Was the dotcom mania “mad”? (And let’s lower the relative status of pessimists)

Tim Harford has a very good piece on bubbles in the FT.  This caught my eye:

Yet even with hindsight things are not always clear. For example, I first became aware of the incipient dotcom bubble in the late 1990s, when a senior colleague told me that the upstart online bookseller Amazon.com was valued at more than every bookseller on the planet. A clearer instance of mania could scarcely be imagined.

But Amazon is worth much more today than at the height of the bubble, and comparing it with any number of booksellers now seems quaint. The dotcom bubble was mad and my colleague correctly diagnosed the lunacy, but he should still have bought and held Amazon stock.

I wish I had bought Amazon in the 1990s, just as I wish I had bought Bitcoin at $12, when I was writing posts claiming that it was not a bubble.  But I didn’t, and given what I knew at the time there was really no reason for me to do so.  But what about the claim that “the dotcom bubble was mad”?  I do recall people saying that in 2002, after the bubble had burst and the NASDAQ fell to 1200.  But is that true?

The argument made in 2002 is that tech valuations made no sense unless you believed that tech companies would push aside old stalwarts like GE, GM and Walmart, and that companies like Apple and Amazon would become the most dominant corporations on Earth.  Well, hasn’t that happened?  Another argument was that you’d have had to believe that all the dotcom companies would be successful.  Actually, if you didn’t know which ones would be successful, it would have made sense to buy an index fund in the NASDAQ.

The NASDAQ peaked at just over 5000 in early 2000, but that was for just a very brief period.  The average “mad” dotcom investor would have purchased stock at some time during 1999 or 2000, probably at a NASDAQ level closer to 3500 or 4000.  NASDAQ is now above 7200, and if you add in dividends it would not be unusual for an investor to have doubled their money over 18 years.  That’s not particularly good for a risky investment, but it’s not horrible.  It’s a higher rate of return than T-bills, but lower than T-bonds.  But keep in mind that T-bond investors lucked out, as actual NGDP growth was far less than expected when T-bonds were yielding 6%, and if people had known what was going to happen to the US economy, yields would have been far lower in 2000.  Alternatively, if NGDP had grown as expected, the NASDAQ would be far higher today.

Just to be clear, even today it seems like the tech market was a bit frothy at the peak in March 2000, I’m not denying that.  But my point is that all of these judgments are provisional.  If people really believe that markets are irrational, they ought to be writing posts in the FT talking about the negative bubble of 2002.  What were those morons thinking when they sold tech stocks when NASDAQ was at 1200?  Were they insane? Were they idiots?  Instead, pessimism is intellectually respectable so the pessimists get off scot-free, while optimists are ridiculed for being wrong.  Why?

Here’s how the FT article starts out

“Prices have reached what looks like a permanently high plateau.” That was Professor Irving Fisher in 1929, prominently reported barely a week before the most brutal stock market crash of the 20th century. He was a rich man, and the greatest economist of the age. The great crash destroyed both his finances and his reputation.

The fact that Fisher’s wrong prediction had any impact on his reputation is a sad commentary on our society.  His forecast should have attracted no more attention than his forecast as to who would win the World Series.  Would Fisher’s reputation have been damaged if he got a baseball game wrong?

And if we really should trash people for their bad calls on the market, why isn’t Robert Shiller’s reputation damaged for his claim that stocks were overpriced in 2011, when in fact it was near the beginning of one of the great bull markets in US history?  Why trash the optimists but not the pessimists?

And why aren’t the Chinese bears being called to account for all their predictions of a crash in the Chinese economy, or of 3% average real GDP growth during the decade of the 2010s?

Just to be clear, I’m not saying anyone’s reputations should be trashed.  My complaint is that other people are trashing great economists like Irving Fisher with no justification at all.

