by elmads

Introduction

“You have to understand the past to understand the present.”

-Carl Sagan

A lot of financially successful individuals always share with everyone the importance of investing in assets that have value and will appreciate over time. They say that it is a prudent and strategic path to make our financial lives better in the long run.

If this is the case, then why are there a lot of stories that say otherwise? People lose a substantial amount of their lifetime savings, if not all, on an asset in which they have invested.

If investing is so important and helpful, then why are there still stories like this? Is there even a way to tell the right approach from the wrong one?

To be honest, there are no exact answers or solutions for every financial investment problem in this world, but there is one depending on our circumstances.

Such as, how would you know if investing in the shares of a company is a good investment or not? Are you paying the right price? Is it a safe investment or not? How likely is it that you will make more money than lose money on it? There are methods for answering such questions today.

When it comes to equity investing, it is more about understanding the underlying company and its businesses.

No matter how high the company’s stock price goes, what dictates its value is and always will be the company’s ability to generate cash flow for its investors, not its stock price. How many times has this happened in the past? And yet, people still always get caught up into market manias. What most successful investors have said has been true, the intrinsic value of the underlying asset is its ability to generate real returns to its investors based on its probable future cash flows.

The Mississippi Bubble was a market mania where the stock price of the company reached sky-high levels because of its perceived potential profits in the future. The dislocation between the public’s extreme expectations and the real ability of the company and its management to keep up with its promise. It is also a story where finance, politics, and economics were all at play.

To understand the Mississippi bubble, we need to go back in time, in early 18th-century France.

The Indebted Early 18^th– Century France

France was a powerful country in Europe during the reign of King Louis the XIV (See photograph above), also known as the “Roi Soleil” or the Sun King, as he strongly believed in his own power as king and the power of the sun. He also compared himself to Apollo, the Greek god of the sun.

His high regard for himself was not just in empty words but backed by his actions and the success that he had achieved as King of France. He won various wars during his reign, such as the War of Devolution (1668), the Dutch War (1678), the War of Reunions (1684), the Nine Year’s War (1697), and the War of Spanish Succession (1714).

Wars are costly and it exhausts resources. King Louis the XIV’s wars were in the expense of the country’s resources and manpower. France was in the brink of bankruptcy; debts were taken, and taxes were increased to finance the war. Famine spread across the nation because of the consecutive wars it joined and raged, among other things.

As King Louis XIV died in 1715, his great-grandson King Louis XV succeeded him at the age of five. At that time King Louis XV was too young to govern the country, therefore a regent (a person appointed to govern a state for a time being because a monarch is still a minor) was needed until he reached the right age to rule France. That regent was Philippe II, Duke of Orléans, who is the uncle of King Louis XV.

As the regent of France, one of his tasks was to manage the finances and treasury of France. To pay off its debts and stabilise its economy. Recall that France during this time was heavily indebted. Philippe II tried his best to pay off the interest on their national debts, but they were behind schedule to repay most of it and couldn’t even barely pay the interests on their existing debts.

It was indeed a monumental task for Philippe II, the King’s regent to handle. He needed someone with the experience, skills, and knowledge to help him turnaround this financial predicament. And in a timely manner, someone emerged and gave out a helping hand, and that someone was John Law.

John Law

John Law is a Scottish economist. He was born in Scotland into a prosperous family of goldsmiths and money dealers.

Law was a rebellious student during his education days; he didn’t continue his university; instead, he went to London to gamble and womanise with his inheritance. Due to this, he accumulated large amounts of debt and was nearly sent to a debtor’s prison, but he was bailed out by his mother. This experience made Law read pamphlets and books to increase his chance of winning gambling games. This was where he expounded his knowledge on probabilities and risk management and applied it with dice and cards.

Law put his newly acquired knowledge and skills to use by gambling. He took his gambling seriously and made a living out of it, which made him a lot of money (Faro and Bassey were two of the most popular gambling games in Europe at that time).

Due to his great gambling knowledge and skills, he was able to build connections with London’s elite and nobility. He was able to enter influential circles, which gave him the opportunity to attend debates and talks about economics, including monetary policies, commodities, and currencies. This piqued his interest because Law wanted to understand the concept of money.

