John Law inflation in France

The inflation of paper money of John Law's bank has led to speculation with shares of the Compagnie des Indes. The boom of 1718-1720 - also known as the Mississipi Bubble - has turned into a crash in 1721, which has obliterated the bank and wealth of many speculators, who took part in the boom.

Prelude
In 1640 introduced France the golden Louis d'or in value of 10 livres. One year later it began to mint the ecu blanc equal to 60 sol (corresponding to the German thaler), later known as sous. In 1689 was the fiscal situation of the French state so bad, that all circulating money had to be withdrawn and re-stamped to a higher value.

In 1693 was instituted a "reform" of the currency: all coins were devalued, withdrawn, and restamped with a higher nominal value. It became a repeated source of income. 1703 were for the delivered coins given paper notes with a temporary currency status. 1705 began the state to pay with interest-bearing paper notes, and by law could be a quarter of all payments made with paper. A few years later was the budget in a complete disarray. Desmarets was named minister of finances to remedy it, and had some limited success.

After the death of Charles II of Spain broke out a succession war. France used it to take over Spain's foreign trade with South America to great profit, including direct imports of gold and silver, which were used to withdraw some of the paper notes from circulation. But the budget was not to be saved. After the death of Louis XIV, the Sun King, in 1715, was the state debt at incredible 2 billion livres.

The new regent Philippe of Orléans tried to reduce the state's expenses. With an income of 69 Millions livres against expenses of 147 Million, it was close to impossible. The entire state debt was reexamined, from over 600 Million were only 250 recognized, with a reduced interest rate - but a promise was made to stop with the reformations.

The trust in government was heavily hit, when a reformation followed only two months later. It was calculated, that 1000 million coins would be withdrawn, with a profit of 200 million for the state. But only 380 million were delivered, the profit reduced to 76. Private counterfeiters have ruined the whole operation.

Another attempt to find more income was a revision of all financial contacts with the state. Special Chambers of Justice have prosecuted every person, that was in some kind of a financial contact with the state. Over 4000 were convicted, to a sum of over 200 million in livres in fines. But since most of them were very influential, only 70 million were actually paid. When the chambers attempted to charge all rich people, the regent was forced to disband them. Then came John Law and his ideas of paper currency.

The Banque, Compagnie, and the boom
In 1716 was Law allowed to create the Banque Générale with the right to create banknotes. The capital was 6 million livres and consisted of 12.000 shares at 500 livres; three quarters could be paid in state paper notes. The banknotes were called Ecus de banque, and came in nominal values of 1000, 400, 100, 40 and 10 Ecus. They had all the marks of modern banknotes, with special care devoted to their quality and how easily discernible they were.

The bank proved to be popular and profitable within a short time. But Law had greater plans. In 1717 he received a patent for the Compagnie d'Occident (Mississipi Company), with ports and islands of Louisiana, and a monopoly on the beaver trade in Canada. It was strongly connected to the bank from the start. In 1718 it obtained a rent on the tobacco trade.

In December 1718 was the Banque Générale turned into Banque Royale, all shares had to be paid back. Besides banknotes in Ecus were also issued notes in livre tournois. At the same time, large payments were limited to banknotes, silver was limited to amounts of up to 600 livres, in token coins down to 6 livres.

Law became a director of the Banque in January 1719. In April, the printing of Ecu banknotes was stopped, and the livre tournois notes were limited to 110 million (100 for circulation and 10 to exchange defect notes in reserve). Also, banknotes were not to be affected by devaluations of coins, reasoning, that the notes were more reliable than gold or silver coins and should be trusted by the public after the hated 'reformations'.

In May 1719 added Law the badly performing companies of East India and China to his own, renamed to Compagnie des Indes. (As a first, the share-owners received an option to one new share per four old shares.) In July the Compagnie bought a monopoly on coinage for nine years. It could keep the whole profit, but could not change nominal values or content of coins. Another emission of shares followed (option to 1 new per 5 old shares), and the amount of banknotes in circulation was raised to 400 million. A general economic boom followed, accompanied by a speculation in shares.