Speaking of China, remember all those predictions that it would get stuck in the middle-income trap?  Read the following from another FT story, and ask yourself how often you read those sorts of things about Turkey, Brazil or other countries that are actually stuck in the middle-income trap:

Here, too, China is catching up. Chinese internet leaders Tencent and Alibaba have a combined valuation of $1tn. Add in another $200bn or so for Baidu, JD.com and Netease plus other listed or unlisted companies, such as Toutiao, Meituan and Didi, and the scale of the Chinese market becomes apparent. Trends emerging in China are beginning to shape the future of the global tech landscape. To its dominant role in the supply chain we can now add a “demand chain” aspect to the country. . . .

Massive investments in mobile broadband and a highly competitive handset market means that nearly all of China’s approximately 750m internet users use smartphones. Payments via QR codes, led by Tencent’s WeChat and Alibaba’s Alipay, are making cash obsolete. Dockless bikes line the streets of Chinese cities. The country’s physical infrastructure — roads, high-speed trains and airports — are facilitating as big a boost to consumption as President Eisenhower’s roll out of the Interstate Highway System in the US in the 1950s.

I have lived in Beijing for more than 20 years, yet only in the past year have I felt on returning to London or Silicon Valley that I’m going backwards in time. For urban residents, China is increasingly a study in frictionless living. Hopping on a bike, ordering a meal from a huge range of restaurants, paying for utilities, transferring money to friends — all can be done at the touch of a button. Internet services in the west offer increasing convenience no doubt — but nothing beats the experience in China.

What part of “developed country” is China not going to be able to do by 2035?  Be specific.



32 Responses to “Was the dotcom mania “mad”? (And let’s lower the relative status of pessimists)”

  1. Gravatar of Kevin Erdmann Kevin Erdmann
    15. January 2018 at 11:46

    I was just thinking about the same topic and had a post fired up and ready to go on it.


    It occurred to me that if coastal urban home prices were justified by monopolist rents on existing housing stock, that part of the decline in equity values in the dot com bust was because producer surplus was claimed by real estate owners (routed through inflated wages) instead of by firms. So, part of the story is that the internet bubble didn’t fully bust. It’s just that the spoils were claimed by real estate owners, so the value of the new production is reflected in real estate values in addition to equity values.

    The conventional response, which is based on the ad hoc theory that monetary accommodation pumped up a stock market bubble and then a housing bubble, would be that I am making excuses for those events. But, it is the insistence on attributing all of these valuations to unsustainable monetary injections that diverts one’s eyes from the reality. Clearly these high valuations are funded by real innovation and productivity. Those extremely high wages are funded by real production, which is in some way geographically captured in these urban enclaves. What we saw between 1999 and 2005 was a political transfer from profits to rents.

  2. Gravatar of Kenneth Duda Kenneth Duda
    15. January 2018 at 12:04

    That’s funny, I was just about to post a link to Kevin’s blog post, but Kevin beat me to it!

  3. Gravatar of BC BC
    15. January 2018 at 13:58

    “What part of ‘developed country’ is China not going to be able to do by 2035?”

    Search for articles about Tiananmen Square on the internet?

  4. Gravatar of M M
    15. January 2018 at 15:54

    I agree with your points about bubbles. But I still can’t help but call bitcoin and the whole crypto currency market a bubble. Here’s my attempt at putting a value on that market.

    What part of transactions comprising world GDP will be in bitcoins in the future? Let’s call this fraction b. What will the money velocity of bitcoins be? Let’s call it V. The maximum number of bitcoins is M (21 million). World GDP is about 78T USD. p is the price of a bitcoin in USD.

    M * V * p = b * 78T (the equation of exchange)
    p = b * 78T / (21M * V)
    p = 3.7M * b / V

    So now we only have to guess b and V. If we use b = 1 (bitcoin kills all other currencies) and V = 17 (the velocity of USD base money in 2007) we get p = 218k.

    V will be lower if bitcoin has lower inflation (and it will since M is capped at 21M).

    V will be lower if bitcoin uses less fractional reserve banking.

    V might be higher due to a lack of physical coins and bills.

    V might be higher due to security concerns for holding bitcoins, but if others lose bitcoins your bitcoins will increase in value.

