Important Voices: interviews Doug French, author of Early Speculative Bubbles

In Economy, Federal Reserve, Important Voices, Inflation, Interviews on February 8, 2010 by Josiah Schmidt

This is interview #9 in’s “Important Voices” series, where we talk with key figures, such as elected officials, candidates, authors, commentators, and policy experts, about the issues of the day.  A new interview is released every Monday and every Thursday, so check back often!


Our guest for today’s Important Voices interview is Doug French.  Doug is president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine.  Doug is also the author of Early Speculative Bubbles & Increases in the Money Supply. He received his masters degree in economics from the University of Nevada, Las Vegas under the famous economist, Murray Rothbard, with Professor Hans-Hermann Hoppe serving on his thesis committee. 

Josiah Schmidt: Thank you for agreeing to do this interview, Doug.  How did you come to hold such a liberty-oriented philosophy?

Doug French: This point of view developed rather late in life for me.  I had moved to Las Vegas in 1986 from Topeka, Kansas.  After a couple years there I decided to pursue a Masters in economics from UNLV.  After taking a couple classes, I enrolled in a History of Economic Thought class.  The instructor was Murray Rothbard.  The rest is history.   
Josiah Schmidt: What is Austrian economics, and why is it so important in this day and age?

Doug French: Austrian economics is a school of thought that can be traced back to the Spanish Scholastics in the 15th century along with Frenchmen Cantillon, Turgot and Say in the 19th century.  But it was Carl Menger’s Principles of Economics published in 1871 that founded the Austrian school. Menger spelled out the subjective basis of economic value, and fully explained, for the first time, the theory of marginal utility (the greater the number of units of a good that an individual possesses, the less he will value any given unit). In addition, Menger showed how money originates in a free market when the most marketable commodity is desired, not for consumption, but for use in trading for other goods.

Ludwig von Mises used the marginalist tools to develop the Austrian Business Cycle Theory that F.A. Hayek would later share a Nobel Prize for his further work on.  Mises also showed that because of a lack of a price system in a socialistic economy, the system is doomed to collapse, because no calculations can be made to determine what goods and services should be produced to satisfy consumer demand.  

For these two reasons alone–explaining the business cycle and why socialism can’t work–Austrian economics is important today.  But also, Austrians view economics as a tool for understanding how people both cooperate and compete in the process of meeting needs, allocating resources, and discovering ways of building a prosperous social order. Austrians view entrepreneurship as a critical force in economic development, private property as essential to an efficient use of resources, and government intervention in the market process as always and everywhere destructive. 

Josiah Schmidt: Well said!  You’ve done a lot of study of monetary policy and asset bubbles.  Could you explain to our readers just how such bubbles are formed?

Doug French: The key point of the Austrian Business Cycle theory is that an increase in the supply of money engenders an economic “boom” followed subsequently by the correction of that malinvestment, or “bust”, which is characterized by less money or credit. The business cycle is initially generated by some sort of monetary intervention in the market, typically in the modern world by bank credit expansion to business. 

People, as they earn money, spend some on consumption, keep some in cash balances, while the rest is saved or invested in capital or production. For most people, this means setting aside a portion of their income by buying stocks, bonds, bank certificates of deposits, or savings accounts. People determine the amount they wish to put in savings by their time preferences, i.e., the measure of their preference for present as opposed to future consumption. The less they prefer consumption in the present, the lower their time preference. The collective time preferences for all savers determines the pure interest rate. Thus, the lower the time preference, the lower the pure rate of interest. This lower time-preference rate leads to greater proportions of investment to consumption, and therefore an extension of the production structure, serving to increase total capital.

Conversely, higher time preferences do the opposite, with high interest rates, truncation of the production structure, and an abatement of capital. The final array of various market interest rates are composed of the pure interest rate plus purchasing power components and the range of entrepreneurial risk factors. But the key component of this equation is the pure interest rate.

When a monetary intervention, as talked about above, occurs, the effect is the same as if the collective time preferences of the public had fallen. The amount of money available for investment increases, and with this greater supply, interest rates fall. In turn, entrepreneurs respond to what they believe is an increase in savings, or a decrease in time preferences. These entrepreneurs then invest this capital in “higher orders” in the structure of production, which are further from the final consumer. Investment then shifts from consumer goods to capital goods industries. Prices and wages are bid up in these capital goods industries.

But the money does not immediately go into production, as Mises writes:

“The moderated interest rate is intended to stimulate production and not to cause a stock market boom. However, stock prices increase first of all. At the outset, commodity prices are not caught up in the boom. There are stock exchange booms and stock exchange profits. Yet, the ‘producer’ is dissatisfied. He envies the ‘speculator’ his ‘easy profit.’ Those in power are not willing to accept this situation. They believe that production is being deprived of money which is flowing into the stock market. Besides, it is precisely in the stock market boom that the serious threat of a crisis lies hidden.”

This shift to capital goods industries would be fine if people’s time preferences had actually lessened. But this is not the case. As the newly created money quickly permeates from business borrowers to wages, rents, and interest, the recipients of these higher incomes will spend the money in the same proportions of consumption-investment as they did before. Thus, demand quickly turns from capital goods back to consumer goods. Unfortunately, capital goods producers now have an increased amount of goods for sale and no corresponding increase in demand from their entrepreneurial customers.