While in London, he was able to learn and see what was happening in the financial system of England at that time. The shortage of precious metals (used to mint coins), the devaluation of the coins, the importance of having sound money to sustain spending in a country, and in turn the stability of the economy and its political system.

John Law Escapes to Amsterdam

One event changed John Law’s life. Due to his womanising lifestyle, he got into trouble when he had a duel with Edward Wilson over his affection for Elizabeth Villiers (later becoming the mistress of King William III of England). The duel resulted in Edward Wilson’s death and John Law’s conviction of murder with the death sentence, but this was eventually negotiated down to manslaughter with the punishment of imprisonment. With John Law’s connections, he was only imprisoned for a short time and was able to flee England.

John Law roamed around various parts of Europe, such as Amsterdam, Italy, and France. His conviction for manslaughter did not stop him from continuing his womanising lifestyle. He also continued gambling to make a living during his travels around Europe. While jumping from one city to another, he continued to expound his knowledge about monetary policies. He saw how paper money worked well in Italy and Amsterdam.

NOTE: During this time, paper money was just a new monetary invention in Europe. Not all countries on that continent used paper money back then. Gold and silver coins were still the most trusted for exchange.

With his accumulated knowledge about monetary systems, he wanted to try this out himself, but for this to happen, he needed someone who would agree with his ideas. And that fateful date arrived when he went to France.

John Law and Philippe II, Duke of Orleans, the King’s Regent

As John Law set foot in France, he wasn’t immediately able to get the chance to take action to realise his visions. At that time, King Louis XIV, “the Sun King,” was still alive. The ministry of finance during that time wasn’t too keen on Law’s ideas. He hit a setback, but he didn’t stop, and he looked for other ways. Law, who had the skill of building connections, was able to meet Philippe II and establish a friendship with him.

When King Louis XIV died, his grandson, King Louis XV, succeeded him. Philippe II, duke of Orleans, became the king’s regent because King Louis XV was still too young to govern France. Because of this, John Law, with the approval of Philippe II, was able to start his own private bank named Banque Générale in May 1716.

The purpose of this bank is to operate like the Bank of England did at that time. The Bank of England started in 1694.

John Law’s plan was to have a private bank that would get as much gold and silver as possible, including the gold and silver coins of the country, and in turn, exchange paper money/bank notes out to the public. The paper money/bank notes promised and guaranteed that the notes would be worth the value of a coin at the time they were deposited. This made the coins not subject to devaluations by the crown like coins.

Let’s say, for example, that you deposited 500 livres in Banque Générale. The bank will give you a bank note stating that paper is worth 500 livres and can be exchanged back for your deposited 500 livres at Banque Générale.

NOTE: The livre was the currency used by the Kingdom of France from 781 to 1794.

There should be a corresponding amount of precious metal coins for every bank note, in theory. If not, then a possible disaster could happen, which could cause the bankruptcy of a single bank or the whole financial system of a country. How? Usually via a bank run. This is where a large number of people exchange their bank notes for gold or silver at the same time.

Let me give you an oversimplified example.

If 1,000 bank notes were given out by the bank, then their gold coin reserve is 1,000. This makes it 1:1.

But what if there are 1,000 bank notes, but then the gold reserves decrease to 800 because the bank loaned the 200 gold coins to others. Then suddenly everyone who owns the 1,000 bank notes wanted it to be exchanged back to gold coins? That would be problematic because the bank is short of 200 gold coins.

Bank runs were one of the problems that a bank needed to handle and face even into the 20^th century. Usually this occurs when economic problems and shocks happen, as people panic and lose confidence in their economy.

John Law faced such a problem before, which was instigated by other banks at the time.

But because he was a friend of Philippe II, the king’s Regent, he was then able to survive a near-bankruptcy episode with the backing of the monarchy. Banque Générale was able to gain the confidence and trust of the French, who eventually accepted the concept of paper money due to this backing. Being backed by the monarchy was one of the greatest honours that a business could ever have during those times.

Why Use Paper Money?

John Law believed that money is not the value for which goods and services are exchanged but the value at which they are exchanged. It is a functional medium with no real value, but if backed by something of stable value like gold, it can work well for everyone.

Only two banks used paper money at the time. Holland (the Netherlands), and Venice, Italy.

