Odd Lots - How an Austrian Economist Explains The Tulip Bubble

Episode Date: September 11, 2017

The tulip bubble is the quintessential bubble. If you want to call something a bubble, just mutter something about tulips, and everybody will know what you're arguing. But what was the tulip bubble, really, and how did it form? To get a unique perspective on this historical episode, on this week's podcast we speak with Douglas French, an adherent of Austrian economics, and the author of a book on Tulip Mania. He argues that like many bubbles subsequently, this historical episode can be traced to bad monetary policy, which encouraged reckless speculation.See omnystudio.com/listener for privacy information.

Thanks for listening to Oddlots. Follow the show on Amazon Music for more future episodes or just ask Alexa play the podcast, OddLots on Amazon Music. Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway. And I'm Joe Wisenthal. So, Joe, did you know I went to Amsterdam this summer? I think I recall seeing some Instagrams that look pretty awesome. Okay. Well, yes, the Instagrams were awesome because of, It's a really gorgeous city. But I got to say, they take flowers pretty seriously there.

I'm pretty sure that's one of the things, too, that I remember from your Instagram. And that's sort of like, they're sort of famous for that. Like, just gorgeous, gorgeous horticultory. Is that a word? Horticulture of all types. Yeah. Yeah. But tulips is clearly a big part of that.

And Amsterdam and Holland is famous for growing varieties of. tulips. And in Amsterdam, they even have a tulip museum that I actually went to. I kind of think I know where we're going with this because we're still part of our bubble series of episodes where we look at famous bubbles throughout history. And of course, you're talking about Amsterdam's tulips. That's right. And we actually already teased this one in some of our previous episodes. I think I actually called it the quintessential financial bubble, which isn't entirely correct, I have to say, because although Tulip Mania has a reputation as one of the first ever financial asset bubbles, there are a lot of people that take issue with that description and actually

say it wasn't a bubble at all. It was a rational investing behavior for the time. Yeah, it's very controversial because, first of all, it is in a sort of pop culture sense, probably the quintessential bubble. Whenever you talk about another bubble, you always, hear people say, oh, this is tulips all over again. So I like when, you know, when we talked about the Beanie Baby Bubble on an episode a long time ago, they're like, oh, this is the new tulips. Whatever it is, people just sort of know tulips. But it is a very controversial episode throughout history. Obviously, it was prior to a lot of the financial press. So there's still a lot of an examination of what really happened. Yeah. And let me just lay the scene, I guess,

before we dig into it. So in the 1600s, tulips became this massive thing in Holland, as we all know. And there are these famous statistics about a single rare bulb trading for the price of a whole house in Amsterdam or one bulb being worth 12 acres of land, that sort of thing. And when we look at it retrospectively, we think why in the world were people paying that kind of money for what was basically an ephemeral thing? right? You have the tulip that lasts for a little while, but then eventually the flower dies. And unless you grow some more tulips out of it, it's this thing that just passes by really quickly. That's absolutely right. But you know, like, it's funny because obviously, supposedly people paid all this price for tulip bulbs, but they are really beautiful. So sometimes I wonder, it's like, maybe it's worth it. I mean, they're really nice. And you have to figure, like, most things didn't look very good back then. You know, 1600s, everything is sort of grimy and life was dirty. Like, maybe it was worth it. That's the romantic in you, Joe. All right.

So we're actually going to look at the tulip bubble today, but we're going to look at it from a slightly different angle. Never let it be said that we don't bring you something unique on the Oblots podcast. Today we're actually going to be looking at the tulip bubble from a sort of Austrian school of economics theory. This should be good. So we're taking one of the most sort of controversial bubbles, and we're going to look at it. through the lens of perhaps one of the most polarizing schools of economics. So I feel like that should be a, that's a winning combination right there. Yeah.

And can I just say the Austrian School of Economics is the only one that my dad, who is my barometer for all things sort of mainstream America has ever asked me about. He never asks me about Keynes or monetarism or anything like that. Only the Austrian School of Economics. I suspect he'll like this episode then. Yeah. All right. With us to discuss the tulip bubble is Doug French.

