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Douglas French Interview

May 16, 2012, 5:40 PM

1. What defines the difference between the Austrian versus the Keynesian approaches?

Ludwig von Mises wrote, "The essence of Keynesianism is its complete failure to conceive the role that saving and capital accumulation play in the improvement of economic conditions."

Keynes believed that people are too future oriented, save too much, under consume and because of the unused savings the flow of money is interrupted and leads to unemployment with unemployment reducing society's income.

Keynesians see a recession or depression as a lack of aggregate demand and insist that the government fill the breach to spend and consume if consumers and businesses are saving more and consuming less.

Keynesians fear that as people save and under consume, businesses lay off workers and laid off workers can't consume as much and the process spirals into a liquidity trap that an economy never emerges from.

Austrians see depressions and recessions as the healing that must take place after a malinvestment boom created by the Keynesian monetary policy that forces interest rates below the natural rate, leading to stock market booms, housing bubbles, higher prices and the like.

What Keynesians fear, Austrians cheer: increased savings (hoarding) helps facilitate the process of deflation, leading to lower prices especially in the early stages of production. The assets don't go away, they just change hands as debt is liquidated. The increased savings speeds up the corrective process as the structure of production changes to reflect what consumers really want.

Unfortunately, Keynesian policies focus on bailing out industries with excess capacities and were malinvestments. Lower interest rates and tax credits for auto and home purchases only delay the required downsizing of these industries for instance.

Savings should be encouraged to hasten the rebuilding process, capital cannot be created by government, only through the delaying of consumption and saving on the part of consumers and businesses. Forcing rates lower keeps people from saving and less capital is accumulated, delaying the recovery.

2. There is a book titled “Why Austrian Economics Matters.” What is the answer?

Civilization is built and progresses by the accumulation of capital and the division of labor. When government intervenes this process is interrupted. Resources are misallocated and society is not only made worse off, but the process of civilization stops and begins to devolve. It is the Austrian school that recognizes this.

3. Are there any valid parts of the Keynesian Approach?

I haven't found any valid parts. However, I would say that Keynes was quite adapt at turning a phrase and wrote some interesting things about speculation in chapter 12 of The General Theory.

4. According to the Austrian approach, what is the real cause of the 2008 meltdown?

The 2008 Meltdown was the bust of the housing boom created by the cheap money policies engineered by the Federal Reserve in response to the Mexican debt crisis of 1996, the Asian Contagion of 1997, Long-Term Capital Management in 1998, the Y2K crisis of 1999 and 2000, the dot-com collapse, and finally the 9-11 terrorist incidents in Washington and New York.

Specifically after 9/11 the Fed lowered the Fed funds rate from 6 1/2 % in May 2000 to 1% on June 25th of 2003 and was kept there for a year, before being raised by a quarter in June 2004. Ultimately the Fed Funds rate was raised to 5.25% in June 2006. The housing market peaked in 2006 and has been correcting ever since.

5. Why haven't the Obama stimulus programs and QE succeeded in stimulating the economy and easing unemployment? Why aren't banks lending? What is the likely impact on gold and silver prices in the short- and long term?

Like the Japanese have been doing for 20 years, the Obama stimulus has been directing money into not what consumers want but what government wants. It's been money for infrastructure, green energy, education, cash for clunkers (cars), tax breaks for home purchases (housing). This does not reflect what consumers want to consume. Because the structure of production hasn't been allowed to change, failed businesses are being propped up, but aren't expanding and thus unemployment is high and the number of people on food stamps is over 42 million a new high. Government has only stimulated dependence on government.

Banks aren't lending because they are still writing off bad real estate loans. Healthy banks won't make new loans when they can buy failed banks from the FDIC and assume the loans on the failed banks' books with a government loss-sharing agreement. Also, bank regulators are being very tough on banks in terms of their credit decisions. Banks have plenty of money to lend but no reason to lend it for the moment. There is a lack of credit-worthy borrowers, the bread-and-butter business of the last two decades--real estate lending--has gone away and buying failed banks is a better business plan. This process will likely take years.

The more government props up failed businesses and stands in the way of asset and consumer price deflation, the better it is for gold and silver prices long term. Short term, who knows.

6. Paul Krugman says that if not for the bailouts etc. we would be in a depression and that we need more QE? How is that view looked at by the Austrian approach?

Austrians would say that the recession/depression would be have been deeper without the government intervention because the boom was so overblown the needed correction was massive, but that if left to correct without the bailouts and stimulus, the economy would already be recovering.

7. Is it possible theoretically for a government to “fix” economic problems? Is there any way they can try to do it without making gold even more appealing investment?

