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Help Understanding The 1990s Internet/IT Bubble

Thu May 27, 2004 1:57 am

Hmm. Economics have never really been my strong suit, but I'm learning.

A pet project of mine lately has been to study and attempt to dissect the late 90s fast-rise/fast-fall of the internet and infotech stock bubble.

I'm particularly curious as to why it imploded as quickly as did, with such few voices predicting that within the time frame in which it occurred. And for that matter, how it became the darling of Wall Street and so heavily-vaunted (it's not like investors havent seen a thousand bubble economies before...)

For us amateurs: we see a zillion stories & testimonials about 25yr-olds who were broke, became miltimillionaires, then were broke again; all within a five or so year span.... but never any explanation as to why.

....your views?
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RE: Help Understanding The 1990s Internet/IT Bubble

Thu May 27, 2004 2:03 am

Lots of wealthy and greedy but ignorant people combined with "analysts" who told them preposterous stories about the internet.

Most people in the industry knew it would end the way it did; Most just rode the investor money wave while it lasted.

Or in short: Greed clouds judgment.

[Edited 2004-05-26 19:06:47]
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RE: Help Understanding The 1990s Internet/IT Bubble

Thu May 27, 2004 2:10 am

You don't need to understand anything about ecomomics to understand the bubble. What you need is psychology. It was a big, bad experiment in 'group think'. Much in the same way that the LCCs are the new darlings of the aviation industry, the dot-coms were believed to be the new way of doing things. LCCs "have changed the model", "revolutionized this that and the other"--all nonsense; they've just done the same exact thing as everyone else but much more efficiently. The dot-coms were by in large doing absolutely nothing, but somehow convincing themselves and everyone else that they were creating massive amounts of revenue. I think if you study the psychology behind Wall Street and the dotcommers, you'll find your answer moreso than if you look at the economics. The economics were terrible behind just about every business proposition; but everyone was somehow convinced that this was the new economy, the new way to do things...
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RE: Help Understanding The 1990s Internet/IT Bubble

Thu May 27, 2004 2:22 am

First, I would recommend an article I read recently (within the last 6 months) in Fortune Magazine that likened the tech boom of the 1990's to the railroad boom and bust of the 1890's. The purpose of this article was to say that now the bust has happened, it may once again be a good time to invest in tech again.

Investors have always sought out that "next big thing" that is going to get them rich quickly! To truly dissect the "boom/bust" you can start by looking at a handful of different types of companies. For example, Cisco was a huge play because everyone thought that the rapid growth of the Internet would mean a huge demand for routers and other equipment that Cisco had the market on. Those who invested in Cisco and got out fast did well; however, those who bought for the long-term didn't see that other technologies would come along to take away from the expected growth for Cisco. Then there are all the E-tailers that failed. Study the history of E-Toys. Everyone thought that was the new future for retailing and venture capitalists poured billions into different companies. E-tailing didn't catch on as anticipated, and these E-tailers burned through all their cash very quickly and many shut down. They tried to model themselves after traditional retailers with traditional infrastructures and inventories. They didn't see that traditional retailing itself was evolving. Amazon is only now becoming a success story after becoming a network for retailing.

Anyway, a lot could be discussed here. I can only recommend you track down and read the Fortune article I referenced above. If anyone comes to you with that "next big thing" you should invest in, the first question you need to ask is why the big guys haven't thought of it before. With a handful of models for operating over the Internet maturing, successful investing might be looking at who will become the dominant player in each area.
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RE: Help Understanding The 1990s Internet/IT Bubbl

Thu May 27, 2004 2:29 am

And for that matter, how it became the darling of Wall Street

well one must also remember that these "new economy" ventures were all based not necessarily on new technology, but taking the technology we currently had and applying whole new uses for it. it was assumed that these technologies that new ventures were based upon (internet retailing for example) were extensions of what we already use, and thus would be a boon for investors. hence its position as the good son for wall st.

of course we know what happened to a majority of these ventures, but what has happened to the technology behind it? yeah, its still here. so you can see how wall st was not totally mis-guided.

(you want to talk about spinning, and investor fraud related to this, well thats a whole different topic, and yet another reason wall st loved em--they were qiuck, cheap deals (to fund) and absurdly profitable on the short)
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RE: Help Understanding The 1990s Internet/IT Bubble

Thu May 27, 2004 3:24 am

Well, there are as many different explanations are there are schools of economics, so it really depends on your leanings. Personally, I think the Austrian School's business cycle model comes closest to describing the most recent cycle. Basically, the story goes like this.

