Evaluating Pluses and Minuses of Irrational Exuberance

In its April 1 edition, the Economist published what it called “A Thinker’s Guide” to Internet economics. It took the view that most Internet investors are probably doomed. “In all technological revolutions from the railways to the Internet, the only sure long-term winners are consumers who gain from lower prices and hence higher real wages,” the Economist said. This isn’t exactly an original thought. The trouble with new technology, from the investor’s point of view, is the difficulty of turning the benefits it delivers into profits. Investors and entrepreneurs sink huge sums of capital and time into creating some new technology-based businesses only to find, just when they appear to have viable enterprises, that newer companies with lower start-up costs are poised to pile in and drive down returns. This observation raises some questions. Why do people invest huge sums of capital to develop new technologies? And don’t they know the history of technology investing as well as the Economist? One answer is that they choose to believe that this time will be different from all the others. Which is to say that they become irrationally exuberant. Trivial consequences It’s easy to list the bad things that happen when people become too hopeful. Some quit productive jobs to become day traders; others get sucked into fraudulent schemes. But most of what has been indisputably bad about the Internet revolution also has been fairly trivial. According to Amy Butte, an analyst at Bear, Stearns & Co., there are only about 50,000 online investors who make between 25 and 40 trades a day. And as for fraud, there has been surprisingly little of it. Who needs Ponzi schemes when Internet stocks have soared as they have in the past two years? The real price that a society pays for its irrational exuberance is measured in the time and money its citizens sink into enterprises they sincerely believe in but which, in the end, prove unprofitable. A great deal of human and financial capital fails to earn a return. But, as the Economist suggests, that hardly means that there is no return. The gold rush metaphor so often used to describe the Internet revolution does not fully capture the spirit of the event. Gold miners who failed to find gold produced no benefits for anyone. (Though they did more or less invent California as we know it.) It’s a waste of capital to dig holes to find only dirt. But that isn’t what Internet entrepreneurs and their irrationally exuberant investors have done over the past few years. In their spree of foolish hope they have erected a massive infrastructure that will benefit all of us for a very long time. Thanks to them, the U.S. economy is booming, industry is slashing costs, consumers are reveling. It’s hard to say that these benefits justify the costs. But it’s just as hard to say that they don’t. And the benefits are as much the fruit of America’s current gift for irrational exuberance as the costs. Thank you, dreamers New technology may be the single most important ingredient for economic growth. And that raises another question: If, as the Economist’s “Thinker’s Guide” suggests, new technologies often benefit society without benefiting the people who create them, why is there not a systematic under-investment in technology? If they sense that new technology doesn’t pay, rational investors and entrepreneurs will not hurl socially optimum amounts of capital at it. If investing in new technology is a fool’s game from the investor’s point of view but a wonderful thing from society’s point of view it only stands to reason that investors will not do it as much as the rest of us would like them to. One of the themes of the Internet boom has been its lack of philanthropic spirit. And it is true that the new rich are surprisingly unmoved to engage in old-fashioned charitable giving. In retrospect, the Internet revolution may appear as the greatest period ever for American philanthropy. Investors, workers and entrepreneurs have selflessly contributed huge quantities of time and money into the building of electronic roads on which the rest of us will travel for ages. True, they didn’t think they were engaged in charity. Their philanthropy was unintentional. They acted against their narrow economic self-interest without knowing what they were doing. But that does nothing to diminish the benefits they’ve showered upon the rest of us. The best part of all this is that we don’t need to thank them personally. We need only to thank their irrational exuberance. Michael Lewis, the author of “Liar’s Poker” and “The New New Thing,” is a columnist for Bloomberg News.