The Current Emergency, The Coming Boom
CURRENT ERGEN With the steady rise of the Investor Class over the past twenty years, from fewer than 20 million stockholders to more than 100 million, surely the time has come for economic policy...
...The markets knew that once the tax cuts took hold the economy would surge forward, accompanied by all the accoutrements of healthy growth, including rapidly expanding capitalized economic profits...
...which stitnul.uc•d the &111Land tilt mone...
...King Dollar The foreign exchange value of the dollar tells the same story...
...The falling prices of high-tech goods and other manifestations of rapid productivity growth are not the problem...
...economy did not fall into recession because a few dot-corns went under...
...My read of history is somewhat more aggressive than Breyer's...
...As long as Congress and the president think tax cuts cost money rather than remove economic obstacles and release new energies and incomes, there will be no significant tax cuts and no strengthening of incentives to work, invest, and innovate to invigorate the economy...
...The U.S...
...The danger is a general deflation caused by overly tight monetary policy...
...The price of a transistor and support circuitry collapsed from some seven dollars 30 years ago to perhaps seven millionths of a cent today-that's a hundred millionfold drop-while the electronics industry became dominant in the world economy and decisive in military power...
...Buffett is currently giddy with vindication...
...the result [,or the eeonolm are po,tt-nve.'I'he nto,t poucrtul non-nionetarw Source of lrfl.tticln in this ecumlnn- is intclrm.uic~n tr hnctlogw..accounrutg for roughls iii pcrcexit of re.t] economic growth In recent wear...
...The Perkins brothers name 133 Net companies, like Amazon andYahoo, which together were supposedly "overvalued" at the peak by some $230 billion, as the source of the bubble...
...Higher interest rates, for example, imply that any given future earnings stream will have a lower value when capitalized...
...Why not...
...The public began losing interest in tech stocks...
...As policy, favoring one kind of capital over another is controversial and easy for populists to demagogue, as George Mitchell did to George H. W Bush so effectively...
...Nonsense...
...The steady collapse of transistor prices enabled dramatic expansions of chip fiinctionality, encouraging the spread of silicon intelligence far beyond computer platforms...
...Do they save the bubble theo1. A y Jim "I 14 at 33.3 44 -25.8 31.4 Internet Bubble Babble BY ALAN REYNOLDS In economics, bad metaphors often lead to bad policies and bad investments...
...Cable TV and other broadcast media will give way to Internet multimedia and interactivity...
...We have had an active stock market in the United States from time immemorial where market participants actually price USA Inc...
...economy, allows us to evaluate the appropriate price for aggregate stock market-not too shabby if true...
...Dionne, and abortion...
...The low-pressure economy, however, hugely enhances the demand for money...
...Kessler turns the conventional picture on its head...
...Growth and risk were the lifeblood of the 1990s prosperity, not Internet bubbles orY2K spikes...
...n 1996, the dominant venture capitalist, John Doerr of Kleiner Perkins, vindi cated our confidence of the mid-1980s...
...but unlike' a ,Cncral 1no11ct.trs detl.tnon...
...The NASDAQ went crazy...
...Both in finance and in technology, conditions today are incomparably more promising than in the mid-1980s...
...This is Washington's recession, for which nothing is more to blame than the arrogance of policy makers who refused in the first place to recognize the real sources of prosperity and then refused to acknowledge that slumping stock markets were a referendum on Washington's mistakes...
...By aggressively following his free-enterprise instincts President Bush can lead America to its vast potential of abundance...
...It was described to me as trying to drink from a fire hydrant...
...Far more useful would be to add a reduction of the capital gains tax rate to 15.5 percent, implementing Breyer's 2:1 ratio, which he says would propel the U.S...
...But countries and companies that focus on the scarcities narrow their horizons and becloud their future...
...Over the last forty years, the key resource was transistors, translated into MIPS (millions of instructions per second) of computer power, dropping in price 48 percent per year, and bits of memory, dropping in price 68 per cent per year...
...Again, we are extraordinarily fortunate to have precisely measured market comps that also go way back in time: the market-determined bond price and interest rate data...
...The faster the better...
...trade gap also surged...
...The U.S...
...The DowJones industrial index, by contrast, is typically reported as representing non-tech "blue chips...
...In 1985, Andy was a technology analyst at Morgan Stanley...
...Admittedly, this is an extreme example...
...What jumps off the page is the huge, and I mean huge, divergence between capitalized economic profits and stock prices that took place in 1999 and early 2000...
...Trade policy couldn't be better...
...Venture capital fed on the dramatic reductions in capital gains taxes in 1978 and 1981 and the collapse of the inflation that had pushed after-tax returns on investment into negative territory for much of the 1970s...
...Today's hybrid fiber optics and electronic networks will give way to all-optical networks literally millions of times more efficient with millions of channels-that allow signals to fly from origin to destination entirely on wings of light.A culture of lowest common denominators chosen in Hollywood and Madison Avenue will give way to a culture of first choices made by the customer...
...In the Department of Commerce's Bureau of Economic Analysis there is an incredible amount of assembled knowledge and wisdom that has been used to prepare these data for years and years...
...Today, new car loans from a bank are roughly 8.5 percent, while new car prices have fallen by 0.6 percent annualized in the past six months, making real interest rates on cars over 9 percent...
...Replacing the 1980s anguish over inventory excesses in memory chips as they moved from 16 kilobits on a single silicon sliver through 64 kilobits toward 256 kilobits, today optical equipment stars bemoan inventory buildup as the industry moves from 2.4 gigabits (billion bits) per second to 40 gigabits per second...
...chip designs...
...By reducing prices of each transistor on a chip from several dollars to a few millionths of a cent today, Moore's Law constantly enriched the palettes of semiconductor designers...
...A petabyte is near the total of all Internet traffic in 1999 in a month...
...Simple as that...
...Watch Gold, Not Oil The price of oil is rising, but oil prices are controlled by a near monopoly, and reflect an increase in relative prices, not a general inflation...
...Contemplating the economy as a flow of funds, a demand-sider might look at this number and assert a 60 percent drop in the amount of venture money raised-a collapse of venture capital...
...Yikes...
...to be in the midst of a danknmus general price detlatinn-Thclugh the core Consumer Price Index (excluding volatile• tiiod and energy) notoriously overstates inflation, it dritied drncmvard in the 'c)1 r.K hover irig betwee12 and 3 percent for the last three yea r,~ ((:hart 1 j. TIie core Producer Price Index tells a similar ston-'(:hart 2...
...The evidence from commodity prices suggest even Boskin's estimates were too low...
...He's right...
...Let's compare...
...How could Intel make any money adding to a glut of transistors and driving down the price of its core product by eight orders of magnitude...
...Yet Washington stubbornly refused to heed market signals that warned of...
...As Andy observed, history repeats itself today...
...In the chart below I have plotted both capitalized economic profits and the S&P 500 Index on a semi-log scale going from January of 1970 on up to Profits and share values of USA Inc...
...Since the stock market dropped by some $4 trillion over the 12 months leading up to March 2001, there was obviously much more going on than 133 Internet stocks...
...In fact, as I look out over the next year or two I think the four potential prosperity killers are being held pretty much at bay...
...Greenspan's favorite word, "unsustainable...
...They fit like a glove on a hand (not O J.'s, to be sure...
...I'lutnng the I )IS( :I .ag,iin.t the 101d] 11,111 SAC 11s (:omltu flits Ilteiex, which doe...
...After initially succumbing to the gloom and urging the sale of microchip shares, in July 1986 he began to advocate their massive accumulation...
...Money raised from limited partners rose from under a billion to $4.5 billion in 1986...
...GE joins together NBC television and airliner turbines and GECapital...
...For this essay I start with January of 1970...
...20 z THE AMERICAN SPECTATOR May 2001 ..ai-6C Jar-05 Jar }Jar--75 a^-EC- Ja,-85 Ja,-00 Jar-95 „ar: 00 53...
...This is the true "current emergency...
...Unbelievable...
...The value and the profits are in the design...
...ATT turned off its major DRAM facility in Kansas City and withdrew from the business...
...With viewers seeing only advertisements that they choose, the TV advertising model will collapse wherever it is tried-even on the Web...
...Through their backing of startups like Apple Computer, Microsoft, Sun Microsystems, Oracle, Cisco, and Cienathe engines of America's recent surge of growth and productivity-VCs have added hugely to America's balance sheet...
...Breyer, who raised a $1.6 billion fund for his firm in May 2000, believes that America performs at its innovative peak when capital gains are taxed at half the rate of income...
...This focus on scarcity has rendered most of the U.S...
...With a $100 million write-off, Intel closed its Puerto Rican assembly plant, withdrew from the market for the Dynamic Random Access Memories (DRAM) on which the company was founded, and halted construction of its leading-edge wafer fabrication plant in Corvallis, Oregon...
...Indeed, Michael Mandel of Business Week recently published a book entitled The Coming Internet Depression which assumes that a decline in venture outlays will lead to a slump in economic activity But in a six trillion dollar economy, with some 40 trillion dollars of assets, venture money is trivial as a flow of funds...
