The Mississippi Bubble (1716-1720) was a complex series of financial operations in France devised by John Law to create a paper based monetary system and purge the vast debt of the French Monarchy. To accomplish this he created general fractional reserve bank and a trading company. His schemes generated great excitement in the all levels of the public in France and throughout Europe, hoping to cash in on booming stock valuations. And for a few, it created millionaires (the first time this term was employed) and for countless others financial ruin, when it collapsed. A large part of the financial collapse was brought about by John Law’s desire to eliminate the unmanageable debt of the French Monarchy.
John Law (1629-1729), Scotsman, was an expert gambler,
mathematic wiz, womanizer and convicted murderer, having killed a rival in a
duel. He narrowly missed execution by escaping from prison to flee to Europe, something
that was able to be accomplished when a jailor had received enough monetary
incentive. He dissipated his father’s extensive inheritance and was rescued
from debtor’s prison by his mother’s wealth. He, then with his superior mind, studied
math and its probabilities to become a formidable gambler. He earned a vast
fortune, granting access to the aristocratic elite, including the Regent of
France, Philippe II, Duke of Orleans, (1674-1723), as well as pursuing an
inquiry into the latest ideas about money; its creation, utility and nature. He cohabitated with a married woman, with whom
he had two children. His flamboyant life and scheme inspired many movies, book and dramas.
But it’s not this jaunty life that is of interest to this
student of history; it’s his complicity in the creation of an enormous
financial scheme and subsequent monumental collapse in France that intrigues me.
He’d made proposals to both Britain (where he was still wanted for murder) and
Scotland of his innovative financial systems. Both rejected him, as did Louis
XIV (1635-1715) in his remaining days.
However, upon Louis XIV’s demise he was able to gain the
confidence of the Regent, Philippe II, Duke of Orleans, uncle of the ten year
old child king, Louis XV (1705-1774). Philippe had slyly outmaneuvered other
rivals to gain sole control over the governance of the French Monarchy after
Louis XIV’s death and crowning of his 5 year great grandson.
Why should any of this be of interest?
The French Monarchy’s inability to manage its finances would
eventually at the end of the century lead to collapse of the monarchy and the upheavals
of the tumultuous French Revolution. The Mississippi Bubble’s failure is
critical to this development. After the
propagation of the War of American independence the French Monarchy was deeply
in debt once again and unable to pay the interest on this massive debt. Point
of fact, its debt service was far lower than Great Britain’s own debt, a
smaller economy. The failure of John Law’s national bank along with the ruin of
Mississippi Company destroyed any feasibility of managing and servicing
expanded debt under fractional reserve banking in the style of the Bank of
England. That institution was a reserve bank, holding only portion of its
deposits as specie, a tangible medium of exchange and store of value. It was
able to multiply financing ability of the deposits; yet meet the demands of its
customers to redeem their deposits in gold when desired. Despite many challenges
it financed Great Britain’s wars, principally against France, through the 18th
that encumbered France with debt and brought on revolution.
As a result of these financial disabilities, Louis XVI would
resort to summoning the three orders of Church, Nobility and Commons together into
an Estates General in 1789 to raise taxes to finance the debt. Instead of
financial stability it opened the gates to upheaval, chaos and revolutionary
war. And for a brief frenetic period 1789-1795 it introduced unbridled
republicanism and destroyed the ancient monarchy and the nobility and
expropriated the vast assets of the Church.
***
Many today think John
Law a visionary, who anticipated our modern financial economy. Nevertheless, John
Law would be scorned and pilloried after the collapse of his financial scheme
in 1720. His contemporaries reviled him. I will do little, as some have tried,
to refurbish his contemporaries’ assessment of his system. The goal of his
financial system closely resembles our current, modern fiat financial system,
but led to excesses and financial collapse.
