From: Steven Johnson
To: Wen Stephenson
Date: 1/24/2002
Subject: Beyond the Bubble

One of the points the FRONTLINE documentary makes is that the myth of the Internet as this great democratizing force, "leveling the playing field" and all that, has been exposed, at least when it comes to financial markets. In other words, far from "democratizing the market" and "leveling the playing field," it looks more and more as though the new media associated with the Internet bubble -- and "new media" here includes 24-hour cable outlets like CNBC and CNNfn, as well as the Motley Fool, TheStreet.com, et al., and the online trading firms -- instead gave rise to "new demagogues" (in the form of venture capitalists, investment bankers, analysts, and business journalists), and enabled them, as never before, to manipulate the investing public. You may or may not agree with that whole premise, and I'm curious to hear your reaction to it. But I also want to push a little further and ask, is there truly something about the Internet itself, as a medium, that fed the bubble?

I think before you can answer this question, it's important to stress that the Net medium never existed in a pure vacuum, where its intrinsic properties could do their thing in isolation. What happened in the late 90s was not just the birth of a new, more democratic and distributed medium -- it was also a clash between that medium and the traditional mass media. Certainly in the U.S., at least, I think it's fair to say that the top story between 1995 and 2000 was the rise of the Net and its social and financial implications. (Maybe the Lewinsky scandal was bigger, but even that played out on the Web in important ways.) Everything that happened on the Web was immediately broadcast out via the mass channels of big media. It was a bit like attaching this fledgling new medium to a giant loudspeaker -- which was ironic, since one of the "intrinsic properties" of the Web is its antipathy to loudspeakers.

I think the Drudge Report is a great example of this. Matt Drudge was a minor Net celebrity in his early days, but Net celebrities tend to be minor. He didn't become a mass figure until Big Media starting running concerned stories about the "Drudgification" of the news, which led directly to his absurd Fox News show, and his becoming a household name. I very much doubt that he would have ever built up a fraction of that attention purely on the basis of his Web presence. So it wasn't the Web that made Drudge into someone who actually mattered in terms of his audience reach -- it was the collision of the Web and the mass media. The collision, in other words, of bottom-up and top-down media. The bottom-up part let him create a kind of audition tape, but the top-down part made him a star.

I think you have to keep this overlap in mind when you look at the role that the Web medium played in the dotcom financial bubble. The Web participated in that bubble by doing things that were genuinely cool and genuinely useful and genuinely unlike anything that had come before them. (Remind yourself how amazing it was when you first used a working search engine, or first bought something on eBay.) That generated a lot of hype, which attracted mass-media attention first, and then VC investment, and finally public investment via the endless summer of IPOs that lasted until mid-2000. Along the way, the hype about what the Internet was good for shifted from the relatively accurate hype about how it might change the way we communicate with one another to the lamentably short-sighted hype about the "long boom" in which the Web would change the fundamental laws of capitalism. (Never have so many so-called futurists been proven so wrong about the future in such a short amount of time.) I don't think it's stretching matters to say that the economic hype was primarily emanating from traditional media: print magazines like Fast Company and Business 2.0 and Wired; TV networks like CNBC or CNNfn. Sure, The Street.com and the Motley Fool may have played a part, but I don't think their contribution was particularly dependent on their being Web properties in any way.

The one place where it's probably fair to say that the Web as a medium contributed to the bubble is the day-trading/individual-investor phenomenon. It's clear that the Web does give individuals power that once was the exclusive province of "experts" -- and nowhere was this more evident that in the rise of the day trader. Of course, that rise was largely propelled by the mass-media hype mentioned above, but the fact is that the Web enabled a huge influx of new buyers into the marketplace -- buyers who were often more willing to ignore the traditional rules of investing -- and that influx necessarily drove up the prices of hot stocks to stratospheric levels. But the correction eventually came around, and we seem to have hit a more rational equilibrium point. And of course, beneath all of this, the Web has plugged away steadily, becoming increasingly essential to hundreds of millions of people's everyday lives.

