iTulip.com - Background

iTulip.com Background
January 1999

Some in clandestine companies combine;
Erect new stocks to trade beyond the line;
With air and empty names beguile the town,
And raise new credits first, then cry 'em down;
Divide the empty nothing into shares,
And set the crowd together by the ears.
- Daniel Defoe (1660 - 1731)

Welcome to iTulip.com, the Internet stock mania company. iTulip.com parodies Internet companies that are getting a lot of investors' money for no good reason. iTulip.com is not a real company, but it's not unlike a few of the Internet companies whose stock is the target of wild investor speculation. Founded November 1998 and re-launched January 1999, iTulip.com gets its name from the infamous Dutch tulipmania in the 1630s. In 1637, at the peak of the mania for tulip bulbs, one bulb sold for 4,200 guilders, roughly US$1,500,000 today. Likewise, many Internet stocks have acheived unprecidented prices based not on any reasonable extrapolation of future earnings but, as with tulip bulbs in the 1600s, on buyers' expectations that there will always be more buyers at a higher price.

iTulip.com uses the Internet in the spirit of the Dutch citizens who used the personal publishing media of their day, the printed pamphlet, to warn investors of the dangers of tulipmania in the 1630s

Yes, the Internet is truly revolutionary. Just as expensive proprietary computer networks made large multinational corporations more efficient and profitable since the 1970s, the Internet offers similar productivity benefits at a much lower cost to businesses large and small. New industrial technologies delivered a productivity revolution in the early part of this century in a similar fashion. Companies that in the past deployed new technologies such as the railroad, telegraph and radio, saw their stock prices rise to enormous speculative heights in an atmosphere of euphoria that typically arises during times of low inflation and cheap credit.

"Never before has our nation enjoyed at once so much prosperity and social progress with so little internal crisis and so few external threats. My fellow Americans, the state of our union is the strongest it has ever been."

- US President Bill Clinton, State of the Union Address, February 2000

"No Congress of the US ever assembled, on surveying the state of the union, has met with a more pleasing prospect than that which appears at the present time. In the domestic field there is tranquillity and contentment÷ and the highest record years of prosperity."

- US President Calvin Coolidge, State of the Union, December1928

Recipe for a Financial Mania

A positive event, such as the end of a significant international conflict or war, creates an atmosphere of relief and profound optimism in the nation hosting the financial mania -- in the case of the current mania in the United States, the end of the Cold War. In the 1920s, the defining event was the end of WWI and the invention of new industrial technologies. Even during that New Era period, there were skeptics.

A new discovery or invention sparks the public's imagination and initiates public speculation on its apparent limitless possibility and promise. Early developers of the new technology become wealthy, seemingly with speed and ease, starting in motion a public desire to participate and get rich quick, too. The desire becomes self-fulfilling as the involvement of ever greater numbers of investors causes stock prices to rise. The Initial Public Offering of Netscape marked the start of the public's awareness of the World Wide Web and the wealth it can create for investors in the stock of new Internet companies.

The final ingredient needed to get the mania machine running at full tilt is a new source of liquidity in the markets to provide the necessary fuel for speculation. The end of a war in addition to creating optimism simultaneously relieves the mania host nation of inflationary government expenses, allowing interest rates to fall, such as the so-called "Peace Dividend" of the post Cold War period. Between the start of the mania in 1994 and 2000, 30-year Treasury rates fell from 8.17% to 5.87%. The end of international conflict also opens markets, allowing greater competition to hold down prices and keep inflation in check even as the government allows the money supply to grow far faster than normal. The money supply M3 grew 34% between 1994 and 2000 whereas it grew only 4% from 1990 to 1994. Private sector debt exploded, increasing from the historical peak of 1% of GDP for the previous 50 years to 5% of GDP by 2000. The net result has been a 300% increase in the S&P 500 even as profitability grew only 2%.

Recipe for a Financial Mania - Chart

Indeed the US economy has benefited as a whole from new industrial technologies in the 1929s just as it has from new information technologies in the 1990s. However, eventually the prices of the speculative stocks collapse when an event occurs that causes the investment environment to change, usually an event led by or leading to rising interest rates or inflation, or both. Euphoria is first replaced by fear and later by panic as market participants come to realize that extremely high stock prices can never be justified by earnings growth but only by the presence in the market of buyers at a higher price, who in a moment of mass realization suddenly disappear.

