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. 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. It is the job of entrepreneurs to
exercise judgment about whether its use will really pay off in the long
run.
Hence, it is not new technology that alone 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. 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 meaning because of financial deregulation). These
core measures hit bottom in 1995 and then begin a straight upward climb
until peaking in early 1999. By 2000 a long fall in the rate of increase is
evident in all three, until earlier this year, when the Fed turned on the
spigots once again. Why can't the Fed keep doing this indefinitely? That waylays 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. 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.
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
shows that it underscores the structures of the free enterprise economy, and
vastly out-competes 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 be 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 D.C.