He is the author of a book called Early Speculative Bubbles and Increases in the Money Supply So You Can Sense the Austrian School right there in the title. Doug, thanks so much for joining us today. Well, it's my pleasure, Jill and Tracy. Let's start with, you know, we were describing the tulip bubble as the sort of classical market bubble. Walk us through some of the main thing. mainstream theories behind why it actually happened? Well, the mainstream theory is typically a gentleman by the name of Berber, who has done a lot of work on tulip mania.

And his view is that the rare bulbs tended to trade higher than the more common bulbs, and therefore, you know, it was very rational that people would, you know, trade up to a very high price, these more rare bubbles, or these more rare bulbs, I should say. He also would throw in the idea that there was a plague, and that essentially this was this was Cains' animal spirits in a way that people were just throwing caution to the wind. We're all going to die from the plague anyway, so let's trade in tulips. So that was kind of Gerber's view. Another view is a woman by the name of Ann Golgar. She wrote a book, Tulip Mania.

It's fairly recent 2007. And she said this is very limited. There were only really about 400 families who were trading bulbs, and it was an extension of their art collections, essentially. She believed that it was really no big deal. A few people were trading in these bulbs, and no one was hurt by it. There was no big financial crash that we saw, somewhat to say 2008, 2009 in the United States after the housing bubble. So those are generally – it's viewed as a curiosity.

In fact, Charles Kinderbarger, who wrote on manias and crashes, he – He refers to the Tula mania is really the first mania, first speculative mania, but he said that it lacked the financial framework that you normally would have. And, of course, that's when I did my work on Toulatmania, looking at it through the Austrian lens, as you put it, I found out that there was a financial aspect to this, and that's where the Austrians picked this up. So, Doug, I want to ask you, of course, what you see as the seeds of Tulip Mania. But before I do that, for our listeners who are perhaps unfamiliar, give us the sort of 90-second characterization of what Austrian economics is all about, so that when we talk about examining tulip mania from the Austrian perspective, what are the key ideas and tools that you use

to examine this historical episode? Well, the key idea that I used from the Austrian school was the Austrian business cycle, and that's what the Austrian school is most known for. That's what F.A. Hayek shared the Nobel Prize for in 1974. before he extended Ludwig von Mises's work on the business cycle. And that is that business cycles aren't something that just come and go, as most people think. They're like nature, like the seasons, things like that. It has to do with a government intervention in the money supply.

And when in the modern day view of this, the Federal Reserve lowers interest rates, expands the money supply, and malinvestments are created. In other words, entrepreneurs are fooled by the low interest rates. They believe that there's a lot of savings out there. They believe that there's a tremendous need for what the Austrians would call higher-end investments, say land. say housing subdivisions, say casinos, things like that. And therefore, you get money rolling into those sorts of investments. And eventually the demand that the entrepreneurs thought collectively was there ends up not being there. And we see just this mass number of errors all at once.

You wouldn't see this in capitalism. You see bankruptcies all the time when entrepreneurs are not good at what they're doing. But in a boom and a bust, booms tell them to elevate those that aren't very good at development, and it exposes them when the crash comes. That's, I think, what the Austrian school is most known for. And just as a note, the book I wrote, the book that we referred to earlier, I wrote under the direction of Murray Rothbard, who was a student of Ludwig von Mises. So I'm just carrying on a very long and famous tradition. So walk us through, so that was a great overview, but walk us through how that framework informs your thinking about the tulip bubble.

Well, as I looked at tulip mania, and I look at obviously everyone's work, and you kind of start with a book that a lot of people have heard of, extraordinarily popular delusions in the madness of crowds. It's an 1841 book by Charles McKay, and people have been reading this for, you know, for decades. And it has a few pages in it about tulip mania. And that's generally where people start. And the idea is that suddenly people were trading in tulip bowls, whether they be chimney sweeps or whether they be government officials or whatever they may be. And it just, you start thinking, well, is this animal spirits in the Keynesian view? Does it make sense in the rational expectations view of a Gerber who is essentially, gee, it made perfect sense, supply and demand.