To get the monopoly on all taxes from the Paris brothers, Law suggested to the regent a way to lower the pensions to a 3% interest. In August 1719 was a loan of 120 million offered to pay back all state pensions. To cover the loan, 300.000 new shares had to be issued in several emissions. 200 were eagerly accepted by the speculators, 100.000 were given to the regent free of charge and 24.000 were given to him later for his services as the protector of the company. In November offered the Compagnie another loan of 300 million to the king, to repay the entire state debt.

Meanwhile, the shares were wildly speculated with on the stock market on rue Quincampoix (fr). The 500 livre shares were sold at issue 6-7000 livres, in November for 9800, in December 12.500. Businessmen and adventurers flocked from all countries and millions could be won and lost in a few hours. The aristocratic gamblers played the game as well. Even the banknotes were caught in the boom since summer and were traded with an agio against gold and silver. The agio for gold was then limited by law, silver was allowed only for payments up to 10 livres and gold up to 300 livres. Large amounts of gold and silver were deposited in state treasuries. Great wealth was thrown about, but the price have been rising quietly.

The peak and the bust
At their peak in September 1720, prices in Paris were roughly double what they had been two years before, with most of the increase coming in the previous eleven months. This was a reflection of the extraordinary increase in note circulation Law had caused. In the space of little more than a year he had more than doubled the volume of paper currency. By May 1720 the total money supply (banknotes and shares held by the public, since the latter could be turned into cash at will) was roughly four times larger in livre terms than the gold and silver coinage France had previously used. Not surprisingly, some people began to anticipate a depreciation of the banknotes, and began to revert to payment in gold and silver.

In 1720 was Law named finance minister (as a Protestant he had to first become a Catholic). The shares of Compagnie des Indes were still rising in January, reaching a temporary peak of 18.000 livres. Law worried about the too high price. To reduce it, he sold 30.000 shares for 1000 livres in cash and 10.000 in 6 months. The speculators started to sell. The smarter ones have already left France, buying up precious metals and gems. Others also sought liquidity, buying especially land titles. To support the rapidly falling price, Law opened a company office to buy shares at 9000 livres. The bank also bought them, and the notes in circulation have risen by 600 million. But the notes have also lost trust, and many were exchanged for gold and silver coins. To protect the bank's metal reserves was the hoarding of cash forbidden. The price of a mark of gold was raised to 900 livres and 60 livres for silver, their export was forbidden from February 1st. The Compagnie was also allowed to make house searches for precious metals and to confiscate them. The carrying of pearls, diamonds and gems was forbidden, punished by a steep fine and confiscation. Silverware was forbidden or limited in weight.

On February 22nd called Law a special board meeting, which agreed on the following: the Banque Royale and Compagnie des Indes were united, the 10 Livre notes were to be withdrawn. All payments under 100 livres should be paid in hard money (but this was later recalled). The Compagnie would take over the 100.000 shares given to the king before, for a payment of 900 million. New pensions with a 2% interest should be issued, to be exchanged for shares, which should be summarily destroyed. On February 22 was everyone forbidden from having more than 500 livres in cash. Another edict fixed the price of a share to 9000 livres, to be exchanged for money or back. A mark of gold was raised to 1200 livres, of silver to 80 livres.

There was already over 1 billion of banknotes in circulation. The exchange of the shares required another emission and brought the total over 2 billion. By May the bank held in total 430.000 shares, and Law wanted to reduce the number of banknotes in turn. But Law's enemies were more than active and the regent on their prodding all but declared bankruptcy of the bank. The shares were fixed to 8000 livres, and their price was to be lowered each month until by December it would be reduced to 5000. The banknotes should be similarly reduced to a half. The decree had to be revoked within a week due to the outcry. Law was removed from all offices and the shares were traded at 600 livres by then.

