Webvan, the cockamamie scheme to provide groceries over the Internet, has gone belly-up. Maybe that was in the cards regardless, but it is a paradigmatic case. Owners of dot-com stock funds regret ever having heard of the Internet.
Webmasters who dropped out of school to get rich quick are crawling back to their guidance counselors to be readmitted. Companies that laid many miles of fiber-optic cable wonder whether they made a huge error.
There are a thousand other cases.
Lost in all the talk of the tech meltdown, however, is any distinction between where the Internet has succeeded and where it has failed. Neither has there been much sensible analysis of why the run-up and fall-off of Internet stocks was as dramatic as it was. Let’s take the second question first.
The Internet boom is often chalked up to capitalist man’s tendency toward maniacal waves of overreaction. A new technology appears on the horizon, the theory goes, and people run like lemmings until they find themselves falling off a cliff into the sea (although I’m told that, in real life, lemmings don’t actually do that). Such is life under a system that rewards greed before need, they say. Perhaps we need government to make us more responsible?
The trouble with the lemming metaphor is that it has nothing to do with economics. New technologies are always available for the taking for commercial applications, and have been since ancient days. Technology by itself is not inherently valuable. The key question is whether the technology is profitable relative to other projects. It is the job of entrepreneurs to exercise judgment about whether their use will really pay off in the long run.
Hence, it is not new technology alone that spawns hysteria in a market economy. In a typical market setting, some people are enthusiasts and others are skeptics. Where some see profits, others see losses, and whoever ends up right wins (until something else comes along). It’s not a perfect system, but it prevents lemming-like behavior from becoming the norm.
The necessary ingredient that turns new technologies into market manias is excess supplies of credit that can be burned up by speculators. There’s only one institution in our society that makes such credit appear to be free for the taking: the Federal Reserve. It alone has the power to make money appear out of thin air. Working through the banking system, it can pump money into and out of the economy and bring about all kinds of zany behavior.
Sure enough, when you look at the Federal Reserve policy of the late 1990s, you find dramatic inflation of the core measures of the money stock (M2, M3, and MZM [M1 no longer has much meaning because of financial deregulation]). These core measures hit bottom in 1995 and then began a straight upward climb until peaking in early 1999. By 2000, a long fall in the rate of increase was evident in all three, until earlier this year, when the Fed turned on the spigots once again. Why can’t the Fed keep going indefinitely? That way lies hyperinflation.
This pattern closely tracks the run-up and subsequent collapse of Internet stocks. Because of the loose money policies of the Fed, venture capitalists enjoyed a huge increase in funds available for investment. What they may or may not have known is that the funding was an illusion created by the central bank. It wasn’t based on savings (which actually fell during the same period), and the investments they made were not based on a realistic assessment of firms’ earning potential.
Investors weren’t so much blinded by technology as drowned in seas of cash, freshly created by the Federal Reserve System. Many projects that might have been worth trying out, including even Webvan, expanded too fast too quickly and ended up squandering the phenomenal infusions of cash.
It was inevitable that the illusion would dissipate; it was only a matter of timing. Some of the skeptics figured it would happen in 1997 and 1998, and when the crash didn’t occur, they were called troglodytes who didn’t understand that risk had been repealed in a new era of cyberspace. But once the Fed stopped feeding it, the tech boom did indeed come to an end.
There is a psychological element to the story. In the late 1990s, speculation abounded about the advent of a new economy and a new world, even new modes of being, brought on by the new age of cyber-living. Today, all such talk is regarded as a sign of insanity. Just as ‘Net promoters were once hep and happening, ‘Net debunking is now all the rage.
Just as inflationary finance creates manias, the slump can create exaggerated reactions in the other direction. Regardless of Webvan and Salon.com and other famous failures, the Internet has permanently changed the way free enterprise works. Because of the speed at which information travels, the economy is more efficient than it was. Web traffic, despite the dot-com collapse, is higher than ever. Particularly in areas of news and research, the Web continues to be an unparalleled success.
And while it is fashionable to cite the unreliability of the Web for information, this, too, is sorting itself out. There are reputable and disreputable sources of information on the Web, just as there are in the print media. What a surprise: consumers themselves are figuring out ways to tell the difference. What the establishment doesn’t like is that The New York Times can no longer pose as a national organ of truth because the full story is only a click away.
It’s not only dot-coms that are failing. Print publications, particularly those dealing with public affairs and other boring topics, are failing left and right. It turns out that for those who keep up with politics, the Web continues to be a dreamland of information and commentary. It’s also wonderful to see the way the Web is shaping up to work much like the old economy, with mergers and big players playing a decisive role in driving innovation and profits.
Far from having discredited capitalism, our experience with the Web so far is that it underscores the structures of the free-enterprise economy and vastly outcompetes any services offered by government. To the extent anything should be discredited today, it is the Federal Reserve and its policy of distorting reality and delivering false signals to market players.
And let it never been forgotten that without government backing, the Federal Reserve would be just another marble building in an imperial capital. It certainly wouldn’t have the frightening power to spur global manias. The lesson: Don’t blame the market; place the blame exactly where it belongs, with our masters in DC who prevent free enterprise from bringing discipline to the monetary system.
