Preface to all three parts: I’ve written dozens of books, but the only history book I’ve ever written was Panic Prosperity and Progress. This weekend, I’m sharing one of the chapters from the book in three parts, since it offers interesting lessons about what can happen when governments decide to experiment with finance and economics.
It seems hard to believe that an obscure Scotsman born over 350 years ago would have profound effects that persist in the financial world to this day, but it is true, and that man’s name was John Law. The events surrounding Law’s actions in the 18th century are the stuff of legend, and Law is considered by some economists to be the world’s first Keynesian—that is, a person who supports the notion that flooding an economy with government spending is the best way to address a weak economy. Even the everyday English word “millionaire” was coined during the mania of Law and his so-called Mississippi Scheme. In this section, we will explore what led up to the scheme, its construction, and the devastation it wrought.
Law’s Early Life
John Law was born in Edinburg, Scotland in 1671. He was the oldest son of a banker, and as was the custom at the time, young Law apprenticed in his father’s business beginning at the age of 14. For three years he worked in his father’s countinghouse, learning the principles of banking.
In spite of being in a family of bankers and goldsmiths, Law did not have a passion for the business, and after this father died in 1688, the young Law took the opportunity to leave the family enterprise for an activity with far greater personal appeal: gambling. He set out for London and tried to apply his knowledge of statistics and probabilities to forge success as a professional gambler.
He did quite well for a while, managing to live a life of pleasure pursuing his passion, but after nine years, Lady Luck began to neglect Law, and he lost more money than he could repay.
Law’s plight was soon to exceed that of a mere gambling debt. He was quite taken with a lovely young woman named Elizabeth, and a suitor of hers – one Edward Wilson – didn’t take kindly to the competition. Wilson challenged Law to a duel, which was unfortunate on his part, because Law shot him dead with a single shot.
Duels were a widespread custom in the 18th century, but they were not part of the actual rules of society, so Law was arrested and charged with murder. He soon stood trial at the Old Bailey before a judge who was known as a sadistic “hanging” judge that had no compunction about handing down stiff sentences to criminals. True to form, the judge sentenced Law to death after he was found guilty of murder.
Happily for Law, and for our story, his sentence was commuted to a fine, based upon a decision that the killing was manslaughter and not murder. Wilson’s brother was outraged and, while Law was still imprisoned, sought to have a harsher punishment foisted on his brother’s killer. Law, however, managed to escape from prison and reached the continent of Europe, far away from London judges and grieving brothers.
On the European continent, Law resumed his gambling, spending three years both trying to earn a living and studying the monetary and banking affairs of the various countries he visited. The middle of the 18th century was an exciting, dynamic time for Europe, full of new ideas about science, the economy, and social experiments, and Law’s penchant for numbers and knowledge of banking made him a quick study.
The currency of old France was known as the “livre tournois”. The livre was originally established by Charlemagne as a unit of account equal to a pound of silver, and it was divided into twenty parts (called sous), which itself was further divided into twelve parts (deniers). (Note: To make reading and understanding the events easier, I’ll refer to the unit of currency as the “dollar,” although that is not the historical term.)
In the early 1700s, the French economy was a mess. King Louis XIV had waged a number of wars which left his country a financial basket-case, and the country was at the brink of financial ruin. The national debt about to three billion dollars, and the wealth of the nation (largely in the form of precious metals) was mostly spent. Indeed, the shortage of precious metals meant that not enough money was in circulation.
Using the metaphorical image of the French economy as a body, the blood flowing within that body (in this case, gold and silver) had been largely drained away, so the body’s health was in great danger. There simply wasn’t enough blood to go around, since it had been spilled for unproductive wars.
It’s important to know that during the course of Law’s travels, he had become friends with the Duke of Orleans, who was the nephew of King Louis XIV. Although, when the friendship first came about, Law could not have foreseen the value of this friendship later in life, being close to a royal family usually isn’t a bad connection to have.
In spite of the shambles of the French economy, France did hold a vast expanse of territory in North America surrounding the Mississippi river known as Louisiana (of course, this territory was far greater in size than the state of Louisiana we know today, spanning from the Gulf of Mexico up into Canada). France was the first European country to settle this area, and the territory was larger than France itself.
As gigantic a piece of real estate as Louisiana was, virtually nothing was being done with it, and the vacuum of knowledge about the place was quickly filled with legend. Rumors began to circulate that Louisiana was rich in vast deposits of precious metals. It was heralded as a kind of paradise where beautiful but naïve natives would cheerfully exchange enormous chunks of gold and silver for whatever knives, magnifying glasses, or other near-worthless trinkets that Europeans wanted to offer.
The notion of Louisiana being an utterly unexploited bed of wealth even conjured up a tale of an enormous mountain on the Arkansas River made of emeralds. And, in addition to all of the precious stones and metals just beneath the surface of the landscape, it was also believed that a wide variety of furs were available from the fauna of the land, similar in value to the pelts actively traded with Canadian trappers. The truth is that any furry creature unfortunate enough to live in such a climate of the Deep South would have perished long ago. I used to live there. Take my word for it.
