An Internet Ponzi Scheme? Jude Wanniski March 15, 2000

To: Paul Krugman, NYTimes columnist
From: Jude Wanniski
Re: The Wall Street "Bubble"

As promised, I continue to read every word you write for the NYTimes, helping you learn the ropes as the new twice-a-week Economics columnist, fresh from M.I.T. It is not always easy, Dr. Krugman. In Sunday's Times, I'm sorry to say, I was disappointed to find you joining the ranks of the Wall Street "bubble" theorists. Here you were, hawking "Robert Shiller's terrific new book, Irrational Exuberance," which "makes a powerful case that the soaring stock market of recent years is a huge, accidental Ponzi scheme in progress, one that will come to a very bad end."

Now I know a lot of silly people are writing a lot of silly books about the stock market these days, so I'm not surprised that this Shiller fellow has joined the parade. But Professor, you have a Ph.D. in economics! Your have written a textbook which the youth of the nation are being asked to read in Econ. 101, whether they like it or not!! You have also described yourself as one of the most important big thinkers to come along in years!!! And you have been hand picked to write this extremely important column for the greatest newspaper on earth!!!! How can you have it as a premise that the market does not work? That we are witnessing a giant Ponzi scheme??

You do a good job of describing a Ponzi scheme, I will admit. First, some wise guy comes up with a plausible-sounding but complicated profit opportunity, one that is difficult to evaluate. "From that point on it's all a matter of timing and publicity. An initial group of investors must be pulled in, large enough to attract attention but not too large; then a larger second group, whose investments can be used to pay off the first, a still larger group, and so on. If all goes well, stories about how much early investors have made will spread, attracting even more people, and the continuing success of the company will silence or drown out the skeptics."

Yes, there can be Ponzi schemes involving a few players, con men who can fool little old ladies and even greater fools. For an accredited economist of your rank and prestige to even suggest that the Internet stocks constitute such a scheme makes me wonder if you flunked a standard course in price theory, but they decided to give you a doctorate anyway. I know the schools still teach that even markets that are as broad and deep as Wall Street's can get overheated by speculative fervor -- a thesis I also reject. But I cannot imagine anyone charging tuition for teaching that the rise in the value of a specific industrial sector can be anything but a pure market signal for more capital.

It's like a baby, Professor. When it is in its most rapid stages of growth, it is crying for more milk, and there is nothing irrational about mommy feeding the kid as long as it is taking the nourishment. There are teenage kids who can devour pizzas for breakfast, lunch and dinner without putting on weight. Somehow, the body's need for calories is showing up in hunger pangs. When the growing stage ends, so does the picnic, or the body will expand at the waist. When you were growing up as a fledgling economist, you would observe the equity market rising and falling in gentle aggregate swings, but within the aggregations, some sectors would be rising and others would be falling. That's known as "business cycles." When chemicals were up, paper could be down, and vice versa. As they rose, individual enterprises would attract capital in order to add to capacity. As they fell, capital would stay away and new capacity would not be built. The supply and demand for paper and the supply and demand for chemicals would adjust accordingly, some one enterprise inevitably getting hurt on the roundabouts -- either for having become irrationally exuberant at an earlier point in the cycle, or for being overly pessimistic just before the upturn. This is how market capitalism works.

It doesn't work any differently just because an entirely new industry comes along. A baby does not return the investment of milk within the calendar year. Investments are even made in the child right through graduate school, with no ROI until the kid gets a real job. Even then the returns will be slim until the graduate learns the ropes and takes on added responsibilities with much higher wages and stock options. So it is with Yahoo and Amazon and the other dot.coms. They are devouring capital at a phenomenal rate, at least those who have made it into short pants, with plenty of dot.coms you never heard about not making it out of diapers. Your colleague at the Times, Thomas L. Friedman, two years ago made fun of Amazon.com, writing about a man who was selling cheap books over the Internet out of his garage, as if another several thousand book sellers would soon join him and puncture Amazon's bubble. Please note Friedman last month wrote an apologetic column about how his man had gone bankrupt. The thought occurred to me that Friedman, who specializes in foreign affairs and does a good job at that, may have consulted you back when he made fun of Amazon. No?

If you really want me to help you learn the ropes, Professor, please read my book, The Way the World Works, especially Chapter VII, which explains the reasons for the Wall Street Crash of 1929. There was no "bubble," no "Ponzi scheme." Herbert Hoover did it, with the help of the Republican Congress, Big Business and Big Labor. You should write a column about it as I made my discovery in 1977 and it has not yet been mentioned in your newspaper, the most important newspaper in the world.