As his successor d'Argenson was unable to cope with the crisis, Law was called back in June. At the end of May was the bank closed, it reopened in June 1st and redeemed only 100 and 10 livres notes. The crowding in front of the bank's counters reached such proportions, that casualties were recorded (in the night of 16. July alone it was 15 people, the crowd brought their bodies to the regent's palace). The bank was closed on 18th July. On 30. July were gold and silver coins raised to twice their nominal value, and for a while banknotes were traded at par with them. But by end of August were the notes traded for only 33%.

On August 15 it was ordered, that the 10.000 and 1000 livre banknotes had to be exchanged for life annuities and other pensions, from October 1st only for 2% pensions. More attempts to save the bank followed, but all failed. The bank was declared bankrupt on 10th of October. Neither could be the Compagnie saved, its shares were at 200 livres gold in November, in December at 1 luisdor. Law withdrew from Paris and on December 28, 1720, left the country with a passport from the regent on the name "Du Jardin", with only 800 Luisdor on hand, all other properties left in France.

The Compagnie was not simply a mirage from paper, at its collapse it possessed over 500 ships. It had independent income from the monopolies on tobacco, coinage and taxes. Law sought the opening up of colonies to trade, which he saw brought great wealth to Netherlands and Italy. But colonization required farmers, workers and traders, that were simply nowhere to be found - not even from other countries. The Compagnie continued to exist for several decades. Law was not simply a fraud and fool, as many pamphlets depicted him. The incomes from the bank and company were used to lower the taxes on oil and soap, the tariff on silk was completely removed, tariff on stone coal reduced. These and other measures made food, wood and coal cheaper by 30-40%. Law supported weaving and fishing, mainly by cheap loans. He also planned with the regent the buying back of all sold public offices, including Parliament seats - which would be a major change of the political system. Law has forbidden the bank employers to trade with Compagnie shares, after he found out, that the directors were manipulating its prices. The constant rising and falling, along with the high price of shares, despite the profits it brought, wasn't good for the company.

And how large were the losses in a country, where nearly everyone speculated with the shares? In 1715m before the founding of the bank, were all state pensions lowered from 8 to 5%. The shares were in the end exchanged for 2% pensions. And so, most of the wealth (estimated at 80%) in pensions, banknotes or bank accounts has been lost. For the French state were the consequences much better. The total debt of 2 billion livres from 1715 remained at roughly the same size in 1721, but most of it was in pensions with a 2% interest rate - a significant improvement of the public debt. The economy at large was badly damaged and slow to recover.

Currency before the Revolution
Louis XIV, ostensibly to restore a parity between gold and silver, but actually to finance his extravagant court and wars, had created the utmost confusion in the currency. Between 1696 and 1715 the livre of account had been depreciated, in terms of gold, by 50 percent, through the process of calling in the outstanding coins and reissuing them at a higher value. By 1720, after the collapse of Law's System, some forty different gold louis and ten different silver louis were in circulation. In 1726, in an effort to restore some order to this chaotic system, a general recoinage was instituted on the basis of a ratio of 14.625 to 1. This ratio was subsequently adjusted (in 1785) to 15.5 to 1, but meantime the effect had been to draw off gold and leave the circulation predominantly silver. This was the situation before the currency reforms introduced by the French Revolution.

Links

 * Memoirs of Extraordinary Popular Delusions (Volume 1) by Charles Mackay
 * Fiat Money Inflation in France (pdf) by Andrew Dickson White
 * The Saga of John Law and Richard Cantillon, December 2004, by Sean Corrigan
 * Early speculative bubbles and increases in the supply of money (pdf), May 1992, by Doug French
 * John Law and the Invention of Modern Finance, July 2009, by Doug French
 * The Great Paper-Money Experiment by Elgin Groseclose, from the book Money and Man
 * Mississippi Company on Wikipedia
 * The Great Mississippi Bubble by Washington Irving, 1819-1820