The reality was that hardly any Europeans had colonized Louisiana, and those who were there found life to be extremely hard. Some attempts had been made to colonize the area with workers willing to till the land for its agricultural potential, but precious few French wanted to be involved in such a hard life within a strange and mysterious place. The government of France was so eager to prop up the image of its Louisiana territory that it hired artists who had never set foot outside of Paris to draw lush and inviting landscapes of the North American territory as if it was a differently-situated French Riviera.
During the years that Law worked at his family’s countinghouse, gambling his way through Europe, and attending the salons of both royalty and common folk, he became somewhat of an economic philosopher. Quite aware of the stifling effect that the lack of precious metals was having on some European economies, he took the view that replacing metallic money with something more convenient and representative of a store of value would be superior.
In Law’s mind, gold and silver coins were a crude and outdated method of exchange, and the currency which circulated through an economy need not have to be wealth itself but merely serve as a means of exchange. National wealth, after all, depended on trade both within and without a country’s borders, and the more currency that could flow within an economy, and the more effortlessly it could flow, the better it would be for the nation’s collective fortune.
Back in his native Scotland, Law published a proposal for what he called a Land Bank. The idea was relatively simple – – a given country (in this instance, Scotland) would “deposit”, in a sense, the value of all its land holdings into a national bank. The bank, in turn, would issue notes whose collective value would never exceed the entire value of the land on deposit. These notes, each of which represent a tiny portion of the country’s wealth, would be the kind of paper money that Law envisioned as a more efficient means of exchange. It was a way of monetizing the value that the country already owned but had not yet unlocked – in this instance, its own land – and thereby pump value into the nation’s economy.
Although the proposal garnered some interest, it was not embraced by the Scottish government, and a disappointed Law abandoned his dreams of bringing his vision of paper money to his homeland and so returned to his familiar role as a gambler. The idea did not leave him, however: in his own words, “When blood does not circulate through the body, the body languishes; the same way with money which does not circulate.”
He spent the next ten years moving between France and the Netherlands. During this time, he renewed his friendship with the Duke of Orleans. During their conversations, the Duke was increasingly impressed with Law’s apparent financial prowess, and he eagerly sought his advice on how to deal with his country’s financial maladies. Louis XIV’s reckless spending had put France in a bind, and there wasn’t a clear way out of it.
As with Scotland, the notion of paper money was alien to the French, who perceived “money” as being either silver or gold.
A Golden Opportunity
As fate would have it, France’s sovereign, Louis XIV, died in 1715, when the heir to the throne was still a young child, wholly incapable of leading a great European state. That task therefore fell to none other than the Duke of Orleans. The same Duke of Orleans who happened to be a friend of Law’s.
The Duke was not himself made King, but he assumed the reins of government until such time as the young Louis XV reached majority age. Law shrewdly seized upon the opportunity and presented himself to the court, where he was warmly received.
Law proposed to the court that a great nation such as France should not be shackled by the inadequacies of a metal currency. France need not be a pioneer in this area, either, as both Great Britain and Holland had adopted paper money with success. Law proposed the establishment of a new bank which would manage the royal revenues and issues notes based on landed security, very similar to the scheme that had been rejected by Scotland.
France was far more eager than Scotland to embrace Law’s idea – and, given its dire straits, it perhaps felt there weren’t any better choices to be had – so a royal edict was issued on May 5, 1716 granting Law the right to establish a bank.
The bank would be capitalized with one-fourth precious metal coinage and three-fourths French bonds. The capitalization was fixed at a sum of $6 million in the form of 12,000 shares at $500 each. The bank would also be responsible for the collection of taxes. The structure wasn’t everything Law had proposed, but it was a good start, and the Duke was willing to grant more privileges once Law and his bank proved themselves.
The public was all-too-willing to make use of the new, convenient banknotes as a form of payment. For one thing, the notes were assigned a specific value, backed by bonds and metal, which was permanently fixed. In prior years, the state had no hesitation devaluing the metal coinage, which meant that a citizen could wake up poorer one morning not because of any fewer coins in his pocket but merely by those coins being deemed of lesser value by royal decree. These new paper notes, however, were not subject to that kind of arbitrary depreciation.
The name of this institution was Banque Generale, and it was effectively the first central bank of the nation. The bank’s notes were payable on sight, and the paper swiftly was regarded as more valuable than the silver coinage that most citizens used, since the latter had a nominal value that was at the mercy of the state. Indeed, over the course of a year, the paper notes rose 15% in value based on their purchasing power. It seems that this modern view of money was swiftly accepted by the public with greater success than anticipated. Paper was not just as valuable as metals, it was actually perceived as being safer and more valuable.
Part Two will appear tomorrow. If you are enjoying this piece, consider purchasing Panic, Prosperity, and Progress, my book about 500 years of financial history.
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