Table of Contents
| Introduction | 1 |
| 1 | The Gildered Age | 5 |
| 2 | Progress, Perfectibility, and the End of History | 37 |
| 3 | John Law and the Origins of a Bad Idea | 69 |
| 4 | Turning Japanese | 92 |
| 5 | The Fabulous Destiny of Alan Greenspan | 125 |
| 6 | The Era of Crowds | 160 |
| 7 | The Hard Math of Demography | 192 |
| 8 | Reckoning Day: The Deleveraging of America | 223 |
| 9 | Moral Hazards | 256 |
| Notes | 277 |
| Bibliography | 285 |
| Index | 291 |
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Financial Reckoning Day
Surviving the Soft Depression of the 21st Century
By William Bonner Addison Wiggin
John Wiley & Sons
Copyright © 2003
William Bonner, Addison Wiggin
All right reserved.
ISBN: 0-471-44973-3
Chapter One
The Gildered Age
The real trouble with this world of ours is not that it is an unreasonable
world, nor even that it is a reasonable one. The commonest kind of
trouble is that it is nearly reasonable, but not quite. Life is not an illogicality;
yet it is a trap for logicians. It looks just a little more mathematical
and regular than it is; its exactitude is obvious, but its inexactitude
is hidden; its wildness lies in wait.
-G. K. Chesterton
Sometime in the late 1990s, Gary Winnick-chairman of the then $47
billion enterprise, Global Crossing (GC)-did something unusual.
He decided to take time off from touring art galleries with David
Rockefeller, playing golf with Bill Clinton, and enjoying the Malibu
beach to learn a little about the business he was in: He bought a video
describing how undersea cable was laid. The video was all Winnick
needed to know about laying cable. For he understood what business he
was really in, and ithad nothing to do with ships or optic fiber. Winnick
was doing nature's work: separating fools from their money. And he was
good at it.
Supposedly, Winnick knew the undersea cable business well. Likewise,
the people from whom he raised money were the "best pros" on Wall
Street and were supposed to be capable of managing big bucks. After all,
if they did not know how to place money to get a decent return, what did
they know? And those who provided these "best pros" with money were
also supposed to know what they were doing. As it turned out, no one
had a clue.
One of the great marvels of life is not that fools and their money are
soon parted, but that they ever get together in the first place. Life goes
on, we note, for no particular reason other than the vanity of it all. One
lie replaces another like cars along a Paris street (where a parking spot
rarely remains vacant for long).
Not only does life imitate art, but it slavishly tries to model itself on
science, too. In the course of the 20th century, a simple idea had become
stuck in investors' minds. Everything worked like a machine, they
thought, especially the economy. If the economy was growing too fast,
Alan Greenspan would "put on the brakes" by raising interest rates. If it
was growing too slowly, he would "open up the throttle" by lowering interest
rates. It was so simple. The mechanical image seemed to describe
perfectly how the Fed worked. There was no experience in the last two
decades to contradict it. It had worked so well for so long: It was almost
as if it were true.
In his book, A Random Walk Down Wall Street, Burton Malkiel popularized
the efficient market hypothesis, claiming that stock prices moved in a
random fashion. The best you can do, he proposed, was to buy the indexes
and stay in the market. Over time, the market goes up ... and you
get rich. According to this view, the market is a benign, mechanistic instrument
that merely distributes wealth evenly to those who participate:
As long as you are "in the market," all the riches of capitalism will flow
in your direction.
The trouble is that the market may look mechanistic, but it is not. The
market is an unbounded, organic system; mastering it is a human science,
not a hard science. The financial markets reflect the activity of the
human economy; they are unbounded chaotic systems. The best metaphor
for understanding such a system is the nature of which they are a part-infinitely
complex and ultimately uncontrollable. Markets are neither
kind nor forgiving. If markets do the work of God, as has been suggested,
it is the God of the Old Testament, not the New.
But in the late 1990s, we lived in a wonderful world. It was rich and
lush ... the sun shone every day. Progress seemed inevitable and unstoppable,
and compiling information in digital form was thought to hold
the secret to an ever-increasing abundance of resources for mankind. It
seemed so simple: Computers and telecommunications would provide
people with increasing amounts of information, and this in turn would
allow goods to be produced faster and at lower costs. Humans, hitherto
Neanderthals in a low cave hunched in ignorance and darkness, would
now be able to stand upright and edge a little closer to perfection every
day. There was no chance that they would slip up, as they had always
done in the past, we were told, for this was a more fully evolved species,
better adapted to the Information Age. This really was a "New Era," we
were assured.