...A key to Warren Buffett's success, however, is insider trading, perfectly legal if, like Warren, you do your investing under a capacious corporate umbrella, with holdings large enough to justify a share in management and the information that goes with it...
...But America's most productive capital demands the star treatment...
...By the fourth quarter we will have paid back all of the expenditures we borrowed from the future in 1999 and early 2000...
...For my purposes I capitalize the economic profits of USA Inc...
...At the margin, that is for the next additional bit transmitted, bandwidth will be nearly free...
...Gold prices fell and corporate credit spreads widened...
...t.1)III I11E1111L1itI11n...
...When prices drop because of new technological abundances, deriving from innovations such as the all-optical network, it signals a surge of productivity and opportunity that will enhance the demand for money...
...That deflation has been the real issue since the mid-1990s becomes clear from the price of gold...
...In the midst of this chill of low chip prices, semiconductor stocks retreated below the levels last reached in the midst of the catastrophic recession year of 1982...
...While profits may continue to decline for some time, I would expect the stock market effect of these declines to be more than offset by the capitalization effect of falling interest rates-the denominator will more than compensate for the numerator...
...Likewise, higher tax rates will reduce asset values directly and indirectly...
...Among the leading proponents are Anthony and Michael Perkins who in their eponymous book boast about warning in September 1996 that Internet stocks were too pricey, shortly before Alan Greenspan went on his "irrational exuberance" rift...
...But the only time it took more than two years for the S&P 500 to recover lost ground was during the 1970s, when chronic inflation made Hummel figurines a better bet than stocks or bonds...
...Yes, deflationary money and excessive tax and regulatory burdens today threaten the ing," nor a budgetary consequence of "guns and butter...
...But it makes no more sense to conclude that this cyclical slump demonstrates the digital revolution was a "myth," as Yale Professor Robert Shiller put it, than it would to interpret every cyclical down turn in auto sales as evidence that people will henceforth prefer to walk...
...At this level, the demand for dollars exceeds the supply...
...Connectivity is the ability to intelligently route, link, and exploit that bandwidth by hooking users into an ever more functional and productive network...
...And as long as the price of gold is below $300, deflation is a threat...
...The unemployment rate had fallen to nearly 4 percent...
...In the meantime, the government's fecklessness has inflicted fire-sale prices on a heap of companies now driving the greatest episode of wealth creation in the history of the world...
...Monetary policy is never in the position of "pushing on a string," and government borrowing never "primes the pump" or "kick boom of the past two decades...
...Accustomed for years to real interest rates being lower than nominal rates because of the corrosive effects of inflation, monetary authorities easily slip into a regime in which real interest rates are higher than nominal rates because of a deflation premium...
...But with higher tax rates there will be less output, employment, and production, which also means less pre-tax profits...
...But as long as the Fed targets stock prices and economic growth, the risks remain...
...Putting this munificence to work were companies like Microsoft, Sun, and Oracle...
...THE AMERICAN SPECTATOR May 2001 37 Deflation's Death March THE CURRENT EMERGENCY THE COMING BY BRIAN WESBURY The economy is in the grip of a general price deflation that seems to have started in 1996...
...1978 saw the passage of California's Proposition 13-the massive property tax cut measurc and the federal SteigerHanson capital gains tax rate cut legislation...
...As a result, the S&P stock price index, depressed by the ubiquitous pessimism about America's future, was much lower than capitalized economic profits...
...A central concept in finance is that the price of an asset is the discounted present value of that asset's future earnings stream.While rarely employed in macroeconomics, this concept, when judiciously applied to the overall U.S...
...Bad policy will chase productive capital into the ditch every time...
...Real-time, market-based indicators, such as commodity prices, gold, and exchange rates, each show the purchasing power of the dollar has appreciated rapidly...
...I don't foresee any tax increases and we might even get some much-needed tax cuts...
...Much of Adobe Acrobat's value derives from its ubiquity, fostered by Adobe's free distribution of the Acrobat Reader...
...tell tnrrn 54(4 1n 1996...
...The U.S...
...The current crash, like most before, will be a boon to the most innovative technology companies...
...Europe and Japan were studying American venture capital and stock markets closely for insights on how to prosper in the new age...
...I had just given up my role writing the semiconductor sections of the Rosen Electronics Letter (formerly the Morgan Stanley Electronics Letter, later Release 1.0 under Esther Dyson) and I was beginning research for Microcosm, my book on the past and future of the microchip and the new economy it was creating...
...The effort to reduce chip geometries and increase cycle speeds by millions of times has been one of the great scientific and engineering feats of the age...
...The next decade will see a complete transformation of the global communications infrastructure...
...As Andy Kessler observed, it was these conditions that set the stage for his career...
...11 ,1;11L I11t•Ilt• tr1;ILIL' tllr't II IL-11C 51 it IIIL' LI PI 1tL-rt IItt': ( )lill)IItllt'l11:11 Lsll-gift ittlllIllLillItJitkUI, LtiliL't- Itlli t;111 11,t' itI t:llt't 111111 Lirrlils, Ix lrrttllicl•:UhI LIftitt...
...Thus, between 1992 and 1998, a period of surging U.S...
...Take the stock market, for example...
...Better yet, let's try a flat 20 percent across-the-board income tax rate and drop the capital gains rate to where it really belongs: zero...
...stock market "mania," and scolded the Fed for not bleeding the patient, thus joining the great line of bubble logicians who have argued that bubbles are bad because they might pop and therefore we should avert this disaster by popping them...
...The collapse of dot-corns repeats the earlier collapse of computer startups...
...Think of it as shock therapy...
...No wonder banks have tightened up lending standards and corporate bond spreads have widened...
...But this story has been around a bit too long...
...Previously adequate money supplies become inadequate in the face of the huge new demand unleashed by the collapsing price of new goods and services...
...it is a fundament of the new economy, enabling information and intelligence to displace matter in the creation of value...
...And you are wise to give a break to capital that risks its neck on the future Suns and Cienas...
...While I can't be sure how much longer the mistake the Fed made in 1999 will continue to reverberate through the economy, my belief is that the longerterm outlook is now pretty good...
...Cellular phones are giving way to digital devices that do everything from conferencing with your office to taking a photograph to reading you a book on the beach...
...The Fed chairman has conceded as much, for instance pointing out in a recent speech that government statistics show medical services productivity dropping during the 1990s despite advances in surgical procedures and better patient outcomes...
...Investors correctly feared yet another rate hike from the Fed, and they reacted violently...
...The data are calculated on an accrual basis and employ estimates of useful lives for the depreciation of capital...
...and perhipherals has-e been ranging front negative 3.5 percent to as los+' ac negative 20 percent (('hart 6), Between 199-} and 2000...
...Information technology has indeed been hit hard, because it involves precisely the sorts of investments (such as upgrading computers) that can easily be postponed when profits are pinched...
...And so it is: design advances are intimately enabled by heroic improvements in manufacturing process...
...The historical series on economic profits goes back as far as the eye can see...
...Forbes publisher Rich Karlgaard, founder of the now solidly profitable Internet venture company 48 THE AMERICAN SPECTATOR May 2001 Garage.com, offers evidence that venture capital remains near the all-time highs of last year...
...Also vital is the delta between top income tax brackets and capital gains...
...The challenge is to find the right companies...
...Back at the river head, venture funds began to dry up, too...
...A thousand dollars invested with Buffett in 1974 would be worth $2.4 million today...
...past its current emergency and straight toward the coming boom...
...In the Treasury market the yield curve began to invert in February, a classic recessionary signal, which deepened through the spring and summer as the Federal Reserve mercilessly kept raising the Fed funds rate and draining high-powered cash from the economy...
...His roundtable partners, Tim Draper of Draper, Jurvetson, and Michael Moritz of Sequoia projected that some $40 billion will be added in 2001...
...This difference between tax rates on income and capital gains is a cornerstone of good fiscal policy and needs an explanation...
...In fact, it is the most enduring symbol of the new economy, in which value rapidly migrates away from the underlying physical components of a device and towards the intellectual value added in its design...
...The NASDAQ fell 7.64 percent on April 4 alone to news that the government was going to try to redistribute Microsoft's intellectual property...
...The most interesting companies in the Telecosm, from Avanex, Broadcom and Conexant, to AMCC, Terayon, and Qualcomm, are nearly all focused on connectivity and thus aligned with the new century's governing vector of growth...
...economy will emerge as amazing as ever, and technology is a big reason...
...Bold souls who bought the S&P 500 in July 1982-four months before that recession ended-saw the total return index jump from 186 to 680 in five years, and to 1073 in ten...
...computers have reduced inflation t1.5 percent per year on average [(:hart 7...
...Every industrial era is constrained by key scarcities...
...ins lode Oil .uhi i iiural go, shnus the hens energy prices c.ui 1ll.ike letlatio n look like inflation ((:h.1rt -1) . (2) The core Producer Price Index flirts with zero 6-0% 5-s% 50% 4-5% 4.0% 3.5 3.0 2.5 2.0% 1.5 5,, 7 1990 1992 1994 1996 1998 2000 S...
