This is a cautionary tale of what can happen to an entire economy when a speculative bubble bursts.
It all started with John Law, a Scottish economist and gambler, who it was claimed was able to win card games by mentally calculating the odds. Furthermore, he believed that the creation of money led to the stimulation of the economy. He also believed that paper money was preferable to coins and dividend-paying shares were the best type of money.
Now this man, with these ideas, became the French Controller General of Finances during the regency of the underage Louis XV of France.
To this must be added that he understood that in those days, it was possible, with the right connections, to get away with anything.
This led him in 1716 to set up a private bank called Banque Générale in France. Then within a year he got it nationalised and had its name changed to Banque Royale.
The bank was funded by a private bank backed by John Law and the underage Louis XV, through his Regent, the Duke of Orléans.
Interestingly, most of the bank’s capital was made up of government bills and bank notes printed by the bank that were backed by silver. Unfortunately, it was only partly supported by silver, but it made people think it was a reserve bank.
The Mississippi Company
Law set up this company and then funded it through the bank. It became a business, which had a monopoly in the French colonies of both North America and the West Indies. In 1717, it even got a royal grant giving it exclusive trading rights for 25 years.
The lessons from the Mississippi Company
The Mississippi Company is a tale of what happens in speculative bubbles and the sort of effect their collapse can have on a country’s economy. It shows how when everything goes mad and everyone speculates on the assumption they will become rich, things can go wrong.
France at the time
France was struggling with an unbalanced currency and an unpredictable treasury as it had been for some time, this led John Law to introduce a plan to settle the nation’s debts. He decided to sell the Mississippi Company’s shares, and to start paying off the vast debt that had been created by King Louis XIV.
At this time the Mississippi Company was investing in the U.S. French territories and appeared to be phenomenally successful. Very quickly it appeared to have a monopoly on French tobacco in the region.
Within two years it had a monopoly of all French trade with the new world, thanks to the support of the French government.
The share price grew, the public started buying more and more shares.
Law then realised if he could sell these shares at this high price, he could use the profit to pay down France’s national debt. Now as France didn’t have the money to pay for them, he created billets d’etat, state-issued public securities, which immediately rose in value.
This led to a period of wild speculation, which in turn led to a general stock-market boom across Europe. The French government started printing more, and then more paper money, which the state’s creditors immediately used to buy even more shares in the Company.
With so much paper money around they got galloping inflation, with the result that paper money and state-issued public securities lost value. They became valueless.
Now at the same time those expected profits from the Mississippi Company’s operations didn’t happen. Therefore, as the company’s stock was so linked to the state’s finances, when the share value dropped, there was a stock market crash. However, the crash wasn’t just in France, but it was found that other countries had also invested, which resulted in a complete disaster in 1720.
Of course, they had to find a scapegoat, that was easy, Law, he fled from France, leaving behind the shell of his Mississippi Company. The enormous debts of his company and bank were then taken over by the state, which increased taxes to clear them, as governments always do!