The Gildered Age

The essay that inspired Chapter One of Financial Reckoning Day. The essay was originally broadcast March 10, 2000 – the exact day that the Nasdaq peaked at 5048!

The history of the New Era will record that it was Metcalfe and Moore who, like Moses and Aaron, led their followers out of the bondage of the Old Economy and into the land of stock options and café lattes.

Metcalfe and Moore handed down the laws by which the sons and daughters of Silicon Valley live their lives. [You can find both described in our Contrarian’s Glossary at the DR website ( ).]

Metcalfe described a well-known phenomenon: that each element of a system or collectivity becomes more valuable as it expands. You can see this by thinking about the phone system. When the Bell Telephone Company was founded in May 1877, its products were almost useless. You couldn’t call anyone because no one had a telephone. But three years later, there were 30,000 phones in use.

This led to the further insight that you could afford to spend a lot of money selling and installing telephones, realizing that you would make your money later on. What’s more, it was critical that people get your telephones rather than a competitor’s. Ultimately, the most valuable, and presumably most profitable, service will be the one that is most ubiquitous.

This insight, of course, cleared the way for the current Internet investment mantra: don’t worry about profits…fight for market share. We have made the point previously, but will repeat it (it is so good we are sure you would like to hear it again): the telephone system was a quasi-monopoly. It made sense to pay a lot of money to put it in place, because you could expect monopoly-level profits for a long, long time. Bell Telephone and its derivatives are still in business. But has no hope of ever getting a monopoly or anything close to it. Metcalfe’s insight doesn’t help justify AMZN’s price.

George Gilder: The Other Major Delusion

Moore, meanwhile, handed down his own law: he noted that computational power would double every 18 months – which it has. This growth rate astonishes everyone and leads to the other major delusion of Internet investors – that just because computer power increases exponentially, so should Internet businesses and stock prices.

Moore’s law only applies to the speed at which computers process information. Government quants assume, wrongly, that this is equivalent to an increase in the nation’s wealth – as expressed by GDP. This in turn leads to distortions in other measures – such as productivity and inflation levels.

This statistical mess has become a poster child for what I will now style as "Michel’s Law": the more information we have available to us, the dumber we become. Government statisticians, for example, so impressed with the speed of information processing, have turned into idiots – unable to make any sense at all of the nation’s financial condition. The figures mean nothing.

But the protagonist of today’s drama is neither Moore, Metcalfe nor Michel. It is George Gilder.

George Gilder: The John the Baptist of the Digital Age

Gilder is described in an article (from which I borrowed today’s title) by Michael Malone printed in "Forbes ASAP," as the "John the Baptist of the Digital Age."

Gilder was a speech writer for Romney, Rockefeller and Nixon. He authored several well-read books, including "Wealth & Poverty" and "The Spirit of Enterprise." He was quoted more often by Ronald Reagan, the record shows, than any other writer.

His book, "Microcosm," took him farther than anyone had ever gone into the distant reaches of new technology and the enterprising spirit. Since then, some would say he has drifted a bit too far. I find it difficult to read his "ASAP" pieces – they are simply beyond anything that makes sense to me.

Never mind. He’s a genius and he’s been right about a great many things. He has gotten himself into a state of rapture over the possibilities of the Internet and never ceases to rhapsodize about it. His rap has been followed by many of the shrewdest investors of our time…to such an extent that this "pale, nervous Yankee" is seen as a demi-god himself.

But "I don’t do price," says Gilder. Too bad. Because prices are important information. A technology may be spectacular. The company that owns it may be a great company. But the stock is only a good investment at the right price.

Malone, himself, got rich in Silicon Valley – by accident. He got founders’ shares from both Tom Siebel and Pierre Omidyar. He had no idea what they were worth and was astonished to find himself a rich man. But he lacked faith and sold his shares as soon as he could.

Malone reflects on the difference between himself and his father:

"It had taken him 60 years. An abandoned child, passed from family to family, razor-blade swallower in an sideshow, 30 missions in a B-17, 20 years in espionage, under fire crossing the Polish border, a dozen years at NASA, two heart attacks, he and my mother eating hamburger in order to make down payments on income property. He had bled for every penny…And in the end it killed him.

"Now I had traversed the same rugged path as if on an airplane, a distracted traveler thumbing through a magazine, rarely glancing at the landscape below, I hadn’t even kept track of my portfolio."