At the dawn of the 21st century, a half-century of progress and a
25-year-long bull market had created a race of geniuses. Americans were
on top of the world. Their armies were unbeatable. Their currency was
accepted everywhere as though it had real value. Dollars were the United
States' most successful export, with a net outflow of nearly $1.5 billion
per day. And dollars were the product on which the nation enjoyed its
biggest profit margin. It cost less than a cent to produce one, and each
one was valued at par.
But America's greatest strength was its economy. It was not only the
strongest in the world, but the strongest the world had ever seen. The
United States had increased its economic lead over the competition in
the 10 years running up to the end of the century. In the minds of
many, the U.S. economy was unstoppable, and its continued success inevitable.
They believed that the nation's leadership position was not
merely cyclical, but eternal. It had achieved a state so nearly perfect
that improvement was hardly imaginable. American music, art, films,
democracy, and American-style market capitalism were everywhere
triumphant.
"America is the world's only surviving model of human progress,"
President George W. Bush told the graduating class of West Point in June
2002. America has its faults, wrote Thomas L. Friedman in the New York
Times at about the same time, but without it, "nothing good happens."
Oddly, during this golden era of silicon chips and Internet domain
names, no one was able to explain why the Information Age never made
its way across the Pacific to Japan. No one even bothered to ask the question.
But that is one of the comforts of a great boom; question marks disappear.
Societies, like markets and individual humans, are infinitely
complex. The harder you look, the more you see. When things go well,
people are content not to ask questions and not to look too hard. They
think they know how the world works and are happy with the jingles and
simple metaphors that explain it.
The new information technology, it was claimed, would boost productivity
and the growth rate. Few people doubted it. More information
would make things better; it seemed as simple as that. For question
marks, like winter clothes after Easter, get packed away during a bull
market. Not until a chill autumn wind blows do they come back out.
And at the end of September 2001, the drafts of cold weather were just
beginning. The Nasdaq was down 73 percent from its high. The Dow was
down 32 percent. A recession had begun in March. Although, at first it
was reported to have ended after a single quarter, later revisions showed
that it lasted through the end of the year. Investors had no way of knowing,
for they had no crystal balls, but they were in for a spell of bad
weather. Yet only a few people began rummaging through their cupboards
for their coats and mittens.
We humans understand things by analogy. Indeed, since before Noah
built his Ark, humans have tried to understand the world by extrapolating
from the known to the unknown. Comparison was the only tool they
had to explain what they observed. Once upon a time, a bear might have
been said to run "as fast as a lion," for example, or "like a holy hellcat"
because it was not possible to time an animal's running speed precisely.
After a period without rain, villagers might have remarked that it "was
just like the Great Drought" of a few years earlier. They had no way of
knowing what might happen, of course, but the analogy warned them to
conserve their food. By comparing one thing we don't really understand
to another we understand only slightly better, we think we understand
both. We imagine Alan Greenspan, for example, pulling levers and turning
knobs as if the economy really could be run like a machine.
Yet, strangely, in the new world at the close of the 20th century, the
analogies from years ago or from across the wide Pacific did not seem to
matter. Things were different. Not only did the old rules and old lessons
no longer apply, analogies themselves were now out of fashion. The New
Era was "digital." It was widely presumed that nearly all of life would
soon be digitized and that mankind would grow better informed, richer,
and morally superior every day. That was ... until the weather changed.
Gurus of the New Era
The history of the New Era will record that it was Robert Metcalfe and
Gordon Moore who, like Moses and Aaron, led their followers out of
the bondage of the Old Economy and into the land of stock options and
caffe lattes. Metcalfe and Moore handed down the laws by which the people
of Silicon Valley in the 1990s lived.
Metcalfe described a well-known phenomenon: Each element of a system
or collectivity becomes more valuable as it expands. You can see this
by thinking about the phone system. When the Bell Telephone Company
was founded in May 1877, its products were almost useless. Subscribers
could not call anyone because no one had a telephone. But three years
later, there were 30,000 phones in use.
This led to the further insight that the company could afford to spend
a great deal of money selling and installing telephones because it would
earn a profit later on. What's more, it was critical that people purchased
Bell telephones rather than a competitor's. Ultimately, the most valuable,
and presumably the most profitable, service would be the one that was
most ubiquitous.