We've heard how the Internet IPO frenzy "fed off of itself," and Robert Shiller, in his book Irrational Exuberance, writes about stock-market bubbles as "feedback loops." (He even points out that "the branch of mathematics that studies nonlinear feedback loops, called chaos theory, may be applicable to understanding the complexity of stock market behavior.") Complexity, chaos theory, feedback: these are things you've written about recently in your new book, Emergence. What do you think -- can the Great Internet Bubble of the late-1990s be discussed in terms of chaos theory and bottom-up, self-organizing systems? But first, can you describe briefly what Emergence is about?

Emergence is a book about self-organizing systems, like ant colonies or some city neighborhoods, that organize themselves and evolve without being planned from above. The book tells the story of how we came to understand these systems, and it looks towards the future, as a new generation of software and media applications are now being built with the explicit aim of mimicking this "emergent" behavior. Along the way, I talk about the Gennifer Flowers affair and the media's propensity for feeding frenzies, the genius of SimCity creator Will Wright, the guild system of 12th-century Florence, and new software that lets you listen to the sound of your brain.

One of the things that's become clearer to me about feedback loops and complex systems over the past few years, as I was writing this new book, is that there are different kinds of feedback, and usually the most successful systems rely on both kinds. Positive feedback is the kind of self-reinforcing loop that causes a microphone and amplifier to suddenly start howling -- the mic picks up some of the sound from the amp, and then sends that signal back to the amp, which then gets picked up by the mic, and so on. Very quickly you have a screeching, unlistenable sound -- unless it's being sculpted by an expert guitarist, of course. Negative feedback is the kind you see in a thermostat -- it's designed to keep a system in check. If the temperature in the room gets too cold, turn off the AC; if it gets too hot, turn off the furnace.

One of the annoying things about these terms -- and they're not my creations by any means -- is that "positive" and "negative" suggest a value-judgement, which is totally inappropriate. Positive feedback is usually the more dangerous of the two, as it turns out. Speculative bubbles -- of which the dotcom insanity is only the most recent -- tend to be examples of runaway positive feedback. Netscape's share price starts to rise, which encourages more people to buy Netscape, which causes more people to write about Netscape and the money people are making from it, which causes more people to start buying stocks on their own, which causes the stock to go up further, and so on.

Now, traditional markets tend to have a built-in negative feedback mechanism, which is the price of the item in question. Positive feedback causes the price to rise to a point where it gets too expensive for most buyers, and the mini-bubble starts to deflate. But in this case a rising price had the perverse effect of making the situation even worse, because the stratospheric prices triggered more media coverage and brought in new buyers. The higher the price, the more attention the stock gets, and the negative feedback is lost in the mix. That's when you get a bubble the size of the Astrodome.

In Emergence, you write about eBay, the successful online auction site, as "a model for the way bottom-up systems can transform the relationship between buyer and seller." Are you familiar with the online OpenIPO, based on a "Dutch auction" model, introduced by W.R. Hambrecht & Co., the online investment bank founded by veteran investment banker Bill Hambrecht? Some people, such as Hambrecht, are saying that the IPO process has become dysfunctional, that it allows for absurd levels of preferential treatment, cuts small investors out of the loop, and fails in the end to serve the interests of the companies that are going public. I wonder if Hambrecht's OpenIPO is another example of the sort of thing you describe in your book, using bottom-up principles to make a market "smarter" (in that it supposedly does a better job of arriving at the "right price" for an IPO) and more equitable at the same time?

I've always found something very appealing in the OpenIPO idea. It's certainly an example of a bottom-up approach that relies on the Web's inherent skills at tapping the intelligence of large, distributed groups of people. What's really interesting is how it was widely disparaged during the boom days, precisely because it didn't create the trademark first-day pop of traditional IPOs. I'm sure this has been covered elsewhere in the FRONTLINE program, but the lack of a crazy first-day explosion in share price is a sign that the OpenIPO system worked -- in that it was getting the highest price possible for the sellers, given the desires of the market. The traditional IPOs were getting the highest price possible for the people who had access to the shares at the offering price: i.e., big institutional investors and Wall Street firms.

Once again, you can see how the Web during the boom years was hardly a triumph of bottom-up, grassroots values. The traditional IPO benefits the old-school financial elites even if it's not terribly good at doing what capitalism is supposed to be good at, which is figuring out the price of things. The OpenIPO is a purely bottom-up creature, that actually finds an optimal price that rewards both big institutions and little investors. But which one ended up dominating the boom years?

Regarding the term "new economy." Now, obviously, the debate over this concept -- whether there is such a thing as a New Economy -- has been going on for some time, and we're not going to resolve it here. I'm more interested in the rhetoric of the "new economy." It's become a kind of cliché that the "new economy" thinking drove the Internet boom and that the concept was revealed as hollow when the bubble burst. This is where the dancers on the dotcom grave seem to have danced most happily, all those people who gloated over the demise of the so-called "new economy." What role did the "new economy" thinking really play in the Internet boom and bust?

The whole idea of the new economy is a bit like the Gaia hypothesis: there's a strong version and a weak version, and one is more compelling than the other. There was a kind of "Squawk Box" version of new-economy theory, which basically revolved around the possibility -- or rather, the extreme likelihood -- that the Dow was headed straight to 20,000 and the Nasdaq to numbers that exceeded the capacities of our simple primate minds. That was the "what-goes-up-doesn't-come-down-anymore-thanks-to-Moore's-Law" notion of the new economy, and it was as bogus and transitory as the share price of TheGlobe.com.

The other new-economy notion is more intriguing, and more valid I think, but it's about a change that will probably take fifty years to unfold, not five. As a planet, it's worth remembering that we're still only halfway through the transition to the industrial age, and the ultimate consequences of that shift are still very much up in the air. The information revolution -- which is the more interesting, and more valid, version of the new economy hype -- might take a little less time to play out, but it's still a process that we're at the very, very beginning of. The boom and bust of the last five years will be a footnote when the ultimate histories are written, just like the industrial boom and bust cycles of England in the 1830s.

What do you think we've learned, and/or failed to learn, about the Internet's real importance? And what might this suggest about the true costs of the Internet bubble, not just in economic terms, but in social, political, even cultural terms? Another way of putting this might be, what was the "opportunity cost" of lavishing so much money, energy, and media attention on the dotcoms? Have we missed something? Can we see any more clearly now what the Internet's real value is?

I'm actually not sure that the costs of the bubble were all that great, even though I think it triggered, or facilitated, a lot of ludicrous behavior, and a lot of posturing. There weren't a lot of good ideas that got trampled in the exodus, as far as I can see. (FEED readers will hopefully disagree, since we were by some lights a casualty of the burst bubble, but FEED was never terribly interesting as a business idea, and it would have never survived as long as it did without the artificial life-support system provided by the bubble.) The good ideas -- the eBays and the Amazons and the Yahoos -- are doing quite well, by any sane measure. Some individual investors lost some money speculating, but how much can you grieve for an investment community that consults -- and contributes to -- a semi-sacred oracle that calls itself the Motley Fool? And a lot of 25-year-olds found out that it actually wasn't all that easy to make a million dollars.

What the bubble did do, though, is popularize the medium at an unprecedented pace, and explore the possibility space of interesting Net-based models with incredible precision. My 89-year-old grandmother one-click shops on Amazon via her cable modem. Would she even be using email now if it weren't for the bubble? I doubt it. So in a way you can see the last five years as a giant public-awareness campaign about the virtues of the Web, financed mostly by the venture capitalists. Kurt Andersen described it best in a piece he wrote about a year ago: almost nobody made money in the gold rush, but the gold rush made California. That's where I think we're living now, at the very beginning of a kind of new-economy "California," with the forlorn prospectors coming down from the hills, looking for better and more sustainable things to do. Not such a bad place to be.