George Gilder: A Parody of the Land of Milk and Honey

It doesn’t seem real. It doesn’t seem right. "Most of us know," writes Malone, "intuitively, that these young web companies minted by the hour will not survive and prosper. In the coming reckoning, investors will lose money, retirement funds will be erased and the valuations that rule the stock market will become rational."

That seems to be the sentiment of Metcalfe and Moore too. It is as if they had come back to the Valley and found their tribesmen had turned the Internet Age into an absurd parody of the land of milk and honey they sought.

Instead of using the power of the silicon chip and the Internet to launch real businesses and create real wealth, they find investors dancing recklessly around the graven image of enterprise – the IPO.

Says Metcalfe: "I’m currently hung up on the stock market bubble, which I’m watching distort, or causing things to happen, in a way I’m not comfortable with. I’m worried that this distortion is going to all blow up. I’ve predicted that blowup for Nov. 8, 1999. So I missed, so maybe it’s tomorrow instead of Nov. 8, 1999. It’s part of my being freaked out. There’s stuff going on out there that I just don’t get yet, and I’m worried."

"I love entrepreneurs," he continues. "I try to hang out with them. And I’m frequently asking the question, `So, what’s your company going to be?’ The answer these days usually contains the letters I-P-O. That’s the wrong phrase to have in the first five sentences explaining what your new business is going to be about. If you’re thinking IPO, you’ve got your eye on the wrong ball. But it’s common now. It’s sad. These people think that an IPO is a significant event. I view it as a minor financial event. They view it as what life is all about."

Is there a day of reckoning coming?

"The [venture capitalists] get in on the ground floor," Metcalfe says, "and they get out early. [But]…these poor schmucks in the public markets. They are going to start looking for profits and they’re not going to find them. It’s all going to come crashing down. Maybe I’m just out of step with the modern world and I just don’t get it, but it looks to me like it’s all going to explode."

Your correspondent,

Bill Bonner

October 01, 2003 — On a Train

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of "Financial Reckoning Day: Surviving The Soft Depression of The 21st Century" (John Wiley & Sons).

There is almost no financial news today, neither in the London Daily Telegraph nor in the International Herald Tribune. Did nothing happen yesterday? With no access to the Internet to tell us otherwise, we guess not. And with no news to distract us, we are forced to think.

What we have been thinking about lately is the way American consumers have been squandering not only their own money but also the savings of the entire world. The U.S. economy has swung further and further towards consumption, so that it now takes the combined savings of 70% of the world’s people…or an amount equal to 2% of the entire world’s GDP…just to cover the current account deficit. But it is not by consuming capital that people get ahead; au contraire, it is by investing it wisely in new means of production.

What a happy race we Americans have been. Being ‘the world’s mouth’ has been so agreeable; if only the rest of the world’s people would continue feeding it forever. But they may decide to stop investing in assets preceded by dollar signs…especially after they realize that their talents will not come back to them 3 fold or 2 fold or even 1 fold. Their hard-earned savings will almost certainly be folded and mutilated by a drop in the dollar before they are returned.

Emerging economies – or fast-growing ones – often take a disproportionate share of the world’s savings. As Addison pointed out in yesterday’s piece on the crumbling ruins of Wyndclyffe, America did so in the 19th century. Then, we were still fresh-faced and frisky – digging canals, building railroads, putting up factories…just as they do in China today.

Then, investors had at least a reasonable chance of getting their money back – enlarged and enhanced – when their capital investments begin to pay off.

This time it’s different. America gobbles up the world’s savings as if they were so many Krispy Kreme doughnuts; it does not invest them. Few new factories are built; we cannot recall seeing a single new one in many years. And when was the last time a new railroad or a new city was built? Few new employees are hired and trained. Few serious new businesses are begun. The big capital investments take place in China, where construction cranes are said to be more numerous than gubernatorial candidates.

How then will America give foreign investors a decent return on their investment?

Our guess is that it won’t. Instead, the Fed and the Bush Administration will try to keep current trends in motion – no matter how grotesque they become – as long as possible.

No easy matter. Inevitably, those who try to sustain the unsustainable run into problems; nature won’t permit it. If the dollar stays at the same level, more and more jobs end up overseas…U.S. consumers go further into debt…and, best case, the economy goes into a long, slow decline.

