numbers, strategizing, and brewing ideas.
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I always came out of these breakfasts smarter than when I arrived.
They were the best forum I could imagine for puzzling out the so-called
New Economy. The dual forces of information technology and globalization
were beginning to take hold; and as President Clinton later put it; "the
rulebooks were out of date." Democrats joyfully labeled the constellation
of economic policies "Rubinomics." Looking back in 2003, a New York
Times reviewer of Bob's memoir called Rubinomics "the essence of the
Clinton presidency." He defined it as "soaring prices for stocks, real estate,
and other assets, low inflation, declining unemployment, increasing productivity,
a strong dollar, low tariffs, the willingness to serve as global crisis
manager, and most of all, a huge projected federal budget surplus." I wish I
could say that it was all the result of conscious, effective policy coming out
of our weekly breakfasts. Some of it surely was. But mostly it reflected the
onset of a new phase of globalization and the economic fallout from the
demise of the Soviet Union, issues I will address in later chapters.
I
I
saw President Clinton only infrequently. Because Bob and I worked together
so well, there was rarely any need for me to attend an economic
policy meeting in the Oval Office except in moments of crisis—such as
when a budget standoff between Clinton and Congress forced a shutdown
of the government in 1995.
I did eventually hear that the president had been sore at me and the
Fed for much of 1994, while we were hiking interest rates. "I thought the
economy had not picked up enough to warrant it," he explained to me
years later. But he never challenged the Fed in public. And by mid-1995,
Clinton and I had settled into an easy, impromptu relationship. At a White
House dinner or reception, he'd pull me aside to see what was on my mind
or to try out an idea. I didn't share his baby-boom upbringing or his love of
rock and roll. Probably he found me dry—not the kind of buddy he liked
to smoke cigars and watch football with. But we both read books and were
curious and thoughtful about the world, and we got along. Clinton publicly
called us the economic odd couple.
I never ceased to be surprised by his fascination with economic detail:
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THE AGE OF TURBULENCE
the effect of Canadian lumber on housing prices and inflation, the trend
toward just-in-time manufacturing. He had an eye for the big picture too,
like the historic connection between income inequality and economic
change. He believed dot-com millionaires were an inevitable by-product of
progress. "Whenever you shift to a new economic paradigm, there's more
inequality," he'd say. "There was more when we moved from farm to factory.
Vast fortunes were made by those who financed the Industrial Revolution
and those who built the railroads." Now we were shifting into the
digital age, so we had dot-com millionaires. Change was a good thing, Clinton
said—but he wanted ways to get more of that new wealth into the
hands of the middle class.
Politics being what they are, I never thought Clinton would reappoint
me as chairman when my term ended in March 1996. He was a Democrat
and no doubt he would want one of his own. But by the end of 1995, my
prospects had changed. American business was doing exceptionally well—
profits at large companies were up 18 percent and the stock market had
had its best growth in twenty years. Fiscal and monetary policy were both
working, with the 1996 deficit projected to shrink to less than $110 billion,
and inflation still below 3 percent. GDP growth was starting to revive
without a recession. The relationship between the Fed and the Treasury
had never been better. As New Year's came and went, the press began speculating
that the president might ask me to stay. In January, Bob Rubin and
I went to a G7 meeting in Paris. During a pause in the proceedings, we
wandered off to the side. I could tell that Bob had something on his mind.
I can still picture the scene: we were standing in front of a floor-to-ceiling
plate-glass window with a panoramic view of the city. "You'll be getting a
call from the president when we get back to Washington," he said. He
didn't come right out and tell me, but I knew from his body language that
the news must be good.
President Clinton set a little challenge for me and for the two Fed officials
he appointed at the same time: Alice Rivlin, who was to be Fed vice
chairman, and Laurence Meyer, a highly regarded economics forecaster,
who would become a Fed governor. "There is now a debate, a serious debate
in this country, about whether there is a maximum growth rate we can
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A DEMOCRAT'S AGENDA
have over any period of years without inflation/' the president told reporters.
It wasn't hard to read between the lines. With the economy entering its
sixth year of expansion, and with the soft landing looking real, he was asking
for faster growth, higher wages, and new jobs. He wanted to see what
this rocket could do.
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EIGHT
IRRATIONAL
EXUBERANCE
A
A
ugust 9, 1995, will go down in history as the day the dot-com boom
was born. What set it off was the initial public offering of Netscape,
a tiny two-year-old software maker in Silicon Valley that had al
most no revenues and not a penny of profits. Netscape was actually giving
most of its products away. Yet its browser software had fueled an explosion
in Internet use, helping turn what had started as a U.S.-government-funded
online sandbox for scientists and engineers into the digital thoroughfare for
the world. The day Netscape stock began to trade, it rocketed from $28 a
share to $71, astonishing investors from Silicon Valley to Wall Street.
The Internet gold rush was on. More and more start-ups went public
to fantastic valuations. Netscape stock continued to climb; by November the
company had a higher market capitalization than Delta Airlines, and Netscape
chairman Jim Clark became the first Internet billionaire. High-tech excitement
brought extra sizzle that year to what was already a hot market for
stocks: the Dow Jones Industrial Average broke 4,000, then 5,000, ending
1995 up by well over 30 percent. The technology-heavy NASDAQ, where
the new stocks were listed, finished even better, with a gain of more than
IRRATIONAL EXUBERANCE
40 percent in its composite index. And the market growth roared unabated
into 1996.
We generally did not talk about the stock market very much at the Fed.