...Hey, if everyone spurned technology hype and bought Coke, Gillette, and the Washington Post, they would be as cleanshaven, caffeinated, rich, and liberal as he is...
...A precipitous decline in commodity prices, a dollar rising against foreign currencies, signs of a recession, and collapsing equity values are all signs we are in the danger zone...
...A near infinite resource implies a near zero price...
...economic growth and stock market value...
...If you measured productivity by counting transistors per worker, it has risen 10 billionfold since 1956, perhaps two millionfold since 1980...
...He's on a crusade to expand venture-backed entrepreneurialism throughout the world...
...And yet stock prices were in the outer stratosphere...
...Today the price of a bit per second per mile of communications power is well into a plunge that will soon prove far steeper than the Moore Law descent of microchip prices...
...When U.S...
...Here is one way to assess the Buffett record of 27 years: spectacular investor returns, honestly derived...
...The technology trade gap signifies the influx of low-margin commodity components like DRAMs to allow production of high margin systems and software expanding U.S...
...Among Buffett's chief investments during this period have been Coca Cola, Dairy Queen, and the Washington Post...
...The Fed controls the monetary base, pure and simple, and does so by buying and selling bonds (open market operations...
...Ignoring the markets is more dangerous to governments than ever...
...The mood of the time was grim...
...The leaders would 46 THE AMERICAN SPECTATOR May 2001 FEATURING SPEAKERS AND PANELISTS FROM COMPANIES LIKE: Avanex Chorilln CoreTe k New Foc w B Ne Appliance (11o ssln titlllt on Phutonics Tcnlvo Suing N rks ('KST Ec )nics 300 Networks Vcri:tln 13rc r dccnn Alcarcl TYCO 111 NIcrrill GEORGE GI LEER'S GLOBAL TECHNOLOGY FORUM 5-7 JUNE, 2001 LONDON • STRATEGIES FOR SUCCESSFULLY INVESTING "'::IN THE OPPORTUNITY OF THE TELECOSM ( rt'tll't~t' ( rlkft't', I L'r'(1,11~• II)L' ttt Il I,f • I11Lt,1 I 1 'L'IllItIt,III illll'I•l11-L'k T t If rt'Li11 1114 hC, Illt Ilk-', Ittul is ,It ILI], IIIL' ( I1ttl'.1] TC{ 11i1, Ill1~t1 I•L k[Wll :It I IhL' 11L...
...But they cannot stop it...
...inflation that pushed modest incomes and non-existent cap gains into the nosebleed brackets...
...Investment conferences thronged with grim reapers touting purchase of gold, coins, and canned goods, bomb shelters and AK-47s to defend them from roving packs of vandals...
...Scores of new firms gave the U.S...
...A supporter of so-called "value investing," Buffett spurns technology and invests chiefly in companies that impart no long-term value to the economy...
...Today's investment prospects have nothing to do with last year, but depend only on the expected return from this point forward...
...The Investor Class, about 60 percent of the voting electorate, knows that-so far-this is the Clinton/Greenspan recession...
...On April 18, 1998, the Economist's cover story about "America's Bubble Economy" fretted about U.S...
...must converge the present...
...Weaving the fabric of all economic and social activity, communications is a force much more far-reaching and catalytic than computing is...
...The NASDAQ took fright as the Clinton Justice Department relentlessly sought to break up Microsoft, quashed the WorldCom-Sprint deal, and threatened fiber-optic component maker JDSUniphase's acquisition of SDL on the absurd theory that it is possible to hold a monopoly in an industry in which groundshifting breakthroughs come by the month, BY LAWRENCE KUDLOW not the decade...
...a• S I-s E 7000 (7) As Information Technology's portion of the economy grows inflation finds negative territory Scat...
...Many top-tier VCs, in other words, would swap tax advantages for a cozy cartel...
...Based upon historical norms, stock prices appeared to be at least 40 percent overvalued in early 2000.The data were shouting a warning to anyone who would listen...
...Inflation-adjusted gross domestic product was growing over 5 percent...
...The problem wasn't policy, we were told, but a speculative bubble...
...The resulting collapse in price is not a disaster for the industry, mostly because of the more potent and broader designs and applications it enables...
...Unfortunately, when economists do step aside they not only avoid making mis THE CURRENT EMERGENCY THE COMING takes, but they also deprive others of their insights...
...economic policygood for global democracy, too...
...SPOf1SDRED BY: i I'or1l I tItIII:II f rl,,,ill_ £ rhl.• Irlltlltyrnrt QUALCONM ELECTRONICS 5-7 JUNE, 2001 AT THE GROSVENOR HOUSE, PARK LANE, LONDON A key to Warren Buffett's success is insider trading, perfectly legal if, like Warren, you invest under a capacious corporate umbrella...
...This concept is definitely useful because it allows us to envision how changes in the economy will affect the overall stock market...
...Barron's is worried once again that communications prices are dropping too fast...
...Ac "the network becomes the computer" the most crucial deflationary force will he the collapsing price of bandwidth (Chart S) (6) In computers, price indexes are always negative N. m 0 m O'7 a a m rn cc rn rn 0 rn rn m m M s°° Y J...
...But it will do little to excite America's most productive capital at a time when massive adrenaline is called for...
...Intel leapt dramatically ahead of all its Japanese competitors in microprocessors and U.S.-based companies dominated the lists of top microchip producers...
...With the Fed deflating nominal GDP-or total spending in the economyfrom 9 percent to 3 percent, technology Financial market behavior is a daily referendum on policy...
...This is what investors did in the 1970s, when inflation ate away the value of the dollar and stocks...
...Even worse: America's most productive capital-venture capital-has already left the field...
...Such successes quickly began to breed more, and venture capital became a serious industry...
...Yo f to Yo tta...
...All at once...
...Transistors on a chip were not Intel's product, but the material substrate on which the design-the real value-was created...
...Today, with over $100 billion raised from limited partners in 2000 and another $40 billion expected in 2001-venture funds under management exceed $200 billion...
...The runs never did occur, and the excess growth of the monetary base had significant consequences...
...The managers of such portfolio companies shift capital quite legally among their holdings and make new acquisitions on the basis of intimate insider information...
...Economists do have a lot about which to be modest, but they also have a great deal to add...
...We won't put up with it for long...
...Excess monetary base growth removed the constraints on the banking system...
...Ale-,s -;5E (3) The best barometer: Gold can't find a bottom 260 1990 1992 1994 1996 1998 2000 -e •• J . s- -; R - (4) Commodities prices in collapse since '97, but oil goes its own way 170 240 160 U U 220 150 200 140 3 9 160 140 120 1990 1992 1994 1996 1998 2000 130 n 120 110 100 40 THE AMERICAN SPECTATOR May 2001 In other words, pushing rates up can always stop inflation, but a central bank cannot always push rates down far enough to end deflation...
...Similarly, bandwidth-raw communications carrying capacity-is not the ultimate product of the communications companies and equipment makers...
...The most effective fiscal stimulus ever invented was a cut in capital gains...
...And with real interest rates above the rate of growth in the real economy, look for these announcements to continue in the months ahead...
...Moore's Law is more than just another story of industrial "learning curve" efficiencies...
...Markets are smarter than Phillips curve trade-offs between inflation and unemployment, or NAIRU estimates of the economy's potential to grow, or monetarist models of money and nominal GDP, or numerous other discredited theories...
...In 1986, some $4.5 billion flowed into several hundredVC funds...
...The world economy is increasingly unified and if the U.S...
...Inflationary expectations and real yields soared...
...exdudln rolarlle rnert v. snail ,t ch)Xs livrarci Nil de ihllos+IIIg the I'1')- tax cuts...
...Dollars) includes conference attendance, documentation, all official functions and three nights (room and taxes) accommodation at The Grosvenor House...
...All said, the crack dealer's capital produces a negative return, too...
...Venture capital is more than just another source of capital fueling the expansion of existing capacities...
...Too many people working and producing would lead to higher wages...
...In both cases the confusion is natural...
...A real interest rate on cash of 3-4 percent would be bearable if the real economy were growing at 3-4 percent, but not after real growth had been fine-tuned down to zero or less...
...essentially infinite...
...Those who bought the S&P 500 in October 1990five months before that recession endedsaw their return rise from 727 to 1611 within five years, and to 4295 in ten...
...Between 1982 and 1987, American IPOs spiked to levels surpassing the go-go days of the late 1960s...
...If you ask people to invest in young companies that will make America's future, you have to make it pay...
...While meditating the lesson plan, I welcomed a call from Andy Kessler, the former Bell Labs researcher and growth 45 THE AMERICAN SPECTATOR May 2001 fund guru who not only manages the growth of my money through his Velocity Capital but also often renews my intellectual capital as well...
...That's why few of them lobby for lower taxes...
...are as sensitive to changes in intlation as conunodities prices...
