Until the 1990s, the United States was thought to be a mature industrial economy. Economists were saying that at a mature stage an industrial economy should typically maintain steady if unspectacular growth and its various markets, from real estate to equities, should reflect such stability. Fluctuations from mean are a measure of risk in finance, and wild deviations and frequent boom-bust cycles were expected in places like Hong Kong and South Korea, which were, of course, emerging, rapidly growing economies.
Since the mid-1990s, however, the nature of the American economy has changed and the U.S. appears to have entered a bubble economy stage. Manufacturing, previously the backbone of the economy, gradually disappeared, making that “giant sucking sound” H. Ross Perot famously described during his presidential bid early in the decade. Other sectors became the driving force of the economy and, as a result, economic growth has been strong in some parts of the country and industrial sectors, but weak in others, as well as extremely uneven.
Markets have started to fluctuate wildly, not only in stocks and bonds, but in previously stable residential and commercial real estate. The Dow Jones Industrial Average, a broad financial measure of the U.S. economy, has been gyrating around the 10,000 mark for nearly a decade and a half. House prices, after a spectacular run-up in the early years of the decade, now are back to levels of 2002.
Worse, the entire economy now seems to be growing by fits and starts. One bubble inflates, providing breakneck growth for a while, and then bursts, creating deep recessions not seen during the “mature” stage. It is then succeeded by the next bubble. Currently, there are several bubbles, notably in U.S. Treasuries and in government bonds around the world, where plentiful extremely cheap liquidity has pushed yields on 10-year bonds well below inflation. Commodity prices are also in a bubble stage. While oil prices, for example, continue to climb, Saudi Arabia is cutting output because world demand for oil is falling. This is not how markets are supposed to work.
In stocks, a new mini-bubble is inflating in the social networking sector of the Internet. Valuations of companies have gone through the roof. The leader of the whole social networking phenomenon, Facebook, has gone from around $10 billion less than two years ago to over $75 billion in early 2011. Worse, there seems to be an unstoppable bubble mentality at work. Even though everyone realizes that it is a bubble, there is a buying frenzy that compels investors to keep buying small stakes in top-tier social networking firms at astronomical prices. Even smaller or less well-known ones have been affected. Russia’s search engine Yandex.ru is getting ready for an IPO on the New York Stock Exchange and is being valued at around $9 billion ahead of the sale.
Ready for Yesterday
Some Silicon Valley professionals have started to raise a red flag. But on whether or not it is a bubble, opinion has been sharply divided. While there are some similarities to the late 1990s environment, when dot.com valuations got out of hand, today’s situation is fundamentally different. There are fewer companies involved than a decade and a half ago, when literally hundreds of companies rushed first to the stock market and then on to the bankruptcy court. Today’s social networking operations have a solid business model and are, by and large, making money — some hand over fist. They have not only been able to create solid and durable traffic but found ways to monetize it. There is little evidence of a bubble on the Nasdaq Composite index, which has been trading at no more than 50-60 percent of its 2000 peak.
The problem with this reasoning is that analysts, like European generals in the 19th and early 20th centuries, are always preparing to fight the past war, not the future one. They said in the 1990s that we were dealing with a new economy, with all new rules, and therefore the dot.com boom was not a bubble. In 2008, many economists said that a house was not a dot.com stock and therefore could not decline in price dramatically. Now there are claims that the social networking bubble is not a bubble but a legitimate valuation for the new era of high-speed Internet and an online population of 2 billion people worldwide.