The Birth of Modern Economics: John Law, the Mississippi Company, and a French Financial Crisis

     Modern banking got off to a bad start. France’s economic downturn in the early 18^th century led to using the theories of John Law to establish the first national bank. It also led to the burst of the first economic bubble. Modern capitalism, from the start, was never a smooth and easy road to travel on. Economic booms and busts continue to be a hallmark of this particular system whose birth was traumatic to say the least. The mental character of the Scottish economist who introduced the concept of paper money should have been a good indication of where capitalism would go and eventually end up.

     By the 1820s, France was nearly bankrupt. After a lifetime of waging wars, the king Louis XIV had amassed a national debt that was impossible to pay off. The supply of valuable metals was dwindling which made the minting of new coins a struggle. Fewer and fewer coins were in circulation which made commercial transactions more difficult. Lucky for him, he died leaving France broke and poor but at least the old king did not have to watch the country he ruled degenerate into poverty and despair.

     The new king, Louis XV had only reached the age of five when he ascended the throne. By that time, John Law had been living in France for a little more than a year. Law came from a wealthy family in Scotland. His father had been an economist and as he got older he dreamed up a lot of economic theories. John Law was tall, handsome, and reckless; he loved to wear the finest clothes he could buy and once killed a man in a duel. He also gambled avidly. His personality may have indicated why capitalism took on the form it did.

     In 1716, John Law made a proposal to the royal family. It involved replacing gold with paper credit then issuing larger and larger amounts of credit to stimulate the economy. The paper credit would then be used for business investments. The French allowed him to open the world’s first national bank. Investors would supply the bank with gold coins and outdated government bonds. The bank issued its own paper money with its value backed up by the amount of gold or silver originally deposited by the investor. The value of these banknotes would remain stable as long as the value of the metals remained stable as well. The gold standard was born. After the establishment of this Private National Bank, Law used the deposited livres to start the Mississippi Company by issuing company stock, also corresponding to the value of the coins and metals held in the vaults of the bank.

In 1720, France owned the Mississippi Territory which stretched from the Southeast coast of North America up into a section of the Midwest. The United States later purchased it as the Louisiana Territory around the time of the Civil War. But in John Law’s day it was wild and rough land, barely explored and with little in the way of settlement. The Mississippi Company was established as a monopoly trading firm. They sold the story of fast, easy, and gigantic dividends for investors who were temped by tales of vast caverns of gold, money to be made from land speculation, and agricultural profits from the harvesting of exotic spices. John Law issued 5000 shares in the company at 500 livres a share with an initial payment of 75 livres due at the time of purchase while increments of 25 livres were to be collected monthly until the debt was ended. These stocks sold so quickly that a second batch were put on the market with the price doubled to 1000 livres a share.

     John Law’s mental wheels were not the only ones turning. Some smart businessmen began thinking that if the price of stocks in the Mississippi Company doubled so quickly, they would be valued for even more in the future. Speculators quickly bought up the next round of shares made available and sold them at inflated prices based on estimations of what they would be worth in the future. The bankers also realized that if they wanted more money themselves, all they had to do was issue more stocks in the company. Word got around Paris that buying stocks in the Mississippi Company at low prices that would yield extremely high dividends was a quick and easy way to get rich. Hordes of people descended on the street in front of John Law’s chateau so that every time a speculator emerged with a pile of stock certificates, a swarm of starry eyed buyers mobbed them and bought whatever they could. Stock certificates and cash changed hands rapidly and the economy swelled almost instantaneously. The cash flowed in many directions too; owners of businesses near the chateau profited themselves. Tavern owners made a bundle off dealers who had turned a quick profit. The word “millionaire” was coined at this time to described those who excelled at this buying and selling game.

     The money made from investments in the Mississippi Company was used to buy a fleet of 800 ships that would soon set sail for North America. There were very few French people who wanted to leave their homeland. Making easy money from stock dividends appealed to most but the danger of colonizing an unknown land did not. The royal family came up with an idea. During his wars, the previous king, Louis XIV, had conquered and taken possession of Alsace which was primarily inhabited by Germans. An easy way of getting rid of them would be to ship them off to Louisiana. They could do all the dirty work of settling the land while the French citizens reaped the rewards. This also led to a plan to reduce the prison population. Criminals were given the option of setting sail for the New World if they agreed to marry a prostitute and homestead the French owned overseas territory. Those who agreed were chained to the whore of their choice for the entire trip across the Atlantic Ocean and released as soon as they got ashore.

     They found that Louisiana was not a land of riches beyond belief. Instead of gold and diamond mines they found humid swamps full of alligators, mosquitoes, and malaria. The tribes of Native Americans were wary and hostile because they were tired of rapacious Europeans showing up uninvited on their shores. The Germans, criminals, and prostitutes who were forced to be colonialists did not thrive as a society and the Mississippi Company eventually went bankrupt.

     Meanwhile, back in Paris, some of the more clever speculators decided it was time to take the money and run. Some of them began to take their bags of cash to the Private National Bank and ask for the respective amounts of gold in exchange. Some took their specie and left the country to live like kings abroad while others buried their loot near home so that no one could find it. More and more people began taking their banknotes in and exchanging them for precious metals and eventually the bank began running low on gold. The realization that they had printed more paper money than they could back up set in. The bank decided to cut the value of gold in half. On top of that, the promised returns on investments made in the Mississippi Company never materialized. When thousands of people learned the stock certificates they held were worth nothing, they took what paper money they had and the first bank rush in history began. Even with the gold devaluation, the bank still did not have enough to back up the paper money. The downward spiral reached its nadir when the government passed a decree banning the use of gold currency.

     The hordes of people turned away at the bank formed a mob and marched to John Law’s chateau. Bricks were thrown, fists flew, and fires were lit. Soon the army was called in and started beating people and chasing them away. By nightfall, fifteen citizens had died in the violence and the rest went home to begin their new life of poverty.

     The government was furious with John Law. They arrested him and seized his property; twenty chateaus and holdings of land were the most valuable assets he had acquired by spending the money he had made in France. After liquidating these possessions, they used the money to pay back people who had lost their fortunes after the period of rapid economic expansion.

     Law was deported to Belgium. He used the remains of his fortunes to travel around Europe and ended up in Venice. Being the gambling addict that he was, he wasted the remaining money he had at the card table and died penniless in a poorhouse.

     Not to be outdone by their rivals, the English across the channel embarked on a similar banking and business venture that came to be known as the South Sea Bubble. In imitation of the French economic disaster, the English bubble burst in the same way.

      John Law, the compulsive gambler, probably never meant any harm. At least the idea of expanding an economy by issuing credit had far reaching implications that still affect economics today. It was, at least theoretically, beneficial to large portions of the world population. Whether you see this as a good or bad thing probably depends on where you stand financially right now. But if the trajectory of his monetary experiment and the course his life took in the end serves as an omen or a prediction for where capitalism is going, he may not be judged so sympathetically in the future

References

Ferguson, Niall. The Ascent of Money: A Financial History Of the World. Penguin Books, 2008.

Mackay, Charles. Extraordinary Popular Delusions and the Madness of Crowds, Harmony Books, 1980.