PAPER MONEY

We skip now to 1716 France, where the crown has incurred massive deficits due to
wars waged by Louis the 14th, as well as the building of extravagant palaces.
Compounding the difficulties, a shortage of precious metals leads to a shortage of
coins minted and, to top it off, creditors want their money back without delay.
France turns to a Scotsman, named John Law, who implements his theory on how
to lower the national debt while stimulating the economy at the same time. With
the Crown’s permission, he forms a National Bank. The Banque Generale, issues
promissory notes as currency – paper money, backed by depositor’s land, gold and
silver. These notes could be traded for whichever precious metal requested upon
the immediate demand of the note holder. The Banque Generale was private, but
75% of The Banks’s capitalization consisted of Government issued notes, and
government accepted notes-- again, paper. France was not the first country to issue
paper money. China issued paper bank notes in 806 AD. Sweden issued paper
money in 1661 and England in 1694. But John Law was in an entirely different
league when it came to finance. If he were alive today, he’d likely be running one
of the investment houses on Wall Street.

Law believed that the more paper money in circulation, the more commerce would
be generated. He allowed people to pay taxes with paper money. He also
instituted many beneficial reforms such as helping peasants, building roads,

abolishing tolls, and offering low interest loans to start new industries. Within two
years, the number of French export ships went from 16 to over 300.

Now, here’s where it gets a bit tricky. After replacing gold with paper credit, Law
allowed holders of Royal debt to replace their notes with shares in speculative
economic ventures. One such popular venture was the Louisiana Company. In
1717, investors, eager to own shares in gold, diamonds, and gems to be harvested
in Louisiana flocked to invest. Shares sold out, and then investors bought shares
from other investors with paper money. By 1719, the value of shares in The
Company rose 36 times their original value with no real riches discovered in
Louisiana. The millions of paper notes traded, even among the working class,
gave rise to a new term-- “Millionaire.” Remember, a precipitous rise in value for
no sound economic reason translates to-- a bubble.

Eventually, John Law effectively controlled all of the trade between France and the
world outside of Europe. He was granted control of French charters for trading
companies to the East and West Indies, China, Africa and the U.S. territories. He
purchased the right to mint new French coins, and to collect most of France’s
taxes. Essentially, he ran Europe’s most successful conglomerate. Law paid for
these privileges by issuing more shares in his companies. The shares could be
bought with notes, either from his bank, or with government debt.

Even though Louisiana never produced real value for France, no precious metals or
gems, the main problem with the system of paper money, was only one fifth of that
paper money was backed by gold. When word spread that there wasn’t enough
gold to back the notes, panic ensued. Fifty people died in a stampede in Paris, to
exchange their notes. The crown tried to stem people from exchanging their notes
by devaluing the price of gold, but that didn’t stop investors from wanting to cash
in their notes. The Government next responded by prohibiting the printing of
paper money, but that didn’t work either. Next they prohibited selling gold.
Finally, they closed the Banque, and seized control of the trading companies. John
Law fled France, disguised as a woman, and died a pauper. This episode was
known as the Mississippi bubble. The experience was so distasteful to the French
that they didn’t issue paper money again until Napoleon needed to fund his war
efforts in 1800.

Meanwhile, over in England in 1720, before the Mississippi bubble burst, shares in
the South Sea Company were also skyrocketing. The South Sea Company, had a
monopoly on British trade from South America to the Pacific. Taking a page from
John Law, the government sought to reduce their national debt by offering to exchange government bondholders shares in The Company. Within 8 months, the
share value increased eight fold. By year’s end, shares were back to their original
value. At the same time, there was a proliferation of unincorporated joint stock
offerings (companies not authorized by royal charter). Many, if not most, of these
offerings were fraudulent.
Arguably, this proliferation of fraudulent offerings led England to pass the “Bubble
Act” in 1720, which restricted the formation of joint stock companies, not
authorized by Royal Charter. I say “arguably” because many scholars believe that
the passage was really not in response to fraud, but to stem competition with the
South Sea Company shares, since the bubble hadn’t burst on the South Sea
Company at the time of The Act's passage. An important consequence of the Act,
was that investors circumvented the law by forming joint stock companies but
calling them something else-- particularly insurance companies.