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Tuesday, June 1, 2010

Out of the Depths, Part III: Law Succeeds — Apparently

France was, speaking conservatively, on the verge of ruin as the 18th century got off to its shaky start. The national debt was three billion Livres, approximately half a billion Spanish Dollars. The Spanish Dollar — "Piece of Eight" — was the basis of the American monetary system a century or so later. The magnitude of the burden of debt is relatively easy to gauge in today's terms when we understand that five Spanish Dollars a week was considered an extremely high rate of pay in the early 19th century.

A Nation in Debt — and Desperate

Annual revenues of the kingdom of the Franks in the early 18th century were 145 million Livres, with a projected annual surplus of three million Livres. The projected surplus was not enough to pay the annual interest on the debt, much less reduce the principal. The Regent, the Duc d'Orléans, was, to put it mildly, at his wit's end. A plan to declare national bankruptcy was only tabled due to his personal aversion to such a desperate remedy.

The first expedient adopted to deal with the situation, however, was as dishonest as the Regent considered bankruptcy itself. A "recoinage" was ordered. That is, all the old gold and silver coins were called in, and replaced with coins of the same denomination but lower metal content. This depreciated the gold and the silver coin by a substantial amount. Naturally there was inflation, but the treasury was ahead in the end by 72 million Livres. A slight diminution in taxes silenced some of the complaints.

The number of coin denominations and values in circulation in France at this time would have been regarded as phenomenal by a modern observer. There were thirty-one separate denominations covering twenty-five different values. This incongruity results from the fact that, depending on when they were issued, some denominations were in fractional Ecus. The same value coin, still in circulation, had only a few years earlier been struck with the denomination in Sols or Sous.

The situation was made even more confusing by at least two competing factors. A number of denominations were extremely close in value, such as the copper Sol and the billon ("billon" is an alloy containing less than 50% silver) 15 and 16 Deniers, worth, respectively, 1, 1-1/4 and 1-1/3 Sols. The other was that weights of the silver coinage were continually being adjusted, both to stabilize the currency and maintain the parity between gold and silver in the officially bimetallic currency. France was one of the few economies in Europe that succeeded in achieving a regular circulation of gold and silver, but at the cost of constant revisions in the first quarter of the century. The silver half Ecu, for example, was assigned a constantly changing valuation in Sols and was struck in a bewildering variety of standards.

The depreciation for the Regent's recoinage was not even for all denominations. Gold was lowered by a little over 25%. The Ecu and Quarter Ecu were decreased by slightly over 20%, while other silver coins were adjusted in varying degrees to conform to the new Ecu weight of .7216 Troy ounces of silver. Some of the minor coins had been adjusted downward a few years earlier and were left alone. The burden of the depreciation was felt by a number of denominations that had been greatly increased in weight near the end of the previous reign, and were now reduced by far more than their previous increase.

Having put the squeeze on the people in such an artful fashion, the next step was to put pressure on the most unpopular class of people ever to inhabit the earth: tax collectors. In keeping with the usual arrangement at the time, taxes were "farmed out." This means that tax collections were auctioned off by selling anticipated collections in advance at a discount, and then leaving the tax collector to keep any overage as his profit. Of course, if tax collections exceeded the estimate and a "fair profit," the "tax farmer" was supposed to remit the excess to the government. Strangely enough, few tax farmers ever paid in any excess collections.

Investigations were opened, as they usually were upon the death of one king and the accession of another. The government collected 180 million Livres in fines and confiscations after handing down a few death sentences. Over half the additional collections, however, ended up in the pockets of various courtiers. This caused a great deal of indignation among the people who, the moment they saw one set of thieves being persecuted for the advantage of another, instantly began sympathizing with the formerly hated tax collectors. The stage was set for the entrance of a savior, someone who could offer a reasonable plan to save France (and the Regent) from disaster.

The French Monetary System

The French monetary system at this time, although badly depreciated, was essentially the same reformed system instituted by Pepin and Charlemagne nearly a thousand years before. The old Denier (Penny) was still the basic coin of the currency, although by this time the formerly silver Denier denomination only circulated as a copper Liard, a Three Denier piece, equal to one quarter of a Sol.

