Remarks before the Richardson Chamber of Commerce

I became president of the Dallas Fed on February 1, 1991—10 years ago yesterday. A recession had begun in August 1990, and it bottomed out in March 1991. So it took me only two months to straighten things out. The recovery and expansion began in April 1991, almost 10 years ago. A year ago it became the longest expansion on record. So, we’ve already added a year to the record.

The first five years of that expansion were so-so. The last five years have been anything but. Because of technology and innovation and entrepreneurship and investment and risk taking and animal spirits, and better monetary and fiscal policy, if I might say so, productivity growth increased—at least to twice the depressed levels from the early 1970s to the early 1980s. With the labor force also growing rapidly, potential output growth increased from around 2.5 percent per year to somewhere around 4 percent per year. Employment grew faster, and the unemployment rate declined to 30-year lows. And until fairly recently all this happened with declining—not increasing—inflation. The Fed—in my opinion—showed remarkable restraint in not trying to enforce the old lower noninflationary speed limit. It worried about inflation picking up as the unemployment rate fell below levels that had triggered an acceleration of inflation in the past. But it practiced forbearance for a good while and let the good times roll. In effect, it was testing the growth limits of the New Economy.

Many people—especially establishment economists who taught economics at universities that don’t have good football teams—ridiculed the idea of a New Economy. They thought it naive to suggest—as I and some others had done—that something was different this time. They thought "something is different" naive and "nothing has changed" sophisticated. But the economy was like the Energizer Bunny; it just kept going and going and going. The pessimists and the naysayers were mugged and drowned out by the continued good performance of the New Economy. I wasn’t the most vocal advocate of the idea of a New Economy—and certainly not the most articulate. But I did become associated with that viewpoint, and among my more cautious and more learned and more sophisticated colleagues, I did become known as the Fed’s most vocal advocate of the New Economy.

And all this time, I was never invited to address the Richardson Chamber of Commerce. Then, suddenly, out of the blue, the New Economy hits an air pocket and here I am.

Here I am in the middle of the Telecom Corridor, on the Silicon Prairie, near the NAFTA superhighway, not far from where Jack Kilby put together the world’s first integrated circuit, and just a few miles south of what is probably the largest Lincoln Navigator dealership in the world—on Plano Parkway, in Greater Richardson. Now, we all know that the Chevrolet Suburban is the national car of Texas, but that’s Old Economy. And it’s hard to walk behind your Suburban with the garage door closed, especially if you have bags of groceries from Whole Foods, a New Economy place to buy your organic foods. So, some of us get the Tahoe or the Expedition for practical reasons. But "practical" is an Old Economy virtue. So, my research says that the official car of the Silicon Prairie is the Navigator, which is an Expedition with bigger hair and more lipstick—essential Texas virtues. Lest I’m offending any of you, let me confess to being a two-Navigator family. Mine is red; Suzanne’s is white. I wanted her to get a red one too, but she thought it would be pretentious.

I had these insights while reading Tom Wolfe’s new book, Hooking Up, which has a chapter on Robert Noyce, who co-invented the integrated circuit just a few months after Mr. Kilby and who went West and pretty much started up Silicon Valley and was pretty much responsible for its unique style, including a preference for small foreign sports cars—especially the Porche and the Ferrari. According to Tom Wolfe, the prototypical Mr. Noyce wasn’t reluctant to spend his money; he was just reluctant to show it.

As Tom Wolfe put it, "The high performance foreign sports car became one of the signatures of the successful Silicon Valley entrepreneur. The sports car was perfect. Its richness consisted of something small, dense, and hidden: the engineering beneath the body shell." As Suzanne would say, "Well, pooh!" You could get two real cars for the price of one Porche.

Anyway, another good read on Silicon Valley culture is Michael Lewis’s The New New Thing. He’s the guy who wrote Liar’s Poker in the 1980s, and he tells how the center of the universe shifted from Wall Street in the ’80s to Silicon Valley in the ’90s. I appeared on a program with him a few months ago, which for him was part of his book tour for The New New Thing. He said that a book tour was like politics, but without the sex.

As I recall, he dated the shift in the center of the universe to Netscape, which gave regular folks a browser to surf the web. That was the technology part, in 1994. The financial part was when Netscape went public in 1995—18 months after it was created and before it had made a dime. On the first day, the price of the shares went from $12 to $48. Three months later it was $140.

To quote Michael Lewis further, "In the frenzy that followed, a lot of the old rules of capitalism were suspended. . . .It had long been a rule of thumb with the Silicon Valley venture capitalists that they didn’t peddle a new technology company to the investing public until it had had at least four consecutive profitable quarters. Netscape had nothing to show investors but massive losses. But its fabulous stock market success created a precedent. No longer did you need to show profits; you needed to show rapid growth."

The rest—as they say—is history.

I believe it was about a year later, in late 1996, that Chairman Greenspan asked his rhetorical question about the possibility of irrational exuberance in the stock market. A debate ensued about whether the exuberance was irrational or rational, but the exuberance continued. I believe the Nasdaq gained 86 percent in 1999 alone, before peaking in March of 2000 at over 5,000.

Meanwhile, back at the Dallas Fed, we published our 1999 Annual Report in March 2000. The title of our feature essay was "The New Paradigm," written by our chief economist, Michael Cox. In my accompanying Letter from the President, I admitted that "paradigm" was a pretty big word for a country boy. I illustrated its meaning with the familiar recipe for boiling a frog. You don’t boil a frog by dropping him into boiling water. He’ll jump out. Instead, you drop him in cold water and raise the heat. The frog won’t jump out because he doesn’t know his paradigm is shifting.

