As published in The Wall Street Journal, August 6, 2001
When Bill Clinton assumed office nine years ago, I predicted he would enjoy one of the greatest economic booms in the history of the world. Impelled by the spread of the Internet, the onset of fiber optics, and a tenfold increase in venture capital — unleashed by the lower tax rates and deregulation of the Reagan administration — the Clinton economy had it made. Moreover, until the election year of 2000, Mr. Clinton actually pushed the economy along with beneficent trade policy, an astonishing opposition to Internet taxes and restrictions, and a 30% capital-gains tax cut that yielded hugely more revenues than projected by demand-side models.
The Bush economy, unfortunately, not only possesses no such immunity to bad policy, but also is gravely vulnerable to policy mistakes accumulating by the end of the Clinton term. A high-tech depression is under way, driven by a long siege of deflationary monetary policy and obtuse regulation that has shriveled hundreds of debt-laden telecom companies and brought Internet expansion to a halt.
The entire telecom sector — what I term the telecosm — is engaged in a heroic capital-intensive buildout of a communications infrastructure thousands of times more cost-effective than today’s. Promising to make interactive video as pervasive as voice telephony today, such infrastructure projects create demands for funds that outreach the resources of venture capital. Just as some $200 billion of junk bonds from Drexel Burnham and others sustained the previous hybrid build-out of optics, cable and cellular, similar debt issues are crucial to the new infrastructure of all-optical networking. But there ends the similarity with the previous build-out, which emerged during a time of real supply-side tax cuts, OPEC tax collapse, deregulation, and general monetary stability, and was vindicated by soaring cash flows and equity valuations. By contrast, the far more promising new infrastructure is withering in the face of monetary, tax and regulatory blunders.
For debt-burdened companies, nothing is so oppressive as deflation — a dearth of money — which inflicts soaring real interest burdens, sinking asset values, and collapsing growth. The leaders of the telecosm have to pay off debt in appreciating dollars while cash flow and collateral declines, and banks deny the kinds of rollovers that saved the likes of MCI in the 1980s. Real interest rates are now drifting upward faster than the Federal Reserve can reduce them. Monetary economists prattle about too many dollars while the dollar soars against deflated currencies, such as the yen, with its interest rate near zero. From industrial staples such as steel (down 42% in four years) to the monetary tocsin of gold (down 40% in four years), commodity prices lie in a deep trough.
Meanwhile, the Bush “tax cut” degenerates into a ten-year gantlet of meaningless shifts and shuffles, the OPEC tax hike persists in its wanton gouge, and regulations strangle the broadband Internet.
Essential to the Internet economy is the expectation of a steady increase in the speed and capacity of connections. Nearly every dot-com was betting on it. The glitches and delays of dial-up modems abort 70% of all intended Internet transactions and bar the business plans of thousands of dot-coms and Internet service providers, not to mention vendors of streaming video, distance learning, video telecommunications and Internet malls.
The only reason for the so-called “fiber optics glut” is the near deliberate starvation of connections to homes and small businesses. It is a classic socialist famine, where the warehouses are full but the people are starving for lack of market distribution systems. Part of this is because of a few poor business decisions in the industry, but most of it comes down to intrusive regulatory policy in an era of deflation.
Typical of bad regulation is a Federal Communications Commission policy called Total Element Long Run Incremental Costs, or Telric, summed up simply as a price cap on what telephone companies can charge for links to homes and businesses. Designed in the late 1990s to prevent “monopoly rents,” the cap is based on an estimate of costs that would apply in a fully competitive environment when bandwidth is a commodity.
But in dynamic technology markets such as Internet broadband, monopolies are inevitable, virtuous and fleeting. Every innovation creates a monopoly at the outset, and monopoly rents pay for financial risks and costs entailed in bringing innovation to market. Like any price-control scheme, Telric choked off supply, taking the profits out of the multibillion-dollar venture of deploying new broadband pipes.
Compounding Telric were “open access” and “unbundling” rules that require companies installing advanced Internet gear to share pipes with others. The goal was to stop monopolies, but what regulators did was to bar Internet investment by privatizing the risks and socializing the rewards. No entrepreneurs will invest in risky, technically exacting new infrastructure when they must share it with rivals. At first restricted to telcos, the open-access rules have since been extended to cable, where they balked Michael Armstrong’s bold AT&T plan to compete with the Bell companies using cable TV plant.
The absence of broadband local loops also withers the optical Internet. The $44.8 billion write-off and $8 billion loss announced last week by JDS Uniphase signals the devastation of the most promising communications technology in the history of the planet. Treating JDS Uniphase as a budding monopoly, the Federal Trade Commission permitted its merger with SDL only on condition that it sell its Rushlikon pump laser facility to Nortel.
Some monopoly. Uniphase last week devalued its SDL pump laser acquisition by some $35 billion. The write-off — the largest in business history — was partly because of the collapse of last-mile traffic growth. But it was also because an efflorescence of new laser and amplifier technologies — from such companies as NP Photonics and Princeton Optronics — are already making conventional pump lasers obsolete. Regulators can’t keep up.
Before the FTC attack on Uniphase, regulators casually destroyed the Internet strategy of WorldCom. Under Bernie Ebbers, Worldcom planned an attack on the real telopolies around the globe through the use of Internet for both data and voice. Suffering from mazes of conflicting connections, with each data packet making some 17 hops between routers before reaching its destination, today’s Internet competes only fitfully with the telecom establishment. But by purchasing and upgrading the Internet facilities of MCI and Sprint, WorldCom planned to transform its portions of the Internet into a coherent broadband system.
Instead, upholding the fantastical view that WorldCom was becoming an Internet monopolist, U.S. regulators defended the existing monopolists against the WorldCom challenge, forcing the sale of MCI’s Internet facility to Cable & Wireless in Britain and barring the acquisition of the Sprint network. By upholding a false notion of competition — one in which no one can win or make any money — the FTC largely wrecked WorldCom, the most aggressive monopoly buster on the planet. Internet Sclerosis As difficult as it may be for Republicans to acknowledge, they have become part of the Internet sclerosis. Led in Congress by regulation lovers such as Sen. Ted Stevens of Alaska, pressed by Republican governors such as Nevada’s David Levitt to impose Internet taxes, and beset by conservatives who blame the Internet for pornography (rather than prosecuting pornographers), the party is imperiling the crucial expansion of the Internet economy.
Meanwhile, the president is preening for pollsters and junk science greens while hundreds of telecommunications companies tumble into the telechasm, choking on debt easily sustainable under favorable tax and regulatory conditions, but now rendered devastating by a global deflation.
Mr. Gilder, editor of the Gilder Technology Report, is author of “Telecosm: How Infinite Bandwidth Will Change Our World” (Free Press, 2000).