The 1990s bubble in NASDAQ stocks

Stocks in the United States are traded on either the over-the-counter mar-
ket or on one of the organized stock exchanges, principally the New
York Stock Exchange or the American Stock Exchange or one of the re-
gional exchanges in Boston, Chicago, and Los Angeles/San Francisco. The
typical pattern was that shares of young firms would initially be traded
on the over-the-counter market and then most of these firms would in-
cur the costs associated with obtaining a listing on the New York Stock
Exchange because they believed that such a listing would broaden the
market for their stocks and lead to higher prices. Some very successful
new firms associated with the information technology revolution of the
1990s—Microsoft, Cisco, Dell, Intel—were exceptions to this pattern; they
chose not to obtain a listing on the New York Stock Exchange because
they believed that trading stocks electronically in the over-the-counter
market was superior to trading stocks by the open-outcry method used
on the New York Stock Exchange.
In 1990 the market value of stocks traded on the NASDAQ was 11
percent of that of the New York Stock Exchange; the comparable figures
for 1995 and 2000 were 19 percent and 42 percent. The annual average
percentage rate of increase in the market value of NASDAQ stocks was
30 percent during the first half of the decade and 46 percent during the
next four years. A few of the newer firms traded on the NASDAQ would
eventually become as successful and as profitable as Microsoft and Intel
and so high prices for their stocks might be warranted. The likelihood

that all of the firms whose stocks were traded on the NASDAQ would be

as successful as Microsoft was extremely small, since it implied that the

profit share of U.S. GDP would be two to three times higher than it ever

had been previously.

The bubble in U.S. stock prices in the second half of the 1990s was asso-

ciated with a remarkable U.S. economic boom; the unemployment rate

declined sharply, the inflation rate declined, and the rates of economic

growth and productivity both accelerated. The U.S. government devel-

oped its largest-ever fiscal surplus in 2000 after having had its largest-

ever fiscal deficit in 1990. The remarkable performance of the real econ-

omy contributed to the surge in U.S. stock prices that in turn led to

the increase in investment spending and consumption spending and

an increase in the rate of U.S. economic growth and the spurt in fiscal

revenues.

U.S. stock prices began to decline in the spring of 2000; in the next

three years U.S. stocks as a group lost about 40 percent of their value

while the prices of NASDAQ stocks declined by 80 percent.

One of the themes of this book is that the bubbles in real estate and

stocks in Japan in the second half of the 1980s, the similar bubbles

in Bangkok and the financial centers in the nearby Asian countries in

the mid-1990s, and the bubble in U.S. stock prices in the second half

of the 1990s were systematically related. The implosion of the bubble

in Japan led to an increase in the flow of money from Japan; some of

this money went to Thailand and Malaysia and Indonesia and some

went to the United States. The increase in the inflow of money led to

the appreciation of their currencies in the foreign exchange market and

to increases in the prices of real estate and of securities available in

these countries. When the bubbles in the countries in Southeast Asia

imploded, there was another surge in the flow of money to the United

States as these countries repaid some of their foreign indebtedness; the

U.S. dollar appreciated in the foreign exchange market and the annual

U.S. trade deficit increased by $150 billion and reached $500 billion.

The increase in the flow of money to a country from abroad almost

always led to increases in the prices of securities traded in that country

as the domestic sellers of the securities to the foreigners used a very

high proportion of their receipts from these sales to buy other securities

from other domestic residents. These domestic residents in turn similarly

used a large part of their receipts to buy other domestic securities from

other domestic residents. These transactions in securities occurred at

ever-increasing prices. It’s as if the cash from the sale of securities to

foreigners was the proverbial ‘hot potato’ that was rapidly passed from

one group of investors to others, at ever-increasing prices.