Twelve Deniers, obviously, made up one Sol, also by this time a copper coin. The French copper Sol was the final incarnation of the ancient Roman Solidus of 1/72 of a pound of gold in what was once Gaul. The fineness and weight of the Solidus (.1109 of a Troy ounce, .986 pure) although known under many names, had been maintained through the Middle Ages. The purity of the standard only began to deteriorate during the Renaissance — a bad time for money and credit all around. It was at that time Europe began to confuse consumer credit and capital credit, with the consequent rise of widespread usury. Usury, which originally meant simply taking a profit on something that did not generate a profit, was considered a serious sin, as well as poor financial policy, until the 16th century.

Twenty Sols, also known as Sous ("Sou" was later applied to the copper Five Centimes as well as Half Pennies, from the proximity in size and value to the older coin), made up a Livre, under Charlemagne a unit of account equal to a full Roman pound of silver, or 1-1/2 Marks. Six Livres made up one Ecu, a crown-size silver coin that was the real workhorse of the economic system. The Ecu denomination was to enjoy a brief rebirth during the first stages of European unification as an acronym for "European Currency Unit," but was replaced with the Euro, short for "European Currency Unit."

Four Ecus went into one "Gold Louis," the Louis d'Or. The Louis was the basic gold coin of European commerce in early modern times. It replaced the once-supreme Solidus of the Middle Ages and the late Roman Empire. The Louis was known in various locations under different names, such as Pistole, Friedrich d'Or, Christian d'Or — or whoever the issuing ruler might be, depending whether the issuing country was France, Prussia, Denmark, or anywhere else.

While France was strong enough to maintain a fixed ratio between gold and silver and pursue it as a definite policy, gold in Europe during this period, regardless of the laws passed and the wishes of the ruler, generally passed as "Trade Coins." That is, gold coins were generally valued for their bullion content, and the exchange rate between gold and silver fluctuated in direct response to supply and demand. This made maintenance of a bimetallic standard difficult, as Frederick the Great was to discover in his attempted reforms of 1750.

Silver was the currency of most of Europe until about 1870. This resulted in swings of deflation and inflation as supplies of silver came on the market, or disappeared in response to an increase in price relative to gold. In the early 18th century, the problem throughout Europe was a scarcity of silver. The Spanish mines in the New World as well as the German mines in the Tyrol suffered from reduced production over the amounts generated in previous centuries. Further, trade with the Orient was draining away vast quantities of silver, and new sources of the metal had not yet been developed.

Hence the problem in France in the early 18th century was symptomatic of monetary conditions throughout Europe, but made worse by the large government debt. The country was nearly bankrupt from the wars of the Sun King. Conditions were exacerbated by the insufficient supply of metallic currency to meet the demands of commerce. This inhibited economic growth and development, with a consequent erosion of the tax base. The government was forced to borrow in order to meet its expenditures. Naturally the situation became worse the more the government borrowed and spent in an effort to improve matters.

The "Billets de Monoye" issued from 1701 to 1710, and the "Billets de l'Estat" issued in 1716, to float the State debt were consequently backed by nothing more than the government's rapidly decaying ability to collect tax revenues and make good on its IOUs. This caused the State notes to depreciate rapidly.

Enter John Law

It was at this point that John Law again appeared on stage. The Regent had the empathy to feel the people's pain, but was not quite conscientious enough to do anything about it. The Duc d'Orléans was known to sign important papers without reading them, and to delegate important personal responsibilities to others. John Law made his proposal in clear and forceful style, supporting it with well-argued reasoning and sound logic.

In the years since Law had made his proposal to the Scottish parliament he had even corrected the essential flaw in his system. Henceforth he would not make the mistake of backing the money with a commodity, but with a private property right in the present value of existing and future marketable goods and services. This meant that the money supply could expand and contract directly with the total present value of marketable goods and services in the economy. There need never be a case of inflation or (more pressing at this time), deflation to cripple a nation's economy.

Nothing could have fallen more sweetly on the Regent's ears. Here was a man with a plan to solve all of France's debilitating financial woes, and at the same time had the potential to take all responsibility off the shoulders of the Duc d'Orléans. John Law's plan was exactly what was needed to save the economy and very likely France herself — had it been properly implemented. The problem was not in Law's system, but in what happened once the State seized control. As should instantly be obvious, money should never be created in excess of the present value of existing and future marketable goods and services in the economy. To do anything else, as seems inevitably to happen when the State starts printing money to satisfy political rather than economic ends, is to court disaster. As Hildreth pointed out,
It is now well understood, that the currency of any country, whether it be coin or bank-notes, cannot be increased beyond the mercantile wants of that country, without producing a depreciation in the parts which compose the currency. The total value of the currency of a country, — business being supposed to remain the same — will always be a fixed and settled amount; and if the coins or notes which compose the currency be increased, and if there is no outlet by exportation, it follows, that the value of all the separate coins and notes composing that currency, will diminish in a just proportion, so that altogether they may make up exactly the same sum total as before. (Hildreth, op. cit., 17-18.)
Law was given a charter on May 2, 1716, and a bank was formed under the name of Law and Company, or La Banque Générale. In a move unusual at the time, the notes issued by the bank were given full legal tender status in a decree of April 10, 1717, that is, they would be received in payment of taxes. The original capital of La Banque Générale was six million Livres, divided into 1,200 shares of 5,000 Livres, payable in four installments, one-fourth in coin, three-fourths in Billets d'Estat.