There was less supply of the bulbs that were rare. There were more supply of the other bulbs, and those prices didn't go up. But I looked for another cause, and it turns out that the money supply in Amsterdam during Tulemania exploded. And exploded for a good reason. It was the Bank of Amsterdam, which created. And not that it created money out of nowhere, like modern central banks do. It actually offered something called free coinage. And free coinage was all money from Europe was flooding into Amsterdam because of golden silver discoveries in the new world.

Pirates were collecting booty on the high seas. There were coins that had been debauched by various kings throughout Europe, and they were all flooding into Amsterdam because the Bank of Amsterdam would coin them for little or no fee. And that was essentially what created a huge boom in the money supply. And when I say a huge boom, I mean 60% increase in the supply of money. right before tulip mania occurred. The Dutch economy, obviously, Amsterdam is very well located to seaport. There was much commerce going on there. It began to boom in 1631 and 32, and with all this money flowing into the economy,

it created a ripe environment for speculation from all types of people, whether they be the Golgars, Mennonite art collectors, or whether they, I'm not sure there were necessarily chimney sweeps that were buying bulbs, but all sorts of people, as they are wont to do, when things are going good, They want to speculate and trade and make a profit. So, Doug, here is a question that I have, and I've had this thought in regards to sort of Austrian theories of bubbles even more in the contemporary setting. So you draw the line between the central bank, or in that case, the Bank of Amsterdam, creating some sort of ultra-loose monetary conditions. that brings in the conditions where people want to speculate. But what I don't fully understand is

why does it go to these activities that appear so bubbly? So it's one thing to say, okay, that's going to create a lot of activity, but why couldn't it theoretically go to more conventional enterprises like opening up, you know, building new ships or sort of traditional channels, why does it go towards, you know, flipping these assets, very speculative vehicles? Because more people can participate in trading tulip bolts, whereas it would have been more difficult to, and I'm sure there was more money was funneled into shipping, but not a lot of people could, you know, flip clipper ships, if you will, at the time. you know, if you could get a hold of a tulip here or there, you might be able to,

you might be able to flip it, buy the next, the more popular tulip and trade from there. These trades took place in taverns. They were called colleges, interestingly enough. the Dutch were already very astute in futures markets, in the grains and so on. So a futures market took hold very quickly. And as you can imagine, they weren't trading flowers. They were trading the bulbs, and the bulbs were in the ground. So before anybody ever saw the flower, it was being bought and sold many different times. and so I think when when people think of Tuleomania they think oh you know they were trading these flowers that were only going to be in bloom for a week or whatever

but no they were trading the bulbs that were that were in the ground you know months before before they would see them and that's why it was a fairly short short-term episode it went from essentially 1634 to February of 37 but at the end you you had this huge blow off top where the wet wheat cruning bulb went up 35 times in the space of a month and then crashed, you know, in one single day. But that's an answer to your question. You know, more people could participate in a trading instrument like a tulip bulb. Also, tulips were fairly new to Amsterdam, although, you know, as Tracy said, the ten, is certainly known for it now. And you see pictures in the fields of tulips are extraordinary,

but they were actually shipped in from Turkey in the Middle East and other places. So they're a fairly new phenomenon to Amsterdam at the time. Yes, and one thing I learned from the Amsterdam Tulip Museum is that the tulips were highly associated with Oriental. at the time, probably because they were coming through the Middle East. So see, Joe, I did learn something. I never doubted that you learned something. Doug, I wanted to ask you, or just press you on the association between the tulip mania and the money supply, because, you know, one other thing I also learned was that the Dutch at the time, they kind of described this tulip trading as wind handle, which means wind trade in Dutch, because no bulbs or not many bulbs were