There are those at present who have predicted our own
financial collapse over the past couple decades; those include the Austrian
School of economics who look askance at these complex monetary arrangements
that prop up modern economies. Nonetheless, this financial system continues to
maintain itself, in contrast to those who view our financial system as a house
of cards. I suspect our financial system
will work until it doesn’t; meaning to say that all fiat currencies fail
eventually and so will ours but no one knows when. Crypto currencies are
largely a hedge against this failure as gold acts as well.
***
John Law largely had to formulate his own ideas regarding the
yet nascent field of economics. He saw that the society suffered for the lack
of circulating currency. The gold specie that did circulate was degraded,
shaved and devalued principally by the monarchy. Silver because of its
abundance, especially sources in the New World owned by the Spanish, was
inflationary. John Law wanted to lubricate the wheels of the economy with
plentiful sound money, as he saw the Bank of Holland do, issuing reliable bank
notes backed by specific measured weight of gold. This avoids the clipping and
debasing in general that all were employed in, governments and private
individuals despite the capital penalties.
Before I go further let me explain, bank notes as you might know are the way banks create money, in a manner of speaking. They issue notes or better described as loans, on the promise to pay later. They are utilized to acquire goods and rights of ownership. Banks charge interest on these notes and thus are enticed to generate as many of these are practical. Banks haven’t been able to create actual bank notes that circulate as legal tender since the American Civil War. But commercial and consumer loans play much the same role. Banks without oversight will often produce loans far in excess of the actual cash and cash equivalents on hand such as US Treasury Notes and the like to back up their deposits. When there’s a run on the bank, the system fails. Like I say this works until it doesn’t as in 2008 or most dLife” without Jimmy Stewart to hand out cash in dribbles to obliging customers. The whole accordion collapses unless the taxpayer comes to the rescue to bailout Wall Street Bankers; little to their taxpayer’s benefit, other than having another Great Depression averted. Profits go to the ones that created the mess. That’s the societal cost of fractional reserve banking.
What the U.S. Federal Reserve Bank purports to do, is to create
Federal Notes, that is to say dollars, backed by the full faith and credit of
the U.S. government. Of course no one has been able to exchange those notes for
gold since 1972 to settle foreign exchange transactions and individuals domestically
since 1933. So what is backing the Federal Dollar? Trust that others will
accept it for full value. That works until it doesn’t.
But this is the system John Law tried to establish in France
in a matter of a few years, a paper note system unbacked by the limitations of
an arbitrary metal like gold. Some today call it visionary. When the scheme
collapsed, France called it a swindle, cheat and scam.
After creation of a bank Law’s scheme was to expunge the
massive debt of the essentially bankrupt French Monarchy brought on by extravagant
building programs, especially the palace Versailles, and a succession of wars
carried out by Louis XIV. This debt was previously financed by a group of wealthy
aristocrats, employing third party front men, the hated financieres (bloodsuckers-sangsues).
The French Monarchy owed over two billion in livres and had
over 90 million livres due in annual interest. Outrageously, future tax
receipts up to 2 or 3 years in the future were assigned away to pay current
expenses, as well. These dire straits lead the monarchy to devise various artifices
to reduce this debt. One was to convert the debt to a perpetual annuity paid
over a lifetime or simply in perpetuity. The one holding the debt had little
recourse since it was that or having your debt forfeit.
Various floating debts, not specifically assigned to tax
revenues, were arbitrarily and drastically reduced from 597 million livres to
198 million livres, shortly after Louis XIV’s death in December 1715. The 198
million was converted to what were called billet
d’etat (literally debts of the state).
These will be discussed shortly.
Between December 1713 and December 1715 prior to Law’s
arrival, further chicanery by the monarchy involved devaluing the currency to
14 livre from 20, so coin or specie was re-calibrated in relation to the
currency of account, livre-d’or. This
devaluation was eventually reversed as being seen to be detrimental to the
economy. This re-evaluation involved bringing your coin in to have it stamped
as “reformed”. A fraction of the coins (25%) were retained by the royal mint.
