“Money...Money…Money… Anyone can get rich quick. No risk. All you have to do is think big and have faith in your government.” These were the words of John Law, a convicted murderer and millionaire gambler, who also set up the first bank in France, the Banque Générale Privée (General Private Bank) in May 1716.
The most sensational get rich quick schemes exploded 300 years ago in France. The great King Louis XIV wanted to build a magnificent palace and fund his wars. He borrowed most of the gold from his countrymen. The wars waged by Louis XIV left the country completely depleted, both socially and financially. The resultant shortage of precious metals led to a shortage of coins in circulation, which in turn limited the production of new coins. The government’s borrowings were guaranteed by the king’s ability and willingness to repay. Upon his death, people became unsure about the return of their gold. They demanded their gold back and protested in front of the palace. At that time, the new king (Louis XV) was only five years old. Therefore, a regent took over the rule on behalf of the king. He had a shrewd plan to pay back the public. He thought of IOUs in the form of government guaranteed bonds. He believed that not all lenders would come to redeem the bonds at one time. Therefore, it would, ease the pressure off the government to pay back in gold. The bonds bore a promise of interest on outstanding amount and also the guarantee of safety by the government. The public gladly accepted the offer of government bonds and left for their homes with the first ever financial instrument in their hands.
But the regent had another trick up his sleeve. He decided to devalue the value of gold to half, thus reducing the royal liabilities by half in one shot. This move didn’t go down well with the public and the protests started again.
This brings our hero of the Mississippi Bubble, Mr. John Law, into the picture. Law was born into a family of bankers and goldsmiths in Scotland. Law was a compulsive gambler and a brilliant mental calculator. He was known to win card games by mentally calculating the odds.
On April 9, 1694, John Law fought a duel with Edward ‘Beau’ Wilson in London. Wilson, one of the richest people in London, had challenged Law over the affections of Elizabeth Villiers, Countess of Orkney. Law killed Wilson with a single stroke of his sword. He was arrested, convicted for murder by the English courts and sentenced to death. His sentence was later commuted to a fine, upon the ground that the offence only amounted to manslaughter (a lesser criminal offence than murder). Wilson’s brother appealed to the court and had Law imprisoned, but Law managed to escape to Amsterdam.
During that period, Amsterdam was at the peak of its economic success. The Dutch had evolved several advanced financial tools. For over 20 years, Law studied and fell in love with their currency system, banking system, the concept of company and stock markets.
Upon hearing about the public unrest in Paris on account of the recent economic changes, Law sensed an opportunity and paid a visit to the Regent of Paris to introduce his methods of solving the bankruptcy crisis faced by the French government.
“Try paper money. Yes, paper money. I will open a Bank where people will deposit their gold and will get a receipt, a bank note, from me. It will be just as good as real gold. It is inconvenient for everyone to carry physical gold around for any kind of trading,” explained John Law to the Regent of Paris.
The proposal was accepted on a trial basis. Very soon, the bank notes became so popular with the rich traders that the regent declared bank notes as the official currency of France. The royal palace got involved in running the bank. But unfortunately, the regent got carried away.
The regent didn’t understand that the paper currency must represent the real wealth, i.e. the actual gold deposits available with the bank. He ordered massive printing of bank notes, paying no heed to the actual bank deposits. With the increase in money supply, France became a rich country again.
Meanwhile, John Law was dreaming of a new city as a mark of his fiscal prowess. He wished this city to be named after King Louis XIV, to be called Louisiana, where everyone would be rich in diamonds, gold, rubies, etc. He incorporated a company wherein he offered the subscription of its shares in exchange for government bonds held by the public. Instead of interest rates from the government, now the shareholders would receive dividends out of the profits of the company. The offer was gladly accepted by the public as they didn’t wish to be left out of the ‘get rich quick’ opportunity coming their way. Almost everyone in France indeed wanted to hold shares of Louisiana.
But the Louisiana venture didn’t get off the ground. It remained an undeveloped swamp. But let’s forget Louisiana. Shares were the thing that mattered most to investors. People were trading shares with each other and making profits purely by share trades. No one gave a damn about the basic business progress of the company. Thanks to the excess paper money available, the price of shares sky rocketed.
At frequent intervals, John Law would issue a fresh lot of shares. People would throng to his house. All this while, the regent would print more and more bank notes from the bank.
A small street in Paris was designated for stock trading. Huge iron gates were erected on both ends of the street, one end for the nobles, and the other for the commons. Every morning, at eight ‘o’ clock, the gates were flung open for trading. There used to be massive chaos owing to the crowds. Such was the rush that some people earned a fortune by renting out their backs to be used as writing desks.
‘One day a pauper, another day a prince,’ became a common phenomenon. Ample supply of paper money and wildly rising stock prices gave birth to a new term: ‘millionaire’.
Then, on a January morning, a wealthy prince walked into the bank with all his paper money. He demanded an equivalent quantity of physical gold. It took three wagons to carry it away.
Eventually, sanity prevailed about Louisiana shares and the stock prices also collapsed. All this gave rise to massive unrest and threatened the kingdom’s stability. But this was not enough to scare John Law and the regent. They came up with yet another trick.
They issued an edict that the company would buy back the shares. This edict didn’t go down well with the public, as they no longer wanted paper money in exchange of stocks. They wanted actual gold. But the problem with the bank was that the gold quantity available was painfully inadequate.
The royalty, to save their skin and make paper money valuable, issued another edict making gold coins illegal. In one stroke, using the heavy hand of the government, the regent declared that anyone who demanded gold would be tried as a criminal, and thus artificially curbed the demand for gold. Along with the edict, the regent ordered an increased supply of paper money by running the printing press day and night.
This caused inflation to go through the roof. The prices rose to such maddening heights that John Law was forced to break the guarantee offered by the bank. Now, the paper money was worthless, the stocks were worthless and they couldn’t trade in gold. This made Paris a thief’s paradise and forced the regent to legalize gold again. This resulted in a stampede with people rushing to convert their gold for paper, due to which at least 15 people were crushed to death.
It was all over. The four-year reign of paper money had ended in utter disaster. The Mississippi Bubble was the first ‘Rags to Riches to Rags’ story in modern economics history. John Law then escaped the country in disguise and never returned to France again. Before his escape, he was the richest person in France. The massive losses to the public of France are untold and unaccounted for.
The Mississippi Bubble is a good example of the Greed and Panic of investors, and the systemic failures of the government. There are important lessons to be learnt.
Excerpts from Book : Say Goodbye to the Herd Mentality, authored by Sameer Rastogi