    M might be lower due to some coins already being lost (due to people having lost their private keys).

    Since bitcoin has a third of the crypto market and is priced at 14k USD, we can tripple it to gage the whole market. So 218k should be compared to 42k (and remember that 218k is if crypto currencies take 100%, hence killing all fiat currencies, not very likely). It seems to me that the crypto market is highly overvalued.

    Did I mess up the calculations somehow?

  5. Gravatar of Viking Viking
    15. January 2018 at 16:23

    “What part of “developed country” is China not going to be able to do by 2035?”

    Free press?

    Property rights?

    Impartial courts?

    This might be the best “is already developed country argument”:


    Has been capable of resisting colonization by nuclear counter strike since 1981.

  6. Gravatar of ssumner ssumner
    15. January 2018 at 16:30

    Kevin and Ken, I agree that that’s a very interesting point. Maybe I’ll do a post on that.

    M, It wouldn’t surprise me if Bitcoin prices fell sharply, but I’d be careful in treating it like “money”. It seems more like a commodity to me.

    Viking, Why wouldn’t they be able to do those things by 2035? And why do you assume that a country can’t be developed without them? Does Singapore have a free press?

  7. Gravatar of Matthew Waters Matthew Waters
    15. January 2018 at 16:38

    Saying NASDAQ had an OK value in 2000 brings up the same question as the 1987 crash: how could both the 2000 and 2002 NASDAQ prices be efficient? For that matter, how could both 2002 and 2003 NASDAQ prices be efficient? End of 2002: NASDAQ was at $1,300. End of 2003: NASDAQ was at $2,000.

    Maybe bona fide news on future cash flows accounted for a 75% drop followed by a 50% increase within three years. I doubt it. For its part, Bitcoin has such swings in WEEKS rather than years.

    Is there anything that could falsify the EMH? It should be dramatically reformulated from “prices reflect all available information.” It would be far stronger and more predictive to say “it’s very difficult to beat the market on a 6 month or 1 year timeline.”

    Most investment managers have real-world incentives for such timelines, leading to real-world possibilities for multi-year profit compared to market index. So much empirical evidence for multi-year portfolios points against what should be efficient behavior. Fama’s book value factor makes little sense from an efficient perspective. Higher beta stocks underperform lower beta stocks, when CAPM predicted the opposite being true.

  8. Gravatar of Benjamin Cole Benjamin Cole
    15. January 2018 at 17:42

    The China story is remarkable.

    I do wish there were more stories/research about the People’s Bank of China.

    From what I can gather, the PBOC plays an essential role in the continuing resilience and prosperity of the Sino economy. The central bank buys bad loans, for example.

    The threat to China’s economy is political. The increasingly heavy-handed party control of everything, including large business enterprises, is demoralizing.

  9. Gravatar of Alec Fahrin Alec Fahrin
    15. January 2018 at 18:25


    You cannot criticize the ruling family in Singapore without getting caned. Is it not first world? Free speech has nothing to do with being a developed world.

  10. Gravatar of Dikran Karagueuzian Dikran Karagueuzian
    15. January 2018 at 20:32

    Bubblemonger: We see 2x overvaluation–bubble!

    Sumner: Nonsense! Over a short 18-year horizon, the rate of return is only 4 percent lower!

    But of course both are correct, because (1.08/1.04)^18 = 1.97.

    Simple calculations show that if your metric is rate of return, even a 10x overvaluation is not a bubble at long time horizons.

    Sometimes one needs to write down a definition to make progress.

  11. Gravatar of BC BC
    15. January 2018 at 22:01

    Alec Fahrin,

    Scott asked for examples of things that one can do in developed countries that one may not be able to do in China in 2035. One of those things may be researching information on the internet. I have no idea whether one can read wikipedia or stream CNN in Singapore. Both of those activities seem to be part of daily life in the developed world.