So if someone turns in 10 coins to have stamped only 8 came back revalued at 20
livres. The Crown argued they’d gotten 160 livres in return for just 140. In
effect it was a cheat and a tax.
The Monarchy would reap additional funds under a Chamber of Justice on March, 1716 that
was setup to mete out punishment on the “financieres”
for their cupidity and profiteering. This was a ploy used several times by the
monarchy, held previously in 1601, 1607, 1625 and 1661. In this case there were
no executions just tenure on galleys, imprisonment, periods of being locked in
the stocks or pilloried. This had a dual purpose of squeezing more funds from
them in a new tax of 220 million livres.
If the Monarchy wanted to engender trust in its financial
dystopia, the above flimflams were not the way to do it.
The Regent consents to Law’s ventures. Law establishes the
bank in May, 1716 as mentioned. The bank before it was taken over by the
Monarchy in Dec 1718 was stable. However, there were very curious operations
indeed. Only 825,000 livres were actually paid in to establish the bank of
which 450,000 were the heavily discounted (60%) the aforementioned Billets d’etat, accepted at full value and
375,000 livres as coin or specie. In the ensuing period to December, 1718 the
bank repaid its initial shareholders a whopping 5,238,000 livres. One
contemporary analyst, the former Controller-General Desmarets, estimated the
bank would engender something like 45,000 livres on the fully valued 1,125,000 billets d’etat accepted as capital (true
value discounted at 60% was far lower only 450,000 as stated). Yet, dividends
and “return” of capital amounted to some 5,238,000 when the bank was
nationalized December 1718 into a Royal Bank. By this time the bank had
generated some 148,560,000 livres value in bank notes. Baring a large measure of investment into the
bank, this Bank was very thinly capitalized. Records of the bank were destroyed
so it can’t be stated with complete certainty that the bank had extravagantly
extended credit and written bank notes they couldn’t cover but it would appear
so.
The Mississippi
Company
After the successful creation of his bank, Law had bigger
visions. He envisioned relieving the French Monarchy of its massive debt. A
trading company, titled the Company of the West, was established in August
1717, later to be referred to as the Mississippi Company, representing a
monopoly of French trade with the New World. The French lands in the New World,
largely what would become the Louisiana Purchase in 1803, were touted as a
cornucopia, a land of great potential. As Law ran the Mississippi Company,
glowing reports about Louisiana began to appear in the official newspaper, Noveau Mecure. Louisiana was described
as a land of milk and honey, where the climate was temperate and soil fertile,
the woods possessed abundant materials for building and export, and the
countryside rife with wild horses, buffalo and cows. The ground swelled with
seams of gold and silver ore and copper, lead and mercury could be found. The
natives spoke of an enormous dark green rock, very hard and resembling an
emerald near the Arkansas River. Great rewards would arise from these domains.
New Orleans was founded in 1718, as an impetus of the
Company. The official reports in 1719
described it as a prosperous town of 800 very prosperous and well-appointed
houses, each with 120 attached acres. Further mineral finds exceeded all
expectations, stating that samples had revealed themselves to be of the highest
purity. “One scarcely finds the same quantity in the richest mines in Potosi”,
wrote the Noveau Mecure, the official
news of the monarchy. The information regarding the Company went far beyond any
standard advertising puffery; it was outright falsehoods. The public was led to
believe that the rewards from the Company would easily support elevated price
levels of its stock. Law is not on the
record anywhere refuting these specious claims.
The public became feverish about the prospects of the
Mississippi Company. In a scheme to enrich the original shareholders, of whom
the Monarchy and Law were substantial investors indeed, a series of three stock
sales were offered. Only owners of the original shares could participate in the
purchase of the subsequent shares, which could then be offered to the public at
large. The shares could be purchased by the heavily discounted billets d’etats that the Monarchy issued
for the drastically reduced debt.