Paper money worked well in Venice and Holland; it spurred economic growth and stability because their central banks made sure that there were enough gold reserves in their banks. The balance between the paper money/bank notes, gold reserves, and their loaned-out gold was all met.

Maybe you’re wondering, “How about today?” Gold is still essential, mostly for investment purposes as a store of value, but it is not as essential as it was centuries ago.

So, what makes us believe in paper money? Somehow, we trust the central bank of our own country that they will follow their mandate to stabilise the currency we use and the prices of goods and services. That’s what we trust in our own currency.

Tackling the Debt Crisis of France

The Banque Générale was nationalised in 1718 at John Law’s request.

The bank’s name changed to Banque Royale, making it the nation’s first central bank and naming John Law as its director. All paper money/bank notes that were issued by the bank were guaranteed by the King of France.

Despite this, there was still one problem that John Law needed to solve, and that was the sizeable outstanding debt of France.

Recall that France was highly indebted due to the decades of war it joined and raged with other countries during King Louis XIV’s reign. France couldn’t even repay the interest on their debts; what more on its existing debts? This was the first and foremost financial task that Philippe II and John Law needed to solve together.

Law’s solutions were to print more paper money to increase the supply of credit—this was to increase and encourage spending—and decrease the national debt by replacing it with shares of a company.

• Printing more money. Printing money gives the illusion of more wealth, which can be used for spending. But what really happened here was that it created more credit for spending, not wealth.

Bank notes printed by John Law and Philippe II were used to encourage spending, but there was no real creation of wealth because the amount of gold remained the same, which provided a stable value at that time. If the rate of increase of paper money exceeded the rate of real value creation in an economy, namely the products and services it produced and its gold reserves, then this could lead to a fundamental economic problem like inflation. 

Just think of it like this: 1 bank note = 1 gold, then Bank Royale prints more money, let’s just say it reached to 1,000 bank notes = 1 gold. In here, the increase in bank notes circulating in the French economy would be invaluable because the amount of gold where it was pegged did not even change. In short, real wealth stayed the same.

• The second method that John Law did to tackle the debt of France was to replace its existing debts, which were in the form of government bonds, with shares of a company.

Enter the Mississippi Company.

The Mississippi Company

The age of exploration and colonisation further strengthened Europe’s world dominance during the 15^th and 19^th centuries. The English, Spanish, and French owned territories in the North Americas during those time periods.

The French owned Louisiana (see photograph above), naming it after King Louis XIV, “The Sun King,” when it was claimed for France in 1682.

In 1717, John Law established the Mississippi Company, which received a royal grant with exclusive trading rights for 25 years in the French territory of Louisiana.

Louisiana is a land with unearthed precious metals, such as gold and silver, which could bring riches. This was what John Law marketed to everyone in France.

What he wanted to do was make the people of France, who hold government bonds, swap those debt assets for the shares of the Mississippi company.

Why? to reduce the debt of the French government.

To understand this what John Law did here, we must go back to the fundamentals of both bond and equity asset classes.

Bonds are debts for the issuer, while they are an asset for the one who lends out the money. In the case of the 18^th-century Kingdom of France, they needed capital for the war, hence they issued government bonds. While the persons who bought the government bonds were the ones to whom the Kingdom of France owed the money.

These government bonds are legally binding. It requires the issuer to repay the principal amount loaned to them after the bond matures, including the interest payments they promised.

To know more about bonds, see my blog titled “The Bonds Asset Class”.

Now let’s go to equities. It is a partial ownership interest in a public company. When you invest in a public company, what you’re looking for are the future earnings that it could generate. We don’t invest because of its past earnings because those earnings are in the past and had been allocated already to different financial endeavours, such as to pay off debt, purchase another business, reinvested back into the business’ operations, bought back the shares of the company, and/or paid to their shareholders via dividends. Therefore, we look at the company’s ability to generate more money for its shareholders in the future. That’s the simple gist of it.

To know more about equities, see my blogs titled “How Shares Are Made and How the Stock Market Works” and “Stocks & Shares”.

As John Law consistently marketed the possible riches that the Mississippi company could bring not just for its shareholders but also for France, people flocked and hurriedly swapped their bonds for equity ownership of the said company.