A masterstroke was to have the notes of the bank payable on demand in coin current at the time the notes were issued. This would prevent any official depreciation of the gold or silver coin (such as had just taken place) from having any effect on the real value of the notes. Before long, the notes of Law's bank were passing at a 15% premium over face, while official State notes used to finance the national debt were discounted by 78.5%. Public confidence in John Law was boundless. Law's notes were considered extremely desirable as the medium of exchange because coin was scarce and the ease of transport and remittance by means of paper banknotes made financing development in the provinces easier.

New Orleans and the Louisiana Company

Law then put forward his plan to finance the development of Louisiana. A company would be formed, and the capitalization paid in using the State notes at full face value, which, it should be recalled, were discounted nearly 80%. Official State notes were thus current at about one-fifth their face value. In modern terms, this means the notes were good for the equivalent of a little over twenty cents on the dollar. The total amount of the capitalization of the development company was 100 million Livres (200,000 shares at 500 Livres each, although one source claims that 500,000 shares were initially authorized).

In August 1717, the bank organized La Compagnie des Indes Occidentales, or "West India Company," better known as "the Mississippi Scheme." It also operated under the name La Compagnie de la Louisiane ou d'Occident. The Company obtained a grant of Louisiana from the Crown and established headquarters on a strip of ground along the Gulf. A number of sources maintain that Law's company was responsible for the founding of New Orleans. This is untrue, but the Company was responsible for kick-starting what development took place. Law's plan provided the impetus, although not the financing, that turned New Orleans from a city of cloth into a city of wood.

While there is some doubt as to the actual date of the founding of the city, it is generally given as 1718, after the establishment of the West India Company headquarters some distance away, having been moved to its present location from the original site selected in 1705. The life-long French governor of Louisiana, Jean Baptiste Le Moyne, Sieur de Bienville, originally from Montreal, founded La Nouvelle Orléans. (Vide Thomas B. Costain, The White and the Gold. New York: Doubleday and Company, Inc., 1954, 454-456.) The city was named in honor of the Regent, possibly to instill in that gentleman some sense of the responsibility he had assumed. Only after the Sieur de Bienville moved the city to its present site was it proposed that the headquarters of the Law Company also be moved from the barren coast country to the new site at the mouth of the Mississippi.

Jean Baptiste Le Moyne was a member of the great Le Moyne family of Quebec, known as the "Canadian Maccabees." He was the eighth son of Charles Le Moyne, founder of the clan, who had twelve sons (two of whom died in infancy), and two daughters. The surviving children all had significant influence on the development of French America, both Canada and what became the United States.

After shifting the Law Company headquarters to New Orleans, a few adventurers of the better classes, together with a mob of outlaws, vagrants, and whores, were herded together and shipped to Louisiana. These were the worst choices for starting a development scheme, however desirable it might be to remove such elements from France. The Sieur de Bienville was far from pleased with these colonists, especially as he had sunk most of his own money into his new city and was committed to making it a success.

On arrival, a part of the band of emigrants started out to enslave the Indians and mine for gold. As there was no gold found and the Indians were well able to defend themselves against any attempt at involuntary servitude, the effort failed. Apparently relying on the "if at first you don't succeed" theory, initial optimism was undimmed. This was not, however, as naïve as it sounds.

Assuming that the actual development of Louisiana proved financially feasible, the undertaking, again, could not have been more sound. The outcome of the planned capitalization would be effectively to retire approximately 3% of the unbacked national debt, and "reissue" new notes in the same face amount as capital financing of a private project. This would back the reissued notes with hard assets in the form of productive trading and other commercial projects in Louisiana.