...As costs drop, companies capture profits, enlarge investment, lower prices, expand market share, and trigger an ever-larger demand for money...
...disk-storage industry was kaput, with "floppy" disk drives entirely dominated by Japan, and an obvious wretched excess of venture money pouring into floppy harddisk companies, from Seagate and Prairie to Connor Peripherals and Quantum...
...More than in any other investment arena, the elite high-tech venture funds are run and staffed by entrepreneurs and innovators, scientists and researchers collectively outgunning the intellectual resources of most of the companies they fund.Whereas most investment decisions in the financial industry are made by stripping away unique information to facilitate measuring and spreading risk, the venture capitalist dispenses intelligent dollars, animated by intimate knowledge of the innovative potential of the new venture, which at the time comprises virtually its entire value...
...Recession, not inflation, was the real problem...
...Heretofore cash-strapped firms all of a sudden were awash in liquidity...
...During the first half of the 1980s, the number of venture capital firms had risen from 25 to over 200 and venture money under management had risen from $4.5 billion in 1981 to $19.6 billion in 1985...
...The yield on the long bond had risen to as high as 6.75 percent, bringing down our market capitalization (because we divide economic profits by long term interest rates...
...They will oppose tax rate reductions in order to pay back debt or balance the budget, as Americans did in the 1930s and the Japanese did during the 1990s...
...has made dramatic gains in market share against the rest of the world...
...And finally, with Clinton gone, it looks as though market interventions such as the anti-trust actions against Microsoft will susbside...
...Right now the market message is clear: lower tax rates on income and capital to reinvigorate investment, reduce regulation to enhance technology innovation and the energy to power it, and provide sufficient central bank liquidity to accommodate the next long boom...
...By Breyer's reckoning, the 2:1 ratio is also when a talented manager in the Old Economy becomes willing to trade his high incomes at big corporations for a chance to pioneer at a speculative startup...
...Early in 2000 the Fed realized its error and abruptly took all of the excess monetary base out of the banking system-"monetary liposuction" is my pet phrase...
...Since 1980 the share of the economy held by the Forbes 500 companies has dropped from 50 percent to under 25 percent...
...Venture capital is the financial and entrepreneurial force that drives U.S...
...These are the companies that are reinvigorating the still incalculable riches of the computer era with the infinite potential of electromagnetic communications, transforming the world economy and every existing political and cultural arrangement as well...
...While the details are no trifling matter, the concept is simple...
...As Greenspan pointed out, this was "implausible" and "raises obvious questions of the validity of the price deflators currently employed...
...Just as Barron's in the 1980s lamented the plummeting price of memory chips, today the same tenebrous tabloid bemoans a perpetual "bandwidth glut" and the plummeting price of communications...
...This happened because the Fed grew the monetary base way too rapidly in 1999 and early 2000 out of an understandable fear that there would be Y2K runs on the banking system (see chart...
...Why risk your capital on risky technology when there is no tax incentive to do so and inflation is still running at 4 to 5 percent per year, undercutting your after-tax return on investment...
...The stock market fell for perfectly good reasons, as always, but those reasons rarely last very long...
...During those four quarters GDP grew more than 6 percent...
...deflation has not reached the painful level that it did in Japan...
...In a low-pressure economy, capital surpluses, trade deficits, and surging productivity go together...
...Rising faster in the low-pressure area than outside of it, income growth pulls in imports, both capital and consumer goods...
...It's doing so again...
...Absurdly tight money has choked a ten-year boom...
...A Gar, S,..i.i S Cc (8) The price of global bandwidth falls even faster than microcircuits 0 0 0 3 1°a 1988 1991 1994 1497 2000 S...
...Drucker voiced the consensus view: "Making memory chips in America is like growing pineapples in North Dakota...
...economy was on a collision course with the 1970s...
...Call that 7.3 percent an inflation effect since no special factor in the auto industry was driving up relative prices.Thus the effec38 THE AMERICAN SPECTATOR May 2001 I ~ r:r:~c -, r:r:~ The Yottabyte NetStorage Company World-class team 01 Disruptive technology Distributed architecture Intelligent cache technology Massive, high-growth market strong intellectual property portfolio r We are building a billion dollar company...
...Fortunately, destructive Fed policy is, to use Mr...
...computer and software firms and thus ultimately for new U.S...
...ntenlorv c]rtp, pro pre even taster ((hart 5l• (5) Computer memory prices fall even faster than microprocessor speeds rise 1.000 10,000 E 0 Price changes for computers, softss-are...
...As long as the Fed fights inflation by targeting and capping stock prices, and assumes that dollars are too abundant while the dollar is near all time highs-and that inflation is a threat while prices tank everywhere-the economy will be in jeopardy...
...Profitability (profits as share of GDP) was at or near all-time highs and unlikely to get any higher...
...These crude metaphors are just journalistic tricks for concealing ignorance, but they regularly foster poisonous remedies for imagined ills...
...What happened was that people, expecting interest rates to be higher in the future, accelerated expenditures into the present, effectively borrowing GDP from the future into the final two quarters of 1999 and the first two quarters of 2000...
...Neither the CPI Or PPI, however...
...r 4 c-, & Cc O N O 99 F M A M J J A S O N O 00 F M A M J THE AMERICAN SPECTATOR May 2001 41 The Fed's Back on Track BY ARTHUR LAFFER Too often economists defer judgment on issues like the stock market because the depth and breadth of the uncertainties are enor mous...
...Off its death bed came the IPO market...
...In Japan today, short-term interest rates are zero, but prices are still falling 2.5 percent per year, making real rates a positive 2.5 percent when they should be zero or less.The only available course of action is to force money into the economy regardless of the demand for it-the course Japan announced in mid-March...
...Relentlessly reducing the cost of micro-circuits and therefore the price that Intel and others could charge, Moore's famous ordinance might at first seem like a suicide pact...
...Government created the conditions for a perfect storm: a high tax capital to the U.S...
...The collapse of 2000 and 2001 will seem a mere blip in a long-run bonanza...
...Booms need not lead to busts (Hong Kong boomed continuously from 1975 to 1997), and busts need not be preceded by booms (witness the U.S...
...The monetary base and reserve requirements, operating through the banking system, determine bank liabilities...
...In essence, bubble theory holds that falling stock prices are the cause of downturns rather than a symptom, because the crash happens first...
...In 1980 Ronald Reagan was elected and in 1981 the biggest tax cut in generations passed...
...As the price of the key factor of production plummets, wealth flows in from around the globe to take advantage of the opportunity...
...Now imagine how an investment banking firm would evaluate the market capitalization of USA Inc...
...After peaking at $660 in January 1980, the price of gold fell sharply in the 1980s...
...Microsoft fell by 63 percent in 2000, yet nonetheless managed to hold on to an average annual gain of nearly 32 percent over five years...
...In 1977 new car prices rose at a 7.3 percent annual rate, while new auto loans from banks were 11 percent...
...intelligentsia blind to the vast new abundances that are being created by innovation and technology.Thus, during a stock market crash they tend to join the crazies...
...How can they make any money adding to a glut...
...As public investors cooled on tech stocks, IPOs grew rarer...
...Yet these advances are readily routinized within a few years of each breakthrough...
...With 864 fibers in a single cable, one cable can bear as much as a petabyte (10 to the 15th) in information per second...
...Software, for instance, increases in value when more people use it...
...which more than any other com (1) Core CPI, though overstating inflation, drops for a decade BY EILEEN CIESLA mexiin• tunctlcuh like nianie•v...
...Then, annual disbursements of four or five billion encouraged a belief in the viability and resilience of the innovative process...
...Pulverizing costs, expanding markets, easing transactions, shrinking firm size, trashing corporate bureaucracy, boosting entrepreneurship, compromising borders, driving governments to competitive rounds of tax cutting and deregulation, easing access to money capital and hastening combinations of intellectual capital, the New Economy, far from being overhyped, is still pitifully under-appreciated...
...Motorola followed with write-offs and cutbacks...
...But the concept of capitalized economic profits has even more to offer...
...The plummeting price of a key resource-the sudden evacuation of costscreates what might be termed a low-pressure area in the economy...
...It can be compared directly with actual market values of USA Inc...
...Spurred by somber complaints from Sanders, and from Andrew Grove and Robert Noyce of Intel, the press sagged with articles predicting the death of the U.S...
...Fueling hundreds of new companies and inventions, venture outlays and initial public offerings together rose tenfold or more between the late 1970s and mid1980s, and the number of new patents issued annually began to skyrocket after falling in the late 1970s...
...The investment bank, using market comps, would capitalize USA Inc.'s earnings stream to estimate what USA Incas market capitalization should be...
...And, so far, U.S...
...Policy makers must come to realize that financial market behavior-be it stocks, interest rates, commodities, or currencies-amounts to a daily referendum on policy Bear market downturns represent investor pleas for new government policies...
...The key source of today's low-pres Internet and its transformation through the power of fiber optics...
...The banking system in turn granted credit to marginal firms and to creditworthy firms on marginal projects...
