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Wednesday, June 26, 2019
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Is Economic Collapse in the US Inevitable? – Part 2

To repeat the ambiguous assertions made at the end of blogpost 1, it would seem at once highly likely that the industrial and economic might of the United States will always be sufficient to maintain the American way of life, our freedoms, to pay our collective debts, educate its people, and pass all of this power and affluence on to subsequent generations. On the other hand, it seems almost equally likely—after taking a sobering look at the mounting national and personal debt Americans have—that our current near idyllic condition must be radically changed for the worse or even destroyed by an outright failure to pay even the interest on our colossal debt. There is precedent, and for the remainder of these blogposts, the author will describe national catastrophes based almost solely on the accumulation of unmanageable debt.

First consider France in the early eighteenth century. The economy was depressed, and the government wallowed in debt. Taxes were too high and burdensome for the people. The citizens were becoming restive and began to clamor for relief. An additional burden was that the French controlled a colony they named Louisiana after the grand kings of the country. Louisiana was a vast land mass—larger than France itself–which was sparsely settled in the vast and nearly trackless interior of North America. Very few Frenchmen knew even of the existence of the area, and those who did cared almost not at all about it. It seemed to be a poor investment into which unnecessarily large amounts of French treasure were being poured. Almost every French man and woman would come to know one section of the Louisiana holdings and to rue the day they did. The Louisiana Colony included the Natchez district and the area along the Mississippi Gulf Coast in present-day Mississippi.

A rumor that this land was rich in silver and gold—the basis of French currency–began to take hold among the French people yearning to be free from the yoke of poverty and debt under which the populace and its government struggled. Into this fertile milieu came a genuine character named John Law, a Scottish financier, and a man ready to capitalize on those yearnings with a plan that promised great riches in return for a modest investment. He arrived in France in 1714 and sought out an acquaintance, the nephew of King Louis XIV, the Duke of Orleans. At that time, the duke was acting as the regent of France, serving the five-year-old Louis XV, the minor son and heir of the late King Louis, XIV. The resumption of their acquaintanceship was fortuitous for both men.

The duke was being unfairly held responsible for the severe financial straits France was left with from the many years of profligate spending of Louis XIV. Law needed a benefactor and a place in polite society from which he could generate personal wealth. XIV. The Duke of Orleans was aware of Law’s financial acumen and sought out his help to turn around the French financial depression. In 1716, with the duke’s considerable influence and help, Law was able to convince the French government to authorize him to open a major bank–the Bank Generale–that could issue paper money, or bank notes, an almost unknown concept at the time. The paper notes were to be directly based on the bank’s assets of gold and silver and would be allowed to spread freely throughout the kingdom thereby making commerce easier and more profitable by increasing the amount of money in circulation. He convinced the duke and the government that his ideas would be the catalyst needed to revitalize and rehabilitate the finances of the French government.

The following year, in August, Law convinced the duke and regent of France to support him in a major venture in North America. Law made a thorough study of the French holdings in Louisiana, then organized the Compagnie d’Occident (Company of the West). The source of income that was to provide the money and additional profits for the company had to be given the imprimatur of the duke to go forward, and he and the French government gave that one company control of all trade between France and its Louisiana and Canadian colonies—a major monopoly. The Canadians, and the French agreed to trade in beaver skins, and the Louisiana colony would trade in precious metals with the mother country. John Law would take his profit from his appointment as the overseer of the entire project and the territory which would provide the treasure.

The territory was truly vast: It included the present-day states located along the Mississippi River–Louisiana, Mississippi, Arkansas, Missouri, Illinois, Iowa, Wisconsin, and Minnesota all the way into Canada. Shortly the Compagnie d’Occident became known by its popular name, The Mississippi Company. In return for exclusive control, trading rights, the right to appoint all governors and officers, and to make land grants to developers at a handsome profit over the territory for twenty-five years, Law’s company agreed to accept full responsibility of transporting 6,000 settlers and 3,000 slaves to the colony to ensure its growth, stability, and profitability before the expiration of its exclusive charter.

John Law was the very definition of ambition. The scheme to finance the initial operations of the Mississippi Company was simple and was the forerunner of the Ponzi scheme. Law began to raise the necessary money by selling shares in the company for cash and, more importantly, for state bonds—all with the approval of the regent of France and the French government. Law charged a low interest rate on the bonds thereby contributing to French finances and guaranteeing the company a secure cash flow. The involvement of the regent, the government, the financial wizard, and the overpowering lure of gold and silver brought eager investors flocking to put their money in the Mississippi Company.

Law pushed even further to keep the cash flowing. He added new economic activity under the aegis of the company; his ambitions saw the Mississippi Company as only a small part of a much grander empire he was about to create. In September 1718 the company acquired the monopoly in tobacco trading with Africa. The French government was so taken with Law’s Bank Generale that it took the bank over to make it, in effect, the national bank of France in 1719, renaming it The Bank Royale. Law was given full control of the new bank with the government fully guaranteeing the bank’s issue of notes and bonds and all but insuring Law against failure of any enterprise he could dream up. In May of that year he obtained control of the companies trading with China and the East Indies and renamed his entire business interest the Compagnie des Indes, but most people still knew it as the Mississippi Company; and that was the entity in which they wanted to invest. Fortunes were being made by investors, young and old, rich and those of modest means. Law was the ultimate huckster; he now controlled all trade with France and the rest of the world outside of Europe. Not only did Law advance the use of paper money, but the French word “millionaire” came into use as a result of his famous scheme–the Mississippi Company.

