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 and unsettling.
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. There are always theories to explain why it could last. We 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" (IT)--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 mirrors this reality: Stock prices reflect future profits; IT raises profits and lowers the odds that they'll suffer from recession.
Up to a point, the theory is believable. Computers have improved business efficiency. By monitoring sales, companies can better control inventories. They produce more of what customers want and less of what they don't want. Similarly, IT enables trucking companies to reduce the time that tractor-trailers are idle. 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 (IPOs) 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). Among all IPOs, stocks of companies with losses rose twice as fast as stocks of companies with profits. 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. Fewer stocks--rising faster--are driving the market. "People are buying the winners and selling the losers," says Rauscher. It's called "momentum investing." Many stocks are at breathtaking levels. America Online is selling at about 240 times its profits (earnings). Yahoo! is selling at almost 1,700 times earnings.
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. Through November, the utilization rate (as measured by the Federal Reserve) averaged 80.6 percent in 1999. This was well below the peak (84 percent) of 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 after-tax income--was 8.3 percent. In 1999 (through three quarters), it was 2.5 percent. Each one 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. Overconfidence may breed risk by inspiring reckless consumer, business or investor behavior. 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. For a while, everyone's profits may suffer. Disney, for example, has sunk about $500 million into the Internet; its current cash losses are running about $200 million a year. "Globalization" may also increase risk, because--like technology--it's unfamiliar.
What we have now is a momentum economy. Confidence is self-fulfilling. All that IPO money, for instance, enables start-up companies to hire workers, rent offices and purchase advertising. With confidence 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, spook the stock market and send the circular process into reverse.
Clearly, I don't know. But I won't ignore ill omens just because they're inconvenient--and there are enough of them to temper our complacency. Happy New Year.