Where did you get the idea for iTulip.com?
About a year ago (February 1998), I noticed the stock market mania had been going on for a while, with the S&P 500 rising many multiples of earnings. I was still in the market after ten years but was thinking about getting out. After doing my research I decided to get out in May 1998. This turned out to have been excellent timing, since the stealth bear market began then, but I attribute the timing to luck. Some may say I missed the big ride, but they don't know that my day job depends on the stock market, so diversifying out of it when the risk is high made sense for me. While doing my research I became fascinated with the phenomenon of financial manias.
From a section on the 1719-1720 South Sea Bubble in Burton G. Malkiel's A Random Walk Down Wall Street, Fourth Edition, page 36:
|Whom the gods would destroy,
they first ridicule. Signs that the end was near were demonstrated
with the issuance of a pack of South Sea playing cards. Each card contained
a caricature of a bubble company, with an appropriate verse inscribed underneath.
One of these, the Puckle Machine Company, was supposed to produce machines
discharging both round and square cannonballs and bullets. Puckle
modestly claimed that his machine would make a total revolution in the
art of war. The eight of spades describe it as follows:
Of fools at home instead of fools abroad.
Fear not, my friends, this terrible machine.
They're only wounded who have shares therein.
Where did you get the idea for the iTulip.com Bogus Stock Certificate?
At a flea market where a man was selling stacks of old railroad and telegraph company stock certificates from now-defunct railroad and telegraph companies. Someone now long gone once bought these things with real money and here they are going for ten dollars each -- their paper and sentimental value -- at a flea market. I figured, why wait for real Internet stocks to become share value worthless before selling them for sentimental value? Why not print an Internet stock certificate look-alike that's worth ten bucks now and sell it as a novelty?
Who are you? Don't tell me Arnold Greenspatz is your real name?
I'm not really the president of an Internet company, I just play one on the Internet. My real name is Eric Janszen and I'm executive director of Osborn Capital LLC, an angel investment fund that invests in very early stage start-up companies, mostly Internet related. This may appear paradoxical, to manage a fund that invests in companies in an industry that I poke fun at, but it's not really. All of our portfolio companies have business plans for profitable development, marketing, and sale of products and services. They each have strong management, good technology, viable business models, special customer knowledge, barriers to entry, all the basic qualities of good investments. What's so amazing about the Internet investment craze is that many investors don't even take the trouble to get the ticker symbol right when investing their money in the Internet company stocks. Greenspan said in one of his speeches that investors buy Internet stocks the way they buy lottery tickets. But the analogy breaks down when you consider that these Internet lottery tickets go for hundreds of dollars and the industry that's grown around the business of selling Internet stocks is not as well regulated as the state lottery industry, which has to explain the odds on each ticket they sell. On the contrary, reputable stock brokerages push day trading of Internet stocks as a road to quick riches. Equity analysts put absurd price targets and positively biased recommendations on stocks of companies their employers have backed. Most investors as a result are spending money on Internet stocks carelessly and they're going to lose a lot of money.
Why the name Alan Greenspatz?
Everyone on the iTulip.com management team has a name that's a take-off on Alan Greenspan, Larry Summers, and others that come and go from the scene as the financial drama that started with the Asia crisis in 1997 continues to unfold. It's more a fraternity than a formal organization, unified by a shared desire to keep the system functioning. My favorite target is Greenspan. While I respect his profound intelligence, his history suggests a man who has a personality trait that is a serious hazard for a central bank chairman: he wants to be liked. Volker, for example, didn't have that problem. Right now he's enjoying a reputation as the smartest central banker in history. But he's making nearly the same mistakes as his predecessors in the 1920s, providing too much liquidity at the wrong time, fueling a speculative mania during a time of rapid technological innovation. What will be learned from this -- again -- is that the Fed's rate and money supply moves can distort the market's utilization of capital, leading to credit and asset value excesses and potentially a bust. Greenspan may not go down in history as a hero.
What qualifies you to comment on financial manias and to parody the overvalued Internet company phenomenon?
Nothing, really. I have seventeen years of technical, marketing, and sales experience in the high tech industry, several years working for Internet-related businesses, and direct experience managing private investment in Internet companies. I read a lot, but that's about it. I figure I have as much of an idea as anyone what makes a good Internet stock investment, private or public.