From the perspective of John Law.

The national debt was substantially reduced by giving shares of the Mississippi Company to the public and exchanging them for bonds. This strategy of Law was successful; he was able to get a substantial number of bonds from the masses.

As soon as Law received the bonds, he told the French Crown that he would accept a lower interest payment for it.

Henceforth, it significantly reduced the interest payments on the national debt.

Let me give you an oversimplified example to get the gist of it. Let’s say I owe you $10,000, and we have a legal contract for it. Let’s just call this contract “bond”. I promise to return you the $10,000 after 5 years, including a total of $500 as interest payment for the money I borrowed from you.

• My principal debt is $10,000.
• I promise to pay you back that $10,000 after 5 years.
• I also promise to pay you an interest payment worth $500.
• Our “bond contract” legalises our transaction and puts me, “the debtor,” under the law.
• Thus, if you have the contract, I am legally bound to it.

Subsequently, I started my own company. Its future earnings are immeasurable; they will certainly bring riches not only for myself but also for those who become shareholders in my company.

A portion of the company’s future earnings will be distributed to its shareholders via dividends.

One day I went to you and told you about my company. Afterwards, I made you an offer. What if, instead of just receiving back your $10,000 that I owe you plus the total of $500 in interest payments, you could receive more?

If you swap your bond contract with the equity contract of my company and become a shareholder of it, then you’ll be able to get a piece of the riches my company will generate in the future. I also exaggeratedly added that $10,000 plus $500 are meagre amounts compared to what my company can earn. You eventually agreed, as I marketed my company well. Why not, when you could be rich after a few months and/or years?

After swapping your bond contract for my equity share in my company, I now possess the bond contract. This just means that I don’t need to pay back the $10,000 anymore or the remaining outstanding interest on my debt to you because the bond contract is already invalidated the moment you agreed to swap your bond contract for an equity share in my company. There’s no point in paying myself money because I now hold the bond contract.

Your focus now is on the company I own; you’re hopeful that it will do well over time and that you’ll eventually get rich from becoming a shareholder of it.

The only difference between my narrative and what John Law did is that there are three organisations involved in what happened before namely, The Mississippi Company, the French Crown, and the public who owns the debt asset. By taking the debt of the masses and swapping it for the shares of the Mississippi company, Law asked for a lower interest payment from the French Crown to help it reduce its interest on payments (let’s say instead of $500, make it $250). 

This was what John Law and the French crown did to reduce the national debt. Ingenious or twisted?

To tell you honestly, for me, it is an ingenious financial market invention, and it is even done today. It is called a convertible bond, where you can swap your owned corporate debt asset for an equity share of the company. This can only be done with corporations, not government debts. Why? because you can’t swap government bond asset with equity shares of the government, because the government is not even a private company.

Furthermore, when converting your corporate bond to equity shares of a company, we need to consider a significant risk, and that’s with the underlying company. What if the company doesn’t follow through with its promised earnings? What if they’re a failing company? What if the management performs poorly? What if the competitors push the company out of the game? There are a lot of what-if scenarios when it comes to businesses and investing in them. This is the reason why understanding, researching, and analysing the company are very important in equity/stock market investing.

NOTE: Being a bond holder has more of a safety net than owning shares of a company. If a company goes into liquidation bankruptcy, the bond holders are the first to be paid back for the remaining equity of the company, while the common shareholders are the last to get paid (for most of the time, common shareholders don’t get anything anymore).

The Rise of John Law & Compagnie des Indes

The Mississippi company still needed funding to be able to operate its business in Louisiana and keep its promised riches.

John Law raised capital in two ways: first, by making the Mississippi Company a public company, and second, by getting all the public debt by swapping the shares of the company with it.

As he got the public debt contracts, he helped the crown reduce its debt by asking them to lower their interest payment obligations.

Due to Law’s lure of gold and silver marketing strategy, people who owned government debt swapped it for the shares of the Mississippi company. On top of that, a lot of French individuals also poured their hard-earned money into the shares of his company.

John Law owned a lot of businesses other than the Mississippi Company. He consolidated all of his businesses into one company and named it Compagnie des Indes, but most people still called it the Mississippi Company. 

