Are the dotcoms deadcoms?

THROUGHOUT THE 1990s, investors in shares just assumed that share prices would go ever upwards. But in recent months all the froth of the ‘booming’ internet companies – known collectively as dotcoms – has evaporated. Last week, the US Nasdaq high-tech share index fell by 5.9% in one day. It is now 35% off its March high. KEN SMITH asks:

Are the dotcoms deadcoms?

BOO.COM’S DEMISE is the latest European example of an e-commerce company’s collapse. But many others are starting to fill up out trays in Britain and Europe.

And in the US, so-called innovative e-tailers like grocer Peapod and music retailer CD Now are close to collapse. CD Now has to spend an estimated $70 to secure one customer, who may spend less than half that with the company.

In recent years starting a dotcom company has been seen as a licence to print money through a combination of raising venture capital and a shares launch. Earlier this year a record $122 billion was invested in the US stock market, more than half of it in high tech shares.

Free fall

Now, spectacular falls in high-tech shares prices throughout this year has convinced the high-tech economy’s high flyers that the free ride is over. Many of these companies’ share prices have collapsed to 50% or 75% below their initial offering price.

Even the temporary resurgence after the 14 April collapse on Wall Street hasn’t reversed the overall downward trend in all stock markets. The likely break-up of Microsoft, rising interest rates and currency fluctuations all combined with a crisis of confidence in the start-up dotcoms to push down share prices in high-tech stocks in recent weeks.

These shares took a particular hammering in March and April. High-tech funds fell 25% in four weeks. Internet stocks fell 35% on average in the three weeks before 14 April; some individual stocks fell by 60% or more.

In the USA the Dow Jones, the main stock market charting the biggest US companies’ progress, fell by 12.1% between mid-January and the end of April. The Savings and Poor (S&P) 500, a broader measure of stock market values encompassing more companies, lost 11.1% after peaking in mid-March.

The prices-earnings ratio, which measures share prices against yearly profit earnings reached 44.3 this year. This means shares were far more overpriced even than just before the 1929 Wall Street crash when the ratio reached 32.6.

The Nasdaq high-tech share index fell most – 25% down on a year ago. The Nasdaq was only established in 1973 but it had shown the most rapid growth of any stock market measure in recent years.

More sober economic commentators had warned for months that the internet share bubble needed to be rapidly deflated, maybe even burst. They claim that this “necessary adjustment” in over-inflated share prices won’t hit the real, manufacturing economy. But is this true?

‘New Paradigm’

DESPITE MANY similarities with the 1920s stock market boom, which led inevitably to the 1929 Wall Street Crash, investors and even relatively restrained economists got carried away with the delusion that a ‘new paradigm’ was at work.

They believed that a new economy existed of computerisation, new technology, the internet and e-commerce, which guaranteed an uninterrupted and upward curve of growth for capitalism. In turn they concluded that capitalism’s cycles of boom and bust had ended.

They argued that as more and more people bought the so-called ‘fireproof’ IT shares and their value increased, that wealth found its way into consumption and sustained the US economic ‘boom’.

Certainly the strong but uneven US economic growth in recent years has decisively depended on the “wealth effect”. The gains made from speculative activity by the top 10% have fed into the economy.

But once these ‘miraculous’ gains disappear – as they have started to – inevitably the reverse must happen. US growth will decline sharply and there will be a massive debt hangover and credit crunch in the US economy.

The US is the world’s most important market. Any prospect of economic growth in Asia and of Japanese capitalism’s resurgence depends on it. A US downturn will have dramatic effects.

Bubble Bursting

THE SPECTACULAR fall in IT shares in the US high-tech share indices, the Nasdaq, shows that the IT bubble has well and truly burst. As panic hit the markets, all the earlier exuberant acclamation disintegrated.

Michael Krantz, who had recently left Time magazine to work for a dotcom start-up, described to his former employer the doom that hit the dotcoms: “I’m hypnotised at my computer, watching the Nasdaq collapse…

“The fact that the Nasdaq may have hit a new high by the time you read these words doesn’t erase the vague sense in dotcomland that the party, if not quite over, is definitely winding down…

“The Web bubble is bursting. Has burst. Which means that some of us now roaring toward online glory may instead face that Wile E. Coyote moment when you look down and realise you just sprinted off a cliff… New economy, my ass.”

