21st Century Pop

By the year 2000, the Cold War was in the rear view, the Y2K meltdown had been avoided–not by a lack of effort or billions spent on programming–and the United States economy was blasting off. The internet created a new sector of the economy and promised a new age in communication and money making. The information superhighway had an on-ramp in every home–the PC. The period from 1998–2001 was thought to be a great bull-market economy. Unfortunately for those invested, valuations were extreme, and the party would soon be over. It would come to be known as the dot-com bubble.

In the mid-90s, the growing number of internet companies going public and promising to be companies of the future was exorbitant. The federal reserve had interest rates set relatively low, so an influx of cheap borrowing contributed to the flow of capital to new start-ups. Some of these companies would go on to become extremely successful in the long-run, such as Amazon and eBay. Many were doomed to fail in an overcrowded business space with an under-populated user base. The valuations and overnight gains were extreme. Between 1995 and 2000 the tech-heavy NASDAQ index rose 400%.

But what caused the bubble to swell and what was the pin? Was it all because Roseanne’s character Roseanne on the show Roseanne supported Clinton, tipping the presidency race in his favour and diverting money no longer needed for the Cold War to the information superhighway infrastructure? Well, maybe, but in my research for this blog post I set out to ask more definitively, ‘What social, political and economic factors lead to the inflation of and the pop of the dot-com bubble of the year 2000?’

I was 12 at the turn of the new millennium. I was not an investor, but now that I am investing in my 30s, and living in the day of cryptocurrency, NFTs and the metaverse, economics has become important and interesting to me. Could these new digital assets be a bubble? How can bitcoin be used as a medium of exchange if it’s so volatile? A relevant saying goes, “An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.” In looking back, experts point to the hype which led to irrational investor behaviour, resonating signals from corporations and media, as well as economic regulations and monetary policy as leading factors in the dot-com surge.

In 1999, Christmas sales weren’t so hot. Turboman sales were down, and signs of economic weakness were showing. On April 29 of 2000, Warren Buffett and Charlie Munger gave their annual Berkshire Hathaway investors speech, following a 25% drop in NASDAQ. Buffet AKA ‘The Oracle of Omaha’, sipping his signature Cherry Coke (he switched from Pepsi in 1986) described how the time would be remembered as one with a lot of wealth transfer, but not a lot of wealth creation. He likened it to a Ponzi scheme or chain-letter. Simply put, the internet companies were not as profitable as everyone thought, most of them folded with no real useful product or service to offer. The NASDAQ dropped to its lows in September 2002, around the time of Mel Gibson’s Signs and Eminem’s Cleanin’ Out My Closet. The index would not reach its highs again until 2017–adjusted for inflation.

So why did investors veer from the norm and take on such risk in something new and untested with no real certain future of wealth creation? Researchers in 2004 studied the cognitive behaviours of 57 venture capitalist investors during the dot-com period. They showed that the typical process of due diligence was bypassed by a grasp of intense competition for the new territory, with a lack of success criteria. In a wave of groupthink, investors followed each other and surfed into an equity tsunami. The study outlined multiple positive feedback loops that contributed. The initial hype caused valuations to skyrocket, sending the first positive feedback signal, reinforcing the hype. It’s what the kids call FOMO or Fear of Missing Out. Fundamentals didn’t matter, so long as there was a seat at the speculation table. Then came media echoes of the success stories. People who got in and got out at the right time realized amazing gains. Ultimately, potential gain upsides outweighed the corresponding ‘bet premium’ or ‘entry fee’ to buy in.

In 2010 researchers considered how the risk culture of the time was altered through the lens of rhetoric and mimesis. In normal times, investors prefer to avoid loss before achieving a gain. In a bubble–this reverses–the persuasive nature of the feedback loops, and the way people tend to imitate others’ success contributed to the bubble’s runaway nature. Performative economics suggests that financial models themselves influence market behaviour and have a symbiotic relationship of causality, any measure of reality notwithstanding. Research shows that communicated market information is a “self-reflexive use of reference that, in creating a representation of an ongoing act, also enacted it.” This may remind you of the famous lithograph ‘Drawing Hands’ by M.C. Escher, or Douglas Hofstadter’s book ‘I Am a Strange Loop’.

In summary, factors of emergent technology, behavioural psychology, language and communication, government and media were all at play. We see similarities in investor behaviour in the world of cryptocurrency, and other digital assets–potential use cases aside. The uncertainty, novelty, and lack of success criteria are all apparent. During the dot-com era, household stock market investing increased by 30%. I can’t help but notice that in recent years investing has become more ubiquitous, with the ease of investing apps and the emergence of crypto-culture. It may be prudent to check ourselves from time to time, and review the past so we are not doomed to repeat it. As the Wall Street proverb goes, “Nobody rings a bell at the top, or the bottom.”