actually changing hands. People were just kind of trading the futures contracts. So I'm just wondering if you're trading this thing, but you're not actually trading the underlying, what's the association with the money supply? Does it track like one for one? No, I don't think it tracks one for one. But it does give people the confidence to trade in a speculative fashion because there's more money runs into an economy. And people see their neighbors getting rich, and certainly they want to as well, they're more apt to get involved in this. sort of speculation. I mean, when you create money, there's no telling where it would go. And so whether it goes into goods and services or whether it goes into speculation,

but then the next step in this is that then leverage is created. People want to essentially borrow. And as you point out, these bulbs were changing hands without really. changing hands, just the paper was changing hands. And that's essentially the leverage that was involved and that happens in all speculative bubbles. Interest rates went down. When you look at the history of interest rates by Homer and Scylla, Dutch interest rates declined sharply. There were a number of bankruptcies after this in my book. You know, if people were just trading a few bulbs and, gee, it didn't work out,

and they all went on about their business, then why did the number of bankruptcies in Amsterdam double from 1635 to 1637? So clearly people were putting a lot of resources into speculating in these bubbles. And it had a huge effect on the economy. And I will say, your timing is excellent. I don't know if you know this, but there is a movie coming out called Tulipa Fever. I would just go to say, I've actually seen that movie because I saw a screening for reviewers, and I have a review out, actually. And so I wanted to ask you something about the film,

and you talked about half of it, but to me was one of the most interesting things in there. So as you mentioned, and this was depicted in the film, the trading took place in taverns, the trading of these essentially tulip bulb futures. These were, there were a lot of, you know, sort of drunken people, very, you know, they're taverns. However, the actual bulbs themselves, and this is according to the film, so if I'm wrong on this, please call me out. The bulbs themselves were actually maintained by nuns in an abbey. And so you really have this dichotomy between where the finance takes place, which is this sort of like dirty, debauchous tavern,

but then the actual product essentially in this House of God is really showing the sacred and the profane meeting together in this trade. Well, I think either the movie maker or Ms. Mogosh took a little bit of license there with where the bulbs were stored. But I have no direct knowledge to refute that. So possibly it's true. It's just, but it is a guess. But I've read the book. It's a wonderful book, and Stephen Spielberg, it actually bought the rights back in 99 before the book even came out, and then I think it's changed hands, similar to the changing hands of a tulip bulb, if you will, and tulip fever is had a hard time getting off the ground, if you will, but it has a wonderful cast, and but I think what it depicts, I hope it depicts, and Joe, maybe you can confirm this since you've seen the movie, but this artist who has an extraordinary talent, and of course his subject is the love of his life, and of course that creates tension since she's married to an old evil guy, but he dropped his trade to

trade in tulips. He thinks they're going to get rich and live happily ever after trading tulips. And that's what happens during booms and bus. And I'm sure it happened during tulip mania. We saw this in Vegas when houses boomed in the mid-2000s. People who had perfectly reasonable jobs suddenly became realtors or house slippers or became mortgage agents. And that's what happens in all booms. It not only, there's not only the trading of the bulbs or the trading of the instrument, but people whose talents are best left for other things, they become involved in this boom. And I think it portrays that. That's a great point. That was portrayed in the film, and that didn't click to me at the time. But of course, as we've seen through many bubbles in

history. It does seem to be a common phenomenon, whether it's day trading in the late 90s, house flipping prior to the 2008 financial crisis, whatever it is, there are always stories of people leaving their jobs, essentially real resources, human resources, being sucked out of where they're most productive to engage in speculation. And that is indeed one of the points in the film. So I'm glad you brought that up because that specific facet hadn't clicked. A misallocation of human and financial capital. Absolutely. They're both malinvestments. You had a malinvestment of probably too many tulips were planted. Too many tulips were cultivated. And then you had the talent of individuals being siphoned off into this speculative area.