And on that cheery note, here’s Addison with more news:


Addison Wiggin writing in Paris…

– Jobs are hard to find in Chicago. Who cares? Well, lots of people. Chicago is usually considered a hub of the nation’s financial activity. A report published yesterday by the Conference Board indicated that "hard to get" gauge of job availability has reached a 10-year high.

– Despite some rather aggressive backpedaling by Chicago Fed president Michael Moskow, another report issued by the Chicago office of the National Association of Purchasing Management (NAPM) suggested that after a brief spurt of hiring in August, layoffs resumed in September. As is widely noted in these pages, the manufacturing sector has lost 2.7 million jobs since ‘the recovery’ began.

– Fed governor Moskow, a voting member of the FOMC, was trying to convince the press that the weakness in the areas job market is cyclical and a result of slowing demand…which should be picking up. He was not prepared to suggest his region’s woes should be blamed on our brethren across the Pacific, who are willing to work for cheaper bowls of rice.

– Mr. Moskow also paid lip service to the Fed’s favorite hobby horse: productivity. This measure of "worker efficiency" (whatever the heck that is) has been growing at a "robust" rate. In turn, factory jobs have declined month after month for 37 months. Of course, "there are dislocations of workers and households that go hand-in-hand with the shifting and churning of jobs and businesses that take place as we achieve greater productivity."

– Again, we might suggest Mr. Moskow check his premises. Perhaps, workers are getting more and more productive because they’re looking around when they show up at the jobsite – and they’re seeing a lot fewer lunch pails in the company cantina. That’d be enough to motivate you to be more productive, wouldn’t it?

– The Conference Board released their consumer confidence numbers yesterday…and…er…they don’t exactly reflect the financial media’s prediction that we’re already well into a recovery. According to Reuters, the report indicates that consumer confidence fell farther than "experts" expected: down to 76.8 from 81.7. The employment component of the index – which, in August, had risen above 50 for the first time since the stock market did its impersonation of a duck clipped by a hunter’s bullet – fell back to 45.3.

– "The much-lower-than anticipated reading of the NAPM- Chicago report and the drop of consumer confidence," Moody’s John Lonski told Reuters, "tell us that the U.S. economy has slowed from its strong [mortgage refi- empowered] pace of this past summer."

– Retail sales have fallen for three weeks straight. "Consumers need help," a CNN headline tells us. "In July and August," the article suggests, "consumer spending grew at a blistering annual pace of 7.6 percent…the effect of tax credits and tax cuts are already starting to fade. It appears, at least according to Lonski, that "the boost to spending by tax cuts was of greater benefit to foreign manufacturers than to U.S. domestic industry."

– Mr. Market agrees, apparently. Following the ill-auguring litany of bad economic news, the Dow dropped 105 points to 9275, the S&P fell 10 to 995, and the whipping boy of tech traders, the Nasdaq, lost 37 to close the day at 1786. And the dollar? Oh là, the symbolic emblem of all things good and true in the American dream got slogged against the hard rock of reality – dropping at one point to more than 1.17 against the euro, but closing at 1.16. The Japanese government intervened in its currency’s rise and pushed the yen back to 112.

– Fearing a political backlash, Treasury Secretary Snow seems to want to talk the dollar into an orderly decline. But doubts must haunt his sleep. As the dollar declines, prices on imports go up…and the appeal of U.S. Treasury bonds goes down.

– Next year, the administration anticipates a budget hole of nearly half a trillion dollars – which can only be filled by selling Treasury bonds. The effect of a lower dollar will be to push up interest rates, which will put an end to the refinancing boom…and probably be the whisper of doom to the housing and auto industries…

– Our new friend, Richard Duncan, explains further: "In the short term, it is difficult to guess what measures the administration will adopt in an effort to sustain the imbalances in the U.S. economy: record budget deficits, record trade deficits, record low savings rates, the property/refinancing bubble.

– "If China and Japan do escape having to revalue their currencies against the dollar over the next 12 months, they may have the administration’s need to fund the budget deficit at low interest rates to thank for it. Over the longer term, however, the outlook is much more certain. There is nothing than can prevent the imbalances in the U.S. economy from coming unwound. Not even the United States can continue going into debt to the rest of the world at the rate of US$1 million per minute forever.

– "The Dollar Crisis has only just begun."


Bill Bonner, back on the train…

*** The numbers for GDP growth, productivity, and stock prices are nothing more than attractive nuisances, in our opinion; they are an invitation to injury, suggesting that things are better than they really are.