In March, 1718 payments in silver valued over 600 livres
were outlawed; only bank notes or gold were deemed legal currency. Here Law is
making a step to establish a paper monetary system.
In December 1718 upon Law’s suggestion his bank was
converted into a Royal Bank. The original shareholders were repaid with specie
(hard currency, gold that is) and the billet
d’etats, paid to subscribe to the banks shares and those held by the bank
were converted to shares of the Mississippi Company. The King’s Council was
granted sole authority to issue bank notes. These bank notes were promised to
be exchangeable into ecus of the bank
or livres tournois (specie). Branches
in Lyon, La Rochelle, Tours, Orleans and Amiens were setup. Law hoped to
establish a nationwide financial system.
John Law publically pledged to support a second stock issuance
of 50,000 shares priced at 550 livres. Interestingly, only the owners of the
original stock issue could purchase the new issuance at 4 old to 1 new. The
scheme here was to allow the original shareholders to purchase the shares in
ten installments. Once the initial payment of 50 livres was paid the original
shareholder could profit by selling the new shares now worth 650 livres. Law
was making sure his investors would prosper. Reminding the reader that the
original shares were purchased in partial installment with the heavily
discounted billets d’etats accepted
at full value.
The Royal Bank facilitated the purchase of these shares by
issuing 160 million livres of bank notes in the first six months of its
existence by June 6, 1719. Later in June the Royal Bank had issued 400 million
livres of bank notes principally to purchase Mississippi Company stock. The
price of the stock was skyrocketing and the public was in a fever to get into
the action.
This scheme was genius because Law was essentially operating
on both sides of the equation. He ran the Royal Bank that issued volumes of
bank notes to purchase the Mississippi Company’s shares that were skyrocketing
that he and principally his investors including the Regent were party to.
Law understood that eventually, sooner than later the Regent
would draw on the Royal Bank and the Mississippi Company, a dependency that this
thinly invested scheme wouldn’t sustain. That is to say the Monarchy was still
running a current accounts deficit in its daily expenditures. What remained
outstanding for the Monarchy was massive debt related to the annuities
(referred to above), remaining billet
d’etats and shares of the tax operations farmed out to the financieres.
In a masterstroke Law proposes converting the debt of the
Monarchy into debt of the Company. The company would lend the King 1.2 billion
livres at a 3 percent interest rate. Action
rentieres (annuity stock of the Company) would be issued for the Monarchy’s
debt paying 3 percent annual interest. Poof! No more Monarchial debt! Or so
they hoped.
One device boosted the demand for the Companies stock. Shares
were allowed to be purchased on installment with a small fraction up front. Law
expanded the money supply from 400 million to a billion livres by the end of
December, 1719. An immense, unbridled monetary expansion was worked by Law. By
the end of the year 600,000 shares of the Mississippi Company, valued at some 5
billion livres, had been issued largely financed by the Royal Bank under Law’s
supervision.
By May 1720 the Royal Bank has issued an astounding 2.6
billion livres in bank notes, principally to prop up the stocks of the
Mississippi Company. Inflation is always and everywhere a monetary phenomenon. This monetary eruption engendered high
inflation. On a fateful May 21, with inflation raging, a royal edit announced
that the 100 livre notes would be worth 80 on July 1 and only 50 at the end of
the year. And respectively the Company stock would be reduced from 9,000 to
5,000. The uproar over this draconian measure prompted the bank to close for 10
days. On June 1 only 100 livres notes were honored, soon to be limited to one
10 livres note per customer. (Think again of Jimmy Stewart as George Bailey,
handing out the $10 bills in his bank rush.)
