Fall of the Dot Coms
With Dick Cheney’s recent mention of the "R Word," the unthinkable is being openly discussed: Are we headed for a recession? Politicians in the last few years have been assuring Americans that the "New Economy" has made the dreaded business cycle passé, but don’t tell that to the dozens of venture capitalists and "dot com" folks who seem to have lost their shirts recently.
In fact, Business Week has devoted the cover story and an editorial of its December 18, 2000, edition to "The Tech Slump" in which the magazine points out the bloodbath in many of the high tech expansions and startups, not to mention the "Dot Com" market, a massacre that has cut the NASDAQ Index by about 40 percent this year. Of course, BW is ready with its set of suggestions on how to stop this slide that seems to be affecting the economy at large. Too bad the editors didn’t consult Austrian Economists, for they might have learned something about business cycles.
Even the BW editors admit, "Getting the mix right (to cure this downturn) may be trickier than anyone thinks." The editors then go on to ignore why the slump is occurring in the first place as they fashion the usual Keynesian cures that would surely make things worse.
I first list what BW sees as "solutions" to the problem. (I shall explain the real problem later.) The editors admit that politics makes things more difficult, writing, "Fiscal policy was seriously politicized during the Presidential election," as though government taxation and spending before 2000 were the product of something other than the political process.
Nonetheless, the BW folks have the answer. If there are to be tax cuts, they should not be directed at individuals, since government should be interested in "spurring high-tech investment, not consumption."
While I have no problems with speeding up depreciation and the like, I have an even better solution: Why not end corporate and business taxation altogether? No doubt, the folks at BW would editorialize that such a radical move would trigger a recession, since the end of business taxes would hinder the government to enact its supposedly nonpolitical "fiscal policy."
Of course, no call for government action in the face of a business slump is complete without the obligatory demand that the Federal Reserve lower interest rates. Time’s a wastin’ says BW, and Alan Greenspan must immediately pump new money into the economy if these "promising" high-tech companies are to survive.
As expected, the editorialists have given us long-discredited Keynesian claptrap. Like their Keynesian brethren in academe and in politics, they believe that an economy falls into recession because there is a "lack of aggregate demand." Keynesians have held that AD falls because individuals foolishly save money instead of wisely spending it, so it is up to government to flush out those savings accounts by direct taxation, issuance of government bonds, or through the magic of inflation. Thus, government is the "Great Helmsman" that directs that path of the good economy.
Dependence upon the Keynesian paradigm keeps BW and its allies from understanding the nature of the current business slump. The current high-tech morass is not due to any lack of aggregate demand or quirks in the tax code. Instead, we are seeing once again the classic business cycle as first outlined by Ludwig von Mises in 1912 and again by Mises, F.A. Hayek, and Murray Rothbard in later works. This seeming cluster of entrepreneurial errors has come about because Greenspan and the Fed shoved billions of dollars of new money into the economy, triggering malinvestments that now must be liquidated. Any scheme – monetary or fiscal – by the government to reverse this current trend will only make matters worse.
Furthermore, new money does not arrive by helicopter or a Brinks truck at your door. New money comes into the economy through the banking system, as banks lend their excess reserves within the fractional-reserve pyramid. Such actions are accomplished through the Fed’s massive purchases of government bonds in its open market operations, as well as the lowering of the Fed’s key lending rate by fiat.
For much of the second term of Bill Clinton’s administration – and especially during the Monica Lewinsky scandal – the Fed, under Greenspans’s aggressive leadership, pumped new reserves into the system, with much of the lending going into capital markets. Furthermore, the Fed’s lowering of interest rates encouraged venture capitalists to pour their investments into the Internet startups.
At first, the scheme seemed to work. The infusion of new money into the high technology sector soon translated into a stock market boom, which increased both the Dow Jones and NASDAQ indices by huge amounts. Soon after came the parade of "Dot Com" multi-millionaires who saw the value of the stocks they owned zoom to unbelievable levels.
However, as Mises, Rothbard, and Hayek would have noted, the pattern of new investment did not fit the pattern of consumer spending. While the advertisements for some of these new startups made a big splash during the Super Bowl last January, they didn’t translate into consumer demand for their products and services. By the late summer and early fall, many of the once-hot Internet stocks had plunged to near-penny stock levels. The Austrian Business Cycle theory, ignored by academe and the political classes, had once again proven true.
Of course, Austrians also have a cure for such occasions. Unlike the Keynesian editors of BW, who basically advocate that government encourage a return to the disastrous level of capital malinvestment, Austrians argue that the best cure for a recession is for government and monetary authorities to allow the malinvestments to be liquidated. While the Austrian strategy may prove to be unpopular with politicians and their academic allies who like to be seen "doing something," it actually works.
Austrians also point out that the popular notion of what occurs in a recession is false. A recession does not affect all economic sectors equally. Indeed, some sectors of the economy like consumer goods may in fact do well. Even during the worst days of the Great Depression, more than 70 percent of Americans had full time employment, and actually saw an increase in their real wages as prices fell during that period.
Recessions occur because government through new monetary creation and its policies of taxing and spending direct investments into sectors of the economy that would not attract the same level of investment in a truly free market economy. Thus, a recession, as Rothbard and Mises pointed out, is not a failure of capitalism, but yet another chapter in the continuing sage of government mismanagement.
If Cheney and his new boss wish to make a positive economic impact, the first thing they can do is throw away their copies of Business Week and turn to Mises’ Human Action and Rothbard’s Man, Economy, and State. There they will learn that no matter how government says it can provide prosperity, intervention into the market by the state will always have long run disastrous implications. If these men want the recession to end, they should take their seats in the bleachers and watch – from a safe distance – the current process of liquidation. The bloodbath will be over soon enough.
Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.