Meet the 18th century version of Greenspan (notice any similarities)?:
interactive.wsj.com
July 19, 2000
How John Law's Failed Experiment
Gave Us a New Word: 'Millionaire'
THROUGHOUT HISTORY, the people who have become very wealthy
have had two things in common: Each had a great gift or idea, and each
lived in a society where that gift was highly valued. A brawny and
aggressive man with state-of-the-art spears probably wouldn't get rich in
modern America, but he might have been the Bill Gates of the year 1000.
Similarly, today's brainy Internet entrepreneur might very well have been a
slave 1,000 years ago.
In 18th-century France, the scarcity of gold impaired the country's ability
to trade its surpluses with other nations. Many of the French enjoyed great
affluence, yet they and the profligate government of Louis XIV always
seemed to be scrounging for gold.
It was the great fortune of a man named John Law that he could introduce
his ideas about paper money to the country. "My secret is to make gold
out of paper," he once said. The result was famously lucrative and then
even more famously catastrophic for the French, but Law's demonstration
of the flexibility afforded by paper currency and by the creation of money
by bank or government fiat has been the basis of finance ever since. His
exploits gave the world a word it cherishes to this day: millionaire. The
following excerpts from a new book by Cynthia Crossen about the
amassing of great fortunes through the ages shows linkages between Law's
epoch and our own.
***
Born in 1671, John Law grew up in Edinburgh, where his father was a
goldsmith who lent money on the side. As a child, Law displayed an
aptitude for arithmetic, geometry and algebra. When he was 13 years old,
his father died, and his mother took over the family business. Law worked
for the firm for three years, learning the principles of banking, and after
work he studied tennis and fencing. Before he left to seek his fortune in
London, he was described as "nicely expert in all manner of debaucheries."
In London, Law gambled, studied finance, and
practiced what was then called "gallantry" -- all at
considerable expense to his widowed mother. He
was a good athlete, quick-witted, eloquent, and
fastidious in dress. He was also a great favorite
among women, who called him Beau Law. For
reasons lost to history, Law began feuding with a
man named Beau Wilson, another London dandy.
The two arranged to fight a duel, which lasted only
a few seconds: In Law's one pass, he fatally
pierced Wilson's chest with his sword.
Because duels were assumed to be premeditated,
Law was charged with murder and convicted.
Imprisoned while awaiting a public hanging, he
escaped. For the next 10 years, Law drifted
around the Continent, supporting himself by
gambling. In Venice, Genoa and Amsterdam, he
also studied fledgling banking companies. His mathematical mind was
persistently reflecting on the intricacies of high finance.
At Europe's many gambling houses -- Paris alone had more than 60 at the
time -- Law became known as an expert at calculating mathematical odds.
Eventually, he was winning so much money that he commissioned the
casting of a large gold coin to facilitate the handling of his stakes. He began
to travel around in a polished coach attended by men in livery. Charming
and wealthy, Law was able to get letters of introduction to the drawing
rooms of powerful Europeans. At one home in Paris, he met the Duke of
Orleans, who a few years later became regent of France.
Law learned the most about banking and finance in Holland, where the
Bank of Amsterdam was already 100 years old. In Law's time, the bank
primarily handled transfers -- merchants brought coins to the bank and
received credit for their value in the form of banknotes. Because the bank
simply transferred money among accounts, under normal circumstances it
wouldn't be caught short of metal reserves.
***
In the early 1700s, Law continued moving among the Continent's big cities,
gambling for his living. In 1715, he and the woman he lived with moved to
Paris, where Louis XIV had recently died. Louis had passed France to his
five-year-old great-grandson, Louis XV, whose regent, the Duke of
Orleans, was Law's friend.
In Paris at the time, wealth was seen as an
unalloyed good, and the wealthy pampered
themselves with grotesque and silly
magnificence. The mistress of a rich
nobleman wanted to exceed the legendary
Lucullus, who swallowed a diamond worth
100,000 francs, so she ate a bill worth
500,000 francs. While some of the wealthy
were children of the landed aristocracy,
others made their fortunes by milking the
national treasury.
Louis XIV had been living on loans for
years, borrowing from his subjects and
issuing worthless paper that went by
different names to promote confusion. In the
last 14 years of his reign, Louis XIV had
spent two billion livres more than he had
collected in taxes. The coinage had been so debased that it was almost
worthless. Tens of thousands of workers were unemployed, and
agriculture was in distress. Trade was almost at a standstill.