It’s here when his “system” begins to falter that we see Law
effect acts in desperation. His actions could be categorized as wrongheaded or
foolhardy or very possibly those of a charlatan, who’s trying to cover up his
scam. Then again Law, if good intentions are assumed (road to hell is paved
with….?), might be described as a statist, dirigiste,
where he’s employed the monarchy to force France into an advanced specie-less monetary
system (fiat currency). To underline his approach, he initiated a campaign to
forcefully transport criminals, prostitutes, the idle, etc. to the Louisiana
territory, after the French failed to volunteer to colonize the Louisiana
Territory.
And so in 1720 there’s this bizarre struggle between
maintaining the elevated stock price of the Company and constraining the thinly
backed Royal Bank. It’s when word gets back to France that the Louisiana
territory is a wild waste land and most of the settlers to New Orleans sent in
1718 have returned in despair or perished that Law works to maintain the stock
price of the Company at 9,000 livres by financing it with bank notes, drawn on
a colossally overleveraged Royal Bank.
Law clumsily attempts to force France into a purely paper
currency by first decreeing bank notes are the legal currency over 600 livres.
He goes onto in turn to cease financing the Company stock purchases and the
stock takes a sharp nose dive. He then does a 180 and begins to refinance stock
after a short hiatus held to price of 9,000 livres. After the above Royal decree devaluing the
currency and the Company stock, a run on the Royal Bank on May 21, 1720 when
attempting to exchange the depreciated bank notes for specie, Law will rule
that specie is no longer legal tender; eventually when bank notes have become
wall paper, he will decree that the notes are no longer legal and only gold is
the legal tender.
In the end thousands of people, including those across
Europe, are left with worthless bank notes that can’t be exchanged for specie
and Mississippi Company stock that is almost worthless. Fearing for his life
Law absconds out of France, leaving his wife and family behind for the time
being. His wealth remains in France. He is lucky he didn’t suffer capital
punishment or assassination before he could escape the country.
There were those sufficiently sophisticated that cashed out
with huge profits prior to the collapse, most notably Richard Cantillon, a
close business partner of Law and economist in his own right. When the general
bank was converted to Royal, it was seen the initial investors profited
immensely, having invested originally in deeply depreciated billets d’etats with investment paid in
installment. John Law, himself lived relatively modestly in Paris but had
purchased twenty some properties within France from his profits, none of which
was he able to retrieve monetary reward upon his hasty departure, when the
system collapsed. His scheme did enrich those close to Law, including the
Regent, and Law as well for a brief period. Does that make him simply a
charlatan? Law did operate outside of societies conventions: Murder, gambling,
womanizing, cohabitating with a married woman. He generally gets a pass because
for him personally he didn’t gain but that’s only because he was run out of the
country.
In my estimation his vision was so expansive it rises about
mere flimflam. In contrast to Cantillon, Law like a true Statist felt he could
use coercion to force success of his plans. He violated basic economic principles
in pursuit of his idyllic goals, after generating massive inflation and
creating a mirage of value out of the lies that built up the Company. He attempted
to force France into a fiat paper financial system, some four centuries ahead
of time, all the while wiping out the Monarchial debt in what would become worthless
Company Stock. Too be accurate, temptation of paper currency is very compelling;
the French Revolutionary government devised paper
money called assignats, supposedly
backed by confiscated Church Lands, whose nearly unlimited production,
generated run-away inflation. The American Revolution with its Continentals,
backed by the empty promises of the Colonial governments, imitated the same
process of printing IOU’s or paper notes; they became largely worthless.
There’ s a number of observers of Law and his Mississippi
Bubble who want to characterize him as a farsighted misunderstood genius,
sabotaged by the powerful financieres
, some kind of modern financial wizard, but the real consequence of his
disaster was to destroy any hope of France to have an advanced banking system
in the 18th century. France would encounter continued financial
challenges that would finally end the monarchy but worse lead France into a
chaotic revolutionary period of upheaval, riot, destruction, executions, mass
murder (Vendee revolt), and decades of revolutionary war with its neighbors. He
had a vision, but ill-informed and malapropos was his execution of that vision.
He took giant leaps and even greater missteps.
