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Shares re-enter the danger zone

The craze for US Internet stocks has all the classic hallmarks of an asset price bubble
ASSET PRICE bubbles are not an obvious subject for dinner party conversation, but suddenly everyone wants to talk about them. BBC Radio Four is broadcasting a series on the things, "Pop", in which it tries to make a rather tenuous connection between the psychology of crowds, the South Sea bubble, the craze for Teletubbie toys and financial meltdown in the Far East.

At the intellectual end of the debate, it is now all the rage among economists to heap the blame for what happened in the Far East not on the countries themselves, but firmly on the speculative excesses of Western capital markets. Politicians meanwhile talk incessantly about the need to reform the world's "financial architecture" so as to control the herd and stop it stampeding this way and that.

Fat chance, it might be said. The long history of asset price bubbles strongly suggests that such behaviour is a deeply rooted part of the human condition. You can have as much transparency and regulation as you like, but you still won't stop them happening. Perhaps the strongest evidence of this line of thought is the present craze for US Internet stocks.

This has all the classic hallmarks of an asset price bubble. By the look of it, it could turn out to be a real corker, and what is more, it is taking place in the world's most advanced economy. When the.globe.com, a smallish loss-making company specialising in setting up personalised websites, floated on the stock market last week, it immediately went to a premium of 10 times its flotation price. Each share offered for sale changed hands no fewer than five times on the first day of trading, such was the scramble for stock, mainly from small private investors.

The performance of e-Bay, which unlike most Internet stocks actually makes money - albeit not much - is not much different. Floated in September, this two-year-old Internet auctioneer of antiques, coins, stamps and memorabilia is now worth more than $5bn. Plainly Christies International, one of the top two auction houses in the world, undersold itself for pounds 721m earlier this year, but then it doesn't have the magic word Internet attached to it.

More established Internet stocks, such as AOL, Yahoo! and Amazon.com, have also rocketed in value. The sector has taken on the characteristics of a 19th century gold rush. Nobody knows what lies in them there hills, but just the possibility of something is enough. The frenzy has even touched Britain in a mild way. Shares in Dixons, the electrical retailer, added 10 per cent last week after the company announced that its recently launched "free" Internet service provider had already attracted 475,000 subscribers.

Despite the hundreds of billions of dollars which in some shape or form have been invested in the Internet, the Web has yet to generate anything like a corresponding degree of revenue, let alone a decent return. Plainly that could change quite markedly over the next few years if e-commerce takes off in the way many anticipate. Potentially, then, there is big money to be made out of the Web.

Furthermore, as a powerful alternative to established forms of distribution across a large number of industries, the Net offers unparalleled entrepreneurial opportunity to a new generation of wealth creators. So there is at least some logic behind the Internet stock boom.

It scarcely needs saying, however, that not everyone can succeed. Perhaps more important, the Net is the ultimate of market places, offering consumers undreamt of opportunity to seek out the best and the cheapest. Establishment of anything resembling a monopoly position, the secret of most outstanding business success, may not be possible on the Web, which across all areas of activity is likely to remain intensely competitive.

Despite this, the combined stock market value of Internet companies is already way in excess of the likely size of electronic commerce for the immediate future, and that's just the quoted ones. So here's the bubble. Most people know it's dangerous, possibly even insane, but if there is the possibility of multiplying your money tenfold in a single day, then it may be worth the risk.

The same observation could be made about US stock markets more generally. Less than two months ago is looked as if we were heading into the financial abyss. Now the Dow, S&P and Nasdaq are close to their peaks once more. Even in Britain, with a recession more obviously just round the corner, there has been a remarkable bounce in share prices.

Against this backdrop, it perhaps seems hard to understand why Alan Greenspan again cut US interest rates this week - the third such cut in recent months. Mr Greenspan is known to be worried about the level of the US stock market, which he described as suffering from irrational exuberance when it was about a third lower than it is now. So is the situation out of control? Is the US stock market bubble so important to the success of the US economy, because of the way it may underpin consumption, that even Mr Greenspan now feels obliged to support it at this inflated level?

I suspect that the answer is a less convoluted one. Like the Bank of England's Monetary Policy Committee here in Britain, Mr Greenspan is responding to the threat of recession. The level of the stock market is almost irrelevant to this process, though certainly if it were to slip back it would compound recessionary pressures. What this tells us, is that the position of Western stock markets is a precarious one.

Share prices need a continuation of the strong earnings growth of recent years to justify present valuations. Certainly in this country, and possibly in the US as well, that would seem unlikely in the extreme. Not all stocks are doing well of course. Certain sectors are already discounting recession, but on the whole, the market in the US seems to have become divorced from economic reality. The stock market is being sustained, in other words, by the power of the herd.

It would be unduly alarmist to draw parallels with the Japanese stock market bubble of the 1980s. Wall Street isn't that far gone yet, policy makers are a good deal wiser, and in any case the underlying fundamentals of the US economy are much sounder. But undoubtedly we are back in the danger zone again.