Alan Greenspan, the Federal Reserve Chairman, once labeled the nation’s sentiment as one of “irrational exuberance”, and subsequently tightened monetary policy to prevent an overheating economy. It seems pretty clear, however, that this period of optimism and growth was one of the most important periods of technical and social development in human history. New business possibilities, medical breakthroughs, and communications tools mark this period, and drove the exuberance. I propose that the exuberance is not irrational at all. In fact, I believe that the market was correct to be excited about the potential of recent technological advancements.
Value and growth are not necessarily measured best when viewed in dollar terms, and the period of time when a company commercializes its non-financial value can often be many years. Take Geocities for example. This is a company with negligible financial assets, yet was purchased by Yahoo for more than $5 billion… yes. Was that irrational? Or does Yahoo know something that Greenspan does not? There is significant value in information and habit. Information is the better-than-money bits that translate to utility in the information age. Habit is what brings customers back, and signals the acquisition of and demand for future information.
Ok, then how should the Fed think about economic growth? How should they consider information assets in the optimization model for the welfare of Americans? I think that, for the most part, the financial markets do a decent job of evaluating information assets; we see the widening distribution of P/E ratios in public company market capitalizations as investors placing value on non-financial assets. It is not absurd to think that investors are placing large value on the information assets that do not play a role in the traditional valuation models used for equities. Additionally, economic growth can go up without creating inflation as long as productivity increases enough.
Now that the Fed has loosened rates by a full 1% in less than a month, I think that they are attempting to re-ignite the ‘growth’ that marked most of the 1990s. That is not to say that they are looking to raise the level of the stock markets, or increase economic growth beyond 3-4%, but that they will try to create an environment where technical and social development is optimal. Inflation tends to fall as productivity increases, all else equal. I hope that the Fed begins to use their power to encourage gains in productivity as a vehicle to offset inflation under historically high economic growth rates.