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BY GEORGE GILDER
It's the first new Millennial crash. As I write, the End of the World is
apparently at hand. The bottom of the World Wide Web is bursting like Pandora's
piñata 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. All at once.
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. 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.
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. 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). 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. We are not in a tech slump,
or a business-cycle slump, but a policy slump. 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. 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.
In the midst of bad times, many investors look to Warren Buffett for guidance.
A supporter of so-called "value investing," Buffett spurns technology
and invests chiefly in companies that impart no long-term value to the economy.
Buffett is currently giddy with vindication. Hey, if everyone spurned technology
hype and bought Coke, Gillette, and the Washington Post, they would be as clean-shaven,
caffeinated, rich, and liberal as he is. 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.
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. 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. GE joins together NBC television
and airliner turbines and GECapital. Berkshire Hathaway joins Coke, AIC government
employees insurance, and the Washington Post. The managers of such portfolio
companies shift capital quite legally among their holdings and make new acquisitions
on the basis of intimate insider information. Most investors can't do that,
and anyway if everyone could, it wouldn't work. It takes technology and innovation
to make an economy grow and to sustain the value of "value" investments.
As Peter Drucker has pointed out, the only sources of profit in any enterprise
are innovation and marketing. Everything else is cost. The current crash, like
most before, will be a boon to the most innovative technology companies. Benefiting
most of all will be those that make up the sphere I have dubbed "The Telecosm."
These are the companies that are reinvigorating the still incalculable riches
of the computer era with the infinite potential of electro-magnetic communications,
transforming the world economy and every existing political and cultural arrangement
as well. 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 over-hyped, is still pitifully under-appreciated.
None of this changed when the Fed, confronted last year with the failed horror
flick of Y2K, started playing the Pit and the Pendulum with interest rates.
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.
The collapse of 2000 and 2001 will seem a mere blip in a long-run bonanza. But
to grasp the opportunity, we need a lesson in history.
While meditating the lesson plan, I welcomed a call from Andy Kessler, the former
Bell Labs researcher and growth-fund guru who not only manages the growth of
my money through his Velocity Capital but also often renews my intellectual
capital as well.
Both Andy and I began our engagement in technology stocks during the mid-1980s.
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.
In 1985, Andy was a technology analyst at Morgan Stanley. The mood of the time
was grim. 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.
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." Jerry Sanders of
AMD reported a month of negative sales (more returns of chips than new billings).
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. Motorola followed with write-offs and cutbacks.
ATT turned off its major DRAM facility in Kansas City and withdrew from the
business. Drucker voiced the consensus view: "Making memory chips in America
is like growing pineapples in North Dakota."
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. Personal computer stars such as Osborne, Atari, Commodore, Coleco,
Sinclair, and Fortune Systems were going broke. The U.S. disk-storage industry
was kaput, with "floppy" disk drives entirely dominated by Japan,
and an obvious wretched excess of venture money pouring into floppy hard-disk
companies, from Seagate and Prairie to Connor Peripherals and Quantum.
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.
semiconductor industry at the hands of Japanese keiretsus. Nikon, TEL, Canon,
and other Japanese firms moved to the fore in semiconductor capital equipment.
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. 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. 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.
As Andy Kessler observed, it was these conditions that set the stage for his
career. After initially succumbing to the gloom and urging the sale of microchip
shares, in July 1986 he began to advocate their massive accumulation. 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. Meanwhile in
two books and many speeches and articles, I doggedly predicted the revival of
the American semiconductor companies and their ultimate defeat of the Japanese
and European models.
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.
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. 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 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. The value and the profits are in the design. 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.
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.
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. firms still in this commodity
business, but as a huge opportunity for U.S. computer and software firms and
thus ultimately for new U.S. chip designs. Cheaper memory chips meant cheaper
computers and larger markets for microprocessors and other high-end devices
in which the U.S. led the world.
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. The leaders
would 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 steady collapse of transistor prices enabled dramatic expansions of chip
functionality, encouraging the spread of silicon intelligence far beyond computer
platforms. 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. The collapse in prices was
not a glitch in the microchip industry business plan; it was the business plan.
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 Microsoft—who used this computing power,
into the dominant companies of the decade.
Seizing the opportunity of Moore's Law was a resurgence of venture capital.
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. 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. Money raised from limited partners rose from under
a billion to $4.5 billion in 1986. Fueling hundreds of new companies and inventions,
venture outlays and initial public offerings together rose tenfold or more between
the late 1970s and mid-1980s, and the number of new patents issued annually
began to skyrocket after falling in the late 1970s.