...THE AMERICAN SPECTATOR May 2001 51 America's Most Productive Capital THE CURRENT EMERGENCY THE COMING Ireland recently achieved average incomes higher than Germany's, and Sweden recently reduced its national debt by 20 percent...
...When Nortel released its earnings warning in late March, it cited "pricing pressures" as a clear problem...
...The difference in the marginal costs of manufacturing an $8 standard DRAM memory chip and the latest Pentium retailing for $800 account for less than one percent of the difference in the price...
...monetary policy turns excessively tight, many other countries suffer...
...The IPO market was dead, thanks to high capital gains taxes (nominally 49 percent) combined with inflation that pushed real rates on long-term investments often past 100 percent...
...Historical evidence tells us that such companies will end up creating many trillions of dollars of new wealth...
...It proliferates new companies and disaggregates existing companies, externalizing internal non-monetary exchanges...
...Fresh from a roundtable dinner at Forbes headquarters in Burlingame, he estimates that as much as a hundred times more venture capital was raised in 2000 around the globe than in 1990...
...In every era, the definitive abundance is revealed by the price of a key factor of production, plummeting over a cliff of costs...
...Pondering the numbers, many economists will continue to warn against inflation and call for tighter money policy, as they did throughout much of the Great Depression...
...According to in depth studies by Harvard Business School's Michael Jensen and his students, the return on venture capital outperforms internal corporate investments by a factor of 20...
...Today, environmentalists believe in a coming material scarcity-a dearth of fuel, food, farmland, water, minerals and clean air...
...Wealth creation, venture capital investment, and technological innovation had been booming...
...And the Clinton tax rate for top earners, even though it had been jacked in 1993 to 39.6 percent, was offset by a Republican Congress that lowered capital gains taxes to 20 percent in 1997...
...Kessler offers the analogy of weather changes...
...has the most accurate and voluminous earnings data ever...
...Corporate profits are an extraordinary, finely measured data series that surpasses any comparable company data...
...www...
...None of this changed when the Fed, confronted last year with the failed horror flick ofY2K, started playing the Pit and the Pendulum with interest rates...
...rate on capital gains...
...But stock markets typically anticipate bad news, which is why governments should take them more seriously...
...But, putting it all together, the worst is behind us and the next year should be just fine...
...Nevertheless it was the Fed that killed the market...
...While much of the decline in consumer goods prices can be traced to rising manufacturing productivity and globalization, the decline in commodity prices cannot be as easily dismissed...
...Breyer sees it differently...
...That's good deflation...
...Initial Public Offerings 140 The Bush-Lindsey tax plan, as it stands, pledges to lower top-bracket income rates to 31 percent.That's fine in and of itself...
...In the New Era economy such anomalies abound and the complications of measurement are overwhelming...
...Without cutting government spending, plummeting price of bandwidth is emit- sure economy is the rampant spread of the The huge fortunes of the new era will ride the plummeting price of communications bandwidth, falling up to ten times as fast...
...Lower prices of key factors of production are prime signals of value and opportunity...
...Core inflation remained below 2 percent...
...Too many investors creating too much wealth...
...PRESErITED BY: gilder publishing, I_L...
...It's fair to ask what Buffett has added to America's capital base...
...Breyer claims this to be sound U.S...
...The subsequent performance of the market propelled him to the forefront of technology analysts and he soon was to launch a leading Morgan Stanley growth fund...
...But by 2000, the VC inflow had zoomed up again-all the way to $100 billion...
...With the Fed cutting rates aggressively, deflationary pressures are now receding...
...Investors should focus on commodity prices, gold, and the dollar in order to assess the progress of the Fed at eradicating this clear and present danger.', ...Good Deflation f-lig]ter prnkill ctivit- still iho drive down prices...
...This has always been true, but in the political economy of the 21st centurydefined by global markets, more democratic, universal, reacting more quickly and perhaps more ferociously than ever, but especially incorporating more of the body politic than ever-ignoring the markets' referenda is more dangerous to governments than ever...
...In the low-pressure economy, deflation mimics inflation...
...First and foremost, the Fed is now doing a great job...
...Experts pondered the emergence of a "new economy" and speculated on the possibility that stock prices had entered a permanent new plateau of higher valuations...
...Then tax simplification arrived in 1986 and flattened the difference between income and capital gains taxes-both were now at 28 percent...
...But the result-virtually free bandwidth at the margin-fails to be a destructive glut of capacity because it unleashes a demand for "connectivity...
...Because this surge in productivity is driven by little-understood applications of new technologies, much of the resulting deflation will be missed by traditional measures, especially by an economics establishment conditioned by decades of inflation fighting...
...Starting in 1983 the chart looks like two guys racing up the same ladder...
...Was the NASDAQ surge a general tech bubble, based on irrational enthusiasm for the entire sector...
...and the P/E ratios of comparable enterprises, to come up with a comparable price for the U.S...
...It was only by trivializing the cost of their product that the pioneering firms of the industry made the microprocessor the dominant product of the era and made themselves and those-like Microsoftwho used this computing power, into the dominant companies of the decade...
...Or it goes away...
...But he destroys social capital...
...A stable U.S...
...To many analysts, free bandwidth is a disaster for communications companies and makers of equipment for them...
...Both Andy and I began our engagement in technology stocks during the mid1980s...
...And so it goes on up to the present, with major events such as October 1987 and the Republican takeover of Congress in 1995 all standing out...
...Then strap on your seatbelt for the greatest boom ever...
...Believing that all real economic growth comes from the supply side and is animated by innovation, my confidence sprang from Moore's Law-which proclaims that the computing power on a chip will double roughly every eighteen months for the same price-and from an explosion in venture capital...
...The answers are remarkably similar...
...Even the divergences between these two series "make sense...
...The exaggerated growth of the monetary base pushed up long-term bond yields, provided the rationale for the unsustainable stock market bubble, and caused real GDP to exceed its appropriate full employment level...
...Frequently portrayed as being entirely composed of "tech" stocks, the NASDAQ 100 includes such firms as Costco, Starbucks, Staples, Paccar (trucks) and Bed, Bath and Beyond...
...But as with other drivers of the new economy, inVC funds the underlying "material" components-the dollarsaccount for a trivial proportion of the value, most of which is supplied by the unique information and intelligence which are a VC fund's primary resource...
...Since then, patents have catapulted to nearly 150 thousand annually.Then I was enthralled by the Moore's Law microchip learning curve, doubling cost-performance every 18 months.Today bandwidth doubles at least twice as fast, and Metcalfe's Law, which sums up the productive potential of a network as the square of the number and power of the nodes connected to it, suggests a growth in the productive potential of the networked economy far outstripping the advances of the pre-Internet computer era...
...To see how we would do this, imagine the United States as a single company that wanted to go public...
...So productivity had to be reined in through tight money...
...With the excess removed, interest rates have fallen, GDP is at or near recession levels, and the stock market has corrected...
...What about tech stocks more broadly...
...Most investors can't do that, and anyway if everyone could, it wouldn't work...
...Like a giant river reaching a falls, the key resource releases a surge of kinetic energy into the economy as the price drops...
...If anything, stock prices are a little below fair value, and by the end of 2001 the economy should be back to its normal longterm growth...
...By constantly reducing costs and increasing values, the low-pressure economy drives prices down dramatically in the highest growth sectors such as technology-and these low prices reverberate throughout the economy...
...That's right, excess productivity had to be curbed, according to Alan Greenspan...
...it seems odd and unfair to speak of the result as if it were a mere physical precondition for the execution of the real work, the design...
...Most important, large increases in asset prices are never inexplicable "bubbles" that collapse for no reason, or that need to be burst by a cen tral bank assault...
...The Irendline corresponds to the average annual growth rate of the monetary base over the past 10 years of 7.5'e 43 THE AMERICAN SPECTATOR May 2001 r1 Ir U. I] ri COMING is the first new Millennial crash...
...Microsoft, Oracle, Peoplesoft, Adobe, and Computer Associates pushed to the fore in software...
...Yet such prudence (or cowardice) has always proven a remarkably effective strategy for avoiding wealth and postponing early retirement...
...Combining all these indices of the vitality of the innovative process, a reasonable guess is that the opportunities of the next decade are roughly ten times more promising than the opportunities opening in the mid 1980s multi-trillion-dollar wealth explosion...
...Similarly, Japan's prolonged stagnation after the pop of its alleged 1989 "bubble" just shows what happens when tax and monetary authorities become so fearful of bubble metaphors that they take it upon themselves to destroy asset values, in this case by imposing new taxes on capital gains, land and retail sales (see my presentation to Keidanren at www.freetrade.org /pubs/speeches/ar-4-6-98.html...
...This is proved time and again, most spectacularly by Steiger's 1978 cut from 49 percent to 28 percent...
...even Democrats now seem to understand the benefits of free trade...
...All asset values will have to adjust to real interest rates in the double digits (adjusted for expected deflation, raising the real costs of debt repayment...
...The minute it got a peek at the Bush tax package NASDAQ turned tail and now wobbles below 2000...
