The Bear’s Lair: Mississippi Company Economics

We have seen today’s economics in action before. Not in the 1720 South Sea Bubble – that was a simple stock market frenzy, similar to that of 1999, with a debt conversion scheme buried in it, but no excessive leverage. However, the almost exactly contemporary Mississippi Company/ Banque Royale scheme, devised in Paris by the Scots financier John Law – that, truly, bears a hideous resemblance to today’s markets, sparked off by a very similar monetary policy. Its collapse and the denouement thereof is also instructive.

In an era of Keynesian economic manipulation, John Law (1671-1729) has been rehabilitated as an “economist,” the father of several of the unpleasant economic nostrums we use today. His contemporaries, and Charles Mackay’s 1841 “Extraordinary popular delusions and the Madness of Crowds” saw him as a con-man and swindler on a gigantic scale, and this is surely far more accurate in terms of his motivations and methodology. Law himself would be astonished to see the reverence with which modern economic historians treat him.

Law was the son of a Scottish banker who began his career by losing large sums of money gambling and then killed a love rival in a duel. He escaped to Amsterdam, then moved back to Scotland, where he proposed to establish a national bank, publishing a pamphlet in 1705: “Money and Trade Considered: with a Proposal for Supplying the Nation with Money.” The 1707 Act of Union killed that scheme (England already had the Bank of England) so for the next eight years he moved between France and the Netherlands, making a living as a speculator.

Then in 1715, he found an opportunity. The death of Louis XIV in that year, together with the near-bankruptcy of the French state from his incessant wars had left the Regent Philippe d’Orleans (acting for the infant Louis XV) desperate for good ideas. Law’s idea of a monopoly bank, taking in taxes and financing the government through issuing bank notes (which were effectively interest-free debt), seemed a good wheeze and after suitable douceurs to the Regent and other politicians, it was approved. On May 1, 1716, Law’s Banque Générale Privée opened its doors.

The following year, Law’s bank bought the Mississippi Company, which had been formed in 1684 to exploit the resources of the nominally French-controlled Mississippi Valley (Law became the duc d’Arkansas). Then in 1718 Law’s bank became the Banque Royale, making its notes guaranteed by the King of France, and purchased the right to collect most French taxes. Repeated share issues by the Mississippi Company, which purchased the East Indies and China trading companies, and massive further issues of Banque Royale banknotes wildly inflated asset prices (Mississippi Company shares rose 20-fold between January 1719 and December that year). Consumer prices generally were less affected, although they rose 23% in January 1720, as the scheme was heading for collapse.

The scheme collapsed in the spring of 1720, about three months before the collapse of the British South Sea Company’s stock price, with the Banque Royale stopping payment on its notes. The collapse was followed by decrees making gold holdings illegal, with no attempt made to bail out the unfortunate noteholders, unlike in Britain after the South Sea Company debacle. In consequence, most French mercantile capital was lost, and French credit was wrecked for the rest of the century. As a result of its poor credit, France lost a series of wars against Britain, and eventually relative economic and political decline led to revolution.

Law is regarded by modern Keynesians as a great economist, because his half-baked scheme used many of the principles of modern finance. The key was the incorporation of an asset bubble into the money printing, with the purchase of the Mississippi Company by the Banque Royale. This prevented the extreme consumer price inflation seen with the American Continentals in 1775-81 and the French assignats in 1789-96, and forced the upward pressure from money creation into asset prices, primarily Mississippi Company shares, but also real estate.

Far from being a work of economic genius, Law’s scheme produced only ruin, whereas the British innovations in the same time period, the Bank of England in 1694 and Consols in 1751, being soundly managed, produced financial stability, military victory and industrial takeoff. We do not have to believe the rehabilitation of Law by modern economists nearly 300 years after the event. There was a perfectly competent genuine economist present at the time, who saw the fallacies of Law’s approach, in Richard Cantillon (1680s-1734).

Cantillon, an Irish Catholic Jacobite, emigrated to France in 1714 after the Hanoverian Succession and joined his cousin’s bank, which he bought out two years later, becoming banker to the Stuart court in exile. He bought early into Law’s speculation in spite of Law’s threats to use his political connections to hurl Cantillon into the Bastille. Then, realizing that from its money creation and leverage Law’s scheme was bound to lead to disaster, he sold out near the top.

Cantillon then successfully pursued creditors who had borrowed money from him at rates up to 55% per annum to speculate in Mississippi Company shares, thus becoming very unpopular as well as extremely rich. He was thus forced into exile for a decade, writing his great economic treatise “Essai sur la nature du commerce en general” in 1730 before dying in an unexplained house fire, probably murdered, in London in 1734. His fate was thus in marked contrast to that of Samson Gideon, who made a simultaneous fortune out of the South Sea Bubble, but survived to old age, to invent Consols and see his son rewarded with a baronetcy. Then as now, Britain was less punitive towards the financially successful than France.

Cantillon’s Essai was first re-discovered by W. S. Jevons in the 19th century, and he was subsequently praised by Frederick Hayek as “the first person who succeeded in penetrating and presenting to us almost the entire field which we now call economics.” Among other discoveries, he postulated the Cantillon Effect, whereby a rapid infusion of new money enriches the wealth of its original recipients at the expense of others, while raising some prices in the economy disproportionately and leaving prices in general largely unaffected. He also saw, like Lord Liverpool a century later, that paper money was useful in moderation to prevent any scarcities of specie resulting from hoarding, but that it should be strictly limited lest it lead to “fictitious wealth” (Liverpool’s phrase.)

Being a real economist, unlike Law, Cantillon saw the fallaciousness of Law’s scheme, early enough to profit enormously before it collapsed. His analysis, and Law’s fate, have huge relevance today. Like Law, the world’s central bankers have created a monetary bubble, or rather since 1995 a series of monetary bubbles, which like Law’s Banque Royale, have taken the form of a vast debt-induced increase in asset prices without significant inflation.

The central banks have made debt exceptionally cheap, and have thereby allowed speculators and others to create “fictitious wealth” through pushing up the prices of shares, real estate and other assets, real and now through crypto-currencies imaginary. Ultra-cheap money does not automatically make consumer goods more expensive, but it does provide a subsidy to leverage. In this respect the modern bubble, like Law’s, is firmly associated with fixed asset price inflation rather than with consumer price inflation in general. Central banks’ quantitative easing purchases of assets from the banking system has also provided a subsidy to bank lending, but not to inflation in general; it thus resembles Law’s purchases of government bonds in the Banque Royale.

As Cantillon would have predicted, general inflation has remained modest, though as in Paris in January 1720, there may be a burst of inflation during the bubble’s collapse. As Cantillon would have predicted, the cheap money and asset purchases have greatly enriched those with the best access to the new liquidity, while tending to impoverish the remainder of the population.

Like Law’s speculation, as Cantillon predicted, the world’s central bankers’ Law-like activities will end in general collapse, with credit throughout the economy ruined. Whether our recovery takes the remainder of the century, and ends in revolution, is yet to be determined. Since almost the entire world has been involved in these foolish policies, we can at least be thankful that there is no gloating Britain, free from the malaise, to pound us with naval broadsides for the rest of the century.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)