Most people are aware that historically there have been speculative bubbles. Some of them can even name a few – the South Sea bubble, tulips, and more recently dot-coms. Some historians can go even further, quoting the famous account by Charles Mackay of the South Sea bubble, the tulip mania and the Mississippi bubble, published in the mid-nineteenth century.

The most valuable bubble empirically for the purpose of our elucidation has to be the Mississippi bubble, whose central figure was John Law. Law, a Scotsman whose father’s profession was as a goldsmith and banker in Edinburgh, set up an inflation scheme in 1716 to rescue France’s finances. He proposed to the Regent for the infant Louis XIV a scheme that would be based on a new paper currency.

Law was a somewhat louche character, who in his Continental travels had spent his mornings studying finance and the principles of trade, and the evenings in the gaming-houses of Europe. He was a successful gambler, because of his ability to calculate odds. 

Some similarities with the personality of Keynes two hundred years later are striking. Keynes was a mathematician first, and an economist second. Their approach was also similar: see a problem and try to find a solution, instead of seeing a problem and trying to understand why it existed before solving it. Both Law and Keynes felt that sound money was too restrictive for the enhancement of an economy.

Consequently, much of what Law proposed and then enacted in France rhymes with our neo-Keynesian world today. The difference, perhaps, is that when given the opportunity Law seized it, and had ultimate financial and monetary power. He harnessed the roles of a central bank, monopolist in international trade, a stock promoter, and finance minister. The downfall of his schemes occurred in less than five years after he set up his inflation machine. Keynes, by contrast, never directly drove his schemes, acting as an advisor to governments rather than as an executive. Even though he wrote of the gold standard as a barbaric relic in his Tract on Monetary Reform in 1923, gold convertibility for the reserve currency was only completely abandoned long after his death.

This article looks at John Law’s actions in the years following Louis XIV’s death in 1715, and how he brought a brief period of prosperity to France on a mixture of monetary and asset price inflation.^[i]The reason for examining the monetary history of this period in France is to see what lessons we can draw from it, given the similarity between Law’s monetary policies and those of governments today.

The establishment of Banque Generale^[ii]

The death of Louis XIV in 1715 left France’s state finances (which were the royal finances) in a state of bankruptcy. The royal debts were three billion livres, annual income 145 million, and expenditure 142 million. That meant only three million livres were available to pay the 220 million interest on the debt, and consequently, the debt, mostly billets d’etat (the equivalent of modern treasury bills) and billets de monaie (floating and war debt) traded at a discount of as much as 80% of face value.^[iii]

The Duke of Orleans had been appointed Regent to the seven-year-old Louis XV, and so had to find a solution to the nation’s financial difficulties. The first attempt in 1713 was the often tried and repeatedly failed expedient of recoining the currency, depreciating it by one-fifth. The result was as one might expect: the short-term gain in state revenue screwed up the French economy by taxing it 20%. Furthermore, the Controller General of Finances announced the intention of further devaluations of the coinage with a view to adjusting the economy from a war footing to peacetime. This crazy plan was announced as an attempt to somehow stimulate the economy, but the effect was to increase hoarding of the existing coinage instead, as predicted by Gresham’s law.

Following this one-off debasement tax, many tax collectors, who subsisted on a percentage of taxes extracted, were taken to court suspected of swindling the state. For the unpopular tax collectors, it was the ordinary person’s opportunity to get his own back by informing on this hated class, and the courts rapidly filled with those accused. Revenue was raised through fines, but this must have severely compromised further tax collection, leaving the state still insolvent. By now it was early-1716.

At about this time, Law presented himself at court and offered his considered solution to the Regent. He diagnosed France’s problem as there being insufficient money in circulation, restricted by it being only gold and silver. He recommended the addition of a paper currency, such as that in Britain and Holland, and its use to extend credit.^[iv]

Banknotes did not previously exist in France, all payments being made in specie, and Law persuaded the Regent of the circulatory benefits of paper money. He requested the Regent’s permission to establish a bank which would manage the royal revenues and issue banknotes backed by them as well as notes secured on property. These notes could be used as a loan from the bank to the king at 3% interest instead of the 7½% currently being paid.

On 5 May 1716, he gained permission to establish Banque Generale as a private bank and to issue banknotes. But when it came to the royal finances, this permission was withheld until the following year. 

Law succeeded in finding other means to persuade the public to swap specie for his banknotes. He was so successful that after only eleven months, in April 1717 it was decreed that taxes and revenues of the state could be paid in banknotes, of which Law was the only issuer.