Moore's Law is more than just another story of industrial "learning curve"
efficiencies; it is a fundament of the new economy, enabling information and
intelligence to displace matter in the creation of value. Venture capital is
more than just another source of capital fueling the expansion of existing capacities.
Venture capital apparently accounts for a trivial proportion of all the investment
in the economy. But as with other drivers of the new economy, in VC funds the
underlying "material" components—the dollars—account 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. 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.
In 1996, the dominant venture capitalist, John Doerr of Kleiner Perkins, vindicated
our confidence of the mid-1980s. The PC industry and its peripherals had achieved
what Doerr termed "the largest legal creation of new wealth in the history
of the world." Intel leapt dramatically ahead of all its Japanese competitors
in microprocessors and U.S.-based companies dominated the lists of top microchip
producers. Applied Materials became the world's leading semiconductor capital
equipment firm, displacing Nikon. Microsoft, Oracle, Peoplesoft, Adobe, and
Computer Associates pushed to the fore in software. Scores of new firms gave
the U.S. the lead in services, design tools, and capital equipment—and
even in high-end manufacturing. A company called Micron Technology of Boise,
Idaho, even took the global lead in memory chip production from the Japanese.
Although there were no reports of the cultivation of pineapples in North Dakota,
South Dakota became a center of PC production at Gateway computer. 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.
Europe and Japan were studying American venture capital and stock markets closely
for insights on how to prosper in the new age.
As Andy observed, history repeats itself today. 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. 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. The collapse of dot-coms repeats the earlier collapse of
computer startups.
Venture capital is the financial and entrepreneurial force that drives U.S.
economic growth and stock market value. 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. Forbes publisher
Rich Karlgaard, founder of the now solidly profitable Internet venture company
Garage.com, offers evidence that venture capital remains near the all-time highs
of last year. 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. His roundtable partners, Tim Draper of
Draper, Jurvetson, and Michael Moritz of Sequoia projected that some $40 billion
will be added in 2001.
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. 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. 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. 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.
Both in finance and in technology, conditions today are incomparably more promising
than in the mid-1980s. Then, I took confidence from a fourfold rise in venture
funds to some $20 billion. 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. Then, annual disbursements of four
or five billion encouraged a belief in the viability and resilience of the innovative
process. Today, disbursements run at a level some twentyfold higher. Then, investors
concentrated on a few firms in computers, chips, and software. Today, entire
new industries are emerging in communications, storewidth, biotech, and Internet
devices. 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.
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. 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. Today, all computers can roam the World
Wide Web with access to storage facilities containing exabytes (10 to the 18th).
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. The challenge is to find the right companies.
In this search, the crucial insight is the recognition that the communications
power of the electromagnetic spectrum is essentially infinite. A near infinite
resource implies a near zero price. 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. Barron's is worried once again that communications
prices are dropping too fast. Nonsense. The faster the better. 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. Accessible, affordable computing power benefited
the entire economy from WalMart to General Motors, Home Depot to General Foods.
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.
Weaving the fabric of all economic and social activity, communications is a
force much more far-reaching and catalytic than computing is. In the Bible,
the power to communicate at a distance instantaneously is so revered it is reserved
to the angels. 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. Technology now demonstrated in labs and test
beds can put a thousand lightwave bitstreams on a single fiber thread, each
carrying 2.5 gigabits—2.5 billion bits—of information per second.
With 864 fibers in a single cable, one cable can bear as much as a petabyte
(10 to the 15th) in information per second. A petabyte is near the total of
all Internet traffic in 1999 in a month. At the margin, that is for the next
additional bit transmitted, bandwidth will be nearly free. The ability to transmit
any amount of information, to anyone anywhere, anytime, at a negligible cost,
will unleash surges of productivity as yet unimagined.
To many analysts, free bandwidth is a disaster for communications companies
and makers of equipment for them. How can they make any money adding to a glut?
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?
The answers are remarkably similar. Transistors on a chip were not Intel's product,
but the material substrate on which the design—the real value--was created.
Similarly, bandwidth—raw communications carrying capacity--is not the ultimate
product of the communications companies and equipment makers. In both cases
the confusion is natural. 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; it seems odd and unfair to speak of the result as if it were
a mere physical pre-condition for the execution of the real work, the design.
And so it is: design advances are intimately enabled by heroic improvements
in manufacturing process. Yet these advances are readily routinized within a
few years of each breakthrough. 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.