This insight cleared the way for the popular Internet business plan:
Do not worry about profits-fight for market share. Few noticed the f law:
The telephone system was a quasi-monopoly. It made sense to pay a lot of
money to put it in place, because the company could expect monopoly-level
profits for a very long time. Bell Telephone and its derivatives are
still in business. But Amazon.com, the Globe.com, Webvan.com, and
thousands of other Internet start-ups had no hope of ever getting a monopoly
or anything close to it.
Moore, meanwhile, handed down his own law: He stated that computational
power would double every 18 months-which, thus far, it had.
This growth rate astonished everyone and led to the other major delusion
of Internet investors-that just because computer power increases
exponentially, so should Internet businesses and stock prices. Moore's
law only applies to the speed at which computers process information.
Government quants assumed, wrongly, that this was equivalent to an increase
in the nation's wealth, as expressed by gross domestic product
(GDP). As we'll see later on, this in turn led to distortions in other measures,
such as productivity and inflation levels.
If Moore and Metcalfe were the Old Testament prophets of the New
Era, George Gilder was its messiah. Every revolution needs its intellectuals,
its firebrands, its executioners, and its victims. One-third visionary,
one-third fool, one-third incomprehensible-Gilder was all of these
things, and more. A speechwriter for Romney, Rockefeller, and Nixon,
he authored several well-read books, including Wealth and Poverty and The
Spirit of Enterprise. He was quoted more often by Ronald Reagan, the
record shows, than any other writer. His book, Microcosm, took him farther
than anyone had ever gone into the distant reaches of new technology
and the enterprising spirit. Since then, some would say he has
drifted a bit too far.
Gilder's articles in Forbes ASAP were not merely hard to read; they
were incomprehensible. But never mind. He was a genius, and he was
right about a great many things. His reports were followed by many of
the shrewdest investors of our time ... to such an extent that this "pale,
nervous Yankee" was seen as a semi-god or "John the Baptist of the Digital
Age," as one article put it. But he had worked himself into such a state
of rapture over the possibilities of the Internet that he seemed to have
gone a little mad.
One caveat, "I don't do price," Gilder commented. Too bad. Because,
as investors would discover later, prices are important. A technology may
be spectacular; the company that owns it may be a great company; but
the stock is only a good investment at the right price.
Star-Crossed
"Listen to the technology!" Gilder's Caltech physics professor, Carver
Mead, had advised the New Era messiah. Listening carefully, Gilder had
believed that, if he strained his ears enough, he could almost hear the
cosmos speaking. "Buy Global Crossing!" he thought he had heard.
Gilder did not usually buy, and judging from the press reports, he had
little interest in picking stocks. But this Ulysses of the Telecosm had forgotten
to plug his ears or have himself lashed to the mast. Thus, the
sirens at Global Crossing got him ... and drove him crazy. Nowhere was
this more manifest than in his book, Telecosm, in which he announced the
emergence of a new economy, "based on a new sphere of cornucopian radiance
-reality unmassed and unmasked, leaving only the promethean
light." To this day, we do not know what that sentence was supposed to
mean. It was all very well to blather about how Global Crossing helped to
bring "a new epoch of spirit and faith" with its "majestic cumulative
power, truth, and transcendence of contemporary science and wealth."
But with a profit/earnings (P/E) ratio of negative 130, an investor would
have been a fool to bet money on it. Yet even in June 2001, George Gilder
continued to praise Global Crossing, qualifying the stock as "no surer
bet in the Telecosm."
Oh, but we forgot-Gilder didn't "do price."
Master of the Bandwidth Universe
Gary Winnick had been a former Drexel Burnham bond trader before he
got into the optic-fiber business almost by accident. He had seen the possibilities
of bandwidth after financing an undersea cable for AT&T in
1997. His first cable took 14 months to lay, but it was extremely profitable.
Thus, did the simple business plan for Global Crossing emerge-raise
money and lay fiber-optic cable! Early estimates of construction costs were
around $2.7 billion. The money was soon coming into the Hamilton,
Bermuda, headquarters of Global Crossing at the speed of light. The stock
went public in August 1998 at $9.50. Eight months later, it hit $60 a share,
giving the company a market capitalization of $54 billion. Winnick's personal
stake in the company rose to $4.7 billion.
Continues...
Excerpted from Financial Reckoning Day
by William Bonner Addison Wiggin
Copyright © 2003 by William Bonner, Addison Wiggin.
Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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