When the Internet tulipmania ends, if history has any value as a predictive guide, uneconomical Internet businesses will cease to exist and many investors are going to lose a lot of money. The iTulip.com parody is a vehicle for delivering this unwelcome news by means of example to Internet company stock investors who suffer the misguided belief that they are blazing New Era trails. iTulip.com uses the Internet in the spirit of the Dutch citizens who used the personal publishing media of their day, the printed pamphlet, to warn investors of the dangers of tulipmania in the 1630s.

"[T]he consensus of judgment of millions whose valuations function on that admirable market... is that stocks are not at present over-valued. Where is that group of men with the all-embracing wisdom which will entitle them to veto the judgment of this intelligent multitude?"

Professor Lawrence, Princeton University
September 1929

"But bubbles generally are perceptible only after the fact. To spot a bubble in advance requires a judgment that hundreds of thousands of informed investors have it all wrong."

Testimony of Chairman Alan Greenspan
Before the Joint Economic Committee, U.S. Congress
June 1999

Technological innovations created investment opportunities in the past just as the technologies of the information age do today. However, history delivers a discouragingly consistent record of disappointment to investors who believe that the latest new technology allows them to ignore established principles of equity valuation.

In the 1850s, the railroad was widely expected to greatly increase the efficiency of communications and commerce. It did, but not enough to justify the prices of railroad stocks which grew to enormous speculative heights before collapsing on 24 August 1857. Radio in the 1920s also promised to create a revolution in the economics of communications and commerce. Indeed, an entirely new industry grew out of the invention. Euphoria over the promising new technology came to an abrupt end in October 1929. Even stock in RCA, the only company that had successfully built a profitable business from radio, lost 97% of its value between 1929 and 1933. Probably the closest analog to the Internet stock mania was the speculation surrounding the invention of the telegraph. "The hype, skepticism and bewilderment associated with the internet -- concerns about new forms of crime, adjustment in social mores, and redefinition of business practices -- mirror precisely the hopes, fears and misunderstandings inspired by the telegraph," writes the author (of The Victorian Internet), Tom Standage."
On the other hand, the invention of telephone was not attended by a stock market mania. At the time, government spending on WWI was creating inflation and the war itself created an atmosphere of pessimism; neither good for stocks. The combination of a promising new technology or discovery, an atmosphere of optimism, low inflation, and excess liquidity makes a stock mania machine go.

"...nobody has questioned at all that the dramatic acceleration that we've seen in some technologies and the marked increase in productivity and profitability of American businesses has undoubtedly had a significant impact on underlying prices of all capital assets, including equities.

"[However], equity prices are high enough to raise questions of whether shares are overvalued."

- Extract: Alan Greenspan's Senate Banking Committee testimony, February 23, 1999

"There is no means of knowing beyond question how far this recent rise in stock prices represents excessive speculation and how far a readjustment of values to increased industrial efficiency [ . . . ] and larger profits."

- Extract : Federal Reserve meeting minutes 1928

The Internet will increase the profitability of many companies by a finite, not infinite, amount, as the prices of many Internet company stocks assume. When the Internet tulipmania ends, if history has any value as a predictive guide, uneconomical Internet businesses will cease to exist and many investors are going to lose a lot of money. The iTulip.comÙ parody is a vehicle for delivering this unwelcome news by means of example to Internet company stock investors who suffer the misguided belief that they are blazing New Era trails.

On the topic of another financial mania, the South Sea Bubble of 1719 - 1720...

"The public, it seemed, would buy anything. New companies seeking financing during this period were organized for such purposes as: the building of ships against pirates; encouraging the breeding of horses (there were two businesses for this purpose); trading in human hair; building of hospitals for bastard children; extracting of silver from lead; and even for a wheel of perpetual motion.

"The prize, however, must surely go to the unknown soul who started 'A Company for carrying on an undertaking of great advantage, but no one to know what it is.' The prospectus promised unheard-of rewards. At nine o'clock in the morning, when the subscription books opened, crowds of people from all walks of life practically beat down the door in an effort to subscribe. Within five hours a thousand investors handed over their money for shares in the company. Not being greedy himself, the promoter promptly closed up shop and set off for the Continent. He was never heard from again.

"To protect the public from further abuses, Parliament passed the Bubble Act, which forbade the issuing of stock certificates by companies. For over a century, until the act was repealed in 1825, there were relatively few share certificates in the British market."

- Burton G. Malkiel, A Random Walk Down Wall Street, Fourth Edition
South Sea Bubble, 1719 - 1720, The Madness of Crowds, pg. 36.

Bought up to date and applied to an Internet company: "A Company to eventually generate several hundred million dollars in earnings to justify the current stock price, but no one to know how or when."