Krantz added that last year his new company could attract $60 million venture capital (ie money to help start up the company) at “a drop of the hat”, now the “easy money was getting scarcer”.

Many e-companies were consuming vast quantities of start-up cash to try and create an identified company brand, to achieve a high recognition factor through saturation advertising. Many were planning public flotation this year, listing the company on the stock market and issuing shares to raise more capital. These plans have subsequently been abandoned.

An analyst for US firm JP Morgan says that many of these companies are now losing $10 million to $30 million per quarter. What’s more these companies’ commercial strategy is increasingly revealed as hollow.

One reason for the panic about the share valuation of internet companies was precisely the huge amounts the dotcoms were consuming. Their frantic start-up costs weren’t consistent with what the company would achieve in future.

While their share valuation put them under immense competitive pressure to deliver bumper profits in the long run, the truth was that many of these companies would flare up and burn out quicker than a shooting star.

But it’s not just the owners and workers in these dotcom companies who are getting burned by this collapse in confidence.

In recent years more and more middle-class people have followed the lead of the wealthy and ploughed any spare cash they had, even from credit cards and re-mortgaging properties etc., to cash in on the internet share boom by becoming ‘margin traders’.

They buy, say, $5,000-worth of shares, but may only pay for half of it upfront. This works fine as share prices rise. But when they fall margin traders owe more for the shares than they’re worth. A lot of margin traders’ accounts have been called in recent months as stock market dealers got the jitters.

Global effect

DOES THIS mean the new e-economy is finished? Earlier this year the Economist warned investors to “remain agnostic about the new economy”, adding that “the risks this time are big and getting bigger”.

Many of the frothy companies who once hogged the headlines are likely to go to the wall before the year is over. There is also a trend for the traditional giants of the old economy to move in to colonise the e-commerce market pioneered by smaller highflyers. This could also speed up the killing of the dotcom e-tailers.

However, when the International Monetary Fund (IMF) released its annual report on the world economy, coinciding incidentally with the stock market freefall, it concluded the US boom may slow down but it would still pull the rest of the globe along at a steady rate.

But the world’s leading capitalists who previously looked at the global economy’s prospects through the rose-coloured glasses of the 1990s are increasingly worried.

They used to believe that the ‘new economy’, along with a hoped-for resurgence of the Asian economies after the 1997 currency crisis and slump, would avert a traditional capitalist crisis of overproduction or overcapacity.

They are now more pessimistic, mainly because of the fall in share prices. But there are other worries beside the perishing of the dotcoms.

When it was announced that US inflation was rising, a panic ensued on the stock markets which led to the loss of $1.1 trillion in share values, primarily but not exclusively the dotcoms.

The capitalist class see rising inflation as a sign that the economy is ‘overheating’, they fear this will tip it over from boom to bust. Inflation above a certain level also decreases capitalism’s earnings and profits.

The US Federal Reserve (the Fed) had been raising interest rates over a sustained period; they hoped to gradually deflate share prices and ‘cool down’ the economy. But this had had little effect.

Greenspan, the Fed’s chairman, in particular wanted to see a big ‘readjustment’ of the new economy stocks; he wanted their share prices to fall because he felt they helped overheat the economy.

However, raising interest rates increases borrowing and running costs for both the old and the new economy. It also makes people less likely to borrow money to invest in shares. The eventual cumulative effect will be a drop in consumer spending which could tip the US into recession, dragging the rest of the world economy down with it.

Computerisation, new technology and the potential of the internet could mean a brighter future for society. But with the capitalist whiz-kids in charge, their race for fast bucks is likely to pauperise millions once the bubble bursts.

The real question for socialists is: why should new technology merely swell the bank accounts of a few? Under working-class control and management, in a socialist society, it could remove hours of wasted time and allow the development of a whole new world of opportunity.