Wednesday, June 2, 2010

Out of the Depths, Part IV: The Mississippi Bubble

With the initial success of John Law's plan for the economic revitalization of France, the French Regent, the Duc d'Orléans, loaded Law's bank with special privileges and monopolies. Finally on December 4, 1718 Law's bank was reorganized as La Banque Royale, the Royal Bank of France. With the financial health of the country and sound economic growth freed from the slavery of savings, success seemed permanently assured.

The Magical Money Machine

There was, however, one slight problem with making Law's bank an official State agency. Control over the bank was now in the hands of the government, not the private sector. The transformation of La Banque Générale into La Banque Royale gave the key to the money machine to the Regent. This changed the whole situation. Politics, not economic or financial factors, would now be the primary consideration in all decisions. This was not what Law had proposed, and he should have seen the inevitable result. As soon as the bank came under direct royal control, the Regent issued one billion Livres in notes "backed" by an incredibly optimistic idea of the value of the shares in Law's Mississippi Company.

The face value of these new notes amounted to a third of the existing national debt. The Regent apparently had the idea that paper money issued by Law's bank was, in and of itself, somehow valuable. He thought he did not have to go through the troublesome procedure of making sure that the shares behind the notes represented productive assets or were capitalizing a project that would generate a return.

Lest the reader find himself feeling a little smug about the naiveté of the Regent, however, note that this is precisely the way most government deficits are currently financed. The United States, for example, sells new debt to the tune of approximately $1 billion and more each day. The government sells bonds, which are eventually purchased by the Federal Reserve Bank through its "open market operations."

It is necessary to say eventually, because direct purchase of government debt by the central bank of the United States is illegal, ostensibly to prevent the very activity carried out by the Open Market Committee. The Federal Reserve purchases government paper by "printing" the money or, more usually, by creating new demand deposits. Revealing the basic unsoundness of this method of finance, the only difference between what the Duc d'Orléans did, and what most central banks today do is one of degree, not of kind.

A Flood of Paper

The initial notes of the first issue of La Banque Royale were authorized under the decree of January 10, 1719, and consisted of an over-supply of the denominations 100 and 1,000 Livres. The design consisted of a left ornamented border, and a legend in copperplate printing: No. [XXXXXX] Cent Livres Tournois. La Banque promet payer au porteur à vüe, Cent Livres Tournois en Especes d'Argent, Valeur reçeüe à Paris le [date] ("Number [XXXXXX] One Hundred Livres, Standard of Tours. The Bank promises to pay to the bearer on demand One Hundred Livres to the Standard of Tours in Silver Specie, of the Value Current in Paris on [date]").

Notes of 10 Livres were added under the decree of April 1, 1719. The final notes of this issue were in the amount of 10,000 Livres under the decree of January 1, 1720. After that date production was streamlined in view of the Regent's demands for more "free" money. Notes of the first issue were all hand-numbered, dated and signed, in spite of the fact that the vastly increased issues probably gave everyone writer's cramp.

The Etats General, the French legislature, nervous over the rapid increase in unbacked paper and the unwarranted public confidence that caused gold and silver coin to depreciate against the notes of the new Royal Bank, attempted to halt Law's progress. The Duc d'Orléans, however, was quick to eliminate effective resistance to his new program. The chancellor d'Aguesseau was abruptly dismissed, and a creature of the Regent put in his place. Not surprisingly, this was d'Argenson, former chief of police under Louis XIV.

D'Argenson had previously been responsible for throwing Law out of France. Now, however, the former chief of police had evidently seen where his advantage lay, and had ingratiated himself with the Regent. D'Argenson came up with a proposal for a second recoinage to retire the old unbacked State notes. The idea was to call in four Livres in specie and one in State notes, replacing them with five new, 20% lighter Livres in specie. When the new chancellor attempted to put this plan into effect, however, the legislature responded by issuing a decree removing the legal tender status of any specie currency that varied from the old standard.

Then followed, quite literally, a battle royale. The Regent annulled the decree of the Etats General, whereupon the legislature passed another, with the same result, and so on. Law was proscribed, and only saved himself by seeking sanctuary in the royal palace. By carrying out some judicious arrests and exiles, the Regent soon had the legislature cowed. The Mississippi Company was granted greater privileges, and an additional capitalization was authorized, to the tune of 25 million Livres, again by accepting the State notes at their full face value. A 40% annual dividend was promised which, taking into account the heavy discount on the State notes used to purchase shares, meant an effective dividend rate of 120% to the shareholders.

The Bubble Grows

The public, forgetting the difference between productive activity and transactions on the secondary market, now got caught up in a speculative frenzy. This was the same phenomenon that swept through the United States before the 1929 crash and the recent sub-prime mortgage debacle, if somewhat more hysterical. Shares of the Mississippi Company began to be quoted at higher and higher prices. The quoted values sometimes went up by the hour, an unheard of phenomenon before the advent of the modern stock exchange and rapid communications. Thinking he had found a cornucopia of endless wealth, the Regent cranked up the printing presses yet again and began issuing notes of the Royal Bank, formerly Law and Company, at a rate not to be surpassed until the French Revolution seventy years later.

Law either forgot his own principles about the necessity of backing a paper currency with something besides either the government's mere promise to pay or government debt paper (the same thing, only one step removed), or else his better judgment was overruled by the Regent, a man convinced he had found a money machine. Subsequent events suggest the latter. Whatever the reason, Law did nothing — or was able to do nothing — to stop the flood of paper money.

Notes of the second issue were different in many respects from those of the first issue. Instead of an ornamented border, a lettered edge ran up the left side of the face of each note. Although the notes were still hand-numbered, everything else was printed, including the presumed signatures. The typeface was changed from copperplate to roman. Otherwise the notes carried the same legend and made the same promise to redeem their value in specie equal to what was stated on the face of the notes as of the date of issue.

The first series consisted of notes in the denominations of 10, 100, 1,000 and the extremely scarce 10,000 Livres. There are two varieties of each denomination. Some carried the legend that the notes would be redeemed in silver ("en Especes d'Argent"), while others omitted this aspect of the promise to pay. The notes that promise to redeem the value in silver are more common than those that fail to carry this legend.

More notes were emitted under a decree of July 1, 1720, apparently all in the 10 Livre denomination, although some 100 Livre notes listed as authorized under the decree of January 1, 1720 may be a catalogue misprint for notes that belong to this series. This second series of the second issue was printed in enormous quantities.

So many notes of the second series were printed and released that at least two major errors found their way into circulation. On one variety, the normal promise, usually given as payer au Porteur a vüe Dix livres Tournois ("pay to the bearer on demand Ten livres of Tournois") is rendered, payer au Porteur Dix livres a vüe Tournois. On another variety, the ordinarily capitalized Especes begins with a small "e."

Finally, on September 2, 1720 a third and final series of the second issue was authorized. This consisted of large quantities of 10 and 50 Livre notes. The standard roman typeface was changed to italic roman, and the lettering made somewhat larger. Significantly, the handwritten serial numbers appear hurriedly scribbled on most of the notes, a substantial degeneration from the careful notation of the first issue, and even the still clear and legible handwriting of the first series of the second issue. Clearly, the burden of adding handwritten serial numbers to billions of Livres worth of banknotes was beginning to put a strain on the workers.

"Monsieur Law" had succeeded beyond the wildest dreams of most people proposing revolutionary financial, political, or economic schemes — at least to all appearances. His plan had been adopted in its entirety at the highest levels of government. The people, without whose support any significant change in existing social institutions could not be carried out or maintained, were enthusiastic in the extreme about the possibilities. The problem was that, while the Law Plan had been adopted with respect to form, the substance was still missing. The essential feature of linking the creation of new money to existing or soon-to-be-created assets was missing.

The Bubble Bursts

Some heads that were wiser (or craftier) saw the inevitable end. The more public-spirited citizens attempted to issue warnings. All they received for their trouble was verbal abuse, if not actual physical harm. One noble lord, with the interests of both commoners and his own class at heart, began to harangue a crowd of would-be investors. He was nearly killed for his troubles, suffering a beating from which he never fully recovered.

Others took their profits, traded in their gains for specie and, in contravention of the law that prohibited export of gold or silver in such quantities, transferred their wealth to banks or other depositories outside France. This drained the country of the remaining supply of hard currency. In December 1719 the frenzy was at its height. Shares were selling at 20,000 Livres, forty times the stated par value. People began selling everything to purchase shares.

Nevertheless, something still might have been salvaged had the development plans been put into effect. The Mississippi Company had been granted exclusive trading rights not only in Louisiana, but everywhere the French had commercial interests, as well as a few places they did not. Nothing except a brief display of colonization for window dressing was attempted, however. This consisted of men and women conscripted temporarily from the slums and the prisons, parading through the streets carrying picks and shovels.

Before the crash came, another billion Livres in banknotes were issued under the decree of July 1, 1720. All this did was to make the ultimate problems far worse than they otherwise would have been. Coin became so scarce that a law was passed forbidding anyone to possess more than 500 Livres in gold or silver coin. Oddly, the date of the decree authorizing the notes was after the actual issuance of the notes. This was a clumsy bit of finagling by the Regent to cover his tracks. It is important to note that throughout the whole period of the "Bubble" the Regent consistently ordered vast quantities of notes printed under decrees that would not be issued for months.

Intended to restore faith in the paper money, which was finally, after two years, beginning to shake slightly, the edict forbidding possession of specie had exactly the opposite effect. Coin was hoarded, and the paper money began to lose its value with great rapidity. This was a textbook example of "Gresham's Law": Bad money drives out good. (Harold G. Moulton, ed., Principles of Money and Banking. Chicago, Illinois: University of Chicago Press, 1916, 98.) People began turning on one another. Being seen with a Louis d'Or in one's possession was enough to subject one to search, seizure, fines and imprisonment. Apparently believing that it would restore public faith in the national credit and the paper money to engage in massive deficit spending, the Regent ordered another issue of 1.5 billion Livres, under the decree of September 2, 1720.

It was the final nail in the coffin. Coin, which it had been the Regent's goal to depreciate, began appreciating at a tremendous rate against the ubiquitous paper. As the bottom fell out, the Royal Bank stopped all specie payments. The Duc d'Orléans instantly put the blame for everything on Law, and then refused to see the Scot when Law attempted to confer with him as to the best means for extricating France and the Regent — and John Law — from the predicament in which they found themselves. About the only thing Law accomplished was to secure a detachment of Swiss pikemen as a personal bodyguard to protect him against the increasing hatred of the people.

Return to Sanity

The old chancellor, d'Aguesseau, credited with being the only completely honest man of his generation in the French public service, was called out of retirement. He was given the impossible task of restoring confidence in the public credit. His first act was to abolish the law that made possession of coin in excess of 500 Livres a crime. In an attempt to withdraw the banknotes, a new issue of State notes was created in the amount of 25 million Livres, backed by the revenues of Paris. These bore an interest rate of 2-1/2%. These notes do not appear to be listed in any of the standard references, and were probably construed as short-term government loan paper or promissory notes rather than circulating currency.

The new notes were made payable in coin, and the Royal Bank provided with sufficient supplies to change them. When the bank ran out of silver (gold being virtually unobtainable in the necessary amounts), notes were redeemed in copper. So great was the anxiety of the public to exchange paper for coin in any denomination that people were pressed to death nearly every day in the crowds that surrounded the bank. There was at least one riot, and on July 17, 1720 fifteen people suffocated in the crowd.

Anxious as the ordinary people were to redeem whatever paper money they had, large holders of the Mississippi Company securities were reluctant to exchange for the "Two-and-a-half per cent.s" on the chance that there might be a turnaround. Consequently d'Aguesseau promulgated an edict in August that banknotes, which were presumably backed by the worthless shares, of between 1,000 and 10,000 Livres would no longer be accepted for anything except to purchase annuities, make bank deposits, or meet payments on Mississippi Company share subscriptions.

In October, a second edict was issued, stating that all banknotes backed by shares of the Mississippi Company would henceforth have no value after November. Original shareholders were ordered to turn over their shares to the company or, if they had not been fully paid, to purchase them at the rate of 13,500 Livres for each 500 Livre share. This was an attempt to take into consideration the depreciated value of the currency. Even so, this was a stiff price for worthless corporate equity. A great number of the formerly affluent tried to leave the country with whatever effects they could quickly gather. Some were arrested, others sentenced to death in absentia, and many subjected to wholesale fines and confiscations.

John Law was permitted to leave the country after losing everything in the crash. Law's personal financial disaster is presumably an indication of his own honesty and faith in his own program. A genuine con artist would have found some way to secure his ill-gotten gains before everyone caught on.

Circumstantial evidence of Law's rectitude had no real effect, however. The Regent quickly took the opportunity to blame Law for certain inconsistencies in the issue of banknotes and the edicts authorizing their issue. The Duc d'Orléans claimed that Law had persuaded him to antedate decrees covering notes already issued. The exact opposite was the case. The Regent had, on numerous occasions, overruled Law and forced issues of additional notes against Law's better judgment, with the authorizing decrees issued later.

With the exception of a single diamond that he carried with him into exile, John Law was penniless. All he possessed had been invested either in his scheme or in investments in France. The moment it was learned that he had left the country, everything he owned within the borders of France was confiscated. This included an annuity he had purchased for his wife and children under a special edict that declared it could never be forfeited for any cause whatsoever.

This last was possibly to mollify the citizens who were outraged over Law's escape, and wanted him hunted down and hanged. This was not to be, however. John Law drifted for a while through Europe, returning to his old profession of gambling in order to make a living. It is ironic that he was forced to engage in gambling once again, the most unproductive of enterprises, when his scheme would have succeeded if only the original intent had been followed of tying the creation of money to the present value of productive projects. John Law was eventually drawn to Venice by the prospects offered by a lottery scheme, where he died on March 21, 1729, poverty stricken.

Others involved in the project were not so fortunate. The Regent was able to divert blame from himself, but some received sentences of death, in a number of cases commuted to life imprisonment. John Law's brother William was arrested and imprisoned for fifteen months on general principles, but released when nothing could be proven against him.

Over all, the only lasting effect of John Law's Mississippi Scheme, aside from the bankruptcy of France, was to convince many people of the unsoundness of tying the issuance of currency to the creation of productive assets. Even many economists disparage the concept, not realizing that the failure of Law's scheme was because the creation of money was not linked to the creation of new productive assets. Many of these same economists loudly vaunt the virtues of a currency backed solely by government debt or a vague promise to pay. They forget that, while the failure to implement an asset-backed paper currency understandably led to widespread dissatisfaction and distrust of paper money in France, the experiments of the Revolutionary government with "assignats" seventy years later made distrust of paper money almost a French national characteristic.

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