Like all other economic goods, time has a price: the interest rate. On an unhampered market, the interest rate will bring the supply and demand for loanable funds into equilibrium. That is, people looking to borrow money (through mortgages, loans, bond issuances, stock issuances, etc.) will be able to get it from savers (households, banks, businesses, etc.) at a certain interest rate. This rate reflects the aggregate time preferences of the public: if people choose to save more, the interest rate will fall.

Problems develop when the central bank intervenes in the financial markets to conduct monetary policy. The Fed sets interest rate targets and manipulates the supply of money to achieve those goals. For example, if the "natural" rate of the investment markets is 5% and the Fed targets 3%, it will inject new money into the markets to bring the rate down to the target. Note that these additional funds were not supplied by savers; rather, they were created out of thin air by the central bank. They represent a claim to economic resources with no real backing, like printing extra tickets to a football game when the stadium isn't getting any bigger.

When the Fed pumps new money into the credit markets, businesses are typically the first recipients. They use this money to embark on new investment projects that were not feasible at the old, higher interest rate. Some money is also diverted into the financial markets and can produce booms in the stock, bond, commodity, and/or housing markets. Households will save less and consume more because the interest rate has dropped. We get increasing consumption and increasing business investment at the same time, with the difference between household saving and firm investment being covered by the central bank's monetary injections.

This process is unsustainable because, as I described above, the newly-created money is not backed by anything. As they receive new money from the central bank, businesses and consumers fight over scarce resources, which when combined with growth in the money supply, creates inflation. The central bank (supposedly) hates inflation, so eventually it will tighten its monetary policy and raise interest rates.

When this happens, the capital projects begun by firms are no longer profitable and have to be liquidated. Consumer spending also drops as the interest rate rises. Economic activity slows as firms write off their malinvestments, reduce capacity, and adjust to post-boom reality. This process happens fairly quickly, as the "house of cards" created by an easy-money environment collapses and people realize they've been had.

Certainly there are psychological considerations as well, but without growth in the money supply, funds spent on dot.coms and other buzzword investments have to be diverted from somewhere else. During the 1990s, virtually every sector of the economy expanded in concert - there were not enough shrinking industries to free up the resources being poured into the tech sector. They had to come from somewhere else. They did not come from household savings: the personal savings rate went from 7% in the early 1990s to about 2% in 2000.

Despite the fact that the US economy was at or below the natural rate of unemployment in the late 1990s, the Fed carried out a very loose monetary policy in those years. To quote from Dr. Roger Garrison:

After increasing at a rate of less than 2.5 percent during the first three years of the Clinton administration, MZM [a measure of the money supply] increased over the next three years (1996–1998) at an annualized rate of over 10 percent, rising during the last half of 1998 at a binge rate of almost 15 percent.


The party was in full swing. The Fed cut the fed funds rate 100 basis points between June 1998 and January 1999. The rate on 30-year Treasuries dropped from a high of over 7 percent to a low of 5 percent. Stock markets soared. The NASDAQ composite went from just over 1000 to over 5000, rising over 80 percent in 1999 alone.


The business plans for many of the start-ups involved negative cash flows for the first ten or 15 years while they “built market share.” To keep the atmosphere festive, they needed the host to keep filling the punch bowl. But fears of inflation led to Federal Reserve tightening in late 1999, which helped bring MZM growth back into the single digits (8.5 percent for the 1999–2000 period). As the punch bowl emptied, the hangover—and the dot-com bloodbath—began.

Garrison's article ( has additional information on the Austrian theory of the cycle and how it played out in the tech boom. If you'd like a more detailed (and somewhat more technical) analysis, I have a great journal article saved as a PDF file. E-mail me or post a reply if you'd like to see it.


[Edited 2004-05-26 20:29:13]
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RE: Help Understanding The 1990s Internet/IT Bubble

Thu May 27, 2004 3:49 am

It's really quite simple.

$1,000 Aeron chairs in every cubicle and your pet black lab "Sparky" roaming the halls with all the other "at work" dogs is/was never how a profitable business operates.
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RE: Help Understanding The 1990s Internet/IT Bubbl

Thu May 27, 2004 3:28 pm

Having relatives in the IT feild, I agree with a lot of the explanations on this thread. It survived on a fad...somewhat like the Atkins fad going on right now. Another factor is that many of these dot-com startups didn't even have a product when they went IPO, yet these company shares would rocket to 200% increases. A system like this was sure to fail...
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