Demand for computer products is up. We should be celebrating.
Contrary to what you might have heard, American businesses are buying more high tech equipment and computer software than ever. So far this year the pace of investment is faster than during the heroic phase of the 1990s boom, and even faster than at the prime of the dotcom bubble in early 2000. Yes, the notable exception is purchases of fiber-optic cables and network gear. Telecom companies are not buying to increase their systems' capacity. But everybody else is.
Economists forecast that the inflation-adjusted amount of computer equipment being bought by businesses this year adds up to more than $300 billion. That's more than one-fifth higher than the summer 2000 peak. High tech investments have been growing at an average rate of more than 20 percent per year since the recession's low point in the summer of 2001.
Meanwhile, some experts claim the recession just past (or still happening, and perhaps even leading us to deflation, depending on whom you ask) was different than other post-World War II recessions because of genuine overinvestment and a genuine overhang of capital. Though right about telecom, these observers are wrong about the rest of the economy. Two generations of Moore's law have passed since the peak of the Nasdaq: Machines become obsolete quickly, affording programmers the opportunity to write more software and manufacturers to build more and better machines than ever before. Whatever the causes of our current economic slump or near slump, it is not that US businesses have decided they have too many computers and stopped buying them.
So why isn't Silicon Valley celebrating? For starters, tech companies are peddling their wares at much lower prices. This year companies will buy more than $300 billion in computers and peripherals measured at 1996 prices, but they will pay less than $100 billion of today's dollars for them. What's more, exploding productivity in high tech manufacturing means fewer workers are needed to build the same real value of product. And fierce competition means profits that during the boom flowed to producers, like Applied Materials and Sun Microsystems, now almost all flow to the businesses buying computers and peripherals, like Google and Wal-Mart.
Still, the boom of the 1990s continues. It is spreading outward from one active center to a lot of nodes around the globe: Businesses manage supply chains and track resources in real time; countless people write about their cats on their weblogs and collect entire music libraries in a box that's only slightly larger than a deck of cards; massively distributed news operations like South Korea's OhmyNews and massively multiplayer games like Legend of Mir claim more than half a million simultaneous users.
As the action spreads from producers (the few) to users (the many), it becomes much, much harder to get an overview of the revolutionary things occurring. We have anecdotes of brilliant new uses and applications, but do they add up to an enduring boom or just a few isolated pops that make good copy?
The answer is clear: The 24 percent-per-year growth rate in investment in IT equipment and software could not happen without powerful justifications for new machines and programs. And inflation would not be so very low today were it not for the falling prices of high tech goods; these products make up such a large slice of the market's demand that their price trends matter. But it does raise another question: Could the low prices go too low and ultimately lead to deflation - falling prices on an economy-wide scale?
The Russian economist Nikolai Kondratieff argued (before he was silenced by Stalin) that technological revolutions consist of an A phase of booming stock prices and high profits for producers, followed by a B phase of pessimism, consolidation, and rapidly falling prices. The second phase initially would be good for purchasers but risked triggering deflation for the economy as a whole. Consider the boom in steam-powered textile manufacturing in Britain during the early 19th century, which was followed by the "Hungry Fourties" as prices and profits plummeted and handloom earnings collapsed. Or think of the worldwide deflation that occurred from 1873 to 1896, when manufacturing output rose about 6 percent a year even as the general consumer price index fell about 1 percent per year. (Kondratieff also thought that each phase had to be 25 years long, but let's ignore that.)
Today, Kondratieff's B phase deflation could become very painful if it were to shake confidence in the entity - the bank, hedge fund, company - to which you entrust your money. Deflation makes hidden insolvency much more likely and has made the temptation to pull an Enron irresistible for some. It happened in 1873, and in 1907, and again in 1933. It won't happen now. Why? An interventionist Fed working to keep inflation at a healthy level. Falling prices of goods produced by technologically revolutionary sectors won't turn into economy-wide deflation. Instead, they help the tech boom continue.
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