Law’s ambitions were not satisfied by the accumulation of great wealth and influence he achieved with his company and with his bank. The Mississippi Company next purchased the right to mint new coins for France, and by October it had purchased the right to collect most French taxes as a result of the amazing turnaround of French financial problems effected by him. In January 1720, Law was made the Controller General and Superintendent General of Finance. With this new appointment Law gained control of all of France’s finance and money creation, foreign trade, and colonial development. John Law with his business interests and success came to hold most of the French government’s debt. The Duke of Orleans recognized that the faith he had in the man who was now his firm friend was fully satisfied. The man had created a stable source of income for future business ventures for his company and for France itself. John Law had created Europe’s most successful conglomerate, and its stock values were rising fully apace. People all over Europe rushed to be sure they could put their money into the company in time to reap the great profits, even to the point of transferring nearly all of their earthly holdings to buy the stock.

Law paid for these activities and privileges by issuing additional shares in the company. These shares could be paid for with bank notes from his own bank or with government debt which he controlled. The Mississippi Company and John Law could not lose. The value of shares in the company rose dramatically as Law’s empire expanded. Investors from across France and Europe ever increasingly and eagerly played in this new market, even frugal working class small farmers and businessmen were pouring in all the small amounts they could scrape up. The financial district in Paris became so agitated at times over the fervor of investors that soldiers had to be sent in at night to maintain order. Greed was in full flower, and new millionaires were becoming commonplace.

When the company first issued shares in January 1719, the offering was a modest 500 livres tournois (the French unit of account at the time) per share. By December, the price per share prices reached 10,000 livres, a 1900 percent increase in less than a year. And here is where the comparison to present day America and Europe begins to become apparent.

Remember the world’s Great Depression of the 1930s, the community credit scandal, and the Great Recession of 2007-2008. What follows will seem reminiscent to those of you who do.

There was a weakness in Law’s grand scheme which has played out repeatedly in American history even to the present day. His relationship with the government was too cozy, and his own and his investors’ grasp of the bubble that was forming was obscured and flawed by the “greed is good” philosophy that drove stock prices ever higher—well beyond the level where a firm basis in gold and silver existed. Law’s weakness, based on greed, was his willingness to issue more bank notes to fund purchases of shares in the company—more than the real value of the company. A few major investors began to realize that there was little foundation for the soaring Stock prices.

The prices began falling in January 1720 when some those wiser investors began to sell shares to turn capital gains into gold coin. Prices began to decline, gradually at first. To halt the growing sell-off, Law restricted any payment in gold that was more than 100 livres. The paper notes of the Bank Royale were made legal tender backed by France to shore up strength of the stock values, which meant that they could be used to pay taxes and settle most debts. Law, through his Mississippi Company and his national bank made a huge effort to get people to accept the paper notes rather than gold, with an especially ardent sales pitch to his investors.
The bank subsequently promised to exchange its notes for shares in the company at the going market price of 10,000 livres. This attempt to turn stock shares into money resulted in a sudden doubling of the money supply in France. It is not surprising then that inflation started to take off. Inflation reached a monthly rate of 23 percent in January 1720. Unfortunately, the company’s prospects turned out to be little more than empty promises; hyperinflation set in; and the company shares crashed back down to earth, taking down France’s stock market and public finances with it.

Law devalued shares in the company in several stages during 1720, and the value of bank notes was reduced to 50 percent of their face value. By September 1720 the price of shares in the company had fallen to 2,000 livres and to 1,000 by December. The fall in the price of stock allowed Law’s enemies to take control of the company by confiscating the shares of investors who could not prove they had actually paid for their shares with real assets rather than credit. This reduced investor shares, or shares outstanding, by two-thirds. By September 1721 share prices had dropped to 500 livres, where they had been at the beginning. Courtesy of Jon Moen, PhD, John Law and the Mississippi Bubble: 1718-1720, MississippiHistoryNow, Mississippi Historical Society, October, 2001. See also Jesse Colombo, The Mississippi Bubble of 1715-1720, article written June 23, 2012; AndrewBeattie, What burst the Mississippi bubble?

The rise and fall of the Mississippi Company became known in history as the “Mississippi Bubble.” Indeed, Law is most famous, or perhaps infamous, for his involvement in this prominent financial disaster. A “bubble” in the world of finance is a term applied to an unusually rapid increase in stock prices or the value of some other asset such as real estate. The increase is then followed by an equally rapid collapse in prices. The wild fluctuations in prices are usually viewed as irrational and the product of uncontrolled speculation rather than sensible investment practices.

The Mississippi Bubble ruined Law and his company, and brought France temporarily to its financial knees. As a result, France was forced to sell its New World holdings to the United States and Spain at a huge loss just to keep afloat and to continue the king’s endless wars of vanity. In the end, many of the new millionaires were financially destroyed, and so was France; it took eighty years before France’s economic status among nations again allowed it to introduce its paper money into its economy and as a medium of exchange on the world stage. And the French example is not unique as will be made clear in the next posting.

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