From: Michael Mandel
To: Wen Stephenson
Date: 1/24/2002
Subject: Beyond the Bubble

Far from "democratizing the market" and "leveling the playing field," it looks as though the new media associated with the Internet bubble -- the 24-hour cable outlets like CNBC and CNNfn, as well as the online 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 ask, is there something about the Internet itself, as a medium, that fed the bubble? It's common to speak of stock-market bubbles as "feedback loops," and we hear about how the Internet IPO frenzy "fed off of itself." Had we ever seen a feedback loop like this one before?

The Internet clearly allows access to more information than ever before. Combined with regulatory changes, investors now have easy access to all the public documents, the earnings conference calls, the background information. In that sense, it really has leveled the playing field, when it comes to information.

Moreover, small investors weren't being deprived of accurate information. There was plenty of negative or cautionary information out there if people wanted to read it. I can make a long list of well-known journalists and market strategists who repeatedly warned of the downside risk. For myself, at the same time I was writing positive stories about the long-run benefits of the New Economy, I was also writing negative pieces warning of the possibility of a tech-led bust.

But there's one important thing to remember. Having more information does not necessarily make a system more stable. In fact, the nature of the New Economy -- with its close link between technology and the stock market -- makes it less stable rather than more. On the upside, each innovation in technology fueled a rise in the stock market, which provided more money for the next round of innovation. That was the upward spiral. But technology and finance feed off of each other on the downside as well.

So would the bubble itself have been as inflated if not for the role the Internet played in the flow of information and communication. Is that one way in which "technology and finance feed off of each other"?

Did the Internet itself contribute to the stock market bubble of the 1990s? Only to a small extent. In reality, both the Internet and the soaring stock market were caused by the same factor -- the rush of money seeking higher returns from a new wave of innovations. Risk capital funded the dotcoms and the new telecom companies. Risk capital also poured into the stock market, hoping to get a piece of high returns.

My second question is about the term "new economy." Obviously, the debate over this concept -- whether there is such a thing as a New Economy -- has been going on for some time, as you well know, 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 it's been revealed as hollow now that the bubble has burst. This is where the dancers on the dotcom grave seem to be dancing most gleefully. Now, you've had a few things to say about the "new economy" over the past five years or so. How large a role would you say the "new economy" thinking really played in the Internet boom and bust?

Many people misunderstood the true nature of the New Economy. They assumed that the Information Revolution and the Internet had eliminated recessions, and that the economy and the stock markets were now on a permanent upward trajectory. In some cases this was explicit, when journalists would write about the end of the business cycle. In other cases it was implicit, when market analysts and corporate executives would predict 20 percent growth in revenues as far as the eye could see.

But they completely missed the point. The New Economy is more risky than the Old Economy, not less. There is a lot more reliance on innovation and high-risk investments to drive growth, which is great when the innovations pan out. But when big gambles, such as the dotcoms, fail to pay off, then the whole economy suffers.

Actually, this is probably the biggest mistake that investors made. Because they didn't understand the high-volatility nature of the New Economy, they took far bigger risks than they should. They didn't realize that by investing in new initial public offerings, they were effectively taking the same risks that venture capitalists do -- which means facing the possibility that a lot of your investments will go bust.

You make a good point here about individual investors acting like venture capitalists -- it's a point that we've been hearing a lot. But I can't help wondering, in this particular case, if you aren't letting the VCs themselves (and the investment banking community) off the hook, and placing too much blame on the public. Weren't VCs (and the investment bankers doing the underwriting) pushing many of these dotcoms to go public far too early in the game -- IPOs taking place at what would normally have been a first-round or mezzanine round of funding? Weren't they in fact exploiting the public's willingness to take these gambles?

If someone offers to sell me a lottery ticket, is that exploitation? No. People wanted a piece of these deals, they begged for a piece of these deals. I would much much rather err on the side of encouraging people to take risks, rather than discouraging them.

What do you think we've learned, or failed to learn, about the Internet's real importance? And what might this suggest about the true cost of the Internet bubble, not just in economic terms, but in social and even political terms? That is, what was the "opportunity cost," so to speak, of lavishing so much money, energy, and media attention on the Net economy? Now that the dust has settled (and the economy has sunk into recession), can we see any more clearly what the Internet's real value is? Are we any wiser than we were in 1995, when Netscape went public?

With any new technology, there's a process of experimenting, of trying to understand where it is useful and where it isn't, and figuring out how to apply it. It's often very hard to predict what the ultimate applications of a new technology will be.

Part of the genius of the American New Economy -- and one of our great advantages over Europe and Asia -- is that it permits an accelerated rate of experimentation with a new technology like the Internet. The availability of capital meant that we could try a lot of different approaches at once, to see which ones worked.

Here's what we found out. First, the Internet has only an incremental benefit as a channel for retailing. Ultimately, retailing is mostly about producing and moving around goods as efficiently as possible, and the Internet doesn't bring all that much to the party. Thus, the great dotcom experiment -- moving all manners of retailing onto the Web -- turned out to be mostly a failure.

But we also learned that one of the biggest virtues of the Internet is that it revolutionizes the transmission and manipulation of information. We have not fully exploited this yet, but I think that over the next ten years, the Internet will transform those industries which are primarily about moving bits and bytes around. That includes media, financial services, and a large portion of health care.