The projectors, unfortunately, still presumed that the territory contained vast quantities of gold and silver. The rich agricultural, commercial, and industrial possibilities of the region were overlooked completely. This was a mistake not made in Quebec, particularly since the late king had taken a deep personal interest in French Canada, (Costain, op. cit., 282-310) even to the extent of ordering special coinage. (R. S. Yeoman, A Guide Book of United States Coins. Racine, Wisconsin: Western Publishing Company, Inc., 1987, 28-29.)

The resultant public confidence would restore parity to the remaining State notes, and also provide a means for their eventual retirement as the development scheme began to generate income. In a single move, the national credit would be restored, a substantial provision would be made for repaying the national debt, and an adequate supply of sound and stable currency would be provided.

Economic Development Without Past Savings

"Monetizing" the productive capital of the company would finance the economic development of Louisiana. This would provide adequate circulating media in the same way as the land banks already in operation in Scotland. The method for doing this was based on models developed centuries before. It involved having a bank of issue print banknotes to lend to a borrower who put up existing wealth as collateral, or, most especially, soon to be created income-generating assets of any kind for security. The effect would be to break the formerly iron constraint that a limited or even diminishing amount of existing wealth put on economic growth and development. This deflation was, in fact, the main problem that Law was attempting to address.

Commercial and central banking were invented, in part, to solve this problem. One of the first financial institutions to operate along the lines of what became central banking was the Banco della Piazza di Rialto, established in 1587. As with earlier, similar banks, it was strictly forbidden to make loans to the government. When it got into difficulties as a result of violating this prohibition, the bank merged into the Banco Giro in 1619, effectively terminating its charter. Later banks, which developed along with the basic principles of central banking, also prohibited or were prohibited from extending credit to the government, such as the Bank of Amsterdam, which, nevertheless, did extend credit to the Dutch East India Company and the City of Amsterdam.

The Bank of England was formed primarily to provide the commercial community with banking facilities and to monetize bills of exchange. The bank secured its charter of incorporation in return for a £1.2 million loan to the government. It was not until 1715, however, that the Bank of England became the agent for the issue and management of a government loan. Other national central banks were established along similar lines, including Scotland.

It is important to note that the aspect of government finance was always secondary to the stated purpose of providing commerce with a stable money supply and a sound currency. The fact that governments have nearly always found a way to finance deficits through the central bank merely shows the ingenuity and skill with which any human institution can be corrupted, given sufficient incentive and means.

In a properly run central banking system, however, the borrower would use the newly created loaned funds to finance some presumably productive project (i.e., one that, in financial terms, was "self liquidating" — the project paid for itself out of income generated by the project) that did not, however, yet exist. The banknotes, as with the usual land bank issue, would circulate in the community the same as specie, and, if the arrangement was well managed, would pass at par with "real" gold and silver money. As the project began to generate income, the borrower would repay the loan out of the proceeds of the project itself, usually in notes issued by the bank holding his loan. As portions of the loan were repaid, equitable amounts of banknotes would be "destroyed" or canceled, thus preventing inflation or the creation of unbacked currency.

This is, obviously, very close to the general concept of a standard bank of issue as already embodied in the Scottish land bank system. The significant difference was that the printing and retirement of currency would be linked directly to the project being financed, instead of to the collateral put up for the loan. That is, the amount of currency that could be printed would not be tied down to the amount of existing wealth in land, but could be increased to the limit of the present value of all productive projects and economic development available or potential in the area.

An Astounding Success

Law's bank was organized, a royal patent issued, and the company incorporated. The royal patent was an absolute necessity at this time, as limited liability was available only to the select few before incorporation laws were liberalized in the late 19th century. Law was made "Duc d'Arkansas" in recognition of his services to the State, and embarked upon other improvement schemes. He revived the fisheries, built bridges, dug canals, and constructed asylums for the poor. He even carried out the initial steps to make Paris a seaport. All of this lends support to the theory that, whatever its objective worth, Law himself had absolute faith in his system.

The issues of Law's bank, La Banque Générale, because they were issued in strict conformity with principles of sound banking, are difficult to come by. The first issues under the decree of June 16, 1716 were in denominations of 10, 100 and 1,000 Ecus. These were followed in October with notes of 40 and 400 Ecus. The second issue, authorized by the decree of June 8, 1718, consisted of notes of 10, 50 and 500 Ecus. Except for the identification of the issuer as "La Banque Générale," there was nothing particularly special about the design of the notes, all of them having the generic look of early paper money, wherever issued. What makes the notes of special interest to numismatists and historians was the sudden frenzy that was soon to have all of France in its grip.