Rumors are afoot of a web 2.0 bubble, which raises a sore point for me. People believe that bubbles are inflationary. From 1999 to 2000, the much-lauded Alan Greenspan raised interest rates six times in an effort to tame “irrational exuberance” and stave off inflation. The sixth interest rate hike sparked the crash of April, 2000, ending the longest peace time economic expansion in US history. Greenspan’s subsequent interest rate reversals then fueled the housing bubble, a fact which the now retired Greenspan has admitted.
The point I want to make here is, academically, a stock market bubble is not inflationary. This is a difficult point to articulate, so follow me like a leopard…
Let’s say I take my company public, selling 10 shares for $1 each. Zach (the public) buys all 10 shares for $1. Zach spent $10 and Jon got $10. Net change in dollars in the economy = zero.
Now let’s say there’s some “irrational exuberance.” Bob buys 1 share of Zach’s stock for $10. Now Zach has $10 and Jon has his $10. And Bob spent $10 and Zach spent $10. Net change = zero.
Let’s say Bob goes ape, and buys all remaining shares for $100 bucks a pop. Zach now has $910 and Jon has $10. Zach spent $10 and Bob spent $910. Net change = zero. The amount of real money in the economy doesn’t change! Just because there are millionaires-on-paper does not mean there is any change in real dollars in the economy.
Yes, there was irrationality when the stock market soared in the 90’s. But there was certainly some irrationality when it crashed, too. Greenspan got a lot of praise for being fortunate enough to preside over a technology boom and an economic expansion. But for a guy famous for the “soft landing” philosophy, he sure created a hard bump in 2000, precipitated the recessession of 2001-2002, and helped to create the housing bubble. Is that fair to say?
Maybe I’m being a bit harsh on Greenspan. I certainly couldn’t have done a better job! But I’ve always been intrigued at the disconnect between the media’s high opinion of Greenspan’s Fed performance, and opinions of those of us in the finance world.