Maybe it wasn’t a bubble after all.
For more than a year a majority of economic commentators have tried to persuade the world that the collapse of technology stocks, the slump in technology-linked capital spending, and the economy’s overall decline represented nothing more profound than a puncture in a speculative bubble. Sort of like 1929, they said, or perhaps the Dutch tulip craze of the 17th century.
Commentators spread the blame to stupid investors who kept bidding up tech shares, and equally stupid tech CEOs (especially dot-com CEOs) who kept raising money to expand businesses that were doomed to fail. Since free-market capitalism is so inherently unstable, they claimed, a prosperity as great as the second half of the 1990s — or for that matter the seven fat years of the Reagan ’80s — just had to come crashing down.
Or did it? The economic chattering class has been wrong before, and maybe it’s time to burst their latest bubble of blame.
A new study from the Federal Reserve Bank of New York disputes the popular view of what caused the recent economic collapse. After conducting extensive statistical analysis on the proposition that high-tech firms “overinvested” in capital goods as a result of the strong stock market, economist Jonathan McCarthy came to reject the bubble hypothesis.
Mr. McCarthy looked at stock market values, the drop in computer prices, and the so-called rental costs (depreciation and interest rates) of purchasing and holding capital equipment. He concluded that none of these factors sufficiently explained the substantial decline in tech spending that still plagues the economy today.
In fact, he points out that old economy capital spending for transportation equipment retrenched as much as new economy investment. Actually, low-tech equipment (such as construction, manufacturing, and farming) contributed slightly more to the economic downturn than a large chunk of information equipment (outside of computers and software).
What’s more, while McCarthy acknowledges that the stock market boom and the decline in tech equipment prices did have some impact on the capital spending surge, it was a relatively small effect. Instead, McCarthy found that “the variable most responsible for the decline would appear to be slower output growth. . . . Firms believed that the economic boom would continue and, as a consequence, they made capital expenditures based on this expectation. . . . Then, as the economy began to slow in the second-half of 2000, firms re-evaluated their assumption and abruptly revised down capital spending plans.”
So, the demise of the tech boom was not so much over-investment as it was under-growth. It was not so much the speculative bubble as it was the collapse of GDP — down from 9% growth two years ago to the present recessionary contraction. And the blame for that collapse rests squarely with the money managers at the Federal Reserve.
Plagued by the idea that the stock market was “irrationally exuberant” and the economy “overheated,” the Fed raised interest rates nine times between mid-1999 and mid-2000 in order to clamp down on the money supply and restrain the boom. Clamp down they did. And as the central bank deflated liquidity and credit, they also deflated the stock market, the technology sector, and just about everything else.
Of course, the New York Fed’s Mr. McCarthy does not come to this conclusion. (Never bite the hand that feeds you.) But the evidence is clear for all to see: excessive monetary restraint, coupled with rising energy prices, was the chief recessionary culprit — not a tech bubble.
Perhaps the Fed has learned from its mistake. The good news today is that the central bank has spent most of 2001 replenishing the money supply and reducing its interest-rate targets. A second piece of good news is that energy prices have substantially descended across-the-board. Each of these developments have had tax-cut effects on the economy, and have laid the groundwork for an economic revival that could well begin as early as next year’s first quarter.
Still, if total recovery is what we’re after — meaning the recovery of the moribund business and technology equipment sector — Congress and the Bush administration have some work to do. Namely, they must lower the cap-gains tax to bolster stock market values, create faster expensing write-offs for business equipment purchases, and bring the entire income-tax cut fast forward to 2002, promoting economic growth incentives for individuals and small businesses. These measures will free-up business rather than impeding it, and will help turn a tepid recovery into a strong one.
Let’s not forget this fact: It was the recession that vanquished the technology boom, and only full-throttle growth will restore it.