What Has Changed in the Last Three Centuries?
— “The Financial World According to Inya” Column
by Inya Ivkovic, MA
Apparently, not much! Perma-bears want to get their message across, which is that the market is still stuck in a super bear cycle loop and that the economic woes already undergone and those still to come will be the worst and the longest-lasting since the 18th century. I like to listen to perma-bears, they always present the most interesting parallels of worlds gone wrong in the past. The latest parallel is the one drawn between the events in the 18th-century France and our world of the 21st century. So, what on earth happened in the 1700s? Why are today’s markets reminiscent of that long ago period and what then may await us if current events indeed progress as they did 300 years ago?
Apparently, the cautionary tale of the 18th century is one about John Law, the fascinating Scottish gambler and brilliant human computing device, who was known to win at card games by mentally calculating his probability to win or lose. Law believed that money was merely a means of exchange of goods and services and not wealth in and of itself and that what constituted national wealth was heavily depended on trade. After the death of Louis XIV of France, he managed to propel himself to the top dog position of France’s central bank and, for all intents and purposes, also to the position of the top banker of all Europe.
Law also wanted to establish a national bank, the main function of which would be to facilitate credit and the issuance of banknotes that are backed by real estate, gold or silver. He pushed for the replacement of gold coins with paper money, effectively creating excess money supply and leading to one of the first and greatest — albeit fuelled with fiat currency that lacked proper backing — hikes of economic growth in history.
But Law’s uncanny connection to the 21st century does not stop there. John Law was also instrumental in the creation of the Mississippi Company bubble and the eventual and rather chaotic economic crash in France. The story of the Mississippi Company started in May 1716, when Law set up the General Private Bank to further his goal of replacing gold coins with paper money. Although the bank was privately owned, about three-quarters of its capital were tied up in government securities.
A year later, Law bought the Mississippi Company to help establish the French colony in Louisiana. Soon after, Law floated shares of the Mississippi Company as a joint entity with another bank, Compagnie d’Occident, which held a monopoly over the West Indies and North America. In 1718, Compagnie d’Occident became Royal Bank and acquired a number of its rivals, emerging another year later as the Company of the Indies, having a monopoly over trade on all seas. The latter’s shares became a proxy for the value of paper money, spurring speculation and inflation.
The entire structure was based on Law’s concept of trading shares in the Mississippi Company in exchange for the government debt, thus effectively becoming the central bank of France. In 1720, Law became Controller General of Finances and his main job was to attract capital to France. He set out to accomplish this mandate by exchanging shares of the Mississippi Company for government securities, eventually diluting the value of each share and exhausting all capital on the purchase of each new government note. In the beginning, as the speculation built the momentum, the appearance of economic value was great. But there was something seriously wrong with Law’s idea of national wealth and value of paper money.
In 1719, shares of the Mississippi Company became wildly volatile, because Law had grossly exaggerated the wealth of Louisiana. Because of Law’s effective, albeit fraudulent marketing scheme, shares in the Mississippi Company rose from 500 livres in 1719 to as high as 18,000 livres in the first half of 1720. But by the time summer arrived, investors had started wondering about Louisiana and how justified the share price was, leading to a sudden loss of confidence in the scheme and to a 97% plunge in the value of Mississippi Company’s shares by the time 1721 came about.
As one could imagine, when the “bubble” burst, investors rushed the bank’s doors, trying to sell their notes for money or gold, preferably the latter. Predictably, most never recovered their investments. The Mississippi Company collapsed, leaving France bankrupt and forcing Law to flee from France in disgrace and poverty. That is how another one of the “smartest guys in the room” bit the dust.
The story of John Law is not only sobering; it is also uncannily relevant to the 21st century. Law was a financial genius, no doubt, and an innovator. He more or less invented the system of paper currencies, as well as an entity such as the central bank to control it. He came up with the system of backing up paper money with gold that has held for 300 years. And, he orchestrated the first major stock market boom in history.
His schemes attracted investors from all over Europe, who couldn’t get enough shares of the Mississippi Company, launching its price into the stratosphere in a matter of months. Don’t forget; that was a time without modern means of transportation or communication, so such performance was truly spectacular. But when the crash finally came, it was catastrophic. The stock market in France, and much of Europe, simply caved in, leaving thousands penniless and desperate. In Paris, the mob took over. Law himself barely escaped public execution, while those left to pick up the pieces banned paper money and returned to gold and silver. Of course, anyone privately owning gold in whichever form was risking a potentially deadly brush with the law.
Investors soon left France, salvaging what they could, and moved to London to another bubble that was just forming, the South Sea Company, which eventually led England to a market crash of its own. Another lesson not learned; another case of history repeated. At the same time, Parisians warmed their hands and hungry bellies in front of bonfires that burned Law’s paper money. At the same time, the lucky gamblers smart enough not to stay too long in the scheme, danced their happy dance in front of bonfires of their own. Never had France had such great polarization of classes as after John Law was done with it, effectively setting in motion events that led to the French Revolution.
Here is a checklist of sorts from John Law’s 1720 France: the creation of a central bank; the establishment of one, all-seeing central banker; easy credit; financial innovation; high taxes; and a mountain of government debt. Could the tragedy of 1720 be a unique and unrelated event to anything that has happened since? Certainly, such a notion is possible. However, I find all the resemblances too close to home to ignore and find the thought that not much has changed in three centuries unsettling.