The Compagnie des Indes, still commonly referred to as The Mississippi Company, was the largest conglomerate in Europe at the time. It enjoyed not just monopoly in its trading routes but also financial and economic control. It was able to gain the rights to mint new coins and the rights to collect taxes. In 1720, John Law was appointed as France’s superintendent general of finance (minister in charge of finances in France).

At the initial public offering of the Mississippi Company in 1719, one company share was worth 500 livres (French currency at the time). August 1719 came and its share price rose to 4,200 livres per share, then on September it was 5,000 livres per share, and on December of the same year, one share of the Mississippi company was worth 10,000 livres.

Who wouldn’t invest in this company when the CEO was also France’s superintendent general of finance. A lot of people invested a sizeable amount of their hard-earned money on the Mississippi company, others even sold some of their belongings to raise cash to invest, while some went into debt just to be able to ride the rising tide.  

To give you some context, a $100,000 investment initially made in the Mississippi company during its initial public offering would be worth $2,000,000 at the peak of the market mania. That’s 20 times your initial investment.

Riches were indeed made to the extent that the word “Millionaire” was coined during this time.

This was a really great time for the French people. The pauper became the middle class, the middle class became the rich, and the rich became richer. What could go wrong?

What Could Go Wrong?

Everything at its core. That’s what went wrong.

Mississippi Company’s Promise

1.) To start, the Mississippi Company couldn’t keep up with its promise, and the lands of Louisiana remained an underdeveloped swamp. The company did not have the gold, silver, and other precious metals it said it would generate for everyone. A sham promise of its future earnings. Although the speculation continued, some wealthy investors started to sell the shares of the company to secure their gains as they deemed its price to be too high already.

Printing More Paper Money

2.) Bank Royale continued to print more paper money. Recall that the paper money used during this time was backed by the French crown, which gave the confidence and trust among the French people as an honoured and valid means of value and exchange. Unfortunately, the paper money continued to be printed, but the gold, where the true value lies and where the paper money was pegged, did not increase. It went something like this: 1 gold coin = 1 paper money, then 1 gold coin = 100 paper money, then 1 gold coin = 100,000 paper money, and so on. But then the public did not know about this, and even if they did, they most probably wouldn’t even care because they were experiencing the best time of their lives. It was becoming a millionaire in paper money due to the increasing number of it in the economy, and the amount of the shares of their invested paper money in the Mississippi company was also massively increasing.

Share Dilution

3.) John Law continued to give out shares of the company. This was to raise more money for the company. The French people didn’t know anything about the stock market during that time, and they just thought that if the stock price of the company went up, they would be rich; they didn’t even consider the probable downside. How could they when everyone was exuberant and elated by the paper money fortunes it brought? You wouldn’t even be able to do fundamental analysis during this time because financial statements were not yet required to be disclosed by law.

The more John Law gave out shares of the company, the more people bought them, but unknown to these people, their percentage ownership of the company also declined. How? Because John Law kept on making and selling more shares of the company, the total number of shares increased, which diluted the percentage ownership of the previous owners of the company.

I’ve discussed this in a blog post titled “Beware of Share Dilution”.

As the Mississippi Company reached its peak of 10,000 livres per share in January 1720, there were some wealthy French individuals who saw this as too high a price. Some of these wealthy individuals sold their shares, then exchanged the paper money proceeds for gold to secure a true value gain.

The paper money would be okay as long as no one exchanged it for gold, but someone did. A problem occurred as the gold reserves significantly decreased.

As the Mississippi company failed to keep up with its promised revenues to their investors and some wealthy individuals wanted to secure their wealth by selling their shares and immediately exchanging them for gold, the share price of the Mississippi company continued to go down.

To stop this fall in share price and regain trust in paper money, Law intervened and made paper money a legal tender, meaning it can now be used to pay taxes and settle debts. John Law further tried to control the stock price decline of the Mississippi Company and even promised to exchange paper money for the shares of the company at the current stock market price, which was 10,000 livres per share at the time. By doing this, John Law doubled the paper money supply of the country, and most of the time when this happens, inflation usually follows. And it did.

NOTE: This rhymes with the massive money printing by different central banks around the world in 2020–2021, which was followed by inflation. Yet, we couldn’t specifically put money printing at fault here as the main reason why inflation spiked during the COVID-19 pandemic era. Recall that the Russia-Ukraine War also happened, which strangled the oil supply and trickled down into the world economy.

