Kevin Duffy on inflation and the tech bubble

Much of the debate over New Economy vs. Old... comes down to a difference in how inflation is defined. Austrian economists tend to define inflation in terms of credit expansion and money supply growth. They recognize that inflation can show up in unpredictable areas. New Era economists tend to focus solely on consumer prices. Some, like Brian Wesbury, go even further, removing food, energy, tobacco, or whatever else causes the unintended effect.

Signs of inflation were obvious to readers of the latest issue of Barron’s:

• Inflated stock prices – Cisco trades at 101 times estimated 1999 earnings, Oracle: 81x, Microsoft: 56x, Nortel Networks: 81x, Sun Microsystems: 83x, Lucent: 61x, and AOL: 304x. (p. MW4)
• Inflated art prices – Recent auctions brought over $45 million each for a pair of Picassos and a record $129,000 for a 100 year old West African spoon. (p. 48)
• Inflated earnings – In its latest quarter, Hewlett-Packard beat Street estimates by two cents (adding $17 billion in market value), by lowering its tax rate. (p. 6)
• Inflated egos – Louis Rukeyser, apparently feeling viewers only need to hear his eternally optimistic message, ostracized his last dissenting Elf, Gail Dudack. (p. 6)

To this list we could easily add inflated real estate prices, inflated credit, inflated expectations, and inflated forecasts (e.g. “Dow 36,000”). Despite inflating its balance sheet 7.1% over the past year, the Fed assures us that last week’s rate hike should “markedly diminish the risk of inflation.”

This combination of credit expansion, asset inflation, and low or no consumer price inflation is a benign-looking, but potent mix. These conditions accurately described the bubble economies of the United States in the late 1920s and Japan in the late 1980s. This New Era will meet a similar fate. It’s a shame asset bubbles, according to our Fed Chairman, are “incontrovertibly evident only in retrospect.”

~ Kevin Duffy, "New Era or Old?," Barron's (letter to the editor), November 29, 1999