John Law's 'Mississippi Bubble'|
November 27, 2012
This article was originally printed in Bank Note Reporter.
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In the last two years four nice examples of bank notes connected with French North America, aka La Louisiane, have been offered in the United States by Archives International, Heritage Auction Galleries and Stacks Bowers. These unremarkable notes and their siblings contributed to the bankruptcy of 18th-century France. They were a product of the economic theories of Scotsman John Law.
Financial commentators such as William Bonner and Addison Wiggin have drawn parallels between events surrounding Law’s note issue and the Global Financial Melt Down of 2007-08. There are also strong similarities between the financial crisis of 18th-century France and those happening in Europe today.
Wine, Women and…
John Law came from 17th-century family of Scottish goldsmiths/bankers. He joined the family firm at age 14. When father died in 1688 Law took off for London determined to spend the family fortune on wine, women and song, with song being optional.
In this he proved singularly successful, winning and losing large sums at gambling.
On April 9, 1694 Law killed Edward Wilson in a duel. He was arrested, charged with murder, found guilty and sentenced to death. His sentence was subsequently commuted when his offence was adjudged manslaughter. Wilson’s brother appealed and Law was re-imprisoned. He escaped and fled to Europe.
For the next nine years Law spent his time making a fortune at gambling. He had a superb mathematical brain and found he could calculate the odds very quickly at faro. He won enormous sums—without cheating—before being politely but firmly asked to leave a succession of European cities. Louis XIV personally signed his expulsion order from Paris.
Returns of the Prodigal
In the early 1700s he returned to Scotland to take part in the debate over the Treaty of Union. He found the country in a financial crisis with the savings of many Scots wiped out.
Law proposed getting the Scottish economy moving again through creation of central bank that would issue paper money backed by land, gold, and silver. The canny Scottish parliament rejected his ideas and Law returned to Europe to increase his personal fortune at the faro tables. When Louis XIV died in 1715 the way was clear for him to return to France.
The new monarch, Louis XV, was just five and the regent was one of Law’s old gambling buddies, the Duc d’Orleans. France was close to bankruptcy through the excesses of the Sun King such as building Versailles and fighting—and losing—endless wars with the likes of William of Orange and the Duke of Marlborough.
The accumulated debt totaled some 3 billion livres. Given the country’s annual tax take was just 145 million livres and the annual interest payments on the debt were 120 million livres, France’s financial situation was only marginally better than Greece today.
The French wars had been financed by the issue of billets d’état. These had become tantamount to junk bonds with their holders pressing for payment. The Duc was desperate to avoid default and collapse. This “anything” led to hiring Law as France’s Contrôleur Général des Finances enabling Law to put his notion of a central bank into practice.
Law argued that money generates wealth by changing hands. For example, a faro player wins 100 livres. He uses it to replenish his wine cellar. The vintner buys a ring for his mistress and the jeweler has a night on the tiles. The 100 livres have circulated with everyone benefitting.
This notion was the opposite what the French upper class did. They sat on their capital and lived off the interest. Law proposed getting these savings circulating. This, he told the Duc, would renew France’s wealth.
Law also instituted many reforms including abolishing tolls on roads and canals and reviving overseas commerce. To finance these plans he founded a government-chartered private bank on May 5, 1716: Banque Générale Privée. It had a capital of 6 million livres. He issued stock in the bank and initially exchanged shares for junk billets d’état. This retired some debt.
He now printed new paper money to compensate for a shortage of gold and silver. These notes were in part backed by bank deposits but largely underwritten by the monarch. The bank accepted deposits in coin but issued all loans and withdrawals solely in the newly printed paper. The success of the bank was assured when the Duc declared all taxes must henceforth be paid using Law’s notes, i.e., these private bank issues had become French legal tender.
Law issued his notes at their full par value in gold. He also insisted they be redeemed in specie at face value. The French bought into the scheme to the extent that within a year the notes were trading at a premium of 15 percent over face.
As Law had anticipated, the sudden upturn in money supply kick-started the French economy. If Law had stopped at this point and begun to pay off the nation’s debts, France might have prospered. But he now believed he could eliminate the entire Crown debt in one fell swoop.
He approached the Duc and obtained a monopoly over trading rights on France’s La Louisiane in general the Mississippi in particular. Today this scheme is known in economic lore as the Mississippi Land Scheme or Mississippi Bubble. Charles Ponzi and Bernie Madoff would have admired the way it played out.
With the Duc’s blessing Law set up a joint stock trading company named Compagnie d’Occident. It was granted a trade monopoly not only in North America but also the West Indies.