  12. Gravatar of M M
    16. January 2018 at 00:07

    Scott, why do you see bitcoin as a commodity? The only real use that I can see is as a medium of exchange and unit of account (it’s not very useful as UoA at the moment). The use as store of value only comes from the previous two cases.

  13. Gravatar of rayward rayward
    16. January 2018 at 05:01

    Not mentioned but what I suspect motivates many pessimists is history, by which I mean historical patterns that are viewed as having a causal relationship. I’m guilty. How else does one value an investment other than as the present value of future earnings. How silly of me. Who knew that a growing company, such as Amazon, could be valued without regard to its earnings. On the other hand, the pessimists are often correct when investors identify future earnings based on rising asset prices rather than rising earnings. I recall in about 1973-74 a spike in the price of sugar, which my economics professor used to teach the class an important lesson in economics. Sumner’s underappreciated contribution to economics is that the economy is most at risk when it appears to be the strongest, the time when the Fed tightens when it should be loosening. But is that actually true if optimism/pessimism is based on rising/falling asset prices rather than rising/falling earnings? I would be cautious about comparing China with developed countries such as the U.S., for China continues to invest a significant part of savings in productive capital (plant and equipment) even when rising asset prices seem to be the better choice for investment. Will the U.S. become more like China to maintain growth, relying more and more on the government for investment in productive capital as private investors depend more on rising asset prices?

  14. Gravatar of rayward rayward
    16. January 2018 at 06:18

    I am not alone: https://www.bloomberg.com/view/articles/2018-01-16/the-fed-is-losing-control-of-the-financial-markets

  15. Gravatar of Ryan Ryan
    16. January 2018 at 06:23

    Your criticism of bubbles always seem to reduce to “If you wait long enough, you will eventually have made money” but that is true of any investment that does not go to zero.

    People hold pessimists to a lower standard because a) they are generally less credible to begin with, and b) the market is up 90% of the time, so being a successful pessimist is much harder than being a successful market cheerleader.

  16. Gravatar of ssumner ssumner
    16. January 2018 at 09:06

    Matthew, I must have addressed your argument 100 times, but no one seems to get it.
    I guess I’ll have to do another post.

    M, It seems to me that most people use it as a store of value, sort of like gold. But I have an open mind on the issue. I’ve never met anyone who ever bought any good or service with bitcoin. I’ve never met anyone whose salary is paid in bitcoin. I’m not saying it can’t be money, I just don’t think it’s there yet. Does anyone know how many vendors offer the option of paying for goods with bitcoin?

    BC, Just because you can usually do a certain activity in the developed world, doesn’t mean that not doing it makes a country undeveloped. People who are 20 years old can drink alcohol in virtually all developed countries, but places where 20 year olds cannot drink alcohol can still be developed.

    Ryan, That’s false on two levels. It’s not my claim, and it’s not true that investments that don’t go to zero always make money. My claim is that it’s not obvious that the dotcom bubble was “mad” Where is the evidence that it was mad?

  17. Gravatar of M M
    16. January 2018 at 09:32

    Scott, you can pay with bitcoins at some places.


    A large part was the old Silk Road for buying drugs. But due to bitcoin not being anonymous the Silk Road owner didn’t dare to sell any of his bitcoins. So currently the drug market has shifted to Monero, which is much more anonymous.

    Another problem for bitcoin at the moment is that the popularity has driven up transaction fees to about 25 USD. Bitcoin can only handle about 3 transactions per second. But there are new features being developed that might solve this problem (SegWit and lightning network).

  18. Gravatar of Viking Viking
    16. January 2018 at 10:32


    “Viking, Why wouldn’t they be able to do those things by 2035? And why do you assume that a country can’t be developed without them? Does Singapore have a free press?”

    Of course PRC is able to allow a free press, land property rights that can’t arbitrarily be undone by local officials, and impartial courts. I simply doubt they are willing. It could threaten the party’s existence.

    I already did concede (indirectly) these are not strictly required for all definitions developed status in my 1981 comment, other dimensions are economic activity (duh!), and self determination ability, nuclear weapons and a reliable delivery system helps a lot here.

