The bubbles that built America

The cycle of over-the-top hype, vicious competition, bankruptcies and consolidation that characterized the late-90s dot-com boom and this decade's real estate market could be the key to America's economic success.

By Daniel Gross

NEW YORK ( -- Here's a question you might ponder as you Google, on your wi-fi-enabled laptop, for a YouTube video. Without the debacles of Global Crossing, Worldcom, Webvan, Etoys, and a hundred other flame-outs, would there be a Google today? Or wi-fi? Or YouTube?

The answer, historically speaking, is: probably not.

Fortune's Adam Lashinsky explores why Silicon Valley's premier VCs have that old-time eco-religion. (more)

And therein lies a contrary tale of why investment bubbles - far from being lamentable outbreaks of reckless investor behavior - have been a net positive for the American economy. Indeed, some (including me, in my new book, "Pop! Why Bubbles Are Great for the Economy") would say that the way Americans have blown, punctured and recovered from bubbles has been a key to the nation's extraordinary economic success.

After all, the cycles seen in fiber optics and dot-coms back in the 1990s and in real estate this decade - a burst of frantic building and excess capacity, over-the-top hype and vicious competition, bankruptcy and consolidation, losses, self-pity, and finger-pointing - are nothing new. Similar manias surrounded other promising economic and technological developments: the telegraph in the 1840s and 1850s, the railroads in the 1880s and 1890s, stocks and credit in the 1920s.

In every generation, evangelists arise to proclaim that a new technology, or a new set of economic assumptions, promise untold riches. (Remember "Dow 36,000.") In the United States, a good business gets funded - and then funded again, and again - especially when a sector is hot. Bubble-era companies create lots of commercial infrastructure - ethanol plants, web-hosting facilities - but they also spend a great deal of money building what I call the mental infrastructure - convincing people to make Internet phone calls, to reserve hotel rooms by telegraph, to send grain by rail instead of by canal boat.

Finally, when economic reality catches up to dreams and hype, the bubble bursts. Pop!

The pernicious downsides of bubbles are obvious, and the financial losses are plainly evident. The gains - economic, social, and cultural - are less obvious and more difficult to calculate. But they're real.

During bubbles, the competition created by excess capacity - too many e-retailers, too many railroads competing for too few customers - inevitably leads to vicious price competition. (Score one for consumers). Post-pop, the infrastructure - housing and telegraph wire, fiber-optic cable and railroads - doesn't get plowed under. It gets reused, and quickly, by entrepreneurs with new business plans, lower cost bases and better capital structures. And when new services and businesses are rolled out over the new infrastructure, entrepreneurs can tap into the legions of users who were coaxed into the market during the bubble.

Take Google (Charts, Fortune 500). It prospered by lashing together hundreds of thousands of cheap servers, by tapping into an installed base of 172 million U.S. Web surfers, and by selling ads to hundreds of thousands of online advertisers desperate for clicks.

Looking back, it is clear that many iconic companies and industries that have stimulated economic growth, and that helped define America's commercial culture, can trace their origins to the aftermaths of bubbles.

The roots of today's information economy actually lie in the 1840s. The hallmark of today's bits-and-bytes economy is the ability to liberate economic value from its geographic confines. And that's precisely what the telegraph did. Between 1846 and 1852, the number of telegraph miles in the United States rose more than ten fold, from 2,000 to 23,000. Excess capacity caused prices to plummet, and most telegraph companies wilted. But the country wound up with a utility that businesses of all sizes could use. Businesses like the credit rating firm Dun & Bradstreet, which traces its origins to 1849, or the Chicago Board of Trade. In 1871, Western Union (Charts, Fortune 500) first offered customers the opportunity to send money by wire.

Next came the railroad boom and bust. After a spasm of overbuilding in the 1880s begat vicious rate wars, about a quarter of the nation's railroad system went bust in 1894. Railroad investors lost big time. But consumers and businesses won. With the cost of freight falling more than 50 percent between 1867 and 1895, it made sense for companies to acquire commodities in bulk, process them, and ship the finished goods to distant points for sale. In the 1880s a host of branded food products - many of which still fill the aisles of Kroger (Charts, Fortune 500) today - burst onto what had suddenly become a national market, from Campbell's Soup to Heinz ketchup, from Coca-Cola (Charts, Fortune 500) to Ivory soap.

The cycle, which returned with a vengeance with the Internet in the 1990s, is still going strong. With the aid of Federal Reserve Chairman Greenspan, the U.S. economy cycled from the dot-com bubble almost directly into a real estate bubble. And many of the same Silicon Valley folks who brought us the fiber-optic and dot-com bubble of the 1990s have returned for an encore.

Bubbles are exhausting, and people can easily get hurt. But Americans are like fighters who take a punch and climb right back into the ring. In general, the roll-outs of new technologies in other developed economies have proceeded at a slower and more orderly pace than in the United States - and as a result they have created far less collateral economic activity and spurred less innovation. Thanks in part to bubbles, no economy has matched the combination of stability, growth and scale that the United States has shown for the last 150 years. You can look it up on Google.

Daniel Gross is the author of "Pop! Why bubbles are great for the economy" (Harper Collins). Top of page