Are all Internet companies losers?
Not at all. Many, like AOL, are incredibly well managed. All of our portfolio companies are well managed. There are lots of talented and hard-working people running many of these companies, and since I've been a part of six start-up businesses in my career, I'm 100% empathetic toward the people who pour their hearts and souls into these companies. Still, the market capitalizations of most of them is too high based on any reasonable projection of future earnings. And their expectations of quick riches are not realistic. They may have to experience several failures before they make it. Internet company stocks are only part of a greater mania for American company stocks in general, a wild mania within a general mania. Manias always end badly. Even companies that don't have a comma in their P/E will lose big when the heavy selling starts.
So you think the stock market of the past few years is similar to the stock market 1920s? Lot's of folks have been saying that for years but it keeps rising. Isn't it possible we are in a New Era?
Indeed there are similarities between the equities markets today and in the 1920s and many commentators have pointed this out for years. But that's superficial. The cause of the similarity interests me and the potential consequences. From the research I conducted before creating iTulip.com I've thrown together the following two theses about the 1920s and the current New Era in economic growth and stock market performance.
The primary thesis is that we're living in a deflationary boom similar to the 1920s period. New technologies were revolutionizing the world economy then, raising productivity and profitability. Starting a half dozen years after the end of WWI, increasing integration of financial markets worldwide and the growth of free trade, now called globalization, created deflationary price effects in the US economy by exposing US industry to foreign competition. This surge in competition created demand for new technologies from corporations that needed to increase productivity to maintain profitability. New technology industries emerged to fill this demand. Wage pressures also create demand for new technology. Monetary authorities were under pressure then to provide sufficient credit to permit the rapid expansion of these new industries and the economy as a whole. Then as now Fed obliged with loose monetary policy, ostensibly to support economic expansion but in effect the inflationary monetary policy balanced the dual deflationary forces of free trade and technological innovation, both of which increased industrial capacity more rapidly than ever before. Rapid growth in productivity seemed to justify the apparent miracle of rapid economic expansion without inflation. Excess liquidity found its way into the equity markets that offered a greater return than in the so-called real economy. The availability of low cost credit was accompanied by the emergence of new technology companies which investors were unable to valuate and were therefore inclined to speculate on, such as radio and automobiles. When the Fed realized the danger that the asset bubble posed to the real economy, it moved to decrease liquidity and the bubble collapsed. Demand collapsed along with it, leaving an imploding money supply in the face of the enormous worldwide industrial capacity that had grown during the boom.
The rest is history. Economic historians disagree as to whether the Fed did enough or all they could to mitigate the effects of the crash. I don't have an answer to that but this much is clear from my research. The Fed, the banks and financial community, corporate leaders, most of the press -- just about everyone -- seemed absolutely certain in the 1920s that they'd developed a financial system and economic infrastructure that was capable of withstanding any kind of market downturn, unlike the case of previous crashes which had caused serious collateral damage to the real economy. The lesson of the 1920s may be that markets grow to outstrip the capacity of central banks and other institutions to manage them, that markets naturally evolve to operate outside the control of monetary authorities. As a result, these institutions are always fighting the last war. Perhaps the crash of 1987 and the correction of 1998, which did not have a serious impact on the real economy thanks to quick Fed intervention, represent a phase in a longer term economic dynamic. Maybe these corrections and the subsequent post Fed bailouts set the stage for a bigger and less manageable market event in the future.
The second thesis relates to the medium term outcome of a crash should the Fed be not much better at mitigating the effects of the collapse of this bubble better than in the 1930s, or at least no better than the Japanese have been in the past ten years since their market bubble collapsed in 1989.
More than 40% of the sovereign
debt of the US is held by foreigners. History is completely
consistent on this: in the event of a sustained drop in liquidity and economic
growth of an indebted nation, foreigner borrowers demand to be repaid before
other creditors. The dollar is likely to fall like a rock as foreign
held US paper is sold. The domestic impact is inflationary.
So unlike the US in the 1930s or Japan in the 1990s where deflation accompanied
a period of economic contraction, the US is likely to experience a period
of inflation in addition to recession.