...Buffett, sensing correctly a stock market bottom in 1974, created his second fund (his first fund ran from 1954 to 1969), which soon became known as Berkshire Hathaway...
...We are not in a tech slump, or a business-cycle slump, but a policy slump...
...In addition, passenger car prices are down 2.5 percent in the past four years, light truck prices have fallen 4.4 percent, apparel prices are down 2.5 percent, and information processing costs are down 8.4 percent...
...The huge fortunes of the new era, however, will ride a new factor of production over a new paradigm cliff the price of communications bandwidth, falling between two and ten times as fast as the fall in the price of transistors...
...In the Gilder Technology Report I write about technology trends, which can actually be projected on the basis of current information, without reading any policy maker's mind...
...Today, all computers can roam the World Wide Web with access to storage facilities containing exabytes (10 to the 18th...
...Bad policy, on the other hand, can drive American venture capital overseas, just as bad policy in Japan and Europe shifted BY RICH KARLGAARD All capital is not equal...
...Berkshire Hathaway joins Coke, AIC government employees insurance, and the Washington Post...
...Back then it seemed the "malaise" would never end...
...For my purposes I like to use the S&P 500 Index as the actual market value of USA Inc...
...the lead in services, design tools, and capital equipment-and even in high-end manufacturing...
...In the midst of bad times, many investors look to Warren Buffett for guidance...
...High real rates can be seen in the rapid increase during the past few years...
...The two direct effects are lower after-tax profits and higher interest rates...
...at which point, the public becomes keen to share the risks of backing tech stocks...
...semiconductor industry at the hands ofJapanese keiretsus...
...Too much prosperity, according to the bubble theory (devastatingly skewered by Alan Reynolds, page 36) was a bad thing, bound to drive up inflation...
...50 THE AMERICAN SPECTATOR May 2001 By dominating the design and use of this resource over the last decade, the U.S...
...That erodes sales revenues as companies compensate for the higher interest rates faced by customers...
...112!L III, ( li-t 1,\ L'llt IT- I It (III LLnltiLlil" I':I!-k I.;111L, 5-7 liillt' 7L L}I . 111:0,111 It 111 It t IIIL• l1ltLIri11;IrIL111-1~;IlI:L'.f t1:111 11t'i 11111 LL': 1'-1LIlli1~ Ittlllll t'• ill t1'111L1) VtIII L, All L1EIL'rC .11111 JJt'I1;ITt- 151111 ( IL t II' t' ( 1]It1L'r, iLltllhiillL' rthlt' t t11;l1IA" IIlLI It'll' tll tk IL I :11L •, .1 k 1111111k It' 1(It.] I,I rt'ttt11IIt1'~ Llf illt't'1't'ill ,II 11Iu t;ul [t'ie...
...Extending markets and proliferating new products, it lowers the cost of capitalism and raises the comparative price of socialist policy...
...That was a mistake...
...These data are also adjusted for price levels and inflation, making them comparable over wide spans of time...
...This actually hurt short-term profit performance because Reagan's tax cuts were phased in over three years and people deferred income to avoid taxes...
...Moreover, Argentina is facing a national crisis because the peso, due to a quasi-currency-board arrangement, is lashed to the U.S...
...Alas, such sillygisms find an eager audience in Mr...
...Gray Davis's energy fiasco in California could cause some serious damage, especially if it spreads to other states...
...The 1970s turned in the second-worst performance of the 20th century, in economic terms, largely because productive capital went into hiding...
...From horsepower to kilowatt hours, the countries, companies and individuals that exploit the ever-cheaper resource gain market share against all others and end up casting the character of the age...
...With capitalized economic profits in hand-which, by the way, also go back as far as the eye can see-we have a firstorder estimate of how an investment bank would value USA Inc...
...As devastating as inflation is, deflation can be worse, because interest rates are bounded on the downside by zero...
...0 .GILDER.COM/LQ OR CALL + 1 -413-274-3050 Your program fee of $3,900 (U.S...
...In equilibrium models, lower prices normally signify lower value, lower demand, and decreased productivity...
...Everything else is cost...
...In the Bible, the power to communicate at a distance instantaneously is so revered it is reserved to the angels...
...If ever there was a greater example of central planning blunder, I can't think of it...
...Working with millions more transistors on each chip, they could create far more capable devices commanding far higher prices, with functionalities that added far more to American productivity...
...Between 1986 and 1991 the inflow from limited partners intoVC funds shrank from $4.5 billion to $1.5 billion per year...
...Yet it took the central bank nearly nine months to recognize they were fighting the wrong battle and begin to cut rates...
...But you can make a strong case we'd all be speaking Japanese now if not for the late Congressman William Steiger's (R-Wisc...
...J As Brian Wesburv notes above, the ec ononn• appear...
...The PC industry and its peripherals had achieved what Doerr termed "the largest legal creation of new wealth in the history of the world...
...That means that communications power can undergo the kind of plummeting price and surging cost effectiveness that impelled microchips to the central role in the global economy during the last two decades of the Twentieth Century...
...Venture capital apparently accounts for a trivial proportion of all the investment in the economy...
...It can just as easily produce a neg ative return as positive, as it will in the pocket of a crack addicted rock star...
...Stock markets started cracking last April...
...Had Washington moved earlier, the demoralizing $5 trillion stock market wealth deflation, a crippling manufacturing recession, tens of thousands of job layoffs in technology and service industries, and a general rollback of risk-taking animal spirits all could have been avoided...
...Facing tight money and hostile taxes, risk capital is fleeing into Treasury bills and Berkshire Hathaway stock and will sit there for as long as it takes Alan Greenspan and the Bush administration to point it toward better uses...
...Economist David Gitlitz has pointed out that during the first half of 2000, when the Fed was inflicting its deepest pain on the economy, non-farm output-per-hour was rising at a spectacular 5.25 percent twelvemonth rate, the envy of the world, while unit-labor costs (wages less productivity) were declining at a 0.4 percent pace...
...For my taste I use economic profits, which is comprised of corporate profits adjusted by the capital consumption allowance (CCA) and by the inventory valuation adjustment (IVA...
...In part they are correct...
...The ability to put terabits of information on a single optical fiber is the consummation of arduous and exciting advances in both optics and electronics...
...gives up leadership, other countries will move into the breach and growth will shift to the low-pressure regions...
...Despite the onset of recession in the U.S., the dollar has climbed 6 percent against a broad basket of foreign currencies in the past year, and is up 9 percent against the euro and 15 percent versus the Japanese yen...
...Three things: Web browsers debuted in 1994, launching the commercial Internet boom and with it huge opportunities for startups to grow sales in record time...
...Going to cash, investors bulk up savings and money market accounts, boosting the measured money supply at the same time they are compromising the future demand for money by disinvesting from the companies that drive the economy...
...Today, disbursements run at a level some twentyfold higher.Then, investors concentrated on &4L a few firms in computers, chips, and software...
...If the current administration and Federal Reserve follow these well-trodden paths of failure, they will delay the onset of a tidal wave of new growth and opportunity...
...Some would say the Digital Economy was born with Intel's invention of the microprocessor in 1971, a miracle George Gilder has called 52 THE AMERICAN SPECTATOR May 2001 the most important invention of the second half of the 20th century and from which grew the pocket calculator, the personal computer, the Internet, and all the rest...
...The rock star's crack dealer, by acting very businesslike, may side step addiction and indeed multiply his money...
...That one tax change followed by the Reagan/Volcker attack on inflation accomplished what no miracle silicon chip could do by itself...
...With a regime of tax rate reductions, two of Europe's least likely economic successes-Ireland and Sweden-became entrepreneurial stars...
...What caused the boom...
...From 1974 to 1995, the top twentyVC firms kept pace, or slightly surpassed, Buffett's annual percentage return-in the mid-30s-on invested capital, despite the VC's slow start...
...Then, computers tended to be devices on Local Area Networks with access to attached local storage of a few megabytes most of the time, or a few gigabytes in big companies or campuses...
...The Internet lowers the cost of transactions, of price information, and of search, and facilitates the setting ofprices.The Internet saves the key scarcity of the new economy of abundance-time...
...Warren Buffett, the sage of Omaha, is the popular media's favorite securities investor...
...THE AMERICAN SPECTATOR May 2001 35 company sales revenues, profits, and share prices were bound to collapse, combining with higher taxes and over-regulation to send both the stock market and the economy into decline...
...In the next year or so, a transistor on a DRAM will cost about a millionth of a cent.A single semiconductor fabrication line can process in a pipeline some 180 trillion transistors a year, half a trillion per day, and 100 billion per day per worker...
...As Peter Drucker has pointed out, the only sources of profit in any enterprise are innovation and marketing...
...Most, like Sequoia Capital's legendary Don Valentine, an early fonder of Apple, Cisco, and Yahoo, prefer operating in a smaller venture industry, where only a few dozen firms are chasing the best entrepreneurs and opportunities...
...llcroprcl c„or, dcnlblc• Ill •hc•c•d at rcnlg}tlw the ,aloe price e rs 1%) nxuith...
