Book review: John Law, the father of money printing

[Cigarbutt]

I know, I should look for mispriced ideas and, in the end, we will all be fine but, a few weeks ago, I read a book about John Law, an 17th-18th century fascinating character that may be relevant in today’s investment world. Who knows?

 

So, I have prepared a commented book review of this recently updated publication of John Law’s biography. Law lived and performed in 18th century Absolutist France.

 

I understand that this may be of some interest for some.

 

If you want to see a photo of the man.

http://www.eumed.net/cursecon/economistas/Law.htm

 

The book is called: The Mississippi bubble: a memoir of John Law. I read the 2016 French edition but the text is essentially based on the initial book written by Adolphe Thiers (1797-1877). Thiers was a French politician and historian. The book is historical and critical.

 

John Law was born in Scotland (1671). It became clear that he was a gifted individual attracted to higher social circles. After a duel (that was one of the ways to resolve problems then), Law eventually had to flee England. He travelled in Europe to live and learn, spent some time in Amsterdam and studied the functioning of the Bank and amassed money gambling. He came up with and wrote about the potential of paper money as a way to increase trade and wealth. The biography describes well how the money supply was scarce in those days. Also, there were few banks and, as a rule, these institutions did not extend loans on reserves. Basically, Law devised a set of theoretical ideas that he wanted to apply to the real world. He tried to sell his ideas to different rulers and monarchs and ended up in France right after the death of Louis XIV. (After all, Princeton was only founded in 1746)

 

Louis XIV (le Roi-Soleil) ruled the country that was considered a leading European power at the time. However, the king was not a fiscal conservative and incurred a huge debt spent on the lavish lifestyle of the Court and expensive wars, including the War of the Spanish Succession which finished in 1714. When Louis XIV died in 1715, France was basically bankrupt. In those days, Thiers explains, national debt was not based on the issuance of what we now know as government bonds but was financed by the issuance of “billets” and “rentes”. In 1715, these instruments were trading at about 30% of nominal value. Before Louis XV (child) was ready to rule, a Regent, le Duc d’Orléans, took control. Fiscal revenues were incredibly low in relation to general and interest expenses on top of high short term refinancing needs. Taxes were felt to be oppressive and a large part of tax revenues was extracted by intermediate collecting agents. There seemed to be no way out.

 

That is when John Law comes along. He has a plan, a “Système”, that has the potential to create wealth and to cause the debt dead end to disappear.

 

The “Système” application would be painless, so it seemed! The plan included “debt management” with more debt, reform and reorganization of the extractive tax collecting system and some kind of infrastructure spending. (More or less a “drain the swamp” type of approach) From an independent perspective, as the author explains, the entire plan did not make any sense but the Regent decided to go ahead anyways.

 

Personal note: A parallel to the modern era would be that a candidate having the intention to lead a major economic power would promise, in the context of an excessively leveraged economy, to significantly decrease taxes, to massively invest in infrastructure using government funds, to balance the budget AND expect to be elected. When you thought that you could see this only in a Hollywood movie. Time to be “all in”. Isn’t it? Who needs basic math when you can have financial engineering/alchemy?

 

John Law had a plan and was impatient but, to “succeed”, had to go step by step. He first setup a private bank with his own money (1716). He was able to get implicit royal backing and to issue his own paper money. The author rightfully suggests that the creation of paper money satisfied an unmet demand then. Initially, the bank contributed to an increase of money velocity and trade. Interest rates did decrease and the value of government debt moved closer to par. After all, fractional banking became eventually a cornerstone of modern capitalism and Law, in that respect, was an ingenious precursor.

 

Perhaps, at that point, the French would have been better off if Law had fallen from a horse. But that wasn’t to be. He was put on a pedestal.

L’excès en tout est un défaut, and Law went too far (way too far). After the successful exploration by Lasalle (1673) along the Mississipi River, France took possession of a very large piece of land which corresponds today to a territory made up of more or less 15 USA states. Law saw an opportunity for commerce there and also in other areas of the world. (His motto could have been “Make France Great Again”) With the Regent assent, he transformed the private bank into a public bank, “la Banque Royale” (1718), merged the bank with this global trade commercial endeavor, and issued a massive amount of paper money backed by a fraction of the real money in circulation and backed by grossly overvalued shares of the combined entity. The “Système” also eventually involved taking over the collection and administration of tax revenues. Finally, Law planned to effectively refinance the entire national debt (huge) through the issuance of the “Banque” paper money (1719). In essence the “Système” effectively took over the state treasury and took control of monetary policy (issuing paper money) on a large scale. John Law became, after the king, the most powerful person in France. As Voltaire later affirmed, Law was a single foreigner who gambled against a whole nation.

 

What is known as the Mississipi Bubble became characterized by a speculative fever concerning the shares of the “Compagnie” and by a generalized oblivion concerning the value of the paper money issued by Law (Law became equivalent to law). As described in the book, the value ascribed to the paper money became disconnected from the underlying fundamentals. The amount of money printed had no rational link to the underlying economic substance of the “Compagnie”, the state and the economy in general. (The government then did not produce much in terms of graphs but, perhaps, some recent graphs from the Federal Reserve balance sheet may be revealing in terms of the scope of money printing)

 

The inevitable happened. Law tried to stop the unwinding process by using political moves and coercive measures but reversion to the mean was too strong. Parts of his strategy then were capital controls and schemes to make real money disappear. He met resistance. (Personal note: at some point, pushing on a string will meet resistance.) Then, confidence in his system evaporated (1720). Thiers is quite critical about the downfall  when he describes the inevitable pain that comes after a bust of this magnitude. Confidence can be fickle. Law had to basically escape France and eventually died in misery in Venice in 1729. All components of his system disappeared as the financial instruments were retired or refinanced, at a significant loss, using other names (the king went back to the old “rentes”). Apparently Law never admitted that the system he devised was flawed from the start. Instead, he felt that his system had been destroyed by inappropriate outside forces…

 

In France, thereafter, there was basically financial repression and, after the deflation of the bubble, the country remained reluctant to use paper money for a very long time. Paper money was used for a short period after the Revolution (the “assignats” used in the 1790’s) and that was a bad experience as well. For a variety of reasons, France remained behind the leading economic powers for a very long time. (Personal note: some say that they never really caught up but that’s another story)

 

John Law tried a grand monetary experiment. He suggested that there was no limit to money printing and that money creation automatically translated into wealth. Not surprisingly, that did not turn out to be the case. The biography written by Thiers does a good job overall at providing a sufficient amount of financial data to appreciate the size and scope of what Law wanted to achieve. Dissecting the data, the reader is able to confirm that trees don’t grow to the sky.

It is interesting to note that Goethe, the German writer and statesman, was likely influenced by Law when, in the Faust play, the main character ally, Méphistophélès (devil), offers a ruler to pay its claims by magically issuing an unlimited amount of paper money backed by a mostly undefined promise. That story does not end well also.

 

Personal note.

It is also interesting to appreciate that financial alchemy is again in vogue.

If you made it this far, I would only add the following comments that one of our connected elites made in a recent blog in the context of the recent homeopathic rise in centrally managed rates. With  the next recession, says he, “managing expectations” may not be enough and negative world upside down interest rate policy remains a viable option even if it may be difficult to swallow for the populace.

Of course our modern financial geniuses do not wear wigs. They have Gucci suits on too.

That does not completely reassure me.

Wall Street or rue Quincampoix? I think I’ll stay home.

I know, in the end, we’ll all be fine. Most of us anyways.

 

For the artistically inclined: