Just like Britain’s economic bubble, the South Sea Bubble, France also had their own which was the Mississippi Bubble that happened in the early 1700s. The Mississippi bubble is one of the biggest asset bubbles in the modern world. It first led France out of bankruptcy and straight into prosperity. However, this same bubble caused the opposite to happen. It bankrupted France and gave an impetus to the revolution.
The Mississippi Bubble was created by John Law, a Scottish gambler, playboy, a theorist of monetary economics and financier who got into his position as the French government’s primary financial advisor through his friendship with Philippe Charles, the Duke of Orleans. He used his authority to organize the Banque Générale (Banco General) which was a bank that can release paper money and as well as the Compagnie des Indes (Mississippi Company).
They were permitted a monopoly with the development of France’s massive Mississippi Territory in North America. The investors became more interested because of the abundant resource which includes gold and silver in the territory of Mississippi. It caused the shares to increase tremendously. Same with all bubbles, when it reached its limit, it is bound to burst.
What events do you think have led to start the Mississippi bubble, and why did it pop? Read on to know more about the Mississippi Bubble.
How Did the Mississippi Bubble Begin?
The Mississippi bubble saga started in 1715 during the time when the French government was right on the edge of bankruptcy under the burden of debts gained during the War of Spanish Succession. In time, the government failed to pay on a portion of its debt, lowered its interest payments, and raised taxes to very high levels. All of these served to weaken the French economy and these also caused the value of its gold and silver-backed currency to fluctuate wildly.
The French government, led by a group of proxies because King Louis XV was only five-years-old during that time, dreadfully scrambled to find a solution to the nation’s financial and economic woes. The leader of the group of proxies, Philippe Charles who is the Duke of Orleans, decided to look for the council of his friend, John Law, an early theorist of monetary economics.
John Law came from Fife, Scotland where he was born into a wealthy family of bankers and goldsmiths. At age fourteen, John Law became his father’s apprentice. He studied banking business until his father died three years later. After that, John Law went to London in pursuit of adventure. He earned a living as a gambler because of his keen mathematical abilities. When he was 23 years old, he became involved in a duel over a lady friend in which he swiftly killed his opponent. He was charged with murder and was sentenced to death. John Law spent a short amount of time in prison before he escaped to mainland Europe. There, he studied finance in cities such as Amsterdam, Genoa, and Venice.
In 1705, John Law published an academic paper where he argued against the use of precious-metal backed currency in favor of paper or fiat currency. He claimed that the use of fiat currency would stimulate commerce. Because of his distinct views, John Law was often considered to be an early Keynesian-style economist.
When the Duke of Orleans asked him for help, John Law viewed it as his opportunity to put his monetary theory into action. John Law received permission from the French government to establish a national bank in 1716 and that is the Banque Generale. This bank took in deposits of gold and silver and in return, issued paper bank notes. The banknotes that were issued by Banque Generale were illegal but they were accepted as such by the French public because they were convertible in official French currency. The bank reserves of Banque Generale were built up through the issuance of stock and from profits earned through the management of the French government’s finances.
John Law used his growing connection within French society to acquire a struggling trading company in 1717 which was the Mississippi Company. He then renamed it to “the Compagnie d’Occident” or the Company of the West in English. The company was granted a monopoly on trade with the development of France’s North American colonies along the Mississippi River.
When John Laws influence continued to grow, he changed the name of the Compagnie d’Occident to Compagnie des Indes or Company of the Indies. The company purchased the right to perfect new coinage in July 1719. Then, it bought the right to collect all French indirect taxes in August 1719 and took over the collection of direct taxes in October 1719. A plan was finally launched to restructure most of the national debt, whereby the rest of the existing government debt would be exchanged for Compagnie shares. During this time, John Law was powerful because his companies were in control of both France’s foreign trade and its finances.
During the Bubble Phase
The Compagnie des Indes offered shares to the public for 500 livres per share in January 1719. Livres were the currency of France during that time. These shares were bought and paid for with Banque Generale bank notes or with government debt. By December 1719, the company’s shares soared to an incredible 10,000 livres per share because investors began to lust over the company’s potential value of trade with the allegedly gold and silver-rich French colonies.
John Law had gone from a broke gambler to one of the richest, most powerful men in Europe because of the share prices at high levels. Many people of all social classes invested in Compagnie des Indes shares which caused many poor people to become very rich in a short amount of time. The French word “millionaire” incidentally originated as a result of the many people that were made rich as the Compagnie shares raised.
There was a massive demand for Compagnie des Indes shares which caused the total amount of paper money banknotes to increase 186 percent in a year because Banque Generale issued as much bank notes as the public demanded. Due to the expansion of the supply of money, there was a powerful inflationary episode between July 1719 and December 1720 in which the price of goods doubled. A big portion of Compagnie des Indes share price gains were because of this inflation as well.
As real estate prices and rents soared twenty-fold and rich speculators insisted to buy luxury goods, Paris experienced a “bubble economy”-type boom. There were new houses built in every direction, and deceptive prosperity shone over the land, which impressed the eyes of the whole nation. No one could see the dark cloud on the horizon announcing the storm that was quickly impending.
Banque Generale had soon issued enormous quantities of bank notes even though they did not have an equivalent amount of gold and silver-based legal tender for everyone who wants to convert their notes. It is likely that John Law had anticipated fulfilling the precious metals shortage of Banque Generale with gold and silver imported from North America by the Compagnie des Indes.
How Did the Mississippi Bubble Pop?
The shares of Compagnie des Indes began to fall in January 1720, because some investors decided to take their profits in the form of gold coins. John Law tried to control the sell-off by limiting payments in gold of more than 100 livres. In May 1720, a scandal arose when John Law decided that the shares of Compagnie were overvalued which caused him to start devaluating shares. Banque Generale notes, in addition, were devalued by 50 percent probably because of the bank’s precious metals shortage. The discovery of this resulted in major investor disappointment.
The devaluation of shares and bank notes of John Law led to intense public chaos. This resulted in a compromise in which the value of the bank notes was restored but payment in precious metals was stopped. Regardless of the compromise, the public was still outraged against the Compagnie and its almost worthless paper bank notes.
By December 1720, due to the aggressive investor selling and John Law’s devaluations, the shares of Compagnie des Indes collapsed from 10,000 livres to 1,000 livres. Their investors were financially-ruined and lots of former millionaires became poor. John Law was viewed as a scam artist by the end of 1720. Aside from that, his rivals were given control over two-thirds of his companies’ shares.
In 1721, the company’s share prices continued to decrease to 500 livres. Later on, John Law escaped France. For his safety, he disguised as a woman and spent the rest of his life as a poor gambler in different parts of Europe. The failure of Banque Generale and the Compagnie des Indes, which happened alongside with the popping of Britain’s South Sea Bubble, plunged France as well as other European countries into a severe economic depression. It also laid the foundation for the French Revolution that happened later on in the century.
The Mississippi bubble was the result of unsuccessful monetary policies that caused too much money supply growth and inflation. We should all remember that everything we do have consequences and everything has an equivalent. If you were given such a spectacular offer that seems unfair or unjust to the other party, you have to start asking “so what’s the catch?”.