    However, free press, independent courts etc. are nice to have.

    While I am not an economist, and thus might not have that much standing, I question the accumulation of large financial assets as evidence of escaping the middle income trap, or is it the middle kingdom trap?

    I thought the middle income trap was defined in terms of GDP per capita, and this is a personal bias, I think the median is a better descriptor than the mean, especially with various valuations of $10^12, that are not likely to be dispersed too much.

  19. Gravatar of Matthew Waters Matthew Waters
    16. January 2018 at 10:42

    Well, for one piece of evidence, there was the story of 1800Flowers.com. It put a dot-com in its name and everything, but its stock languished. It turned out that investors liked stocks with no earnings much more because they could were not constrained by business realities.

    In February 2000, Jim Cramer said “Most of these companies don’t even have earnings per share, so we won’t have to be constrained by that methodology for months to come.”

    So I do think there was some really mad behavior.

  20. Gravatar of mpowell mpowell
    16. January 2018 at 13:19

    You ask the question so I’ll say it: My opinion of Shiller as a market forecaster is very low indeed.

    Equities markets are a very interesting beast. They almost always offer the greatest long run return, even when they are overvalued. They might be overvalued today, but I don’t think many long term investors would prefer bonds. Both the NASDAQ and the S&P500 were very frothy in the late 90s. It may have been easy to identify that the NASDAQ was overvalued, but if you thought tech stocks offered good long term value, risky to look for an alternative investment profile since the main equity alternative was so expensive as well. Does this mean it wasn’t a bubble? If that’s how you want to define it, okay. Do I have to guarantee we’re going to get a big drop at some point in the near future?

    What if I just tell you – this asset has been growing very rapidly for a while – sometime (most likely in the next 5 years) we’re going to see a return to a lower long term trend line with less than the long term growth for a portion of that period. Maybe it is better to consider statements of this nature than try to say “this is a bubble”.

  21. Gravatar of ssumner ssumner
    16. January 2018 at 13:58

    M, I’m fine with the claim that bitcoin is 20% money and 80% commodity, or something like that.

    Viking, Yes, economists define middle income trap in terms of something like average or median income. I say China will do well by either measure.

    Stuff like nuclear weapons is irrelevant, Pakistan and India have them.

    Matthew, Yes, I recall when people complained that Amazon never earned any money.

    I’ll do a post over at Econlog on your earlier comment, which you and mpowell may fine of interest.

  22. Gravatar of kaveh kaveh
    16. January 2018 at 14:32

    *What part of “developed country” is China not going to be able to do by 2035?*

    World famous pop music icon. Contentious Democracy. 100K+ man strong military intervention in a foreign country.

  23. Gravatar of Matthew Waters Matthew Waters
    16. January 2018 at 15:45

    “One Click,” the book about Amazon, basically said that the CFO saved the company. Bezos took a lot of convincing to try to reach profitability. It was when the CFO showed him common size income statements that he realized Amazon wouldn’t be profitable for decades at their 1999-00 rate of closing margins. The CFO also arranged a bond issue in Europe which probably gave the company enough cash to survive into 2001.

    The newer incarnation of Amazon I just don’t really understand. I saw one Amazon bull in 2017 say “when it reaches $1T of sales.” Sure, $1T in sales could be extrapolated out with several more years of 20% revenue growth. But I will call that absolutely, stark raving mad.

  24. Gravatar of M M
    17. January 2018 at 06:09

    Scott, I suspect that 80% is too low. But the equation of exchange can handle currency hoarding, just pick a lower V. That equation can handle everything since it’s just an accounting identity.

    The question is if it’s useful. Will estimating b and V give us a decent estimate of the value? Is there any other ‘model’ that is better? Some people like to look at world M2 or M3 and try to estimate a bitcoin value from that.

