Prior To The Dotcom Crisis (Essay Sample)

An economic crisis is an economic situation when an economy experiences a sudden downturn in the aggregate output or the real Gross Domestic Product (GDP). This situation results in a decline in real income per capita, increased unemployment and poverty rates. Because of the negative impacts of economic crises, it results in decline in the aggregate demand for commodities within the economy. Economic crises also result in a decline in the nominal value of some financial assets in the economy. Since an economic crisis creates a downturn in economic growth, it affects people’s lives in various ways, including reduced economic activities and purchasing power. Therefore, economic crises results in reduced incomes and wealth, posing a greater uncertainty about future employment opportunities and income (McAleer et al., 2016). It affects all the other aspects of the economy, including the social life and provision of necessary resources to the public. The United States economy has experienced economic downturns multiple times, including the 1929 great depression and the post Second World War recession in 1949. Despite a series of recessions between 1949 and early 2000s, the US economy experienced great recession between 2007 and 2009. The United States also experienced Covid-19 recession in 2020. Recession is measured by the evaluating the country’s GDP. However, there are other important indicators of a recession include income levels, employment rates, retail sales, and the manufacturing activities. Therefore, during an economic crisis or recession, manufacturing activities, retail activities and income levels decline, while unemployment rates increase.
The common drivers of economic crisis or recession include loss of confidence in investments and economy, high interest rates, crash of the stock market, and declining prices of housing facilities. Slow-down of manufacturing orders, and wage-price control measures could also result in recessions. Economic down turns can also result from other specific behaviours in the United States economy, like weak watchdogs, loss of lending standards and immoderate investments and deregulations. According to Griffin et al. (2011), risky Wall Street behaviour was another cause of the 2007 great recession in the United States. This essay examines various causes and effects of economic recessions, an economic overview of the financial and monetary behaviours prior to the recession, the contemporary viewpoint of the recession and the strategies used by the U.S government to overcome the crisis. This paper primarily focuses on the Dot-com bubble, its causes and impacts on the United States economy.
Dot-com Bubble
Dot-com bubble or the internet bubble was an economic crisis in the United States caused by excessive speculations on the growth of internet-related companies between 1995 and 2000. This economic crisis resulted from a rapid rise in the stock equity valuations in the United States mainly fuelled by investments in tech-companies. This period, commonly referred to as the bull market, resulted in an exponential growth in the equity markets, leading to more tech companies dominating the Nasdaq index. Therefore, Dotcom bubble was characterized by increased investments in technological innovations in the US, and a frenzy of buying internet-related stock. Because of the fair growth of the internet-industry in the United States in the early 1990s, venture capitalist firms, lenders and individual investors were up to grab the internet stocks (dotcoms) (Uusitalo, 1996). Because of the increased demands for the dotcoms, the share prices exponentially rose than other shares within the sector because of the excitement and the dawn for the new internet era. Therefore, it is the increased demands for dotcoms that resulted in a market-wide valuation of the tech firms relative to their intrinsic values (Benbya and Belbaly, 2002). This period was also characterized by the rise of several online and technology entities in the US, like pets,co, webvan and boo.com, all of which later faced bankruptcy and were liquidated. However, other tech firms during the period, like Amazon, eBay, Cisco and Microsoft survived the economic downturn.
Other characteristics of the Dotcom bubble is that most start up internet-firms did not adopt more sustainable and viable business models, including cash flow generation, leading to overvalue of their share prices. Such misleading market valuations resulted in investors relying on wrong economic metrics like increased traffic on the company websites. The investors could have evaluated company revenue generation, business plans and other industry analysis to ensure the market trends were favourable. Therefore, the internet bubble resulted in many investors purchasing overvalued shares from internet start-ups. This led to an abundance of venture capital for funding the start-ups. Generally, it is the euphoric attitude towards growth of tech-companies that contributed to the speculative investments that resulted into overvaluing of the stock prices, leading to significant financial losses and bankruptcy of many internet start-ups.
Prior to the dotcom crisis
An economic overview of the US economy before the dotcom crises indicates that the financial markets had recorded significant stability. Early 1990s remain in the US history as the time when the US economy recorded the strongest economic growth, steady job creation and unemployment declining to record lowest, rising productivity and manufacturing in the US and n economic boom. A combination of the rapid technological developments and sound monetary and financial policies resulted in a strong economic growth and consistent performance of the stock market. Therefore, the bond and equity markets performance prior to this crisis was stable, leading to massive wealth creation and increased income levels. This period was as market by political stability and favourable government policies under President Clinton. The United States economy recorded a massive economic expansion, and real economic growth of up to 4.5% annually during President Clinton’s second term. The strong economic growth and declining unemployment rates was remarkable due to the structural budget surpluses, leading to economic stability.
The beginning of dotcoms can be traced to the Netscape communications initial public offer (IPO) in 1995. According to Ghosh (2006), the resultant excitement after the Netscape IPO was the beginning of the dotcoms, leading to an exponential rise in their stock process within hours from $28 to $75 for each share. Closing at $58.25 per share on the first day, this was the highest growth in the value of stock prices according to the reports by the Wall Street Journal (WSJ). However, the company had gone public even before it had accumulated meaningful profits. This resulted into high demands for the Netscape’s stock offers, creating the dotcom mania. Another event prior to the dotcom bubble is Greenspan speech that exuberated confidence in economic performance. The speech led to a decline in the stock prices in Europe, Japan and Hong Kong, while the US market opened by 2% (Ghosh, 2006). According to Greenspan’s speech, the exponential growth in the US stock market was responsible for improving the United States fiscal position. This resulted in an economic rush to purchase the US equity, leading to a massive five-fold increase and growth rate of equity prices from10% between 1990 and 1995 to 21% between 1995 and 2000. These events also led to a faster growth in the US stock market capitalization. Besides, Netscape communication was inexperienced in its revenue generation strategies.
The monetary policies applied by the United States prior to the dotcoms include the short-run simulative effects of the long-run effects of the deficit reduction packages with the monetary policies increased the purchasing power of the middle and low-income earners. This is because of the welfare programs and reduced government regulation. There was also a dramatic growth in the current and projected balance mainly attributed to political stability. The government also implemented reduced taxation at the military, enhancing their spending power. Therefore, the major monetary and fiscal policies in the United States prior to the dotcoms was the increased government spending, tax cuts, and offering low-income household with social welfare programs. The central bank also had implemented fiscal policies that enhanced economic stability. The 1990s budget agreement led to debt reduction and economic growth. Therefore, the monetary policies implemented during the period increased consumer purchasing power, leading to increased demands for internet-stock investments.
1990s is also characterized by various financial policies by the financial institutions in the United States to facilitate constant capital flow. This was due to the 1990s’ financial liberalization, removing regulations on capital movement. Therefore, with the economic boom and stability in the United States, more potential investors considered buying shares within the US market. However, the liberalization of financial institutions in the Asian countries, like Japan, facilitated the increased investments in the US. Generally, the stable economic growth and sound monetary policies in the United States resulted in increased demand for the internet start-up shares (Morris and Alam, 2012). Besides, the period between 1995 and 2000 witnessed a significant innovation in the banking and financial markets. Financial innovations in the US resulted in the repackaging of the financial assets. However, the efficient market paradigm was primarily inspired by the optimism about the economic growth of the internet.
The Crisis
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