Did Y2K cause the dot com crash?

The stock market craze of the 1990s, followed by the crash of 2000, was not a bubble. Valuations of companies are what drive the stock market. These valuations are based on quarterly income statements, the actual earnings from the current quarter and the projected earnings for the next quarter. Wall Street analysts then process these data to project 1-, 3-, 5-, and 10-year estimates of future value, or future profits, and this is what determines a stock’s valuation. You can use any number of methodologies to predict this value, and there is a whole industry dedicated to the determination of this number and the (usually) quarterly updates to it. Since the projection of current earnings is what a company valuation is based on, all companies are subject to pressures to maintain or increase earnings. From that, the market will determine what the ultimate price is for a company.

The reason I don’t believe the stock market of the late 1990s was a bubble is because, as an engineer working in the aerospace industry, I saw firsthand what was propelling it. Technology companies were all the rage, because their profits, quarter over quarter and year over year, kept going up. There seemed no end to the boom. Everyone was heavily investing in hardware and software, and in software consulting. Then the tech-heavy NASDAQ fell from over 5,000 to less than 2,000 – a greater than 60% decline – in less than six months. Why? The answer is Y2K.

The reason tech was so completely overriding everyone’s concerns and expectations was Y2K. Remember that nonevent that occurred at the turn of the millennium? The reason why it was a nonevent was because of the billions upon billions of dollars being spent by every company to make sure it was a nonevent. I was part of a Y2K team at Northrop Grumman when I was working on the Stealth Bomber. Every single computer on the airplane (and there were over 150 different computers processing close to two million source lines of software code) had to be validated. We had to guarantee that nothing would go wrong at the turn of the clock on January 1, 2000.

As it got closer and closer to the end of the 1990s, momentum was building for the event of the century – Y2K, or Year 2000. This event, and the worldwide concern it was generating from computer scientists, was starting to get national attention. The Y2K phenomenon was creating its own cottage industry. There were interest groups, associations, magazines, and societies dedicated to the eradication of potential software bugs that could cause computers to process data as if the date were January 1, 1900, instead of January 1, 2000. This industry maintained an almost religious zeal for making sure the world would be safe after midnight on December 31, 1999. As you can see in the numbers in Figure 1, the sales of computer equipment and software peaked in the last quarter of 1999, in line with completion of Y2K amelioration efforts.

Figure 1. Sales of Computer Hardware and Software (1997-2007)[1]

However, as soon as the crisis preparations had passed – as soon as the clock turned and the end of the world didn’t happen – everything went back to normal. Normal, but with one very large exception: Nobody was buying computers. An entire industry saw a collapse in demand, due to the fact that several years’ worth of computer replacements and upgrades had already been accomplished. It would be several years before the majority of the industry would recover and see demand for PCs and peripherals again. In addition, all those Y2K teams and consultants, an entire cottage industry of technical support, were no longer needed. Now those folks would be out of work, too.

As the need for computers, computer software, and technical support evaporated, it created a vacuum effect, sucking the air out of the stock/Internet/dot-com bubble. It also created a domino effect on the economy as a whole. As these high-paying tech jobs disappeared, so did the spending on toys, tools, and gadgets. As spending decreased, so did growth numbers across all industries. This, in turn, led not only to the stock market crash of 2000 but to the recession of 2001 as well.

[1] US. Bureau of the Census, Merchant Wholesalers, Except Manufacturers' Sales Branches and Offices Sales: Durable Goods: Professional and Commercial Equipment and Supplies Sales: Computer and Computer Peripheral Equipment and Software Sales, retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/S42343M144SCEN

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