John Law and the French crown took this one step further. They controlled the withdrawal of gold by releasing a royal edict banning the withdrawal of gold. The public didn’t like this at all, and the distrust of paper money and the crown continued to swell.

By continuously printing paper money with only the same amount of gold reserves, and the continuous giving out of shares of John Law’s Mississippi company, plus the devaluation of both share ownership of the company and paper money. An imminent downward economic and financial spiral happened and led to the dramatic increase in inflation.

The French economy experienced an approximate 23% inflation rate in 1720. In the same year, the French crown agreed again to let the people exchange paper money for gold. Due to this, a stampede happened in an attempt by the people to quickly trade their Mississippi shares and paper money for gold. 15 people died because of the stampede.

The Bubble Pops

All the financial and economic ruckus took its toll. The price of the Mississippi company fell off the cliff leading to September 1721. From 500 livres per share in 1719 to a high of 10,000 livres per share in January 1720, it fell back to 500 livres per share in September 1721. The stock price was back where it started in 1719.

From a peak of 10,000 livres per share to a trough of 500 livres per share. The Mississippi company had seen a devastating decline of 95%. The photograph above only shows the stock chart of the Mississippi Company until December of 1720. The decline in its share price continued the following year, to 500 livres per share. 

The public was outraged; bankruptcies happened left and right; lives were destroyed; people lost hope; everyone was discontent and distrustful of their financial system and the crown. France became more indebted than it was before.

Everyone wanted John Law to be severely punished; all his enemies took up arms and hunted him down.

John Law fled France and lived the rest of his life in poverty in Venice, Italy. Since then, he has never again set foot in France.

Millionaires were no longer millionaires. Paper money became an ordinary piece of paper that no longer possessed any value.

At the end, it was once again the ordinary people who suffered the most.

The trust on paper money declined, but it would soon after be reintroduce in France after a few decades.

Paper Money and Public Companies Today

Paper money and digital money are widely used today. The strongest currency we have now is the United States dollar. Gone are the times when gold was pegged to every currency. Instead, paper money currency is now pegged to the strongest paper money currency, which is the USD.

“How is that possible? Where is the real value then?” Recall when I wrote in this blog’s portions, “Why use paper money?” that John Law believed that money is not the value for which goods and services are exchanged but the value at which they are exchanged. It is a functional medium with no real value, but if backed by something of stable value like gold, it can work well for everyone.

Gold is no longer pegged to currencies, but paper money is now backed by the government and the central bank. The government is trusted to honour it as a means of exchange, while the central bank ensures currency stability and controls the prices of products and services in the economy. The Federal Reserve, which controls the USD, is an integral part of the global economy, with its decisions affecting imports, exports, and trade prices around the world.

“The Financial System – The Central Bank”, “The Creation of Money Part 1” and “The Creation of Money Part 2”.

From the company’s point of view, laws and regulations have improved since the Mississippi Company popped. Public companies are now required to disclose financial information, including financial statements that outline past performance, present conditions, and future plans.

However, this has not eliminated the chances of fraud and bankruptcy for a public company. Still, investors now have more transparency and better ways to detect poorly managed companies, unlike in John Law’s time.

The times have massively changed since John Law’s era. Though he may seem like a villain because of what he did to France and its people during his time, he still played a vital role in our history. He helped build the financial and economic environment we have today. He distinguished money, as a means of exchange, from national wealth dependent on trade.

His monetary theory has good economic intentions, but he executed it poorly and may have miscalculated the outcome of his monetary actions (the printing of more paper money, the dilution of the Mississippi Company, and the balance on gold reserves).