...stock market and slowing the economy.This bubble-busting crusade (despite zero evidence of higher inflation in anything but oil) was the Fed's only excuse for raising the Fed funds rate from 4.75 percent to 6.5 percent by May 2000, and keeping it that high for another seven months.The last time the funds rate had been above 6 percent was, by no coincidence, the last recession...
...In other words, the market dropped because it anticipated depression, actually underestimating the damage since it did not realize the government's solution would include policy blunders such as tripling income tax rates in June 1932...
...In late 1999 and early 2000, the chairman of the Fed, like his counterparts at the Bank of Japan a decade earlier, repeatedly lectured Congress on the merits of depressing the U.S...
...And bank liabilities, along with the real econ The Y2K money spike - Monetary Base "' Trendlme .:E...
...Nevertheless, it was rapid non-inflationary growth and investor will ingness to take risks that generated the bull market prosperity long before the winter of '99...
...But why take chances...
...The much vaunted budget surplus, heralded by the Clintonites as the principal policy elixir of the new economy, is actually a tax surplus spurred by bracket creep, draining vitality out of the economy by roughly $150 billion per year, mirrored by a roughly equivalent decline in personal saving...
...Qualcomm fell 53 percent in 2000, but only after rising by 2,619 percent the year before...
...On all these points the Bush administration needs to act quickly and more forcefully than the markets expect...
...Accessible, affordable computing power benefited the entire economy from WalMart to General Motors, Home Depot to General Foods...
...dollar is important to the entire globe...
...Now, you might expect a venture capitalist like Jim Breyer to concoct any argument to support lower capital gains taxes, but, in fact, few VCs say that at all...
...But the Telecosm will still prevail and investors who understand its dimensions will be able to spurn the catastrophists and prosper from the largest opportunity in the history of the world economy...
...simply by dividing the economic profits series by the yield on the 10-year Treasury bond...
...The U.S...
...Startup financings are off 80 percent compared to last year...
...Of course the Fed was not the only villain...
...Like General Electric and other conglomerate stars of the market, Berkshire Hathaway is essentially a portfolio of unrelated investments without any real corporate identity or coherence...
...It stabilized at roughly $370 between 1990 and 1995 and then stumbled downward to the current level of near $260...
...If you gauge the physics and the engineering, you can define the limits of the possible, and you can identify companies that are moving in the right direction.What no one can do is predict the timing of market shifts (like the present) that temporarily overwhelm the underlying companies, destroying distinctions and suppressing prices, both of the companies that will lead the new world and those that had scant excuse to live even during last year's boom...
...They cry for a crackdown on global warming and they call the carbon dioxide we all exhale a pollutant.They seek a Kyoto clamp on capitalism in the face of a vast record of historical and paleological evidence that shows average planetary temperatures are actually lower today than they were through most of human history...
...High pressure means good weather, and investment flows toward the high pressure, highpriced regions...
...Second and third: good policy...
...Goodness knows there are still a number of potential problems looming on the horizon...
...Like today's network industry analysts worrying over a "fiber glut" and the sudden "problem" of too much bandwidth, Intel founder and Moore's Law author Gordon Moore inquired morosely "what we could ever do with millions of additional transistors on microchips...
...It was a total repudiation of the Phillips curve...
...Between 1974 and 1980 there were almost no initial public offerings in the U.S.-the primary path to liquidity for VC investments...
...Monetary policy should not be a problem in the future...
...CURRENT ERGEN With the steady rise of the Investor Class over the past twenty years, from fewer than 20 million stockholders to more than 100 million, surely the time has come for economic policy makers to listen carefully to the message of the stock market...
...By April 13, 2000, NASDAQ had already fallen by more than 25 percent from its March peak...
...It takes technology and innovation to make an economy grow and to sustain the value of "value" investments...
...Gold is not a perfect indicator of monetary policy but it is better than the CPI or PPI, which consistently overestimate inflation because it is impossible for the statisticians to accurately measure the value of goods or services in an era of frantic innovation...
...Thus, in the eighties I saw the collapsing price of foreign-produced DRAMs not as a dangerous dumping threat to a couple of U.S...
...Microchip industry keynoters told lugubrious stories of a glut of wafer fabrication capacity and memory chips and declared the end of the golden era of silicon, the move of the semiconductor industry overseas, and its emergence as a mere cyclical part of the national economy...
...a thousand lightwave bitstreams on a single fiber thread, each carrying 2.5 gigabits2.5 billion bits-of information per second...
...More insidious is when the investor class sticks its hard-won money into nonproductive capital, like gold or real-estate shelters...
...Bad Deflation...
...It is true, as Arthur Laffer points out in his stunningly insightful piece below, that the very peak of the NASDAQ run was largely a product of an enormous spike in the money supply in late 1999, offered by the Fed to ensure liquidity in the event of a Y2K disaster...
...Cynics insist it may take many years for the market to get back to its previous peak...
...a possible recession nearly a year ago...
...During the Carter era Americans were pessimistic about the prospects for escape from the 400 300 200 100 250 J- 09 Jul90 J- 00 Jul 00 Jan 01 Source AS LafferAssociates 42 THE AMERICAN SPECTATOR May 2001 redistributionist policies of the JohnsonNixon-Ford-Carter administrations...
...in 1937, or Japan today...
...In January a resurgent NASDAQ had climbed from 2250 to 2860...
...marketshare in the global hightech arena...
...Only 20 or so professional venture capital firms have been around as long as 25 years-today there are 1,200 firms-but those that have, such as Silicon Valley's Sequoia Capital, Kleiner Perkins, and New Enterprise Associates have averaged a spectacular 45 percent return on capital per year...
...Cheaper memory chips meant cheaper computers and larger markets for microprocessors and other high-end devices in which the U.S...
...led the world...
...As I write, the End of the World is apparently at hand...
...Blame bad government policy for chasing it away...
...The fit between these two series is nothing short of amazing for unaltered independent macroeconomic data...
...It got America's most productive capital back into the game...
...You can't let inflation create false paper gains only to be taxed away, thus eroding the capital stock...
...Venture capital is significant as an index of long-term innovation, and the venture capital disseminated over the last five years will be unleashing tides of entrepreneurial creativity and invention over the next five years and beyond...
...A company called Micron Technology of Boise, Idaho, even took the global lead in memory chip production from the Japanese...
...Hardly...
...But during the next eight years, investor enthusiasm waned and the Dow slowed its percentage growth, reaching only 3800...
...Timid folk who instead listened to bubbleheads and gloomsters in 1982 and 1990 liquidated stocks they owned and avoided buying more until the economy and market were clearly well out of the woods...
...But to grasp the opportunity, we need a lesson in history...
...I recently had lunch with Jim Breyer, the frat-boy-looking leader of Accel Partners in Palo Alto...
...What, exactly, was wrong with this picture...
...As with other defining abundances, the ting kinetic energy that spearheads economic growth...
...Evidence abounded last month at the Optical Fiber Communications Conference, where attendance doubled this year to 38,000 in the midst of the stock market slump...
...growth in global economic market share, the U.S...
...over the last two decades...
...The collapse in prices was not a glitch in the microchip industry business plan...
...starts" entrepreneurial spirits...
...Greenspan...
...Economists distrust the low pressure paradigm because low-pressure zones run a capital surplus...
...Fortunately, USA Inc...
...Traveling back and forth across the country, I confronted such academic experts as Lester Thurow, Charles Ferguson, Kenneth Flamm, and Robert Reich who insisted that only sustained government aid could save American high technology from the dominion of the awesome Japanese and dirigiste Europeans...
...By far the most productive money on the planet for the last 25 years has been American venture capital.This is not an idle boast...
...There was no tomorrow...
...1978 upset win in pushing a 28 percent capital gains rate over the heads of a hostile Democratic Congress and president...
...Personal computer stars such as Osborne, Atari, Commodore, Coleco, Sinclair, and Fortune Systems were going broke...
...As the doomsayers see it, economics is the dismal science of scarcity...
...Taxes can kill a bull market...
...But even though capitalized economic profits fell like a stone, stock prices rose anyway...
...The official producer and consumer price indices continue to show moderate inflation, but neither is reliable...
...All typically contended that since market capitalism could not tell computer chips from potato chips, computer chip production would follow a giant sucking sound into socialism, requiring a range of subsidies and protectionist schemes to keep American companies from giving up on memory microchips, an industry the experts proclaimed crucial to our survival as an industrial power...
...Now for the meat...
...But its anger will quickly find a new target in George W Bush if he refuses to accept the disappearance of $5 trillion in wealth and the resulting personal devastation to millions of Americans as the government's responsibility and its most urgent priority...
...Deflation increases the burden of debt, crushes asset prices, shrinks profit margins, and slows economic growth, causing bankruptcies and defaults to rise...
...They could golf with Jack Welch and dine with Kay Graham and ooze disdain for anything they don't understand, such as tax cuts and technology...
...Yet the real reason the Dow fell by less than the NASDAQ in the first quarter of 2001 is that the Dow now includes Microsoft and Intel, which were up substantially early this year while such stalwarts as GE and Pfizer were down...
