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April 06, 2004

John Law : A Short History of a Central Bankers Spectacular Fall
by Paul Tustain

When John Law was faced with crippling sovereign debts in eighteenth century France he issued a lot of successful paper money and made the country feel rich. He was clever, brave, charming, honest and - for a while - extraordinarily popular. Unfortunately he also caused virtually everyone who had any money in France to lose it, which tends to overshadow those other qualities. How it happened is worth understanding; and never more so than now.

Learning his trades

John Law was a Scot. He was born in Edinburgh in 1671, the son of a successful banker and goldsmith. At 14 he was apprenticed into these trades, and he re-emerged at 17 just in time to inherit from his father, who died that same year. He was by then already known for his rare mathematical talents, and for his popularity with the ladies.

Enriched by the family estate he set off for London where he added gambling to his abilities. He won regularly, and earned that mixture of respect and jealousy which follows a man who succeeds both at the gaming tables and the bedroom.

Unfortunately his winnings in the bedroom carried unsuspected hidden risks. London was in those days a place where a lady's virtue was worth dying for (this was very long ago) and when Law was challenged to a duel he accepted and, not unreasonably, shot his challenger dead.

Although originally sentenced to hang it is generally accepted that he was given a little friendly assistance in escaping during the appeals process and, because London had become a dangerous place for him, he set off for Europe.

Getting the top job

For some years he made his living off his wits. He was a high-roller, and this way of life brought him into regular contact with the Duc d'Orleans who also enjoyed gambling. Yet surprisingly for a gambler there were signs of Law believing in a higher purpose. He had without much notice published serious pieces on economics, and had been very interested in the financing of trade, which he had learned all about in Amsterdam. The Duc thought highly enough of him to listen to Law's views on trade and finance.

History, meanwhile, was doing its normal thing with a great king. Louis XIV was dying, and having been widely celebrated and revered throughout his life he was soon to be remembered with some bitterness for the size of the national debt he had left to his heir. Young Louis XV was only seven, and it was the Duc d'Orleans who was appointed Regent. His immediate problem was the 3 billion livres borrowed by the dead king.

Devaluation quickly followed. The government debased its coinage by 20%, which served no particular purpose other than to drive the old coins out of circulation. Then the state decided to offer rewards to informants against hoarders. The guilty were packed into the Bastille.

As things deteriorated Law arrived on the Duc's doorstep in Paris. His plan was simple. He would be granted a bank, the management of the royal revenues, and the right to issue paper money. The paper would be secured on a combination of the royal revenues and on its land - an idea he had proposed in his earnest papers many years earlier.

The Royal Bank of France

On the 5th of May, 1716 Law's bank was created. Its notes would thereafter be used in payment of taxes. Its capital was purchased 25% in coin and 75% in oversupplied state bills at face value (at that time trading at a heavy discount). Then by guaranteeing his paper money not with just any coin, but with the coin in issue at the time of a note's creation he quickly found his paper was preferred over coinage, which had recently been debased once and was expected to be debased further. Through this impressive manoeuvre he collected most of the country's stock of precious metal. By the end of the year his bank notes were worth 15% more than equivalent coinage while the state's debts were trading nearly 80% below nominal.

He hadn't finished. His next plan was to leverage the optimism of France's possessions in North America. He persuaded the Duc to grant him an outright monopoly on France's Mississippi trade. Having got control of the coinage, paper money and tax collection, he now also had exclusive power over France's great hope - trade with the New World. He raised the capital in typical style selling the stock for a fantastic price payable in those deeply discounted state bills which no-one could wait to get rid of.

"It was now that the frenzy of speculating began to seize upon the nation. Law's bank had effected so much good, that any promises for the future which he thought proper to make were readily believed. The Regent every day conferred new privileges upon the fortunate projector. The bank obtained the monopoly of the sale of tobacco; the sole right of refinage of gold and silver, and was finally erected into the Royal Bank of France. Amid the intoxication of success, both Law and the Regent forgot the maxim so loudly proclaimed by the former, that a banker deserved death who made issues of paper without the necessary funds to provide for them. As soon as the bank, from a private, became a public institution, the Regent caused a fabrication of notes to the amount of one thousand millions of livres. This was the first departure from sound principles, and one for which Law is not justly blameable." Charles Mackay - 1841.

Before long the monopoly rights to trade with the east were also granted to the company, and in a succession of stock issues - each at higher prices than the previous one - a willing public fought for the right to surrender its increasingly valueless state bills for Law's bank notes and the mushrooming Mississippi scrip.

The beast had developed a momentum all its own. Paris was booming. Luxury goods were sold out as soon as they went in the shops. Gardens near Law's bank had turned into a tented city which acted as an impromptu stock exchange. Real estate values and rents soared, while the stock just rose and rose until even the speculators' own coachmen became magnates and employed their erstwhile contemporaries.

The good Duc could only conclude that what was clearly so healthy in that particular quantity could hardly fail to be twice as healthy given twice as much. And what with the extra trade and the sheer difficulty of supplying sufficient cash to keep pace with the frenzied exchange of company stock he took to arranging further issues of bank paper over the head of Law, who probably knew better, but may have suspended rigorous banking discipline under the widespread acclaim of his financial ingenuity. Besides, blocking it would have annoyed his boss.

It was at about this time, as Paris fawned and worshipped, that the Prince de Conti arrived intending to buy as much corporate stock as he could lay his hands on. He was outraged at being denied his full allocation, and as a result sent three wagons to Law's bank to demand the immediate settlement - in coin - of his entire stock of Law's paper.

The Prince was paid, but was also instructed at risk of the extreme displeasure of the Duc - an unwise thing to provoke - to return two of the wagons immediately. He complied. But it was enough to make the smarter operators see the light.

At first with small beginnings the professionals started to cash in their paper. Coin, bullion, jewels and anything of transportable value were surreptitiously shipped abroad - to Belgium, Holland and England.

Soon it became necessary to compel by decree the premium which notes had before quite naturally commanded over coin. Parliament declared that from then on coin would by law carry only 95% of the value of paper. The decree was as useful as any similar one before or since.

Law had no choice but to throw the last major dice of his banking career. Gambling his remaining authority he abolished coin as a medium of exchange, and then in February 1720 declared it illegal to own more than the tiniest of sums in gold in any form. Then he closed the borders, and sent instructions to all coach-houses to refuse fresh horses to anyone travelling to foreign lands until an inspector had examined their baggage. The substantial fines imposed were shared with the public-spirited individual who filed the report.

By August of that year it was all over, and John Law was the most hated man in France. Fortunately he was living in Venice. Like all good gamblers he had gone on to the next game, by which means he continued his existence for another 9 years. Much of the money he won at this time would have been that which had previously escaped him.

Articles in the series include :

Regards,
Paul Tustain
BullionVault

Paul Tustain is the founder of BullionVault.com - with 13,000 customers and $600m in gold bars, now the world's largest store of privately-owned investment gold bullion.

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events - and must be verified elsewhere - should you choose to act on it.