Early Speculative Bubbles and Increases in the Supply of Money

You know you have crossed into the Austrian light when you wake up one morning and everything has become clear.  From that point forward, for the rest of your life, you realise that almost every societal problem you encounter, no matter how simple nor how complex, is usually something to do with involuntary coercion, threatened violence, or some other failure of state interference in the free market.

No matter how well the dead hand of government has camouflaged itself, the underlying coercive cause of the problem usually presents itself in short order, whether to explain a failing health system, a rogue schools system, or even a perennial shortage of your favourite vitamin in a local health food store.

Doug French, the current President of the Mises Institute and a former Las Vegas banker, is one such clarity-seeking Austrian.

His journey reached a conclusion when he decided to study for a masters degree in economics at the University of Nevada, where unbeknownst to him he would fall under the tutelage of Professor Murray Rothbard and where his masters work would be examined by Professor Hans-Hermann Hoppe, sitting upon his thesis committee.

Rothbard, the acknowledged (Misesian) Dean of the Austrian School, subsequently opened up an efficient banker’s eyes to the world of real human economics, where both sides of a voluntary transaction always profit, as opposed to blinding these eyes in the egalitarian mathematical maze of the Keynesians.  However, a circular problem emerged which needed to be squared off.

The problem Mr French perceived, in his eventual masters thesis, was the unknown causal factor behind Tulipmania, a huge bubble which took place in the 1630s in the Netherlands, with derivative futures in Tulip bulbs being swapped for fantastical prices until a terrible price collapse in February, 1637, allegedly caused by a sailor mistakenly eating a hugely-priced tulip bulb after confusing it with an onion. French believes he solved this problem with his thesis, which the Mises Institute later adapted into book form; Early Speculative Bubbles and Increases in the Supply of Money is now freely available online as a beautifully formatted PDF.

The problem’s core centred on the Bank of Amsterdam, which dominated the Dutch financial system in the seventeenth century and which possessed one of the hardest monetary systems of all time, with 100% reserves of gold and silver specie supposedly backing all of its monetary promises.

So how did Tulipmania get started under such a granite-hard monetary system?

Orthodox Austrian Business Cycle Theory (ABCT) generally blames fractional paper reserves for expanding bubbles and collapsing bursts, with these bubbles formed upon a state backbone of coercive market intrusions, including central banking, legal tender laws, and legal counterfeit money printing; but how does a bubble expand against a 100% physical precious metals store held by a nominally independent bank, just as Cobden and Bright themselves might have ordained had they been asked by God Himself to create the perfect monetary system in fiduciary heaven?

(Gringotts Wizarding Bank, in the Harry Potter novels, is the only other bank I can think of which even comes close to the Bank of Amsterdam in its demands for specie purity and 100% reserve requirements.)

Did this apparent failure of theory mean that Austrianism was fundamentally wrong in its monetary beliefs?  Did this mean that the Chicagoans and the Keynesians were right to suggest that a medium-of-exchange system based upon gold (or any other physical commodity) was just a barbarous wasteful relic?  If you can get boom and bust with 100% metal reserves, why not just use paper instead and save yourself all of the mining, storage, and insurance costs?

The gun was smoking but where was the powder?

For a brief primer on the standard ABCT you might want to try the following pair of short works:

• The Austrian Theory of Money (Rothbard)
• The Austrian Theory of the Trade Cycle (Mises, Haberler, Rothbard, Hayek)

Getting back to our smoking gun, if we could somehow understand this first modern financial bubble and how it was related to later major paper collapses, such as the Mississippi Bubble and the South Sea Bubble, and if we could align all three bubbles to Austrian Business Cycle Theory, then we would have a great chance to both understand how we got into our current economic mess and how we can break free from its strangulating and all-enmeshing grip, as the Internet bubble, the housing bubble, and the government bond bubble, all twist and spin before us in a three-part symphony of hyper-inflation, hyper-depression, or hyper-stagflation, the next slippery step dependent upon which way the Head of the Hydra turns next.

And this is where Mr French helps us with his superb book, making it is essential reading for all those who wish to understand the causes and the solutions of our 21st century global financial meltdown.

He begins with a thorough examination of the actual tulip bulb market and why it was so peculiar; this peculiarity arose from the strange nature of the most desirable tulip colour and petal patterns being transmitted through bulbs via a mosaic virus, rather than through uncontaminated seeds.

French also explains the cyclical nature of the bulb market, which left it a natural candidate for an annual futures market rather than a commodity spot market.

Once the mechanics are explained, Mr French then moves straight into the heart of the question, which is where did all the money come from to fuel Tulipmania?  An earlier historian of bubbles and busts, Charles P. Kindleberger, avoided discussing Tulipmania because he refused to believe that the money supply had dramatically bubbled, because of the hard money policy of the Bank of Amsterdam.  However, was Tulipmania just a unique bout of insanity, never to be repeated?  Did a rogue mosaic virus invade the minds of men as well as bulbs of tulips, to make a whole raft of Dutch traders behave in this strange one-off way?

Or was this ‘mania’ actually more of a ‘rational’ bubble, with a sane explanation, in the same fashion as all subsequent bubbles, where many intelligent men succumbed quite rationally to the same mass financial error of propping up a particular asset class (such as Internet stocks, housing bonds, or government bonds), in a calm though mistaken belief that this will make them all rich?

