The Bubble Economy
The sure sign of a market bubble is when there’s no way even plausibly to imagine where a stock price comes from. Consider a little company called Priceline.com.
Priceline had the smart idea of running a kind of reverse auction over the Internet. People put in the price they are willing to pay for, say, a flight to Cincinnati next Wednesday, and airlines and ticket brokers compete to fill their order. Sales have grown rapidly, but like many fast-growing companies, Priceline has to plow every cent back into advertising and operations. Over the past year, it lost $125 million on sales of $190 million.
As of last week, the stock-market valuation of Priceline (the stock price times the number of outstanding shares) was about $10 billion--which was at least a bit more conservative than the $22 billion it commanded just a few weeks before, or about the same as Alcoa Inc., or the Axa Group, a giant international financial conglomerate that owns U.S. insurer Equitable. That’s $10 billion for a company that may never make a profit, since it can take only a razor-thin slice of each sale. Amazon.com, the poster boy of Internet-based commerce, had more than $1 billion in sales last year but has never earned a nickel and doesn’t expect to any time soon. Before the recent nose dive in Amazon’s stock price, its market value was within spitting distance of General Motors’ or Boeing’s.
Why would people pay so much for stocks like these? Well, if you had put $10,000 into Amazon within the first few weeks of its initial stock offering in 1997, your stake would have been worth a cool half-million about 18 months later, although “only” about $200,000 now. Those kinds of numbers get attention.
Investors snapping up stock at ridiculous prices because they hope for even more ridiculous prices later is another sure sign of a bubble. Internet companies may never make money, but they might get bought by some other Internet company whose stock prices are even more wildly inflated. The trick is to be the next to the last one out. Isaac Newton bought into the South Sea Bubble in its early days, but figured out it was a scam, and got out with a big profit. In 1720, as South Sea Co. shares soared higher, however, even a smart guy like Newton couldn’t resist jumping back in, and he got killed.
How do bubbles happen? One explanation is that people are crazy and markets are irrational, which is certainly part of the story. But the more interesting reasons are more complicated.
Bubbles almost always accompany a deep, underlying ground shift in the economy. There was a 20-year railroad bubble in the United States starting in the 1870s. Tens of billions of investment flowed in from overseas, and most investors lost their shirts to sharp promoters like Jay Gould, who saw the British as so many sheep lining up to be fleeced. But the railroads really did vault America into the industrial age, powering the rise of the steel and coal industries and the birth of factory farming. Investors were right that some fundamental shift was happening, but it wasn’t until the hectic growth phase was over that railroad investing became safe for honest people.
The 1920s stock-market bubble wasn’t an accident, either. Nineteenth-century America had financed its growth with overseas money. Investment banks like J.P. Morgan’s were financial pipelines to Europe’s wealthy elite. By the end of World War I, however, most of the world’s wealth had emigrated to America, and forced-march wartime growth had left America’s big industries thirsty for capital. A whole new plumbing system was needed to tap into the savings of the country’s burgeoning upper-middle classes. But when Wall Street gleefully built its new money pipeline, we discovered, to our grief, that democratized investing required watchdogs like the Securities and Exchange Commission, standard accounting rules and laws against manipulation and insider trading.
The Internet really is a fundamental revolution, probably as important as the railroads. Analysts estimate that within a year or two, electronic commerce on the Internet will top $3 trillion, most of it between businesses. Internet commerce blows away layers of bureaucracy. Companies can use password-protected Web sites to post production schedules so their suppliers can know exactly which parts to ship each day. Private Internets and internal Web sites can handle most of a company’s busywork, like expense accounts and routine reporting. E-mail has already flattened out the chain of command in most big companies. The Internet-driven productivity surge in big companies may be a key factor in America’s eye-popping economic performance in the late 1990s.
Revolutions upset apple carts. The Internet revolution is a deadly threat to entrenched vested interests, like the telephone companies, and could never have happened without American-style cowboy capitalism. It’s no mystery that the Internet revolution has been so slow to arrive in other industrialized countries that lack our freewheeling venture capital and stock markets.
Are the flashy, consumer-oriented Web and Internet companies the place to look for big winnings? Probably not. There was a biotech stock bubble a decade or so ago, but only a handful of biotech companies ever produced useful drugs. The biotech revolution was real, but its biggest effect was on the drug development cycles of established firms.
Internet consumer sales, like those of Amazon and Priceline, are only a tiny fraction of electronic commerce. The real action is in rebuilding business communication infrastructures, and the companies fighting over that turf are ones we already know: Microsoft, Oracle, 3Com, IBM, Cisco, Lucent Technologies, Nortel.
Market bubbles are the froth on a revolution’s surface. As long as the Internet bubble continues, any company with a “.com” at the end of its name is likely to do well. But once the winnowing comes, hardly one in a hundred will be left standing.
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The Internet market bubble is the fronth on a revolution’s surface.
