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The Rise And Fall Of The Dot.Com Bubble

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What was to ultimately turned out to be known as 'The Internet' was developed in the 1960s through funding by the US military so as to discover a means of making possible communication in the event of nuclear conflict . Until the beginning of 1990s, though, the Internet was the sphere of influence of academics as well as researchers as commercial use was proscribed. A process of commercialization began in the late 1980s and the wider use this encouraged was to be given an additional heightening with the emergence of the World Wide Web in the beginning of 1990s. The progress of browsers in the early 1990s which facilitated web pages to be viewed in a graphical format in color after that brought the benefits of the Internet to a wider community. The World Wide Web was to develop at an exponential rate together in terms of the number of websites as well as users as shown in Figures 1. This changed some in the business community to its potential as a means of communication also as a sales and marketing channel.

Thus the notion of the "New Economy" has been hit hard since the "" bubble burst in early 2000. NASDAQ, the high-tech stock index, shortly after soaring to slightly over 5,000 in the first quarter of 2000, dropped precipitously in the second and the third quarters of 2000, continuing its downward trend through 2002 to roughly one-fifth its peak value. But the problem ran deeper than the failure of most dot.coms to make a profit. The hype around the Internet during the late 1990s included a widely accepted statistic that Internet traffic was doubling every three months. Analysts estimate that Internet traffic actually grew at a rate closer to 100 percent a year. (Marc J. Epstein, 2004)

This is still hefty by most standards, but nowhere near the volume that led more than a dozen companies to build expensive fiber-optic networks, most of which remain unused. Millions of miles of fiber-optic lines were buried beneath streets and oceans, but only an estimated 2.7 percent of this capacity is actually being used. Much of the remaining fiber could lie dormant forever. Meanwhile, the resulting fiber glut caused bandwidth prices to plummet by an average of 65 percent, forcing most of the long-haul data-transmission companies to file for bankruptcy protection

Hence two major areas of technological innovation, the Internet and advanced telecommunications hailed as ushering in a new Industrial Revolution, and indeed did help fuel the remarkable economic boom of the late 1990s in the end seemed to be instrumental in triggering a recession and one of the worst stock market crashes in Wall Street history. This clearly is a case of technological advance getting ahead of the marketplace; earlier examples include computer microprocessors outpacing the demand for computing power and agricultural advances driving down farmers' pricing power . But it also illustrates how even the most conservative and savvy investors can confuse hype with reality in the face of seemingly ground-breaking technological innovations with huge economic potential. (Robert Hargrove, 2001)

Not everyone has bought into the notion of a "New Economy," and many critics undoubtedly feel vindicated by the collapse of the speculative bubble. Some academics, such as Northwestern University economist Robert J. Gordon (2000, 2002), challenge the contention that the Internet/information technology revolution is as historically significant as the nineteenth-century Industrial Revolution, which profoundly altered the material basis of our economy and society . Gordon further argues that the economic growth ostensibly generated by the advent of the Internet, underlying what became known as the "New Economy," does not measure up to the so-called Second Industrial Revolution associated with the "great inventions" of the late nineteenth and early twentieth centuries. (Joseph A. Divanna, 2002)

During the late 1990s, continuously rising prices of high-tech stocks created euphoric conditions, as more and more investors rushed into these stocks in anticipation of large capital gains. Once shareholders became drawn to stocks because everyone else was buying, realistic valuations of stocks based on their earnings potential got crowded out by what Greenspan characterized in 1996 as 'irrational exuberance'. This kind of bull market is typically fuelled by cheap money and lots of debt. The low interest policy pursued by the Fed in the wake of the Asian crisis in 1997-99 induced many investors to take out broker loans for additional stock purchases. With shares serving as collateral for those loans, rising stock prices enhanced the borrowing capacity of investors and so became a funding machine for the bull market. In addition, many firms took out a lot of debt to buy back their shares and so counter the dilution of stock ownership brought about by the extensive use of stock options as a new form of employee compensation. It is this interaction between debt and asset inflation which turns a reasonably bullish stock market into a speculative bubble.

Such a bubble is, however, unsustainable. It will burst when the rosy expectations about future profits underlying those sky-high stock-market valuations turn out to have been unrealistic. As market sentiments shift and disappointed investors try to cash in their capital gains, selling waves ensue to push stock prices rapidly lower. Pressured by high levels of indebtedness in the face of declining asset values and mounting capital losses, investors rush to liquidate their assets. Greed turns into fear, even panic. Precisely such a panic began to unfold in March 2000, causing internet stocks to tumble and pulling the NASDAQ over 60 percent lower . As we know there were always strong business ground rules that would show the way to the ultimate downfall of many of the dot coms. From a crest of 5000 reached in the beginning of 2000 the NASDAQ, where the majority of the dot coms were listed, drop down as pointed up in Figure 2. (Journal of Accountancy, 1998)

The most evident cause for that turn of fortune was a slowing US economy, cooled off by six consecutive interest-rate hikes from the Fed. Why did Greenspan squeeze us so hard? What prompted the Chairman of the Fed to hit the brakes was the prospect of an overheating economy triggering a bout of renewed inflation. He was particularly concerned with increases in spending brought about by large capital gains in the stock market. As this source of income grew amidst one of history's greatest bull markets, consumers began to feel richer and spend correspondingly more while saving less. The steady decline of America's savings rate, becoming negative in 1998 among the richest 20 percent of Americans typically holding a lot of equity shares in their portfolios, illustrated the



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