History is full of bubbles, booms and busts, corporate collapses and crises, which illuminate the present financial world. At Stewart Investors we believe that an appreciation of financial history can make us more effective investors today.
Rue Quincampoix, Paris, 1719. The French capital was in the throes of something unprecedented in history – over the summer, the dirty, narrow street in the heart of the city became the epicentre of world finance, a veritable vortex of share trading. A new financial and cultural phenomenon had appeared on the scene – the stock market bubble.
Investors flooded into the city from all over France and other countries across Europe, appetites whetted by stories of unbelievable wealth creation. The term ‘millionaire’ appeared in print for the first time in a Paris lawyer’s journal in 1720 to describe the lucky individuals who were literally making millions of ‘livres’ (French currency at the time) in the frenzy.
A Scot on the make
At the centre of the bubble was John Law, a Scot whose miraculous journey from son of an Edinburgh goldsmith to Controller General of France matched the stratospheric rise of the share price of the Mississippi Company which he established in Paris in 1717.
After being forced into exile for killing a man in a duel in London in 1694, Law wandered the cities of Europe accumulating vast riches from the gambling tables of Amsterdam, The Hague, Genoa, Paris, Vienna and Venice, before settling in France in 1714. Having made a fortune himself, he was determined to transform the fortunes of entire economies by breaking the link between money and precious metals (gold and silver) which he believed was holding back economic growth.
France was bankrupt after the wars of Louis XIV. Following the Sun King’s death in 1715, Philippe Duc d’Orleans became Regent for the child-king Louis XV. Law impressed Orleans with the boldness of his ideas about finance, putting forward economic reforms which he argued would set France free from its vast debts.
In May 1716, having adopted French nationality, Law was given permission to establish a bank (Banque Generale) with a charter for 20 years, followed by the Company of the West in August 1717, later known as the Mississippi Company, which received a monopoly on French trade with Louisiana for 25 years.
A pivotal point in the development of Law’s ‘System’ was the transformation of the Banque Generale into the Banque Royal in December 1718. After this, printing of money began in earnest with eight printers employed round the clock to print banknotes. This was a crucial moment in financial history – money creation on an industrial scale – a vital ingredient of the ensuing asset bubble.
The mighty Mississippi Company
Law gradually transformed the Mississippi Company into a sprawling conglomerate through a series of corporate deals, which fused together all the French trading companies, tax apparatus, tobacco monopoly, mint, national debt and the Banque Royal into one giant entity which dominated the French economy.
In Law’s System the bank increased the money supply, just as central banks have used quantitative easing (QE) in recent years. Interest rates declined, stimulating demand and the economy expanded. Law also controlled the supply of shares in the Company, and by financial engineering, in particular the use of partly-paid shares, manufactured a boom in the share price and a surge of activity in the stock market on the Rue Quincampoix.
The ensuing financial mania became known as the Mississippi Bubble.
The summer of 1719 was to be remembered across Europe for decades – a glorious few months when anything seemed possible. The demand for luxury goods exploded as investors made fortunes, while Paris was brought to a stand-still by the long traffic jams caused by crowds of investors and the coaches built for the newly rich. The optimism spilled over into the stock markets of other countries, unleashing the South Sea Bubble in London in 1720.
In the Rue Quincampoix, frantic share trading continued over the autumn and into the winter of 1719. Apocryphal stories emerged, characteristic of financial manias or bubbles, which intensified the frenzy. A woman called ‘the Dame Chaumont’ arrived in Paris with only a few banknotes before amassing a fortune of millions. A hunchback rented out his back as a writing desk - this was surely just a yarn, but tall tales like this are often a feature of financial bubbles!
One of the key aims of Law’s System was announced in August 1719. He proposed that the Company lend the French government 1.2 billion livres at an interest rate of only 3% so that all of France’s long-term debt might be repaid. The money would be provided by issuing more shares in the Company. This was to be the crowning glory of the System, aimed at solving the French government’s debt crisis at one stroke. Meanwhile the Company share price continued to rise.
