May 2000 Fraser Forum: Nasdaq Follies?
Alan Greenspan must be glowing. Last month's technology stock meltdown seems to show that the chairman of the Federal Reserve was right all along. Investors are bandanna-wearing warriors of the rising financial sun, pumped full of irrational exuberance, now crashing to oblivion on the carrier deck of economic reality.
But before we allow the loop to close in our minds and accept Greenspan's view, we should consider that maybe these investors have done us all a favour.
No one quite knows what will come out of computers and the internet. One way to find out is to gamble by putting money into hundreds of dot-com companies to see what happens. The gamble appears irrational to an outsider who does not know the odds. It may take billions of dollars thrown into a thousand fallen dot coms to bring forth one Microsoft or a Cisco whose profits eclipse earlier catastrophes.
The stock market works something like a pharmaceutical laboratory. Drug companies test hundreds of thousands of compounds using a process known as combinatorial chemistry; a fancy term for industrialized roulette. The idea is to meld Pasteur's notion that chance favours the prepared mind with the gamblers creed that you have to be willing to get lucky.
Prozac costs very little to make, but cost hundreds of millions of dollars to discover and develop. The profits that pharmaceutical companies earn from successful drugs look obscene until we subtract the cost of all the failed avenues up which their researchers wandered.
Understanding that stock markets work like laboratories takes a bit of imagination. Herds of investors trampling each other like wildebeests on the run from snacking lions may not appear very much like a process of productive economic discovery. Why did so many rush out at once? Why were the dangers not clear before?
Sometimes evidence has to pile up to convince everyone of the truth. Months before the crash, market researchers were warning that dot coms were overvalued. Their opinions grew out of the billions of dollars that firms such as First Boston and Salomon Brothers spend to sniff out opportunity from disaster. Only after a critical number of experts concluded that tech companies were more cellulite than muscle did the scales fall from investors' eyes.
If this sounds like a sluggish way of coming to grips with reality, consider the story of quantum physics.
To explain a problem known as the ultraviolet catastrophe that was vexing physicists at the turn of the century, Max Planck proposed that energy was not continuous, but came in packets known as quanta. Planck did not even quite believe in his own discovery and quantum theory struggled for the next 25 years to be taken seriously. Suddenly, in the mid 1920s, much fell into place. Inside a year, and sometimes within months, physicists would come to the same conclusions from different angles. There was no orderly process of discovery, just academics with poor personal skills sniping at each other and telling everyone else "I told you so" once the dust cleared and the intellectual herd had moved to the same pasture.
The good news in the flight of hundreds of billions of dollars from the technology based Nasdaq is that little material harm has been done. The money has not disappeared from the economy. Investors withdrew their money from an unproven and risky sector to place it in more secure ventures. The only material damage has been the limited effort dot-coms have actually invested in programming and promotion.
Seen in this light, the behaviour of Nasdaq investors seems sober. If only we had a similar exchange for govern- ment infrastructure projects and joint-ventures with firms that claim to work in the public interest, taxpayers could breath easier. Their funds would not be captive to the whims of politicians and machinations of special interests, but could flee the irrational exuberance of technocrats who think they know better than we do where our money should go.
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