In a typical FOMC meeting, in fact, the word "stock" was used more often
in reference to capital stock—machine tools, rail cars, and, lately, computers
and telecom gear—than in reference to equity shares. As far as the tech
boom was concerned, our focus was more on the people who make the
chips, write the software, build the networks, and integrate information
technology into factories and offices and entertainment. Yet we were all
aware of a "wealth effect": investors, feeling flush because of gains in their
portfolios, borrowed more and spent more freely on houses and cars and
consumer goods. More important, I thought, was the impact of rising equity
values on business outlays on plant and equipment. Ever since I'd delivered
a paper entitled "Stock Prices and Capital Evaluation" at an obscure
session of the annual meeting of the American Statistical Association in
December 1959,1 had been intrigued by the impact of stock prices on capital
investment and hence on the level of economic activity.* I showed that
the ratio of stock prices to the price of newly produced plant and equipment
correlated with new orders for machinery. The reasoning was clear to real
estate developers, who work by a similar principle: If the market value of office
buildings in a certain location exceeds the cost of building one from
scratch, new buildings will sprout up. If, on the other hand, the market values
fall below the cost of constructing a building, new construction will stop.
It appeared to me that the correlation between stock prices and new
machinery orders was telling a similar story: when corporate management
saw higher market values on capital equipment than the cost of purchase,
such spending would rise, and the reverse was also true. I was disappointed
when that simple ratio failed to work as well in forecasting during the
1960s as it had in earlier years. But that was, and is, a common complaint
of econometricians. Today's version of that relationship is converted to its
equivalent implicit rates of return on newly contemplated capital invest-
This paper, which appeared in the American Statistical Association's Proceedings of the Business
and Economic Statistics Section 1959, later formed part of my doctoral thesis.
165
THE AGE OF TURBULENCE
ment. It still doesn't work as well in forecasting as I always thought it
should, but the notion was a backdrop to my thoughts at a December 1995
FOMC meeting.
Mike Prell, the Fed's top domestic economist, argued that the wealth
effect might boost consumer expenditures by $50 billion in the coming year,
causing GDP growth to accelerate. Governor Larry Lindsey who would go
on to become President George W. Bush's chief economic adviser, thought
this was implausible. Most stocks were held in pension funds and 401 (k)s,
he argued, making it hard for consumers to lay hands on their gains. And
most individuals who owned large stock portfolios were already very well
off, not the types to indulge automatically in spending sprees. I wasn't sure
I agreed with him on that point, but the issue was new; none of us knew
what to expect.
The morning's discussion also revealed how clueless we were about the
growing strength of the bull market. Janet Yellen predicted that any effect
of the stock boom would surely dissipate soon. "It will be gone by the end
of 1996," she said. I was concerned that the stock boom could set the stage
for a crash. "The real danger is that we are at the edge of a bond and stock
bubble," I said. Yet the market did not seem as superheated as it had seemed
in 1987.1 speculated that we probably were close to "at least some temporary
peak in stock prices, if for no other reason than that markets do not go
straight up indefinitely."
That statement did not turn out to be my most prescient. But then, the
stock market wasn't my main concern that day. I had a different agenda. I
was determined to start people thinking about the big picture of technological
change. In studying what was going on in the economy, I'd become
persuaded that we were on the verge of a historic shift; the soaring stock
prices were just a sign of it.
The meeting was scheduled to wrap up with a proposal to continue
easing the fed funds rate, and a vote. But before we got to that, I told the
committee, I wanted to step back. For months, I reminded them, we'd been
seeing evidence of the economic impacts of accelerating technological
change. I told them: "I want to raise a broad hypothesis about where the
economy is going over the longer term, and what the underlying forces are."
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IRRATIONAL EXUBERANCE
My idea was that as the world absorbed information technology and
learned to put it to work; we had entered what would prove to be a pro
tracted period of lower inflation, lower interest rates, increased productiv
ity, and full employment. "I've been looking at business cycles since the late
1940s," I said. "There has been nothing like this." The depth and persistence
of such technological changes, I noted, "appear only once every fifty or one
hundred years."
To suggest the global scale of the change, I alluded to a new phenome
non: inflation seemed to be ebbing all over the world. My point was that
monetary policy might now be operating at the edge of knowledge where,
at least for a while, time-honored rules of thumb might not apply.
This was all pretty speculative, especially for a working session of the
FOMC. No one at the table said much in response, though a few of the
bank presidents mildly agreed. Most committee members seemed relieved
to return to the familiar ground of deciding whether to lower the fed funds
rate by 0.25 percent—we voted to do so. But before we did, one of our
most thoughtful members couldn't resist teasing me. "I hope you will allow
me to agree with the reasons you've given for lowering the rate," he said,
"without signing on to your brave-new-world scenario, which I am not
quite ready to do."
Actually that was fine. I didn't expect the committee to agree with
me—yet. Nor was I asking them to do anything. Just ponder.
T
T
he fast-paced high-tech boom is what finally gave broad currency to
Schumpeter's idea of creative destruction. It became a dot-com buzz
phrase—indeed, once you accelerate to Internet speed, creative destruction
is hard to overlook. In Silicon Valley, companies were continually remaking
themselves and new businesses were constantly flaring up and flaming out.
The reigning powers of technology—giants like AT&T, Hewlett-Packard,
and IBM—had to scramble to catch up with the trend, and not all suc
ceeded. Bill Gates, the world's biggest billionaire, issued an all points bulle
tin to Microsoft employees comparing the rise of the Internet to the advent
of the PC—upon which, of course, the company's great success was based.
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THE AGE OF TURBULENCE
The memo was entitled "The Internet Tidal Wave." They had better pay attention
to this latest upheaval, he warned; adapt to it, or die.
Though it wasn't obvious, the revolution in information technology
