Internet Stock Bubble

Driving this funding is the fascination with technological innovation, a fascination that characterized previous market bubbles as well. The 1960s technology bubble arose from innovations such as color television and commercial jet aviation. It spawned an IPO boom in electronics and other businesses whose names ended with "tron" or "onics" not unlike that of 1999's dot-com boom. 6 Takeovers surged in both periods, fueled by high-priced stock that built many corporate empires. All the talk was of a new history-defying era— called a "new paradigm" in the 1960s and the "new economy" in the late 1990s and early 2000s. But as Warren Buffett quotes Herb Stein as saying, "If something can't go on forever, it will end." 7

The Internet bubble may not end as abruptly as the 1960s electronics bubble did. It may instead follow the path of the stock market bubble in Japan in the 1980s, which ended in a gradual and total erosion of stock prices in the Nikkei average throughout the decade of the 1990s. One thing the two periods have in common—and one of the most striking common features of speculative bubbles generally—is the emergence of "new" ways to defend the high prices.

In 1980s Japan the fuel was stock prices based not on the earn­ings or cash that can be generated by a business, but on underlying asset values the businesses owned, which themselves had been rising to the stratosphere as a result of aggressive real estate speculation. We'll soon see that the same alchemy plagues the turn of the twenty- first-century United States.

These examples merely manifest in U.S. stock markets the emo­tional drives inherent in human market making, exemplified more generally not only by the 1980s Japanese experience but by classic episodes of bipolar disorder such as the Dutch tulip bulb mania of the 1630s and the British South Sea exuberance just prior to 1720. In each of those cases—as in most others—the initial reason to buy may have been sound. Rare tulip bulbs in Holland were valuable because the novelty of that flower in Holland turned it into a status symbol. Shares of Britain's South Sea Company were valuable when it began to exercise its royal grant of monopoly trade with Spain.

But the excitement of "getting in" on these deals got out of hand, more and more money was allocated to futures contracts on tulip bulbs and shares of the South Sea Company, and the more money that was led there, the more money seemed to follow—until the music stopped and panic set in. In Holland, the price got so high that speculators could not afford to pay for the bulbs they had bought the rights to. In Britain, the company simply did not generate the great gains from Spanish trade everyone had obviously been expecting.

If EMT were true, the U.S. stock market would be unique among all markets throughout human history and across the contemporary globe. 8 Consider this selection from the writings of the market observer Joseph de la Vega from the late 1600s about the Amsterdam stock exchanges of his day, in the style of a tongue-in- cheek dialogue between a merchant and an investor:

Merchant: These stock-exchange people are quite silly, full of instability, insanity, pride and foolishness. They will sell without knowing the motive; they will buy without reason.

Investor: They are very clever in inventing reasons for a rise in the price of the shares on occasions when there is a declining tendency, or for a fall in the midst of a boom. It is particularly worth remarking that in this gambling hell there are two classes of speculators. The first class consists of the bulls. The second faction consists of the bears. The bulls are like the giraffe which is scared by nothing. They love everything, they praise everything, they exaggerate everything. They are not impressed by a fire or disturbed by a debacle. The bears, on the contrary, are completely ruled by fear, trepidation, and nervousness. Rabbits become elephants, brawls in a tavern become rebellions, faint shadows appear to them as signs of chaos. The fall of prices need not have a limit, and there are also unlimited possibilities for the rise. Therefore the excessively high values need not alarm you.

Sound familiar? Why, apart from hubris and chutzpah, should we believe the U.S. stock markets are so special in the history of the world?