at all still possible. 

     Central banks can do this by raising bank reserve requirements one or
more percentage points every month until they peak in the most critical
months before and after the Y2K rollover. This way, banks would be flush
with cash for responding to all but the worst kind of mass withdrawals by
depositors worried about the safety of their funds. Some governments had
actually done this in the past, under the guise of "mopping up excess
liquidity". This reduced the money in circulation and, as banks scrambled
to retain their profitability and borrowers competed over less money,
increased interest rates. In reality, governments did this to 1) finance
their deficits by borrowing from the public, which would be attracted by
the higher interest rates, or 2) make their local currency appreciate
vis-a-vis the dollar, which would be attracted into the country by the
higher interest rates. Because these policies increased debt stock and
encouraged speculation, they contributed to what later became the Asian
financial crisis. In a critical situation such as the Y2K transition,
however, such emergency measure can prepare banks against panicky

     In the past months, however, countries like the Philippines have
actually been reducing, instead of increasing, their mandatory bank
reserve requirements. While this move reduces interest rates and leads to
an appearance of recovery from the crisis, it makes the banking system
even more vulnerable to excessively large withdrawals. There is still time
for the system to correct this perverse policy and gradually raise bank
reserves -- but the banks must do it right away. 

     As depositors and fund managers get their funds out of high-risk
areas, where will they put them? Presumably in real, tangible assets which
do not lose their value so easily -- land, production facilities and
tools, goods, precious metals, and so on. As most who are familiar with
financial statistics know, however, some $20 to $50 of money or its
equivalent is circulating today for every dollar of real goods and
services. If these floating money now simultaneously try to convert
themselves into real goods and services, we'd have the equivalent of some
20 cars racing for the parking space for one. 

     Given these narrow options, perhaps the final option should now also
be seriously considered: that of preparing for the highly probable and
working out the least painful way of transforming what is turning out to
be a fundamentally flawed system. 

----- End of forwarded message from Roberto Verzola -----

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