The unemployment numbers tell a different story, a tale of woe.

"The weak labor market threatens to abort the recovery and possibly even produce the deflation the Fed dreads," explains Bob Reid, cited in Barron’s. Although the labor market is often accused of being a lagging indicator, the ongoing sluggishness of labor demand is not a normal cyclical phenomenon.

"Indeed, the disparity between the current ‘job-loss’ recovery and previous recoveries from recession is striking. Since the cycle’s trough in November 2001, which marked the beginning of the recovery, the U.S. has lost a net of more than 2.4 million nonfarm payroll jobs and the unemployment rate has risen 0.5 percentage points. Even in the notorious ‘jobless:’ recovery of ’91-’92, the economy had created nearly 0.9 million jobs after 21 months of recovery, although the unemployment rate was still 0.6 points higher than at the trough. At the same point in the previous four recoveries that lasted that long, nonfarm payrolls grew an average of 4.1 million and unemployment rate fell by an average of 1.4 percentage points."

Why so few new jobs?

Because there is no real recovery.

Why no real recovery?

Because there has been no genuine recession to recover from; spending and borrowing actually increased during the recession and after.

Why no real recession?

Because the Fed and the administration have tried so hard to prevent it; short-term lending rates were dropped below inflation…meaning the real cost of borrowing has been negative…and the federal government made the biggest switcheroo, from surplus to deficit, of all time.

Isn’t that what it’s supposed to do?

According to most economists, yes. But most economists are wrong. As we have seen, dear reader, the real problem in the economy was not that the cost of money (determined by interest rates and credit policies) was too expensive…but that it was too cheap. Making it cheaper only makes the situation worse and delays the day of reckoning.

At least, that’s the way we see it.

Could we be wrong?


*** "How was the funeral?" we asked last night.

"It was very, very sad. The whole town was there. [Our friend, Guillaume, is the mayor of Montmorillon; his daughter died in a car crash over the weekend.] They are surrounded by friends and relatives…but what can you say?"

You could tell them that they had just won the lottery or just lost a million dollars; it wouldn’t matter. There are times in life when grief speaks so clearly; all of a sudden, the noise of money goes hush.

Another new friend, Byron, sends this reflection:

"Your note on the death of a young girl prompts me to think about other times and circumstances, when fate left an empty chair at the family table.

"When the telephone rings in the middle of the night, it is seldom good news. ‘Something has happened. Things have turned for the worse. Can you get over here quickly?’ And as you travel from where you are to where you must be, you think many thoughts. You are in disbelief, then in fear, then anger, frustration, and perhaps despair. ‘If only this…,’ you think. ‘But what about that…,’ you wonder. ‘Maybe someone can do something…,’ you hope. ‘But do what?’ is the question, to which there is no good answer at that particular time.

"When you boil it all down, all you can really do is hope. There are things that are simply out of your hands, out of any modicum of your control. Fate will run its course. Whether it is your father, dying of pulmonary fibrosis. Or an old friend wrecked by AIDS. Or a Navy buddy on a motorcycle who collided with a driver who pulled out in front of him. Or the young boy down the street, the friend of your children, with an inoperable brain tumor. You recall the times you spent together, and hope that the last minutes of the late deceased were not too bad, and that he or she did not suffer. And you are sorry, in a way. Sorry that for all you did with and for another person, for all the time you spent together, you did not do more. And you hope that if you erred towards another, and because you know it and are sorry, that there really is a better and more forgiving place across the river. At the very least, such an event makes you want to be a better person.

"People say that God works in mysterious ways. He is said to reward the just and punish the unjust. But it seems that many who live waste their precious time on earth, and one wonders if there is a penalty for that in the hereafter. And many who die, particularly those who die young, deserve life, or at least we think so. We know what we know, but is it truly for us to understand? Re-read the words of Isaiah 53:

Who has believed our message?
And to whom has the arm of the Lord been revealed?
For He grew up before Him like a tender shoot,
And like a root out of parched ground;
He has no stately form or majesty
That we should look upon Him,
Nor appearance that we should be attracted to Him.
He was despised and forsaken of men,
A man of sorrows, and acquainted with grief;
And like one from whom men hide their face,
He was despised, and we did not esteem Him.
Surely our griefs He Himself bore,
And our sorrows He carried."