John Law, the first “millionaire”

Originally posted on Thursday, January 16th, 2014

The Federal Reserve Bank of New York’s James Narron and David Skeie continue, in the NY Fed’s Liberty Street Economics continues its superb lessons from history, entitled Crisis Chronicles, to recount the story of the financial havoc wrought by John Law in Crisis Chronicles: The Mississippi Bubble of 1720 and the European Debt Crisis.

An excerpt:

Convicted murderer and millionaire gambler John Law spotted an opportunity to leverage paper money and credit to finance trade. He first proposed the concept in Scotland in 1705, where it was rejected. But by 1716, Law had found a new audience for his ideas in France, where he proposed to the Duke of Orleans his plan to establish a state bank, at his own expense, that would issue paper money redeemable at face value in gold and silver. …. Things didn’t turn out exactly as Law had hoped, and in this edition of Crisis Chronicles we meet the South Sea’s lesser-known cousin, the Mississippi Bubble.

Who Wants to Be a Millionaire?

In 1719, the French government allowed Law to issue 50,000 new shares in the Mississippi Company at 500 livres with just 75 livres down and the rest due in nineteen additional monthly payments of 25 livres each. 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.

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.

The Trickle Becomes a Flood

… in early 1720 some depositors at Banque Generale began to exchange Mississippi Company shares for gold coin. In response, Law passed edicts in early 1720 to limit the use of coin. Around the same time, to help support the Mississippi Company share price, Law agreed to buy back Mississippi Company stock with banknotes at a premium to market price…. To support the stock redemptions, Law needed to print more money and broke the link to gold, which quickly led to hyperinflation….

The spillover to the economy was immediate and most notable in food prices. By May 21, Law was forced to deflate the value of banknotes and cut the stock price. As the public rushed to convert banknotes to coin, Law was forced to close Banque Generale for ten days, then limit the transaction size once the bank reopened. But the queues grew longer, the Mississippi Company stock price continued to fall, and food prices soared by as much as 60 percent.

Note:

Disclaimer
The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

The authors of this paper draw some intriguing observations as perhaps applicable to the Eurozone about the need for coordinated fiscal, monetary and currency policies.  A particularly astute observation, is that “…Law suffered a self-inflicted loss of control over monetary policy once the link between paper money issuance and the underlying value of gold holdings was broken—a lesson that monetary authorities have learned over time.”

Perhaps in time it will appear to our monetary authorities salient to begin to ponder whether an optimal way to create coordinated monetary and currency policies, with or without coordinated fiscal policy, might be through the restoration of the classical gold standard.  This was founded at almost precisely the same time as Law’s ill fated paper-based venture by Sir Isaac Newton, then Master of the Mint of Great Britain.

While Law’s venture failed in about a thousand days, Newton’s classical gold standard served Great Britain, the Bank of England, and the world very well for almost two centuries.  Surely there are lessons to be derived from success as well as from spectacular failures.