On 5 January 1720, following his conversion to the Catholic faith, Law was appointed Controller General of France in recognition of his success in transforming the fortunes of the nation. The share price of the Mississippi Company peaked a few days later. In terms of his personal fortune, Law was probably the richest private individual in the world (excluding monarchs) at the top of the market.
Peak of the Market
However, his System began to falter in the early months of 1720 as the share price became increasingly volatile. It then began to fall. Credit markets tightened and interest rates climbed. Investors began to shift out of banknotes and shares into traditional stores of value, like gold and silver. In modern financial jargon ‘risk aversion’ rose steeply.
Law fought against the tide by attempting to force investors to keep hold of their banknotes and shares rather than switching into ‘real’ assets like gold, silver or jewels. A number of bizarre policies were unleashed. On 4 February 1720 an edict prohibited the wearing of diamonds and precious jewels, while on 11 March provisions were extended for demonetizing gold and silver. Law wanted to break the relationship between paper money and precious metals which he believed was holding back the economy. It was a revolutionary step, one which was too large for people to take at the time, but was finally realised by President Richard Nixon when he took the US dollar off the link to gold in 1971.
Law’s measures were becoming increasingly desperate and suggested the System was close to collapse. The bank’s inspectors were authorized to search private houses, even royal palaces, to confiscate gold and silver. There were strict orders against hoarding precious metals and dire punishments threatened as government policy shifted towards despotism. Unsurprisingly, Law’s popularity among the people of France plummeted.
Miraculously, an escape route was provided for investors wise enough to sell their shares; the Company paying a fixed amount to buy them back. This was viewed by some as a mechanism to allow Law’s cronies to get out at a reasonable price and was funded by more money printing by the bank. As a result, the French money supply exploded, the currency collapsed and the economy crashed into recession.
Death in Venice
The joy of the summer months was soon forgotten as a political storm swept through Paris in response to the collapsing share price and Law’s policies. The mob attacked the Company’s offices, hoping to lynch Law, whose fall from grace was even more rapid than his rise. In late 1720, he was forced to resign from office and flee into exile, becoming a wanderer again and finally settling in Venice, a city he knew well and where he was very much at home. There he sought refuge at the gambling tables and invested his winnings in another asset class. Over a few years he built up a huge collection of Old Master paintings, numbering 488 by the time of his death, and including works by Holbein, Leonardo da Vinci, Michelangelo, Poussin, Raphael, Rubens, Titian and Tintoretto. He was criticised at the time for paying too much for these works, but he clearly had an eye for long-term value!
During his final years in Venice, Law was visited by the French philosopher Montesquieu, one of the major thinkers of the Enlightenment. Montesquieu was delighted to have the opportunity to quiz Law about the intricacies of his System. He believed Law was not motivated by making money but instead he was in love with ideas about money. Nonetheless, Law was also ‘one of the greatest promoters of despotism ever seen in Europe’. His plan to free the French economy from the chains of the past, paradoxically resulted in a huge centralisation of economic and political power.
Law’s System exhibited many of the characteristics of today’s financial world: company creation, leveraged buy-outs, marketing, public relations, huge trading volumes and the creation of money in vast quantities. The modern financial world was probably Law’s creation more than any other individual.
In exile he remained convinced that his System could have worked and dreamed of returning to France to revive it. However, he died in Venice in 1729, without returning. His book Money & Trade Considered, a short philosophical study of money, which was published in Edinburgh in 1705, is now considered a key text in monetary theory. The goldsmith’s son from Edinburgh is viewed, by some, as a key thinker of the Enlightenment. He was also the father of the stock market bubble.
At Stewart Investors we stress the importance of identifying extreme overvaluation in stock markets to preserve client wealth and we remain focused on the potential downside of any investment as much as the upside. The Mississippi Bubble is a reminder of the dangers for investors of excessive money creation.
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