HOW THE Y2K BUG BIT GREENSPAN & WALL ST.

By JOHN CRUDELE

NOW you are really seeing the Y2K bug in action.

As everyone knows, neither airliners nor computers crashed during the changeover to the new millennium. But that panic shifted to the financial markets.

If you've been reading about Wall Street's very poor performance most of this week, you probably already heard that people are afraid that the Federal Reserve will raise interest rates again in early February.

But they shouldn't be worrying about the next Fed meeting, which takes place on Feb. 1 and 2. The real concern about interest rates should have more to do with the ghost of Y2K -- which is happening right now.

I'll explain.

As I said in December, the Fed bought into the millennium hype and flooded the nation's banking system with cash.

The broadest measure of the U.S. money supply, for instance, rose 1.4 percent in just the last two weeks of December. If money growth were to continue at that pace all year -- which it won't -- there'd be 44 percent more cash floating around.

The December jump was an astounding amount and extremely inflationary under normal circumstances.

The idea behind the Fed's pre-emptive action was noble. If Y2K believers ran to their banks and hoarded cash to stuff into their mattresses, then the banks needed to have enough money on hand to keep the country running.

The big problem for the financial markets now is that the Fed will have to drain cash from the banking system in order to keep this extra dough from causing prices to rise.

And by letting liquidity drain from the system, it will also be taking cash out of the hands of people who might put it to work boosting the stock market bubble. This is a potential maket bubble-buster.

As this column predicted last month, this added liquidity helped the stock market in December.

The Fed has started to drain that excess liquidity.

It isn't like the Fed has a choice about the money supply. If Alan Greenspan doesn't drain this extra liquidity -- which is done through something called "matched sales" -- he'll be accused worldwide of fostering inflation. Interest rates could increase out of control and stocks would really skid.

If he does drain, the financial markets will take it as a sign that the Fed is about to get tough.

Rates will still climb in the open market, but the rise will proabably be more controllable. Either way, interest rates are likely to jump substantially between now and the February policy meeting of the Fed. In fact, rates are already up considerably in the past month.

Yesterday, the 30-year government bond was yielding around 6.61 percent. Back in early December, the rate was 6.29 percent, which was still much higher that it was just weeks before that.

Worse, the Fed's invisible hand isn't Wall Street's only worry right now.

There are lots of other things that can go wrong between now and early February -- more that can go wrong than right.

Friday's employment report for December could exceed Wall Street's expectations. That's particularly true because seasonal hiring during Christmas is notoriously unpredictable. Washington's statistics on the labor market are always horrible, but are completely unbelievable during this time of year.

Washington is also scheduled to report December producer and consumer prices next week. The CPI, in particular, could be subject to seasonal adjustments that might cause it to show more inflation last month than actually occurred.

If a too-strong jobs number or an over-robust inflation indicator comes out on top of the money supply aberrations being caused in the Y2K aftermath, then interest rates could suffer extraordinarily in the weeks ahead.

Here's my first prediction for the new millennium.

The interest rate increases that everyone else missed when it began last year will continue for several more months.

The Fed will be forced to tighten credit a least a couple more times, driving the interest rate on the 30-year bond to at least the 7 percent level.

*Send e-mail to jcrudele@nypost.com.

[ENDS]

-- John Whitley (jwhitley@inforamp.net), January 07, 2000

Answers

LINK

-- John Whitley (jwhitley@inforamp.net), January 07, 2000.

WAIT A MINUTE !!!!!!!

I thought the people didn't take the money out of the banks. So, the liquidity didn't change, unless they call a bunch of paper sitting in bank vaults 'liquidity'.

-- billy d (billyd@aol.com), January 07, 2000.

billy d,

Many banks swapped their T-Bill assets and other bank collateral for cash on hand.

If rates move significantly which appears to be the case, the banks can buy back more bonds for the same amount of cash.

With major investors selling off stock market assets, the demand for cash momentarily increases. So brokerages and banks may need some of that FED cash to satisfy demand. This increased demand increase the cost of money (interest) and drives the bond market down. Bond yields go up and stocks go down.

Kinda like a snowball rolling down the hill - this ball is moving and gaining momentum.

Got cash?

-- Bill P (porterwn@one.net), January 07, 2000.

Didn't someone post an article re: the extra cash? If the banks found they didn't need it they would return the cash to the Fed. And, I assume, the Fed would simply bury it.

-- Mark Hillyard (foster@inreach.com), January 07, 2000.

The FED also pumped up the M3 money supply by about $200 bill in anticipation of Y2K. Most say the FED increased both hard currency and digital currency to cover increased demand for domestic liquidity (the unwarrented bank run). I think this absurd. The FED would not facilitate a bank run by providing the currency. The FED increased liquidity for Y2K because they had no idea what might happen outside the US. 39% of US debt is held by foreign investors. The liquidity crisis could have started anywhere. This increase in digital liquidity flowed into the US equities market prior to the CDC. At the time this was the preceived destination for a "Flight to Quality" ?!!! Bubble.com stocks with no earnings. Now that money must leave the overpriced in search of greener pastures.

-- db (weborba@thegrid.net), January 07, 2000.

Crudele is right about one thing.

Given the uncertainty about Y2K, Greenspan had no choice.

He absolutely HAD to make sure that there would be liquidity available in the third quarter.

-- nothere nothere (notherethere@hotmail.com), January 07, 2000.