  25. Gravatar of David de los Ángeles Buendía Edit Profile David de los Ángeles Buendía Edit Profile
    17. January 2018 at 14:17

    Dr. Sumner,

    The word “bubble” has become extraordinarily popular over the last few years. Every time the price of some commodity or asset increases, it is now a bubble instead of the result of a shift in in the balance between supply and demand. This is largely a result of the stock market crashes following the wild run-up the technology stock market (the Dot.Com Bubble) around 2000 and the more recent Crash of 2008. Before that, one rarely heard the word very much.

    I think however one can indeed make a strong case for a bubble in the NASDAQ in the late 1990’s and early 2000’s. The aggregate value of stocks is generally tied to how profitable the companies that issue the stock are. When companies pay dividends, aggregate stock prices increase and when they do not stock prices decline. Were one to plot the dividends paid by nonfinancial domestic (US) corporate business (B1441C1A027NBEA) and compare that to the NASDAQ composite index (NASDAQCOM) it can be seen that the two track each other rather closely [1]. The data presented is on an annualized average basis. The linked graph shows the 46 years from 1971 until 2016. If one were to analyzed the data using the Pearson Product Moment Correlation the correlation coefficient (R2) would be 0.93 p < 0.0001. This is both statistically significant and intuitively obvious.

    The same relationship can be seen between non-finanical corporate dividends and Wilshire 5000 Total Market Full Cap Index (WILL5000INDFC) [2], the two tack each other closely and the PPMC is likewise very strong and very significant (R2 = 0.97 p <0.00001) between 1972 and 2016).

    If one examines the period between 1998 and 2002 one can see that the two graphs differ. The NASDAQ Composite Index line diverges dramatically from the line corporate dividend line while the Wilshire Index did not. The aggregate value of the technology shares represented in th NASDAQ Composite Index rose out of proportion to the rise in the underlying profitability of the non-financial corporate dividends.

    This would seem to be evidence for an actual bubble.

    [1] https://fred.stlouisfed.org/graph/?g=hAex

    [2] https://fred.stlouisfed.org/graph/?g=hAfg

  26. Gravatar of Mike Sandifer Mike Sandifer
    17. January 2018 at 15:45

    I think it’s wrong to think of Bitcoin as a currency. The equation of exchange doesn’t apply.

    I think Buffett had it right when he characterized it as an alternative payment system, with a first mover advantage.

    Therefore, the value of bitcoin will vary depending on its prospects for increased use as a payment method.

  27. Gravatar of Mike Sandifer Mike Sandifer
    17. January 2018 at 15:47


    I’m curious, do you mind making your suspicions about tech valuations circa 2000 explicit?

  28. Gravatar of ssumner ssumner
    19. January 2018 at 08:43

    Mike, My view on tech valuations is that there is no reason to assume there was a bubble. I don’t say tech valuations were correct, just that we don’t know enough to know that they were obviously incorrect, which is what the term ‘bubble’ implies.

    It’s other people that claim to know what stocks should be worth, not me.

  29. Gravatar of Mike Sandifer Mike Sandifer
    20. January 2018 at 01:23


    In past comments, you’ve said you thought the tech boom/bust was “fishy”. I just wondered what you meant by that.

  30. Gravatar of Mike Sandifer Mike Sandifer
    20. January 2018 at 01:25

    By the way, Lars Christensen just put up some excellent comments about how to think about Bitcoin and other crypto-currencies, and what central banks can learn from them on YouTube:


    He already has me thinking about this in a new way.

  31. Gravatar of Dan W. Dan W.
    21. January 2018 at 15:26

    What would be the market valuation if all public companies did an Amazon and opted to forego profits on the premise they were investing in their business?

    If profits don’t matter why do companies produce them and face a tax bill?

    It seems to me stock valuation is much more about creating stories to justify price levels, rather than question them. Which makes sense since markets do not care whether people agree or not.

  32. Gravatar of M M
    23. January 2018 at 03:47

    An example of the current madness in the crypto market. Someone created a new Ethereum token called Useless Ethereum Token.


    The website even says that it is useless and asks people not to buy it. And he still got 300k USD on ICOs (initial coin offerings).


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