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MSNBC: When Black Friday Comes

NEW YORK, Oct. 5  Americans have become hooked on the financial markets. Your taxi driver knows how much the Nasdaq fell yesterday, your mother-in-law wants to talk about whether the Fed will raise rates, and your neighbor is quite willing to share his opinion about the decline of the euro.

YET THERE IS one critical part of the financial system which receives far less attention than it deserves: Venture capital. Over the past 10 years, venture capital - which funds small, innovative businesses - has grown far faster than any other financial instrument, soaring from about $5 billion a year to an annual rate of over $100 billion annually in the first half of 2000, according to figures from the National Venture Capital Association. Thats roughly equal to the amount of consumer credit that Americans borrowed in 1999.

But theres a downside. The new importance of venture capital and IPOs mean that the New Economy, unlike the Old Economy, is subject to tech booms and tech busts. During the good years, a buoyant financial market makes it easy to find financing for innovative new companies. And the success of these companies, in turn, pushes the stock market higher. Technological innovation and financial gains feed on each other.

But when the economy turns down, the cycle could very well go in reverse. When the stock market starts to sag, that makes it less profitable to take new companies public. Venture capital funds, no longer showing big returns, invest less money.

Fewer new companies are created, new ideas reach the market more slowly, and productivity growth falls. With less innovation and lower productivity gains, inflation picks up, and the stock market falls even faster. The same forces which helped drive the New Economy could help push it down.

Theres a good chance that the result will be a tech bust, whose effects will be felt from Silicon Valley to Wall Street and every point in between. The rapid growth rate of tech spending could flatten out as the stock market plunges.

As companies slow down the rate at which they introduce new computer and communication systems, they will need fewer information technology workers, turning the current shortages in the current tech labor market into a surplus. The pain will hit many of the people who prospered during the high-tech boom.


The depth and length of the tech bust, when it comes, will depends on how the Federal Reserve and other policymakers react. If they swiftly and aggressively cut interest rates when the economy starts to slow, then the downturn will be comparatively mild, and the flow of funds for innovation will quickly resume. But if the Fed hesitates, then the tech bust will gather momentum, sending capital spending into reverse and putting the stock market into a tailspin. In the worst case, the U.S. could be hit by an Internet Depression which will last for years.

Such a decline will not happen overnight. Right now, despite the 30 percent decline in the Nasdaq since its March peak, venture capital funds are investing in new companies at a high rate. That has kept Silicon Valley buoyant in the face of the collapse of many dot.coms and the sluggishness of personal computer sales. In particular, venture capitalists are still willing to keep funding new infrastructure-related companies.

History suggests, though, that it takes roughly a year or more for the flow of venture capital to drop off in the aftermath of a sharp market downturn. That means the critical period will come next spring or summer. If the Nasdaq stays weak until then, it is likely we will start seeing declines in venture capital funding, and the pain will start to hit Silicon Valley and other tech meccas. Then it will slowly spread to the rest of the economy as well, just as it took time in the 1990s for the positive effects of the Information Revolution to affect other companies. All told, it could take two or more years for the tech downturn to fully take hold.

No one has seen a tech boom-bust cycle like this one before, since technology and venture capital were never so important a part of the economy. The long-term future of the U.S. economy looks bright - but the next few years could be much bumpier than almost anyone expects.

Michael J. Mandel is economics editor of Business Week. This essay is based on his new book, The Coming Internet Depression: Why the High-Tech Boom Will Go Bust, Why the Crash Will Be Worse Than You Think, and How to Prosper Afterwards.

-- Carl Jenkins (, October 07, 2000


This guy is a little behind the curve. Yesterday was the first time the rattling of the cage began in earnest - the first hints of the coming apart of the vast credit expansion in the financial markets. I think it is hold onto your seats time.

-- Wellesley (, October 07, 2000.

I'm thinking of fitting my seat with a safety belt, even though it would be on my recliner, in my family room, facing my TV.

-- Uncle Fred (, October 07, 2000.

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