The First Modern Financial Crisis — John Law & The Mississippi Company

How irrational exuberance caused the first modern financial crisis.

An economist, gambler, murderer, womanizer, and a man who went from destitution to the peak of European wealth before losing it all again. A man who revitalized the French economy before leading it into a massive bubble that would damage its financial development until the French Revolution. This is the story of the world’s first modern financial bubble — the story of John Law and the Mississippi company.

Early Life

John Law was born on 21st April 1671, as the son of a prosperous goldsmith and money dealer. At age 12, his father died on the operating table during a surgical procedure, leaving his inheritance to Law and his family. Law had always been recalcitrant, he would later move to London where he gambled and womanized his inheritance away. On top of that, Law got into a dispute with an infamous Dandy from London, Edward Wilson. The quarrel ended up in a duel where Law mortally wounded Wilson, resulting in a death sentence for the crime of murder.

Law was eventually pardoned, but fearing the worst, he fled to Amsterdam with the help of his friends. He spent the next 20 years accumulating a sizeable amount of wealth and reading up whatever he could about finance and economics.

Amsterdam was the commercial capital of Europe at the time. The Bank of Amsterdam, also known as the Wisselbank, stood out to Law as one of the key reasons for Amsterdam’s success. People could exchange gold and silver for notes that represented the value of the metal coins they had deposited, creating a safe medium of exchange that was easy to transport and safe from clipping. The issuance of notes was carefully restricted and monitored, which created the necessary trust for the system to work.

Law was enthralled by all of this, and continued to accumulate vast knowledge in finance and economics. He eventually published Money and Trade Considered: with a Proposal for Supplying the Nation with Money (1705).

The publication was first published in Scotland, though the Scottish government would eventually turn down his proposal, it was nothing short of genius. Law understood the concept of scarcity; he understood that money was a medium of exchange which had no real value unless backed by something of value; and he proposed the use of a new banking system and the issuance of paper currency.

Banque Generale

Despite his genius, his proposal for financial reforms was rejected by multiple European colonies. Law eventually made his way to France in 1714. In the early 18 century, the French economy was doing very poorly. France was hit by a famine not long ago and had piling government debt owing to a group of wealthy financiers, the result was a populous but severely impoverished France. This laid the perfect groundwork for Law’s financial schemes.

Law quickly made connections with the French elites. Fortunately for Law, the Duke of Orleans, nephew of King Louis XIV, took a liking to Law. When Louis XIV died, the Duke of Orleans took over as Regent, and Law convinced him to set up a bank, the ‘Banque Generale’.

It worked by issuing banknotes equal to the value of deposits of gold and silver. Since only a percentage of the deposits were withdrawn at any one time, Law could issue more banknotes to increase trade and commerce, thereby stimulating the economy of France.

With the backing of the Regent, the bank soon increased in popularity. People began to prefer the use of banknotes as oppose to gold and silver since banknotes could not be clipped and was easier to exchange.

Mississippi Company

In 1717, Law convinced the Duke of Orleans, to set up the ‘Company of the West’, more commonly know as the Mississippi Company. The company was granted a monopoly of the trade between France and its Louisiana colony for a period of 25 years, a region that stretches across present-day Louisiana, Mississippi, Arkansas, Missouri, Illinois, Iowa, Wisconsin, Minnesota, and parts of Canada.

The company issued shares that could be bought with money or government bonds. This was game-changing. People could exchange worthless government bonds for shares of this new and exciting company, at the same time, it consolidated the government’s debt, resolving the debt crisis the French government was in.

This was only the beginning of Law’s new financial empire. In 1718, the company was awarded the right to collect all revenue from tobacco. In 1719, it took over companies trading with East India and China, forming the company of the Indies, known at the time as ‘Compagnie des Indes’, still referred to as the Mississippi Company. By 1720, Law bought the right to the royal mint for 9 years, paid off the entire royal debt (worth 1.2 million livres), and bought the rights to collect tax revenue. Law now controlled all of France’s international trade, managed its entire financial system, and was the wealthiest man in all of Europe (outside of royalty). Law had financed these massive purchases through the issuance of shares. The share price of the Mississippi company rosed 20 folds within a year ending up at 10,000 livres per share by the end of 1719.

Crash…

Image credit to Bonhams

Perhaps the first sign of trouble was that the Mississippi colony, which promised vast amounts of wealth for the French economy, was a colony struggling to stay alive. There was no fortune to be made in this vast land, no way for Law to keep his promise. Law knew the public’s believe in the colony was imperative, and was desperate to fill the colony with people. A new legislation was passed where criminals, prostitutes, and homeless people were forced into marriages and shipped to populate the new colony. Unsurprising, this did not work and only resulted in a massive epidemic of STDs.

Despite the lack of fundamental value backing the shares, investors were in a frenzy to buy shares of the Mississippi company, aristocrats lined up with pickpockets and peasants as everyone queued up to buy shares of the company. People sold their houses, farms, and belongings to buy shares of the Mississippi company. There were a few people who saw through the mania and insanity that was engulfing Paris at the time. “Have you all gone crazy in Paris?… It is chaos I cannot fathom…” wrote Voltaire to M. de Genonville in 1719.

Moreover, the crown nationalized ‘Banque Generale’ in 1718, turning it into the ‘Banque Royale’. Without proper oversight, there was an excessive printing of money that lacked proper backing through deposits of gold and silver. Loans used to buy Mississippi shares were made too readily available, increasing the money supply at an unsustainable rate.

Up to this point, speculation and the promise of great wealth had kept Law’s financial system alive, but it was becoming increasingly difficult to keep up this mirage. The dramatic increase in money supply resulted in uncontrollable inflation, with monthly inflation reaching 23% in January, 1720. People were starting to get worried, and begin cashing in their shares of the Mississippi Company in exchange for gold and silver, causing share price to fall.

In a desperate attempt to get people to use banknotes instead of gold and silver, banknotes were made legal tender. Furtheremore, the export, production, and sale of gold and silver were banned, and private citizens were limited to a maximum ownership of 500 livres of gold. Unsurprisingly, this caused public outcry and a loss of confidence in the Mississippi stocks.

To make matters worse, in May 1920, Law convinced the regent to introduce a deflationary decree, reducing the value of the company’s share by almost half. He went on to reduce the number of banknote in circulation by nearly half and devalued banknotes after previously guaranteeing this would not happen. This was likely the straw that broke the camel’s back. Chaos ensued, crowds gathered at the bank, breaking windows and shouting profanities. The illusion was beginning to peel off, and people were starting to realise that this was nothing more than a fiasco by a man drunk on his own idealized ambition.

By the end of 1720, the share price of Mississippi stock had fallen to 1000 livres. Law, fearing for his life, fled the country with almost nothing.

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