Is The New Economy Dead?

It was fun at first, admit it--watching those bratty dotcom billionaires, oops, millionaires--ha!--thousandaires squirm as their cyberpriced stocks came screaming back to earth and their dotcoms disappeared overnight. But then something else dawned. It wasn't just kids from Stanford taking it on the chin. It was us. Suddenly, warning lights are flashing. In recent weeks, everyone from mighty Intel--whose microchips power 80% of the world's computers--to lumber and housewares seller Home Depot has signaled a sharp drop in profits, leading nervous investors to pummel their stocks.

To that growing disquiet add the recurrence of warfare and terrorism in the Middle East last week. Result: a full-fledged panic on Wall Street. By the time the rout ended, the Dow Jones average had plunged 379 points on Thursday and the tech-heavy NASDAQ index stood at its lowest level of the year. Though both markets rebounded on Friday, that did little to dispel the underlying unease that the economy may be a Ford Explorer speeding along on Firestones.

Much of that feeling stems from concerns that the thing that got us here--the vaunted New Economy--was looking like a big Sony Betamax that had promised a revolution it could not deliver. The New Economy is supposed to be frictionless, tied as it is to the ultra-productive cyberworld of computers, broadband networks and the Internet, and cosseted by low inflation and low interest rates. But nobody told that to OPEC. Or to Arafat. And if the New Economy is rewinding, what will become of the economic expansion that had already started grinding down after an unprecedented 10-year run?

Such questions could hardly be more pressing for a nation that is entering the home stretch of a presidential election. For Al Gore, the New Economy-led prosperity is by far the strongest selling point on his resume. Voters nervous about their economic future can be dangerous, as the Republican candidate's father will be the first to tell you.

Today's economic risks may be the greatest in recent years. If the U.S. is unlucky, rising inflation, higher interest rates and slower spending could whip up what economist David Wyss calls "a perfect storm" that could turn the soft landing the Federal Reserve is trying to engineer into an outright recession sometime next year. Wyss, chief economist for Standard & Poor's, still expects a gentle slowdown that would lower growth from nearly 5% at present to a more sustainable 3.5% in 2001. But he also sees a 1 in 4 chance of a slump. "Bad things," he warns, "can happen to new economies."

Fed Chairman Alan Greenspan showed few such signs of concern last week. As Wall Streeters reached for airsick bags, he calmly flew to Boston for a long-scheduled session with fellow bankers. Greenspan believes U.S. economic fundamentals are solid. Fed vice chairman Roger Ferguson told TIME, "The economy is cooling from its unsustainable pace of earlier this year, but recent data certainly don't suggest a dangerous slowdown."

If things are so good, why has Wall Street been doing so poorly, especially now that America has become a nation of stock traders? An explanation is that Wall Street has exchanged its traditional role of follower of economic trends for that of economic pacesetter. Consider the way that the dotcom mania showered wealth on every jaunty entrepreneur with the gleam of an idea but not a clue about earnings. In the past, the stock market would rarely show its checkbook to a start-up sans profits. And now that Wall Street has been burned, the fear is that the current stock pullback could leave even companies with real potential starved for cash--thereby stifling innovation.

That's the risk foreseen by Michael J. Mandel, Business Week's economics editor, in a new book darkly titled The Coming Internet Depression. According to Mandel, any failure by the Fed to counter such a cash shortage by slashing interest rates could send the economy into a harrowing free fall. Though government safety nets would prevent a repeat of the Great Depression of the 1930s, he writes, "things could still get very ugly."

But that's not very likely. The U.S. appears to be witnessing something richer and more varied than either New Economy enthusiasts or dotcom alarmists have envisioned: the rapid--if still painful and uneven--merging of the old and new economies. That's evident from deals as complex as America Online's proposed $120 billion acquisition of Time Warner (the corporate parent of this magazine) or as simple as the act of buying a Pokemon video game or a bedding set from K Mart's website, BlueLight.com . "What we're seeing," says Garth Saloner, a professor of e-commerce at Stanford's business school, "is the diffusion of technologies that were popularized by the dotcoms into traditional companies."

Viewed in that fashion, the New Economy is nothing more than a fancy term for the basic infrastructure that allows consumers and companies across the globe to shop, work and play at Internet speed. In New York City, for example, travel agencies routinely farm out chores like updating frequent-flyer miles to online boutiques as far away as India. "All our activities from consumption to production are unalterably changed," says Allen Sinai, chief global economist for Primark Decision Economics. "In that sense, the New Economy is for real, and it's here forever."