Mises pointed out that any government intervention leads to unintended consequences that the government will then have to counteract with further interventions. The cycle continues until the government takes complete control of an economy. There is no third way. Governments have been meddling with economies for centuries and gold has proved itself to be the only harbor of safety.

8. Are we heading towards a Japanese-style deflation?

What Japan needs is deflation and that government hasn't allowed prices to adjust. If you look at consumer prices in Japan for the last two decades, their CPI has been essentially flat. That's not deflation, no matter what Paul Krugman may call it. Meanwhile the Japanese money supply has exploded. Japan has had a high savings rate and is a net exporter; this has kept Japan's economy from melting down. But, it may not for much longer with their debt at 200% of GDP. The United States doesn't have the savings rate and of course lives on other country's products. It will not be near as pleasant for the US when the dollar is no longer the world's reserve currency. The US situation may be more like Greece's or Ireland's than Japan's.

9. Mises was a proponent of the gold standard. Is that practical or feasible in today's global economy?

It is. All the objections to the gold standard are the reason to have a gold standard. Some say there isn't enough gold. However, I remember Murray Rothbard telling us in class that you could have a gold stand with one ounce if you wanted to. It may not be practical or feasible in a political sense (because governments like to control the printing press to pay for wars and domestic programs) but a gold standard is feasible and likely inevitable, whether governments and Keynesians like or not.

10. How do you explain the rise of gold in terms of Austrian economics? What do you think about gold and other precious metals as an investment?

Austrians would explain the rise in gold prices as investment entrepreneurs seeing an opportunity and exchanging paper money for gold and silver. Investors see central banks around the world devaluing their paper and digital currencies, government bonds yielding virtually nothing and selling at bubble prices, stock prices being elevated despite all that is wrong with the economy. Gold is a logical place to store wealth.

Personally I view owning gold not as an investment but as a place to store savings when the world is uncertain--which is all the time. Some periods of time are more uncertain than others--now is one of those times. Also mining stocks should not be viewed as a substitute for holding gold. Mining stocks may be a great buy, but a person still has to consider the business fundamentals of the mining company they are considering. There is enormous risk to turning a ton of earth to pull out mere grams of yellow metal, only one of which is the price of the product.

11. Should gold have some sort of a role in global monetary systems as suggested recently by the President of the World Bank Robert Zoellick?

The market should decide what money is. Governments should exit the money business completely. There should be no such thing as a world monetary system anymore than there should be a world soda pop system.

Having said that, it's great news that Mr. Zoellick has broached the topic of gold.

12. Is there a substitute for fiat money?

Fiat money always finds its intrinsic value which is zero. Gold and silver have proven to be the only reliable currencies throughout history. It will be proven again. Not to say that another metal or substance couldn't be money. Exchange demands that a scarce good be traded for another scarce good. Governments and central bankers are doing all they can to make (fiat) money non-scarce.

13. You did some unique research on Tulipmania. What can be applied from history to today's situation? Would you agree that long-term investing with most of one's capital and using only a part of it for speculation is a good idea for most investors?

Most people are ill-equipped for investing mentally. Our brains get dosed with dopamine when we think a quick profit can be made, leading to a rush into bubbles while often bailing out because of fear, hoping to avoid regret.

Who has time to learn the Wall Street game anyway? Being glued to CNBC and checking on your stocks every hour on the internet is no way to live life. That is what's so spiritually awful about the Fed's monetary policies--everyone feels like they must speculate just to keep up--making them susceptible to chasing bubbles and being pounded financially in the crashes, which is mentally debilitating as well.

Spend less than you make, buy a few coins when you can, put them away and forget about them is a better way.

14. There is a lot of confusion regarding this one important word - would you define "inflation"?

Inflation is an increase in the supply of money. Of course, in modern terminology, inflation refers to price increases--but this is a result of inflation--not inflation.

15. There has been a resurgence of interest recently in the Austrian School of Economics. What is the reason for that and do you see the school becoming mainstream that the theory widely taught in universities?

There is a resurgence because of the financial meltdown. Young people especially are looking for answers that are outside the Keynesian nonsense they have been taught in school. Traffic on has grown tremendously since the 2008 crash as have book sales through our store. Mises, Rothbard and Hazlitt are selling more books than ever.

However, I don't see the Austrian school becoming the dominant theory on college campuses anytime soon. Colleges are not market driven. The Keynesian professoriate have tenure and will continue to teach what they believe to be right from their warm campus cocoons. On the other hand, Wall Street is market driven and the Austrian school is very popular in investment circles.

The entire state-sponsored college education system is slowly crumbling with online and other avenues of education taking over. When employers begin to judge young job applicants without leaning upon expensive diplomas to drive their decisions, then the upper education apparatus will fall apart completely and then the Austrian view will become dominant.

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