And as Joe said, the same thing happens in all booms. Now, before we go, one of the common themes, things that we see with bubbles is that, you know, they can be based on sound fundamentals and they often, several years later, can justify themselves. So obviously, you know, the internet bubble of the late 90s, the internet did, in fact, turn out to be a big deal. The housing bubble did create a large housing stock. And as Tracy mentioned in the introduction, Amsterdam today, there's a thriving, beautiful flower market still in Amsterdam. So what is the aftermath? Okay, then the bubble eventually crashed. You mentioned the bankruptcies.

How did things eventually stabilize? Well, Amsterdam obviously was a city that would eventually continue to thrive. The Bank of Amsterdam, however, changed. It had a very hard money policy, as I mentioned. Free coinage. People would put their money in the bank. And so it was 100% in bank, which us Austrians, we like that sort of thing rather than fractionalized banking that we have today.

But eventually, the Bank of Amsterdam would begin to loan out their deposit. and engage in fractionalized banking. And that gave an idea to a gentleman by the name of John Law, who would create 100 years later, or about 100 years later, the Mississippi bubble that then spawned the South Sea bubble. And I'm not sure you've gotten to those episodes yet. But actually, Tulip Mania and the Bank of Amsterdam is somewhat of a genesis for a gentleman named John Law. Well, I think that is a perfect way to end it. And Tracy, I think we definitely have an episode that we have to do now. Yeah, so many bubbles, so little time.

Doug French, the author of Early Speculative Bubbles and Increases in the Money Supply. Thank you so much for joining us. Well, thank you. It's been a real pleasure. So, Joe, I thought that was really fascinating. And I thought, you know, even though the Austrian school gets a lot of bad press, It's clearly had, you know, something of a revival or many people think it was vindicated after the 2008 financial crisis. So I think it's really important to kind of consider some past bubbles, especially a bubble as important as the tulip mania through that framework.

No, I totally agree. I really enjoyed that. And it's interesting, like, I think there's no question that in sort of mainstream economic discourse, Austrianism is considered to be crankish and all that. But it does seem to be to me that there's like I would call it a soft Austrianism that is fairly common. I mean, if you go back to our episode two weeks ago with Scott Nations, he specifically identified low interest rates as being something that was characteristic of all of the major U.S. stock market bubbles and stock market crashes. And I don't think there are many people, I think a lot of people who would consider themselves mainstream. would identify easy financial conditions as being an important factor in the rise of many bubbles. Yeah, there's a little bit of Austrianism in all of us, but especially me because I am actually half Austrian. But in all honesty, I think there's an emotional allure to the theory, right? Like, it kind of touches on something that we've spoken about before, which is that when you have a bubble,

you have this period of time where you can make a great fortune very quickly or you can lose a lot of fortune very quickly. And that kind of touches on this idea that it's sort of all being controlled by expanding or diminishing money supplies. So you can see how people would make that connection. Totally. One of my issues with it, and maybe I should have brought up with Doug when he was here because I don't want to criticize the theory of that. giving him a chance to respond. I've often found that there's a bit of when all you have is a hammer. So, you know, it's like there's this very distinct view that the sort of the errors and the malinvestments in any economy are caused by easy monetary policy. Right. And so then there's like, I've always thought there's perhaps a bit of a, you know, going back and sort of always finding why

it's a monetary policy phenomenon because that's where your worldview is based. Which, you know, and so everything sort of gets shoved into that. Nonetheless, I did think his perspective was interesting. And either way, the tulip bubble is a fun one to discuss. Yeah, and now we're, well, you've seen it already, but everyone else is going to have to go and watch the movie, right? Yeah, people should watch it. Look, it's the tulip mania, it's, is it the most amazing film? No, but I'll put it this way.

If you're an odd-lots listener, you'll probably enjoy it. That's a good way to put it. All right. This has been another edition of the Oddlots podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Allaway. And I'm Joe Wisenthall. You can follow me on Twitter at The Starboard. And you can follow our producer, Sarah Patterson, on Twitter at Sarah Pat with two T's. Thanks for listening.