The construction of a new conventional wisdom is a wondrous feat. Seemingly, in the middle of the night, a new truth emerges that is impregnable, monolithic and unassailable, and it rises upon a landscape scattered with the rubble of previous conventional wisdoms. The newest "truth" is what appeared this week on the cover of the Economist: "The new tech bubble."
But it's not just the Economist, which does wrestle with some of the complexities of bubble creation. The Economist, in fact, comes a little late to this parlor game. The notion that there's a new tech bubble -- inflated valuations from social media wunderkinds like Facebook, Twitter, Groupon and LinkedIn to the nosebleed-high $8.5 billion Microsoft paid to grab Skype -- has been a blogospheric meme and has recently graced, as if by dictation from above, nearly every major newspaper.
But is it true? Are these ballooning valuations for a handful of tech startups, mostly in social media, a reprise of the dot-com bust of 2001, or for that matter, the mortgage bubble and meltdown? How strong is the evidence? Are their divergences from those previous bubbles, which of course we can only confirm as bubbles because they burst? And the key question really: Why do we believe that we can call this inflation of tech valuations a bubble, when we've been so wrong, so regularly, in the past? What does it say about the power of the media to do anything about it? And what do we really mean when we say there's a bubble brewing?
The Economist offers a compact recitation of the charges that a tech bubble is inflating. The valuations for Facebook and Twitter -- still private companies -- are astronomical. Skype was clearly overvalued by Microsoft, based on its still-thin earnings. "Prices," notes the Economist,
look even more excessive for fledgling firms in the private market (Color, a photo-sharing social network, was recently said to be worth $100 million, even though it has an untested service) or for anything involving China. There has been a stampede for shares in Renren, hailed as China's 'Facebook,' and other Chinese web giants listed on American exchanges.The Economist does offer some caveats. The world is different than in 2001 and the Internet is a far larger, more diverse universe with extensive broadband connectivity. Moreover, many of these startups have real revenues and earnings, unlike the hundreds of dot-com startups of the late '90s that had traffic but no discernible business models. Those '90s startups were also hoisted aloft on a vast surge of initial public offerings, which has yet to develop. And while tech stocks have been rising, as a group they're well below the Nasdaq of 2000. So where's the bubble?
The Economist argues that wealthy angel investors, many of whom made their money in the '90s, are scrambling to take stakes in Web startups, competing with traditional venture capitalists who in turn are feeling heat from "Gucci-shod leveraged-buyout-kings" (oh please) and "bank-led funds hunting for profits in a bleak investment environment." Most of this hot money, the Economist declares, hasn't done its due diligence and doesn't know tech (perhaps, but no evidence is offered). And to make matters worse, they're increasingly investing overseas, adding to the risk.
How does the Economist marry up these two seemingly contradictory realities? The magazine admits that we're still early on in the bubble process. Facebook and LinkedIn look like real companies -- like Google, which stirred its own bubble prognostications after its IPO in 2004 -- but that will just feed the mania to overinflate the startups that the magazine believes will inevitably follow. "The froth in China's web industry could also lead to unrealistic valuations elsewhere. And it may be China that causes the web bubble eventually to burst." Notice the "could" and "may." But even then, "with luck the latest web bubble will do less damage than its predecessor," mostly because telecom isn't mixed up in the mess (though given its latent state, who knows what neighboring sectors will get sucked in). The Economist then asks: "When will that be?" Excellent question. But after congratulating itself on calling the dot-com and mortgage bubbles, it fails to answer it. Someday. In the future.
Could there be a tech bubble gestating? Certainly. But there could also be a bubble in emerging market stocks, in anything China, in energy and commodities and, for all I know, in rare earth metals and university tuitions. The wonderful thing about bubble prediction is that it's so easy. No one will really care if you're wrong -- you're just being provocative, even if you're part of a herd -- and the definition of a bubble can extend from an uptick in prices that aren't sustainable to a crash that threatens the economy. This may explain why, at the end of the day, no one pays attention to bubble warnings: They occur too often, and they're often far too amorphous and far too early. Contrary to the media critics, bubble warnings appeared regularly on both the dot-coms and mortgages. Few listened. Or rather, not enough listened and, importantly, acted to stop the inflation and destruction.
In a decent market, some stocks -- or M&A and private valuations -- are always being driven up. There are always hot sectors that the "smart" money is chasing like a newly discovered cache of Warhols. And as the Economist admits, those investment decisions may be sloppy, but they aren't necessarily irrational or based on fantasy. Facebook, like Google, looks like the real thing, which wasn't necessarily apparent just a few years ago. LinkedIn is a real company, making its IPO valuation a matter of debate, not sheer faith. The process of bubble inflation is not fast, and it's not simple. It requires both a larger supply of startups than we have right now and a broadening beyond the bounds of a single sector. The dot-com bubble grew serious when it drew in telecom and when it spread beyond the smart money, which can make as many mistakes as anyone, and into the broad retail universe. Real estate inflation became a bubble when it spread nationwide and drew in more than just subprime; it became a mortal threat when it sucked in core financial institutions.
For the "new" tech bubble to become a systemic danger, it must diffuse far beyond what the Economist calls "the antics of angels" and into the consumer world, and it must spread beyond social media -- say, to mobile. To drive the bubble, some fundamental innovation needs to occur, which as yet, we do not detect. After all, this is also the age of Tyler Cowan's "stagnation" thesis, which also may be right or may be wrong, but which clearly represents one aspect of the Zeitgeist. The dot-com bubble was powerfully driven by tech euphoria, underpinned by low interest rates, strong growth, robust productivity, low inflation, low unemployment and a sense that the American-centric world grew better and better every day.
A bubble is always the confluence of many streams; the probabilities have to line up. Right now, we only have a few of them. It's a leap -- though always possible -- to predict a few more. But as we project out, our ability to get anything right decays. And the Economist is peering pretty far out in this exceedingly turbulent world.
This is a glib observation, but I'll offer it anyway: The closest thing to a bubble in tech these days may be the rush to declare it a bubble in the media. Even if it turns out to be the case, it would be more luck than prescience.