Initially Law offered shares solely in exchange for the Crown’s remaining junk bonds but he then went public. He hyped the wealth of La Louisiane which, at the time, consisted of far too many alligator and mosquito infested swamps that had returned little of value to previous French companies.
So successful was Law’s sale pitch that everyone with any money—and many without—fought to get in on the act. This sparked a need for more paper notes. With the Duc’s approval the printing presses rolled. Suddenly 16 times the previous number of notes inflated the market. These new notes were not backed by gold but by those swamps in La Louisiane.
To sweeten the pot, in 1718 the Duc nationalized the Banque Générale and renamed it Banque Royale. It was now the world’s first central bank with its notes now fully guaranteed by the monarch. And, of course, when the company appeared to generate profits, investors were paid out in Banque Royal notes.
The Emperor's New Clothes
Law’s seeming Midas touch led to his venture being renamed Compagnie Perpetuelle des Indes with exclusive French trading rights not just in North America but China, East India, and South America.
Further the company now received the right to mint royal coins for nine years and was made royal tax collector for the same period. This was quickly followed by the granting a monopoly on all tobacco trade in countries under French rule.
The demand for a piece of the action led to wild speculation in company shares throughout 1719. The Paris mob underwent frequent feeding frenzies. Aristocrats, merchants, shopkeepers and farmers jostled cheek by jowl outside the company’s headquarters in tiny Rue Quincampoix, waiting for hours to see if their subscription applications had been granted.
The company’s directors soon realized they had a tiger by the tail. The share issue was oversubscribed six-fold. In just months the value of Compagnie des Indes shares soared from an initial 500 to 20,000 livres. For the first time the term “millionaire” entered the lexicon, spelt ‘le millionnaire,” of course.
The profits of the company were now manipulated by registering profits, not from non-existent trade, but from the issuing of new shares. Sound familiar?
In an ideal stock market an issue of new shares would dilute the value of those already existing. However the manic state of the 1720 French equities market led people to turn a blind eye. They mortgaged property and sold jewelry to buy shares.
At some point Banque Royale and Compagnie des Indes merged. This meant that there was now essentially no difference between the bank’s notes, Louisiane/Mississippi shares, and old government bonds. This was singularly apt. For some time Banque Royale had been extending credit to people so they could buy shares in Compagnie des Indes which the bank now owned. This entire situation has been succinctly described by market analyst Charles Sizemore as a self-contained Ponzi scheme.
Dies Irae Dies Illa
The day of reckoning was not far off. Questions were being raised about the real value of Law’s bank notes. As the presses continued to roll at Banque Royale, Law had constantly to manipulate the value of gold and silver to support the notes’ market value. Note holders were becoming suspicious.
And Law had enemies. In late 1720 they moved en masse to ask for their money back—immediately and in specie. Within days the French Government confessed that the number of notes issued by Banque Royale far exceeded the amount of gold and silver on hand. The bank was forced to stop payment on its notes.
In Law’s favor it must be said that for some time he had been trying to deflate the massive hyperinflation bubble his scheme had created. So dire were the inflationary pressures that they were crippling the born-again French economy as well as those of neighboring countries and even affecting England across the Channel.
Law attempted to stop the rot by devaluing the company’s shares. Unfortunately this enabled his enemies to buy them up wholesale and take over the company. The new owners now confiscated the shares of all those who had purchased their holdings with credit, thereby eliminating two thirds of the company’s shareholders at the stroke of a pen.
By September 1721 share prices had slumped back to where they had been at the beginning. Law was summarily dismissed from all his posts and fled France disguised as a woman to die in Venice eight years later in impoverished circumstances.
The inevitable deflation that always follows hyperinflation now wracked France. Over 1 million French families had purchased Law’s now worthless shares. His paper money was valueless. The country’s upper and middle classes were ruined. The monarchy was discredited. France was a basket case, its development set back decades. The scene was ripe for revolution.
Afterthought: John Law has been described as “The Father of Inflation.” That is quite unfair. Kublai Khan beat him by four and a half centuries and Johan Palmstruch had been there and done that in Sweden 50 years earlier.
William Bonner and Addison Wiggin, Financial Reckoning Day. Wiley, 2nd edition, 2009.
Stephen Clarke, 1,000 Years of Annoying the French. Transworld Publishers, 2011, pp. 288-292.
Charles Mackey, Extraordinary Popular Delusions and the Madness of Crowds. New York, 1841.
Available in a free Kindle version.
Antoin Murphy: John Law. OUP, 1997.
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