What have Dutch tulips, the Mississippi Company of France, the English South Sea Company, dotcom and American real estate got in common? They are all examples of financial ’bubbles’: initial euphoria gives way to the realisation of exaggeration and disillusionment, followed eventually by the bursting of the bubble.
In the National Bank’s museum there are two old banknotes: paper inscribed with black letters and numbers on a simple white background. Made by the Imprimerie Royale, watermarked Billet de Banque.
However, the story behind this banknote contrasts with its simplicity: it is a fascinating, surprisingly topical story which also shows that people are not very quick to learn from earlier mistakes.
This month’s object concerns Law’s banknotes.
John Law was a Scot, born in Edinburgh in 1671, son of a goldsmith who was also involved in banking, not unusual in those days. After completing his studies, Law moved to London.
He was evidently a good-looking man, sporty, eloquent, a “dandy” who was attractive to the ladies. He aspired to a wealthy lifestyle, but because he could not afford it he started gambling. And he did it with panache : he had a very good memory, and thanks to his exceptional talent for figures and mathematics he made a lot of money.
However, on 6 April 1694 his life took a dramatic turn. He killed his opponent in a duel ; he was sentenced to death (duels were prohibited) but managed to escape from prison two days before his execution and fled to the continent. For the next ten years he travelled around Europe : the Netherlands, Italy, France and Scotland, hard to trace because, certainly at first, he kept a “low profile” so as not to be arrested again. He continued to make good money out of gambling and built up a circle of acquaintances who would later be useful to him (including the French Regent, Philippe d’Orléans). He also became increasingly interested in banking : in the Netherlands he studied the operation of the Amsterdam Exchange Bank and the United Dutch East India Company (VOC).
The two things worked together : bankers accepted shares as collateral for loans, and conversely, it was possible to borrow in order to buy new shares : an interaction between the stock market and lenders, a new sort of economy that captivated Law.
With these new ideas, Law devised a system based on the use of paper money which could even restore a state’s public finances. He was convinced that credit was necessary for an economy to work well : if a trader had 100 000 livres and could obtain credit equal to ten times that figure, that was bound to be good for the country’s prosperity. An economy that only uses silver and gold as collateral is trapped and can only stagnate.
This led him to present to the Scottish Parliament his Proposal for supplying the nation with money by a paper credit, which also formed the basis for his book Money and trade considered. This was Law’s most important work in which he used new terms such as inflation, money supply, velocity and the relationship between money and labour. His ideas on taxation were actually revolutionary : everyone had to contribute, including the clergy and the aristocracy. Law’s works are still studied and analysed today. They show that he was ahead of his time.
But the proposal was rejected, and in the end the French Regent was the only person prepared to try out the system, albeit with some initial misgivings. The reason was obvious. After the lengthy reign of the Sun King, Louis XIV, the State coffers were completely empty and France had a huge mountain of debt.
Law began by setting up a public bank which issued paper money against deposits of gold and silver coins, denominated in ecus which represented a fixed weight of silver. In the preceding years, the government had changed the nominal value of silver and gold about twenty times, so everybody welcomed a fixed price. Thanks to this strict regulation, the Banque Générale (1716) was an immediate success and people gained confidence in paper money.
Law then proposed to the French government that a number of existing businesses should be merged under the name Compagnie d’Occident, later also known as the Mississippi Company (1717).
This super-sized company’s operations encompassed vast areas of America (comprising roughly 8 states which at that time belonged to France) and acquired some important monopolies : in the tobacco trade, exclusive trading rights in Louisiana, the Mississippi, China, East India and South America. Later it also acquired the right to mint royal coins, and to act as a tax collector.
All these privileges led people to believe that the Compagnie would make huge profits, and with the expectation of an annual dividend of 40 % several share issues were needed to meet the public demand. In addition, Law conducted an aggressive publicity campaign which used all kinds of facts, half-truths and flagrant lies to show that immense wealth was there for the taking in the overseas territories.
The number of people buying shares rocketed, subscription lists could not be produced in time, and that in turn had a psychological effect on new buyers, driving up their number. From early morning to late at night, the rue Quincampoix (where the Compagnie had its headquarters) was teeming with investors keen to try their luck. Some of them rented rooms at crazy rates to be able to keep a close eye on the share prices. The people in charge had to take special measures to ensure that business was conducted in a reasonably orderly fashion.
