The Mississippi Bubble (1716 - 20) The Mississippi Bubble was an ill-conceived financial scheme hatched out of the financial woes of a highly-indebted France. Aimed at solving France’s debt crisis, the initiative triggered a financial mania which, like all poorly conceived financial schemes, ended in financial collapse, economic depression and heartbreak for many. The central players in the scheme were the Duc d’Orleans (Duke of Orleans) and his long-time friend John Law, a Scottish economist who was the architect of the scheme. Law was an interesting character. His father was a goldsmith who lent money on the side. He worked as an apprentice in his father’s business and he became well versed in finance. He soon moved to England where he pursued his passion for women, drinking and gambling. In 1694, he was challenged to a duel over the affections of a young damsel and in the ensuing fight he killed his opponent with a single thrust of his sword. He was arrested and sentenced to death, and whilst awaiting execution his sentence was downgraded from murder to manslaughter.i Law managed to escape prison and quickly fled to Europe where he put his extraordinary mathematical skills to use, earning a living by playing at the gambling houses throughout the major centres of Europe. Law also continued to pursue his economic interests, arguing that tying up wealth in land and specie stunted economic growth as it did not allow money to circulate freely through the economy. Instead, he supported the creation of a central bank which issued paper currency and credit backed by land, gold and silver. Law would soon get the opportunity to put his theories into practice when he was approached by his old gambling buddy, the Duc d’Orleans, who had been appointed regent to the young French monarch, Louis XV on the death of the Sun King Louis XIV. Years of endless wars and extravagant spending on projects such as construction of the Palace of Versailles had brought France to the brink of bankruptcy. The government had financed this largesse by issuing high-interest bearing government (junk) bonds, but time was running out as creditors were becoming restless. Law wasted little time in getting to work, instituting a series of economic reforms which included reviving overseas commerce, building new roads and abolishing tolls on roads and canals. His most radical reform, however, occurred in 1716 with the establishment of a government-chartered private bank, the Banque Générale, with a capital of 6 million livres.ii The bank was nationalised in 1718 and renamed the Banque Royale. He also moved quickly to implement his paper-based monetary policies through several state-mandated measures. These included issuing shares in the new bank in exchange for old government bonds, whilst accepting deposits in specie (coins) and issuing all loans and subsequent withdrawals using the new Banque Générale bank notes. Law sought to build confidence amongst his investors and the French public by insisting that his notes would be redeemed in specie at face value. Duc d’Orleans then mandated that all taxes be paid using the Bank’s notes, in effect making the Bank’s notes legal tender. France was no longer constrained by a shortage of gold and silver.iii 1 of 3 The era of paper currencies and fractional reserve banking had started in earnest as the new bank became one of only six such banks to have issued paper money, joining Sweden, England, Holland, Venice and Genoa.iv Just as Law had predicted, the increase in money supply began to stimulate the real economy as confidence returned, savings were liberated, and money began to circulate through the economy. With his reputation in the ascendancy, Law began to expand his empire by obtaining a monopoly over trading rights with France’s overseas colonies. Initially, this included France’s extensive holdings over La Louisiane (Louisiana) in North America – holdings that constituted almost one-third of the land mass of the U.S., but it went on to include trading rights to the West Indies, South America, China and East India. He also secured the right to mint royal coins and was appointed the royal tax collector for a period of 9 years.v He could do no wrong. Law set up a joint stock company, the Mississippi Company, to fund his ventures. Initially he offered shares solely in exchange for the Crown’s remaining junk bonds but then he went public. In 1719, Law issued 50,000 new shares in the Mississippi Company at 550 livres each, with just 75 livres down and the rest due in nineteen monthly payments of 25 livres.vi Law did such an amazing job of hyping the wealth potential of his alligator-infested U.S. swampland – land that had never returned anything of value to previous French companies - that people queued for hours outside the company’s headquarters just to see whether their applications for additional stock had been successful. In what became known as John Law’s Mississippi Bubble, a speculative bubble of historic proportions had begun. The share price rose to 1,000 livres before the second installment was even due, and ordinary citizens flocked to Paris to participate. Based on this success, Law offered to pay off the national debt of 1.5 billion livres by issuing an additional 300,000 shares at 500 livres paid in ten monthly installments.vii By mid-1719, the Mississippi Company had issued more than 600,000 shares and the par value of the company stood at 300 million livres. That summer, the share price skyrocketed from 1,000 to 5,000 livres and it continued to rise through year-end, ultimately reaching dizzying heights of 15,000 livres per share. The word millionaire was first used, and in January 1720, Law was appointed Controller General.viii The mania was fueled by the Banque Royale, which, unshackled by any constraints associated with shortages of gold and silver, issued an unlimited number of bank notes to fund the purchase of shares in the Mississippi Company. Not surprisingly, the massive increase in bank notes to fund stock purchases quickly doubled France’s money supply. This inevitably stoked the flames of inflation, particularly in food prices, and by January 1720 inflation had reached a rate of 23% per month.ix By early 1720, stocks began to fall as savvier investors began to cash in their shares in exchange for gold coins. To slow the sell-off and to preserve the holdings of gold and silver in the bank vaults, Law restricted the payment in gold to 100 livres, with the rest of the payments being made in bank notes. 2 of 3 Despite the plentiful supply of paper money, with declining confidence, investors headed for the exits and with few willing buyers, stock prices collapsed. By May 1720, prices fell to 4,000 livres per share, a 73% decrease within a year. The rush to convert paper money to coins led to sporadic bank hours and riots. x By late 1720, Law’s enemies moved en masse, demanding payment immediately and in specie. Within days the French Government confessed that the number of bank notes issued by Banque Royale far exceeded the amount of gold and silver on hand. The bank was forced to stop payment on its notes.xi Unfortunately, by this time events had moved too far, and France was left with the worst of both worlds. On the one hand, everyday people were suffering from runaway inflation that was punishing the community through rising prices. On the other hand, stock holders were financially devastated as stock prices collapsed. The collapse of the Mississippi Company plunged France and surrounding Europe into the inevitable deflationary depression. Over 1 million French families had purchased Law’s now worthless shares. His paper money was valueless. The middle and upper classes were ruined, the monarchy discredited, and the French economy was a basket case.xii The seeds for the French Revolution some 60 years later had just been sown. Law’s experiment with paper currency and money printing had failed, just as every other experiment with paper-based money would also fail. i Adams, Gavin John (2012). Letters to John Law. Newton Page. p. xxi ii http://www.numismaster.com/ta/numis/Article.jsp?ArticleId=26139 iii http://www.numismaster.com/ta/numis/Article.jsp?ArticleId=26139 iv Federal Reserve Bank of New York: "Crisis Chronicles: The Mississippi Bubble of 1720 and the European Debt Crisis" (Narron and Skeie) v http://www.numismaster.com/ta/numis/Article.jsp?ArticleId=26139 vi http://libertystreeteconomics.newyorkfed.org/2014/01/crisis-chronicles-the-mississippi-bubble-of-1720- and-the-european-debt-crisis.html vii Federal Reserve Bank of New York: "Crisis Chronicles: The Mississippi Bubble of 1720 and the European Debt Crisis" (Narron and Skeie) viii Federal Reserve Bank of New York: "Crisis Chronicles: The Mississippi Bubble of 1720 and the European Debt Crisis" (Narron and Skeie) ix http://mshistory.k12.ms.us/articles/70/ x https://en.wikipedia.org/wiki/John_Law_(economist) xi http://www.numismaster.com/ta/numis/Article.jsp?ArticleId=26139 xii http://www.numismaster.com/ta/numis/Article.jsp?ArticleId=26139 3 of 3 .