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. But the result—virtually free bandwidth at the margin—fails to be a destructive glut of capacity because it unleashes a demand for "connectivity." Connectivity is the ability to intelligently route, link, and exploit that bandwidth by hooking users into an ever more functional and productive network. 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. 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. Historical evidence tells us that such companies will end up creating many trillions of dollars of new wealth.
The next decade will see a complete transformation of the global communications
infrastructure. 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. Cable TV and other broadcast media will give way to Internet multimedia
and interactivity. With viewers seeing only advertisements that they choose,
the TV advertising model will collapse wherever it is tried—even on the
Web. 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.
As the doomsayers see it, economics is the dismal science of scarcity. In part
they are correct. Every industrial era is constrained by key scarcities. But
countries and companies that focus on the scarcities narrow their horizons and
becloud their future. Today, environmentalists believe in a coming material
scarcity—a dearth of fuel, food, farmland, water, minerals and clean air.
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. This focus on scarcity has rendered most of the U.S. 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.
In every era, the definitive abundance is revealed by the price of a key factor
of production, plummeting over a cliff of costs. Like a giant river reaching
a falls, the key resource releases a surge of kinetic energy into the economy
as the price drops. 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.
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.
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. If you measured productivity by counting transistors per worker,
it has risen 10 billionfold since 1956, perhaps two millionfold since 1980.
By dominating the design and use of this resource over the last decade, the
U.S. has made dramatic gains in market share against the rest of the world.
Continuing to decline, transistor prices assure large markets for companies
that exploit that plummeting cost.
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. As with other
defining abundances, the plummeting price of bandwidth is emitting kinetic energy
that spearheads economic growth. As costs drop, companies capture profits, enlarge
investment, lower prices, expand market share, and trigger an ever-larger demand
for money.
Kessler offers the analogy of weather changes. The plummeting price of a key
resource--the sudden evacuation of costs—creates what might be termed a
low-pressure area in the economy. Low-pressure systems pull in weather from
elsewhere—storms. Conventional economists have long favored equilibrium—economies
that gravitate toward perfect balance, blue skies and moderate weather. This
remains the ideal of Eurosclerosis. In equilibrium models, lower prices normally
signify lower value, lower demand, and decreased productivity. High pressure
means good weather, and investment flows toward the high pressure, high-priced
regions.
Kessler turns the conventional picture on its head. Lower prices of key factors
of production are prime signals of value and opportunity. In entrepreneurial
economies, low-pressure zones such as Silicon Valley concentrate energy in spirals
of growth, twisters of creative destruction.
Economists distrust the low pressure paradigm because low-pressure zones run
a capital surplus. People want to send their money to them, invest in them.
A capital surplus means a deficit in trade. As the price of the key factor of
production plummets, wealth flows in from around the globe to take advantage
of the opportunity. Rising faster in the low-pressure area than outside of it,
income growth pulls in imports, both capital and consumer goods. Thus, between
1992 and 1998, a period of surging U.S. growth in global economic market share,
the U.S. trade gap also surged. 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. marketshare in the global high-tech arena.
In a low-pressure economy, capital surpluses, trade deficits, and surging productivity
go together.
The key source of today's low-pressure economy is the rampant spread of the
Internet and its transformation through the power of fiber optics. The Internet
lowers the cost of transactions, of price information, and of search, and facilitates
the setting of prices. The Internet saves the key scarcity of the new economy
of abundance—time. It promises a downward price spiral of prices and costs
that will pull in storms of economic creativity. Extending markets and proliferating
new products, it lowers the cost of capitalism and raises the comparative price
of socialist policy.
The low-pressure economy, however, hugely enhances the demand for money. It
proliferates new companies and disaggregates existing companies, externalizing
internal non-monetary exchanges. Since 1980 the share of the economy held by
the Forbes 500 companies has dropped from 50 percent to under 25 percent. 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. 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.
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. Previously adequate money supplies become
inadequate in the face of the huge new demand unleashed by the collapsing price
of new goods and services.
In the low-pressure economy, deflation mimics inflation. 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.
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.
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. 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.
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. But they cannot stop it. The world economy is increasingly unified
and if the U.S. gives up leadership, other countries will move into the breach
and growth will shift to the low-pressure regions. With a regime of tax rate
reductions, two of Europe's least likely economic successes—Ireland and
Sweden—became entrepreneurial stars. Without cutting government spending,
Ireland recently achieved average incomes higher than Germany's, and Sweden
recently reduced its national debt by 20 percent. Bad policy, on the other hand,
can drive American venture capital overseas, just as bad policy in Japan and
Europe shifted capital to the U.S. over the last two decades. 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.
The American Spectator, May 2001