The cause of this is incorrect window coordinates in the Finder. The Finder stores the top-left and bottom-right coordinate of each window. Should, for some reason, the bottom-right coordinate of a window be to the left or top of the top-left coordinate, the Finder will get very confused. You'll then see the alternating wristwatch and arrow cursor.
The solution to this problem is to restart with the Option key held down. This forces the Finder to close all the windows, and zero out their coordinates. This may not work if a third party keyboard is in use, for best results, use an Apple keyboard to zero out the coordinates.
Article Change History:
02 Nov 1994 - Added possible problems with third party keyboards.
30 Sep 1994 - Edited to include the words "watch" and "pointer".
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