Every year, I confess my sins (or some of them) even though the exercise is becoming increasingly repetitious. My main sin of 1999 was the same as in 1998: to doubt the Great American Boom. It could be the same in 2000. But I will remain unrepentant until something convinces me that my skepticism is silly and not merely unfashionable.
The essence of a speculative boom is that most people do not believe that it is a speculative boom. If they did, they would behave differently. We always hear that some wondrous new “economic model” can ensure perpetual growth, or something close to it. This was true in Asia in the early 1990s. It was true in Japan in the late 1980s. It was true in the United States in the 1920s. We now hear the same refrain again in the United States.
The favorite theory is that “information technology”–computers, the Internet, wireless communications–has made companies so efficient that they can increase production, wages and profits without raising prices. Because higher inflation often causes recessions (by leading to higher interest rates), the danger of slumps is also reduced. The irrepressible stock market simply mirrors this reality.
Up to a point, the theory is believable. Computers have improved business efficiency. Productivity gains–the measure of efficiency– are running almost 3 percent annually. This is impressive, though not unprecedented.
Still, there are at least two reasons to suspect the theory. One is obvious evidence of speculation. Start with the dot.com mania. In 1999, initial public offerings of stock–companies selling shares for the first time–reached a record $93 billion, twice the 1998 level ($45 billion) and 10 times the 1994 level ($9 billion), reports Renaissance Capital, a firm specializing in IPOs. Half of IPOs (242 of 486) involved Internet start-up companies. In 1998, there were only 26 Internet IPOs.
Companies could once “go public” only if they were profitable or nearly so. No more. In 1999, some 73 percent of IPOs had no profits. In 1995, the comparable figure was 23 percent. Among Internet IPOs, 93 percent (224 of 242) had no profits. These Internet companies had average sales of $18.5 million and an average loss of $17.8 million. In other words: It cost them almost $2 to make $1 of sales. “We’ve never seen a market before when the vast majority of (IPO) companies are unprofitable,” says Linda Killian of Renaissance Capital. The explanation is that people want the dot.com stocks to trade, not to hold as long-term investments.
In 1999, the price of the average Internet IPO more than tripled (from, say, $20 to $60). The same feverish psychology infects the broader stock market. In 1995, the stock prices of 455 companies in the Standard & Poor’s 500 Index rose. In 1999, only 241 stocks rose (through Dec. 21), reports analyst Brian Rauscher of Morgan Stanley Dean Witter. “People are buying the winners and selling the losers,” says Rauscher. It’s called “momentum investing.”
The theory’s second flaw is that it wrongly presumes that only inflation causes recessions. Slumps can occur whenever spending slows, and spending can slow for many reasons–including, most obviously, the possibility that businesses have overinvested and consumers have spent beyond their means. This could be the case now. Business investment has been so strong that U.S. industry still has spare capacity. The utilization rate is well below the peak reached in the 1980s economic expansion. One reason for low inflation is that ample supply has kept prices down.
But this also suggests that investment spending might abruptly slow. Why? Well, if the consumer spending spree halts, then companies won’t invest more to enlarge surplus capacity. And the consumption binge may be vulnerable, because Americans are spending more and more of current income. In 1991, the personal savings rate–savings as a share of aftertax income–was 8.3 percent. In 1999 (through three quarters), it was 2.5 percent. Each 1 percentage point drop in the savings rate raises consumer spending by $66 billion.
People are acting as if economic risk is declining, when it may be rising. Contrary to the theory, new technology increases uncertainty and, therefore, risk. Companies with old technologies may founder. No one knows which new companies may flourish. “Globalization” may also increase risk, because–like technology–it’s unfamiliar.
What we have now is a momentum economy. Confidence is self-fulfilling. Because it is so critical, the future is especially cloudy. The economy could coast on its euphoria. It might be sustained by recovery abroad. It might gracefully decompress at a high level of prosperity. Or something (higher inflation and interest rates?) might wound confidence and send the circular process into reverse.
Clearly, I don’t know. But I do know that there are enough ill omens to temper our complacency. Happy New Year.