To Sum It Up

• The Indebted Early 18^th Century France
  • King Louis XIV left France in massive debt due to his wars, and his successor Louis XV was too young to rule, so his uncle Philippe II, Duke of Orléans became the regent. Philippe II appointed Scottish economist John Law to help with the enormous debt, as it was too much for him to handle alone.
• Who is John Law?
  • John Law was born into a wealthy family of goldsmiths and money dealers in Scotland. He was also a serious gambler who acquired knowledge and skills to increase his chances of winning, and made a living out of it.
• John Law Travels to Europe
  • John Law was a womanizer and got into trouble after a duel over his affection for Elizabeth Villiers, resulting in the death of Edward Wilson. He was charged with manslaughter but escaped prison and fled to the Netherlands. He continued to gamble, womanize, and expand his knowledge of economics, commodities, and currencies while traveling throughout Europe.
• John Law & Philippe II the King’s Regent
  • John Law became friends with Philippe II, who as the King’s regent approved Law’s private bank, Banque Générale. Law aimed to operate his bank like the Bank of England, with the goal of acquiring as much gold and silver as possible and exchanging paper banknotes for them, guaranteeing their value. This prevented the coins from being devalued by the crown.
• Why Use Paper Money?
  • John Law believed that money is a functional medium with no real value but can work well if backed by something stable like gold. At the time, only two banks used paper money, Holland and Venice, and it worked well because their central banks maintained a balance between paper money, gold reserves, and loaned-out gold, which spurred economic growth and stability.
• Tackling the Debt Crisis of France
  • Banque Générale was nationalized in 1718 and renamed Banque Royale, making it France’s first central bank with John Law as its director. All paper money/banknotes were guaranteed by the King. Law tackled France’s debt by encouraging people to exchange government bonds for equity shares in the Mississippi company and printing more paper money.
• The Mississippi Company
  • During the age of exploration and colonisation, European powers like England, Spain, and France owned territories in North America. John Law established the Mississippi Company in 1717, which received exclusive trading rights in French Louisiana. He marketed the possibility of discovering precious metals to make the people of France swap their government bonds for shares in the Mississippi Company.
• The Rise of John Law & Compagnie des Indes
  • John Law raised capital for the Mississippi Company by making it a public company and getting all the public debt by swapping shares. He consolidated his businesses into Compagnie des Indes, which had monopoly in trading routes and financial control. Law was appointed France’s superintendent general of finance in 1720. The Mississippi Company’s share price skyrocketed from 500 to 10,000 livres in one year, making it a highly attractive investment.
• What Could Go Wrong?
  • The Mississippi Company failed to keep its promise of generating gold and silver from Louisiana. Despite this, the speculation continued, and some investors began to sell their shares as they considered the price to be too high.
  • Bank Royale printed more paper money backed by the French crown, but the gold reserves did not increase, leading to inflation.
  • John Law continued to issue more shares of the Mississippi Company to raise more money, but the more he did, the more he diluted the percentage ownership of previous shareholders. People bought shares thinking they would get rich, but their ownership declined. No financial statements were required by law, and people didn’t consider the downside.
• The Bubble Pops
  • The Mississippi Company’s stock price skyrocketed from 500 to 10,000 livres per share but eventually fell back to 500 livres per share in September 1721, leaving investors with nothing. John Law fled France, and paper money lost its value, causing ordinary people to suffer.
• Paper Money and Public Companies Today
  • Paper and digital money are widely used today, with the US dollar as the strongest currency. While gold is no longer pegged to currencies, paper money is backed by the government and central bank, and the Federal Reserve controls the USD.
  • Laws and regulations have improved since the Mississippi Company, with public companies now required to disclose financial information.
  • John Law’s monetary theory has good economic intentions, but he executed it poorly and may have miscalculated the outcome of his monetary actions.

In the third instalment of my Market Bubbles in Financial History blog series, I’ll cover the market bubble that inflated in London, The Kingdom of Great Britain, during the same time as the Mississippi bubble in Paris, France. Unlike John Law’s good economic intentions but poor execution, the individual responsible for the Kingdom of Great Britain bubble acted out of self-interest, for money and power.

“History gives us the opportunity to learn from others’ past mistakes. It helps us understand the many reasons why people may behave the way they do. As a result, it helps us become more impartial as decision-makers.”

-UoPeople

https://www.uopeople.edu/blog/why-is-history-important/#:~:text=History%20gives%20us%20the%20opportunity,more%20impartial%20as%20decision%2Dmakers.

Knowledge is my Sword and Patience is my Shield,

elmads

This blog is for informational purposes only and not a Financial Recommendation. Not all information will be accurate. Consult an independent financial professional before making any major financial decisions.