French believes he has found the sane rational explanation behind Tulipmania that falls strictly within the explainable paradigm of the Austrian Business Cycle Theory, rather than being within the inexplicable paradigm of the madness of crowds.

However, Austrian bubbles need some sort of expansion in the money supply, by definition.  To provide this, French works through several threads in far more detail than this review provides, to gear the underpinnings of a necessary money supply growth:

• Following the regular gold debasements of the previous century instigated by Charles V, the Holy Roman Emperor who ruled over the Netherlands, the Dutch revolt of the late 1560s instituted a policy of ‘free coinage’, whereby any amount of precious metal brought to the Dutch republican state would be minted ‘free’ of charge and returned as the same weight of precious metal in the form of coins.  (This ‘free coinage’ policy came to the Netherlands by way of the Dutch East Indies, via the Portuguese and the Moslem governments of India.)
• This anti-imperial policy encouraged a rising flow of specie to the port of Amsterdam, especially from the Spanish silver mines in South America and from as far afield as Japan. This was especially true after the mercury amalgamation process was invented in the middle of the sixteenth century, which boosted the production of silver, particularly with the opening of the Peruvian Huancavelica mercury mine in 1572 and the discovery of the Potosi silver mine in Bolivia, a single source which produced 45,000 tons of pure silver between 1556 to 1783.
• Due to various complications of Dutch legal tender laws, the Bank of Amsterdam was founded in 1609 and given a state monopoly on the trading of all specie.

Thus, we see already that three government interventions were settled into place before Tulipmania began; ‘free coinage’ of money (i.e. Dutch taxpayers forced to subsidise minting, thereby sucking in specie from all over Europe), legal tender laws (ripped apart by Gresham’s law, which created a flood of debased and clipped overvalued money to push out newly-minted undervalued money), and an imposed monopoly via the Bank of Amsterdam to counteract the two previous interventions (as often happens with government interventions in the free market, where one wrong-headed intervention generates a chain-reaction of further wrong-headed interventions).

So much for a ‘free market’ then.  But French has more to add before he is finished; his colourful brushstrokes lay down two more Vermeerian layers of light and shade before the penultimate dénouement:

• The city of Amsterdam, released from the strictures of the Holy Roman Empire, became a centre for world free trade, thus sucking in even more specie. (Hurrah!)
• The Dutch state naval fleet, one of the most effective in the world at the time, often seized huge volumes of gold bullion from the Portuguese eastern empire and silver bullion from the Spanish western empire. (Boo!)

Thus we have a fourth violent state intervention, though tempered by the more noble causative factor of free trade, boosting the supply of currency to the Dutch homeland. And so the varnished picture is ready for a gilt frame:

• Kings around Europe regularly debased and clipped their nation’s coins, thus many people sent their bullion to the Netherlands which practiced a republican policy of ‘honest’ money, to protect their wealth from royal avarice.
• The Dutch state policy of providing ‘free coinage’ meant that more bullion was turned into coin than a free market would otherwise have produced.

Thus, the scene was pregnantly ripe for speculation and malinvestment in the usual bubble pattern of a typical boom and bust, which manifested itself in something quaintly Dutch; the buying and selling of Tulip bulb futures.

French explains all of this clearly and easily, providing lots of delightful historical anecdotes along the way to frame this fascinatingly baroque period of European history; this type of embellishment always marks a true student of Murray Rothbard.

However, Mr French goes far beyond Tulipmania, because the rest of the book then explains the extraordinary career of Scotsman John Law, perhaps the first real Keynesian and a man inspired by Tulipmania to create the Mississippi Bubble in France, which itself was the inspiration for those who created the similar South Sea Bubble in England, a story itself intimately connected with the early formation of the Bank of England.

These secondary episodes, however, are easily explained by Austrian Business Cycle Theory, involving as they do the creation of paper money, the instigation of legal tender laws and central banks, the forced confiscation of specie and fractional reserves, plus all the usual modus operandi stigmata associated with our more modern booms and busts.

To conclude, all three popped bubbles involved a government-sanctioned bank, large increases in the money supply created by these banks, and the now-familiar pattern of (1) Boom, (2) Speculation, (3) Crash, and (4) Financial pain — as currently witnessed on the angry streets of Athens.

In the final section of his book, French summarises the Austrian Business Cycle Theory and poses the question, “Do we want this boom and bust cycle to continue?”  If we do, we need merely continue with our current state-enforced system of central banking, legal tender laws, bailouts with money from thin air, nationalised money production, fiat paper currency, and fractional reserve banking.  (The next logical move is a global fiat paper currency, though it will do no good — the depressions will merely get even deeper and even longer, perhaps even becoming a permanent feature of all economies subscribing to this new global soviet currency.)

In the hard Misesian view, if we privatised money production then all of these things would disappear overnight to be replaced by 100% gold reserve free banking.  But would boom and bust also disappear, as promised to us in Britain by Gordon Brown, in 1997?

This is a question that I’ll leave you to answer to your own satisfaction, however books such as Doug French’s Early Speculative Bubbles and Increases in the Supply of Money may help you work out a suitable conclusion.

To my mind the first third of his book, describing Tulipmania, pays the entrance fee by explaining a state-instigated boom and bust cycle without a need for paper money. However, the final two thirds of the book are also worth a thorough read to complete the story.

And seeing as the entrance price is free, with the entire book available at the click of a mouse as a print-ready PDF, just what are you waiting for?