The preferred method of paying for shares in the company comprised billets d’état, government bills issued by Louis XIV, which were worth only one-third of their face value but were taken at their full value for the purpose of paying up the capital. As a result, the government bills were bought up on a massive scale for conversion into shares. The securities were then transferred to the State treasury at 4 % interest, which was to be used to finance the overseas trade and generate a profit.
So what Law actually did was to use the Compagnie to persuade the holders to convert their government securities into shares. Ultimately, the Compagnie would then become the State’s sole creditor.
With the Regent’s consent, the Banque Générale became a Banque Royale (1718), a State bank where loans could be obtained against the collateral of shares, after which the money could be reinvested in new shares. The bank’s capital therefore consisted partly of shares. From then on, the Mississippi Company and the Banque Royale became in effect a single company, and the public also saw it that way.
The bank continued to issue paper money (thenceforward in livres tournois) : the volume was initially determined by the Regent, but increased steadily. Special incentive bonuses were offered to holders of government securities to persuade them to exchange them for banknotes, which could then be used to buy lucrative shares in the Compagnie. The Banque Royale became a discount bank and a bank of issue, a merchant bank and a government bank.
And as the finishing touch, Law tried to persuade the Regent to allow the Compagnie to buy up the whole of the French State debt (the English copied this move in 1720 with the South Sea Company, followed by the South Sea Bubble), something which had never been done before.
Meanwhile, the speculation fever raged on, and the rue Quincampoix was thronged with people buying shares. The issue price was 500 livres : by the end of August 1719 the price was 5 000 livres and by December it was up to 10 000 livres.
Princes, dukes, everyone who was anyone, tried to buy as many shares as possible, even by selling off their land, jewels, whatever they had. The word millionaire probably originates from that period. But the poor were also able to become rich within a few days, by speculation or cunning.
For Law, his appointment as France’s Trésorier Général des Finances was the absolute pinnacle. But it did not last long.
The end came quickly. Throughout France, inflation increased alarmingly, owing to the surfeit of banknotes which the Banque Royale had placed into the economy. Prices doubled within two years, and reflected the volume of banknotes (which also doubled in two years). The stock of money (banknotes and shares) was four times greater than in the days when only gold and silver coins were in circulation.
Some people feared that the paper money would be devalued, and changed it back into metal money. Law responded by prohibiting people from holding more than 500 livres in cash, and by making bank paper into legal tender. He even ordered house-to-house searches to check up. Citizens were now only too well aware that they could never ask for more than this amount in cash from the Banque Royale, and that naturally undermined confidence in the paper money.
Law always intended that metal money should eventually be withdrawn from circulation altogether, but owing to this 500 livre limit he achieved the exact opposite : people no longer trusted paper money.
The huge volume of shares now also posed a threat to his system. The return of a number of destitute colonists from America telling totally different stories rather than tales of mountains of gold, and the realisation that the colonial trade did not really amount to much, changed the public’s opinion of the Compagnie.
Panic could no longer be avoided, the Banque Royale had to close its doors, the share price collapsed, and dramatic scenes took place in the rue Quincampoix. In the frantic crowds, a number of people died. It was said that « you can die of hunger with 100 million in paper money in your pocket. »
All Law’s attempts to reduce the money supply and buy up shares in order to drive up the share price were unsuccessful, and only led to him being dismissed as the Finance Minister. With the Regent’s help, he managed to evade the angry crowds and flee to Brussels.
Numerous pamphlets, satirical cartoons and engravings depict the bursting of the bubble, the best known being « The great scene of folly ».
Law went travelling again to various countries, and actually received some new offers for applying his system, but he ended up in Venice where he died in poverty. However, he always believed that he was right, and if the Regent had not died young he would most likely have been recalled to France.
It had always been his intention to make France richer and more prosperous, but owing to various mistakes and the opposition of a few major players who had too much to lose in Law’s new economic world, everything went totally wrong.
It was to be a further seventy years before France risked another paper money venture…
- Het groote tafereel der dwaasheid, gedrukt tot waarschouwinge voor de nakomelingen, 1720.
- James Breck PERKINS, France under the Regency with a review of the administration of Louis XIV, 1892.
- Frans DE VOGHEL, Financiers d’autrefois, 1988.
- Lars TVEDE, Business Cycles, 2001.
- Andrew DICKSON White ph.d., Fiat Money Inflation in France,2004.
- Niall FERGUSON, The ascent of money, 2008.