This wasteful malinvestment is then liquidated, typically termed a crash, bust or crisis, which is the market’s way of purging itself, the first step back to health. The ensuing recession or depression is the market’s adjustment period from the malinvestments back to the normal efficient service of customer demands.

This process or cycle can occur in a relatively short period of time. However, the booms are sometimes prolonged by more doses of monetary intervention. The greater the monetary expansion, both in magnitude and length of time, the longer the boom will be sustained. 

The recovery phase, or recession will weed out inefficient and unprofitable businesses that were possibly engendered by, or propped up by the money induced boom. 

In the final analysis, monetary intervention cannot increase the supply of real goods, it merely diverts capital from avenues the market would dictate, towards wasteful malinvestment. The boom created has no solid base, and thus “it is illusory prosperity,” as Mises explained.

Josiah Schmidt: Fascinating.  So, what was “Tulipmania” all about?

Doug French: Tulipmania has become a metaphor in the economics profession describing a financial market where prices soar irrationally and then suddenly crash.  Leading noted economic historian Charles P. Kindleberger calls tulipmania “probably the high watermark in bubbles.”

In seventeenth century Holland, the Dutch were the driving force behind European commerce.  Amsterdam was the center of this trade and it was in this vibrant economic atmosphere that people began to speculate in the price of tulip bulbs. Tulipmania began in 1634 and climaxed in February 1637.  At the height of tulipmania, single tulip bulbs were bid to extraordinary amounts.  As Charles Mackay recounts, a single Viceroy bulb was traded for: 8,000 pounds of wheat, 16,000 pounds of rye, four fat oxen, eight fat swine, 12 fat sheep, 126 gallons of wine, over a thousand gallons of beer, more than 500 gallons of butter, 1,000 pounds of cheese, a complete bed, a suit of clothes and a silver drinking cup. But when the market crashed, “substantial merchants were reduced almost to beggary,” writes Mackay, “and many a representative of a noble line saw the fortunes of his house ruined beyond redemption.”

Josiah Schmidt: So, what caused this?

Doug French: This link is my explanation as to what caused Tulipmania:
Josiah Schmidt: Now, more recently, why was a bubble created in the real-estate sector, of all possible sectors of the economy?

Doug French: Low interest rates and easy credit fueled a boom in the real estate sector just as all bubbles have been created by loose lending and low interest rates.  The Austrian Business Cycle Theory (ABCT) explains it nicely.  There has always been disagreements among Austrians as to whether housing is a higher order good or consumption good.  I believe that it is when all that goes into building a house is considered.     

To take it a bit further I have written some on how new research in neuroscience supports ABCT. 

Josiah Schmidt: Do the currently skyrocketing gold prices constitute an artificial bubble?  If not, why not?

Doug French: The current gold market is an interesting case.  Many people who rationalized the incredible rises in stock and real estate prices, are very quick to call the gold price ascent from roughly $250 an ounce to $1,200 or so a bubble–probably because they don’t own any. But, just looking at the price increase, one might come to that conclusion very quickly.

Many Austrians, on the other hand, are gold owners and gold fans–Austrians believing in sound money–and they are quick to rationalize the increase in the gold price by pointing out how much money has been created by the Fed and all the government debt and deficits as far as the eye can see.  There is ongoing debate about whether we are heading to hyperinflation or deflation.  Most Austrians are in the hyperinflation camp.  Gold will likely be the only place to hide in a hyperinflation.  History has shown that gold even does OK in a deflation.  

When the dollar loses its reserve currency status and the US government is unable to export inflation, I think that’s when we have hyperinflation.  But I don’t know when that is.  None of the various government fiat currencies are all that great, so the dollar may hold up longer than we think.  

The gold price is set by futures traders that exercise extraordinary leverage.  And there has been increased buying at the retail level (but nothing like the mania in stocks and houses).  It’s more likely a bubble in precious metals will manifest itself in explosive price increases in mining stocks.           

A good argument can be made either way.  Having lived through the housing bubble and rationalized higher housing prices during the Vegas boom, its hard for me to pound the table saying that gold is cheap at the moment.  As a speculation it likely is not.  But should everyone have some as insurance against a hyperinflationary chaos?  Absolutely.     

Josiah Schmidt: What is wrong with the notion that the correct response to a “liquidity crisis” is for the Federal Reserve to simply inject new credit?

Doug French: The liquidity crisis is just the economy attempting to heal itself.  The last thing the Fed should do is inject liquidity.  As Murray Rothbard used to point out, bank runs serve as a healthy cleanser to stop inflation being created by the fractional reserve banking system. 

These injections just prop up businesses (banks and otherwise) that should be left to fail.

Josiah Schmidt: Is deflation a bad thing?

Doug French: Actually deflation is a good thing.  As Jörg Guido Hülsmann points out in his book Deflation & Liberty: “it fulfills the very important social function of cleansing the economy and the body politic from all sorts of parasites that have thrived on the previous inflation.”  

Josiah Schmidt: What do you think is the next, big bubble?

Doug French: I agree with Doug Casey, Marc Faber and others that the next big bubble is sovereign debt, including US government bonds.  Ultimately, there is only one direction they can go–down.

Josiah Schmidt: Anything else you’d like to say to our readers?

Doug French: Your readers interested in economics should go to  All of our books are online for free, not to mention thousand of hours of media content and new daily articles. Also, we debuted on iTunes University in mid-January and all of our media content is there.

Josiah Schmidt: Sounds great!  Thanks again for joining us, Doug!


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