...People want to send their money to them, invest in them...
...On the contrary, shaken out by Greenspan's grim ministrations will be most of the flakier firms, technologies, and business models, leaving stronger survivors to lead a new phase of wealth creation that will leave the Buffetts in the dust...
...to S?-ri 1,1 21 1111 ((:hart 3j...
...dollar...
...It says the crucial delta is a 20 percentage point difference, or a 2:1 ratio, whichever is greater...
...Nikon,TEL, Canon, and other Japanese firms moved to the fore in semiconductor capital equipment...
...Terabits flashing cross-continent are no good to anyone without multi-megabits and now gigabits coursing through local networks and out to their final destination free of all the bottlenecks that make the Net into a mockery of itself, a World Wide Wait of frustration and costly special solutions...
...for the purposes of an IPO.The investment bank would want to know the earnings of USA Inc...
...r .." .- c omy, give us inflation, interest rates, exchange rates, the price of gold, etc...
...Money is too tight...
...There have indeed been some deep drops from the peak, for those forced to sell into weakness, but long-term investors wise enough to keep some cash in reserve have sat out this dance before...
...The bottom of the World Wide Web is bursting like Pandora's pii ata and flushing out a menagerie of Doomsday Adventists, Bad Times Barrons, and Wall Street Wailers, predicting the end of prosperity, the evanescence of wealth, a new depression, a runaway inflation, global warming for socialism, and a new ice age of capital...
...be those that led rapid advances in chip design tools from such companies as Cadence, application specific circuits from LSI Logic and VLSI Technology, new memory architectures from Xicor, Seeq, and Cypress, chipsets from Chips&Technologies, microprocessors from Intel and Motorola, MIPS and Sun, programmable logic just initiated by Altera and Xilinx, and computer software from Microsoft and Oracle and thousands of other companies...
...The Greenspan/Rubin strong dollar policy nipped inflation to 2 percent a year...
...energy policies, including suppressing natural gas development...
...But the underlying forces driving the New Economy are real and not easily suppressed...
...Inflation is never a thermal condition described by "overheat 36 THE AMERICAN SPECTATOR May 2001 rists...
...Generations have been indoctrinated with the folklore that the Depression of 1930-38 was caused by the Crash of October 1929...
...In fact, as Jude Wanniski painstakingly demonstrated in The Way the World Works, the crash occurred as the Smoot-Hawley tariff gained ground in Congress, for the very good reason that investors anticipated the coming implosion of world trade, and the related defaults on trade-related bank loans and bonds...
...As for the poor fools who ignored their advice and bought tech stocks in late 1996, they are still looking at sizable capital gains...
...See chart story, page 40...
...The current recession, as my distinguished colleagues herein argue, still looks likely to be short and shallow More politically devastating and urgent is the danger to the administration...
...firms still in this commodity business, but as a huge opportunity for U.S...
...and a Keynesian-inspired tax code that favored consumption, debt, and dodges over capital formation and productivity...
...The only time it took the S&P 500 more than two years to recover was the 1970s, when inflation made Hummel figurines a better bet than most stocks...
...Now that we have our earnings data for USA Inc., our investment bank needs P/E ratios for comparable assets...
...The 1)o%% lcnic•, Shot ('nnunodtts nldrx...
...For its part, the Bank ofJapan hiked the discount rate to 6 percent in August 1990, rationed bank credit to appease nasty BIS capital standards, and shrank the monetary base by 2.8 percent a year in 1991-92...
...Cold...
...Although there were no reports of the cultivation of pineapples in North Dakota, South Dakota became a center of PC production at Gateway computer...
...Here is another view: 27 years of funding high-tax politicians, sugar water, artery sludge, E .J...
...Today, entire new industries are emerging in communications, storewidth, biotech, and Internet devices...
...Buffett also has done well, of course, but you might be surprised to know how convincingly the top VCs trump him...
...A capital surplus means a deficit in trade...
...Rather than listening to markets, policy makers chose to blame them...
...Too many workers employing new technologies would generate excessive productivity gains, another bad thing...
...In this search, the crucial insight is the recognition that the communications power of the electromagnetic spectrum THE AMERICAN SPECTATOR May 2001 49 In every era the definitive abundance and opportunity is revealed by the plummeting price of a key factor of production...
...Applied Materials became the world's leading semiconductor capital equipment firm, displacing Nikon...
...During its 27 years, Berkshire Hathaway has averaged a whopping return of 32 percent per year...
...Technology now demonstrated in labs and test beds can put is Both in finance and technology, conditions today are incomparably more promising than in the multitrillion-dollar wealth explosion of the mid-1980s...
...It promises a downward price spiral of prices and costs that will pull in storms of economic creativity...
...During the past four years, the CRB Spot Commodity Price Index (which does not include oil) is down 24 percent, the price of corn has fallen 32 percent, soybeans are down 46 percent, wheat is down 30 percent, cotton is down 24 percent, framing lumber is down 36 percent, rubber is down 44 percent, scrap steel is down 42 percent, copper has fallen 29 percent, and the price of gold has fallen 26 percent...
...Meanwhile in two books and many speeches and articles, I doggedly predicted the revival of the American semiconduc tor companies and their ultimate defeat of the Japanese and European models...
...In short, Japan's monetary and tax policy were artfully designed to destroy Japanese assets for no reason other than the bubble metaphor...
...That was necessary given the Fed's earlier mistake, but a lot of collateral damage had already been guaranteed...
...So let me propose an 11 percent cap gains rate under the Bush-Lindsey 31 percent top income rate...
...corn tive interest rate on car loans was 3.7 percent...
...In entrepreneurial economies, low-pressure zones such as Silicon Valley concentrate energy in spirals of growth, twisters of creative destruction...
...In the earlier period, I found encouragement in a fourfold rise in US patents, from around 20 thousand in the late 1940s to 80 thousand in 1985...
...From these well-deserved gains, Buffett funnels some of his own take toward such causes as abortion-on-demand, population control, and presidential candidates who favor high taxes...
...The ability to transmit any amount of information, to anyone anywhere, anytime, at a negligible cost, will unleash surges of productivity as yet unimagined...
...Regardless of the sales price of the main program, its value has climbed dramatically, driving its real price down...
...Dominance of the computer era would not go to the nations and companies that most successfully adapted industrial-era manufacturing efficiencies to the mass production of hundreds of millions of essentially identical DRAMs...
...Conventional economists have long favored equilibrium-economies that gravitate toward perfect balance, blue skies and moderate weather.This remains the ideal of Eurosclerosis...
...Between 1981 and 1986, the Dow climbed from 800 to 2700...
...Seizing the opportunity of Moore's Law was a resurgence of venture capital...
...Then, I took confidence from a fourfold rise in venture funds to some $20 billion...
...Likewise, the prospects of a Democrat-controlled Senate in 2003 with the likes of Boxer, Feinstein, Corzine, Schumer, and Hillary in power is enough to scare the bejabbers out of the bravest...
...Benefiting most of all will be those that make up the sphere I have dubbed "The Telecosm...
...And, if nothing was broke, why did policy makers feel compelled to fix it...
...Jerry Sanders ofAMD reported a month of negative sales (more returns of chips than new billings...
...Where it ends no one really knows, not even maestros reputed to be able to switch from downbeat to up tempo in the wave of a baton...
...But the companies that benefited most from these plunging prices were the companies that drove their collapse: Intel in microchips, Microsoft in personal computers and software, Applied Materials in microchip production gear, and IBM in computer systems and services...
...Most if not all of it could have been avoided if government officials paid attention to the message of markets...
...The amazingly thin-oatmeal Bush-Lindsey tax package contains little stimulus and nothing for capital gains and has spooked the stock market even further...
...That's the kind of dramatic difference the public notices...
...Continuing to decline, transistor prices assure large markets for companies that exploit that plummeting cost...
...This happened in Mexico during 1994, Asia during 1998 and in Argentina and Brazil today...
...Even OPEC price hikes, draining consumer purchasing power and squeezing corporate profits, were made worse by feckless U.S...
...This is dangerous...
...Low-pressure systems pull in weather from elsewherestorms...
...Microprocessors "embedded" in devices other than computers account for 100 times as many units annually as used in the computer industry Such broad applications gave the chip industry a "price elasticity" ratio that has rarely been estimated to be below 1.5.That is, for every 1 percent reduction in cost, demand increased 1.5 percent...
...In December 1996, the Boskin Commission estimated that the CPI was overstated by between 0.8 percent and 1.6 percent annually due to various measurement errors...
...THE CURRENT EMERGENCY THE COMING -D The empty phrase "Internet bubble" implies that the drop in Webrelated tech stocks caused the current recession, rather than the other way around...
...it was the business plan...
...In one of the most tortured examples of economic logic ever, the Fed chairman actually argued that rising productivity, working through the wealth effects of higher profits and equity share prices, would spur inflation through over-consumption...
Vol. 34 • May 2001 • No. 4
