Federal Reserve, Does It Understand The Internet Economy?

As inflationary talk dominates the stock market, has slammed Internet stocks for a 40% loss since mid-April,
the pied piper of the cost of capital, Alan Greenspan, has been talking to Congress about technology. He did so yesterday.
But you have to ask – does Federal Reserve chief Alan Greenspan understand a viral economy, the kind of user and customer-driven digital markets that the Internet enables?

Specifically, companies that are instantly global at low expense to potential sales/earnings, that grow by a biological process of customers telling others, in a 2, 4, 8, 16, 32, 64, etc. model. Maybe, maybe not.

It’s how eBay (NASDAQ:EBAY) became the world’s largest auctioneer in a few short years; or a company founded in 1994, Yahoo (NASDAQ:YHOO), reaches more people than venerable Times Mirror (NYSE:TMC).

Greenspan told the Joint Economics Committee yesterday that while technology led to better productivity levels without price increases, this scenario couldn’t last forever.

“Forever” is quite a long time, but I believe a basic understanding of how Internet economics work could show that productivity can increase dramatically while prices and wages remain in check.

Let’s consider what happens in a digital business world. Web-based businesses can reach 5 million people as efficiently as reaching 1 million, 30 million as easily as 3 million. The costs are incremental or non-existent once a certain threshold is reached and if the model is purely an Internet model.

ICQ, for example, the instant messaging software that allows people to be in touch in real-time using the Web, was and is a great Internet economic model in action. The “viral” of the above (viral meaning good, biological, exponential and not a disease).

ICQ only has any value to you if you encourage your friends, family, co-workers, to also download and use it. As they do then ICQ becomes more valuable, the “productivity” level of the company behind ICQ, AOL (NYSE:AOL) has gone up exponentially at almost zero cost once the initial digital product is released into the Web environment to self-replicate.

Users also get more “productive” as their time is used more efficiently. E-mail provides a great example. Think of office communication before e-mail: paper memos, routing slips, mail carriers, pens, pencils, white out, carbon copies, mail drops, mail rooms, bad spelling.

Granted all that is still with us but e-mail has replaced a large part of the un-productive (or productivity-challenged) era we were in before e-mail. It’s as easy to send 100,000 e-mails as it is just 1. Click!

Think about the cost involved without the Internet to try and sell an item, any item. Cars, PCs, flowers. Distribution eats productivity, inefficient markets juggle buys and sells, information flow is slow, stifled. Anti-productive. Costs go up, inflation rises.

Despite these items all being real-world goods the efficiency the Internet as initial distributor-marketer, combined with a more targeted seller-buyer relationship through computing power, means more customers satisfied. That means more sales, less returns. Efficient marketing reach and customized commerce the Internet enables.

It’s ironic that Internet stocks have been hit the hardest because of interest rate hike fears. Either way I see how the Internet benefits from interest rate moves.

If interest rates rise that puts more pressure on businesses to become more efficient. It puts pressure on buyers to find better deals. Businesses will look to cut costs by Web-enabling sales/marketing/information flow. Meanwhile, I think consumers would turn more to the Web to get the best prices, deals.

These are a few of the economics of Internet business that explain how productivity can go up yet prices for goods stay flat or go down.

In short, digital productivity is by its nature more efficient than the industrial-era output that Greenspan uses with the other Federal Reserve board of governors to regulate the money supply.

The Fed Reserve meets at the end of June — before they vote on any money matters maybe they should log on EarthLink, Yahoo or eBay and get a grasp of the ways of doing business in the 21st century. Maybe AOL will send them a disk for a free trial.

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