Since then the frog—my frog—has become the unofficial mascot of the New Paradigm Economy. "McTeer’s Frog" was the title of a recent article by a Wall Street economist, who happens to be the current president of the National Association for Business Economics. He knew about my frog because I addressed the annual convention of NABE in Chicago last September 11.

I devoted a good part of my speech to chiding those economists for their timidity in forecasting. I pointed out to them that of the 50 top forecasting economists who were in the Business Week summary at year-end 1999, the most optimistic forecast real GDP growth in 2000 of 4 percent—only 4 percent. We had just had four years averaging over 4 percent growth. The second half of ’99 had averaged about 7 percent real growth. The first half of 2000 had averaged over 5 percent real growth. Specifically, the first quarter of 2000 came in at 4.8 percent and the second quarter at 5.6 percent. And these timid souls had let Wayne Angell, a former colleague of mine at the Fed, go to the top of the list of 50 forecasters with a measly forecast of only 4 percent growth for 2000. I shamed them good. Afterwards, I was even interviewed on CNBC by Kathleen Hays, the Econo-queen herself. I’m sure I waxed optimistic.

Then a funny thing happened on the way to the forum. The third quarter came in at 2.2 percent. And the fourth quarter came in—we heard Wednesday—with a preliminary estimate of 1.4 percent. I’ll deny I was ever in Chicago.

If you average the four quarters—4.8, 5.6, 2.2, 1.4—you get 3.5 percent. Not bad, but not over 4 percent either. What happened?

The Fed’s last tightening phase had ended in May, and people had been about evenly split on its effectiveness. Half said it was having no effect at all; the other half said it was slowing the Old Economy, but wasn’t touching the New Economy. The New Economy, after all, didn’t have to rely on banks; it had its own angels. The bubble in tech stocks burst in March–April. We can call it a bubble now that it has burst, but that had little apparent immediate effect on the economy. Remember, growth was at a 5.6 percent annual rate in the second quarter. Energy prices—especially natural gas prices—were lingering higher, longer than many people had expected and eroding purchasing power. We seemed to hit the air pocket in November and December. What unusual was happening in November and December? Hanging, pregnant and dimpled chads!

As you know, the economy has not declined. Not yet anyway; but its growth has slowed—abruptly and significantly. The early fourth-quarter estimate is plus 1.4 percent. In recent testimony, Chairman Greenspan said growth may be close to zero currently. As you know, the FOMC met by telephone on January 3 and reduced the target federal funds rate by half a percentage point, which seemed to have settled financial markets down a bit. January was a plus month on the stock market. On Wednesday of this week, we eased another half point. A full point in a month is pretty aggressive by Fed standards.

My term for what happened to the economy as we were gliding in for the proverbial soft landing is that we hit an air pocket. Fortunately, we were flying high enough so that the sudden decline in growth didn’t cause us to crash-land. If we all join hands and go buy a new SUV, everything will be all right. Preferably a Navigator.

I can explain why the stock market fell like it did last spring. Wile E. Coyote looked down. You remember that the Road Runner always managed to stop just before going over the cliff. Wile couldn’t stop. But he never fell until he looked down. Somebody looked down and saw all foam and no beer!

Looking down will pop a bubble. What I don’t understand is why bubbles form in the first place—we’re all so smart and all. Today, we realize that there must be some prospect for some profit, some time for a stock to be worth a good sum of money. Why do we realize that today, but not yesterday?

Actually, the economics of the New Economy contains a grain of truth in the proposition that volume or size is your friend. Much of the New Economy is characterized by high fixed cost and low marginal cost. The first copy of new software or a new medicine or a new movie is very expensive. Subsequent copies are very cheap to reproduce. The New Economy features declining long-run cost curves and increasing returns to scale much more than most of the Old Economy. Because of that, there is a big advantage of being early and getting started down that declining long-run cost curve before your competitors arrive. If you get a head start, they probably won’t be able to undercut your price if you have more volume. That’s why competition in the New Economy is more about doing things differently than doing them cheaper. You innovate to compete. You innovate to survive.

So while there is some advantage in the New Economy to getting there firstest with the mostest and making size your friend, that concept was taken to extreme lengths. No prospects for profit as far as the eye can see became almost a matter of pride rather than something to hide.

So, is the New Economy dead?

I don’t think so. The new information, knowledge economy is about information and knowledge. Information and knowledge haven’t gone away. The recipes are still around—the recipes for making and doing new things and for doing old things in new ways. The distinction—on financial talk shows—between New Economy companies and Old Economy companies was always a false distinction. The new technology can be used by the old and the new alike. The old established firms with real products that you can touch and with brand identity and financial staying power may be better suited to drive the New Economy forward than the new virtual firm floating somewhere out there in the mist.

History tells us the technology and the innovations and the insights will survive. It just doesn’t tell us what the companies will be called. Remember, there used to be hundreds of car companies.

Markets are playing musical chairs, but the music hasn’t stopped. As we go through this period of adjustment in the economy, it’s tempting to say we have nothing to fear but fear itself. But that line has been taken. Nobody believed it then either.

No, the New Economy isn’t dead. It may have a hangover. It may even have the blues. I can understand that. I’m bad to get the blues myself. As Billy Joe Shaver said, I’m "leanin’ t’ward the blues."

But my New Paradigm frog doesn’t get the blues. Frogs don’t get the blues. They get the greens.

You may remember the Far Side frog band that had the greens a few years ago. The greens went something like this:

Well, my New Paradigm frog may have the greens, but he’s not ready for the formaldehyde yet.

Just remember, the blues and the greens are contagious.

Don’t get near people with symptoms.

Just go out and buy something—maybe a Navigator.

The late Texas picker-poet Townes Van Zandt said all music is either zippity-doo-da or the blues. Invite me back in a couple months when it’s zippity-doo-da again.