Law believed he could fix France with his "system." He began by
proposing a bank that would issue notes and hold and transfer deposits,
much as the Bank of Amsterdam did. As an incentive to the government to
endorse his bank, Law would sell shares of the new bank for a
combination of cash and government securities, which, although then
trading at a deep discount, he would honor at face value.
In 1716, Law established a private bank called Law & Co. So sure was
he of his system's promise that he invested his entire fortune in it and
promised to give 500,000 livres to charity if the project failed.
Many others had tried to replace metal with paper, but it was difficult to
persuade people they should exchange coins, which had a known value,
for the promise of other coins in the future. Coinage everywhere was
subject to sudden and arbitrary devaluation or augmentation, making its
purchasing power somewhat hypothetical. But Law made a promise to the
French people that their government hadn't: His notes were redeemable on
demand for coin "of the weight and standard of the day of issue." That
meant the value of the notes would be unaffected by future fluctuations in
coinage.
Gradually trust in the bank began to build. In 1717, the notes were made
receivable for taxes and other royal revenue. The following year, Law's
bank became the state-royal-bank. One of the nationalized bank's first
actions was to change the terms of its notes to be redeemable for "current
coins" -- subjecting Law's notes to fluctuating values.
Law had become one of the most revered people in France -- he was a
financial pied piper, and the nation danced to his music. He said what his
audience wanted to hear: He could make them rich merely by printing
paper.
In 1717, Law proposed establishing a company that would have the
exclusive rights to trade with and exploit the resources of the Mississippi
River, the Louisiana Territory and Canada's fur trade -- all under French
control at the time. Another part of the scheme: Law would pay down
some of the government's enormous debt from the company's profit.
The regent and Parliament approved the plan,
and the Company of the West was
established. Shares in the company sold
slowly at first: For nearly two years, they
could be bought below par. To attract public attention, Law declared that
in six months he would "call" for a small number of shares of the company
at par, even though the shares were then selling at about half of face value.
Share prices began to rise.
Law's company gradually began to acquire other contracts for government
business, occasionally issuing more shares to finance its acquisitions. It
bought the tobacco monopoly in 1718, when consumption of tobacco was
rapidly escalating. In 1719, the French government gave the company the
right of coinage. John Law now controlled the mint, public finances, the
bank, the sea trade and the Louisiana, tobacco, and salt revenues.
At the same time, Law was encouraging holders of government annuities --
whose debt financing was crippling the crown -- to exchange their
instruments for shares in the company. He issued 200,000 shares of his
company and again accepted discounted paper at face value. Several
months later, he issued another 50,000 shares. All were snapped up
enthusiastically, so Law issued still another 50,000 shares. Then, in
September 1719, Law announced that he would buy the entire debt of
France by issuing more shares of his company and basically swapping
dividends. By the end of the year, he had sold 600,000 shares in the
company.
To keep the share price rising, Law published exaggerated accounts of
Louisiana's riches, mineral resources, and people. He created duchies,
earldoms, and marquisates in Louisiana (and gave himself the duchy of
Arkansas).
The reality, of course, was quite different. Much of the Mississippi valley
was unconquered wilderness. But in Paris, no one knew this. The only
thing the French knew with certainty was that prices of the company's
shares would never stop climbing. Stock that had come on the market at
500 livres was selling for 10,000 livres. This price unnerved even Law
himself, although he had become one of the richest men in the world.
Meanwhile, the regent ordered more money printed. In one year, the
supply of money almost doubled. Inflation soared.
In Paris, people of every class enjoyed the novelty of making a fortune
while they slept. Rags became riches, and riches became inordinate riches.
So many people were becoming rich that the French needed a new word
to describe them, and millionaire was it.
In 1720, Law, the national hero, was appointed France's comptroller
general of finances, making him the de facto prime minister. The day after
he assumed office, shares of his company reached an all-time high. Using
his trading profit, Law bought dozens of parcels of land and buildings in
Paris, some 20 estates, jewels, a 45,000-volume library and a wine cellar.
Eventually, all financial fevers break. In Law's case, professional
speculators began selling, but instead of accepting paper as payment they
demanded coin. Law knew his bank would soon be depleted if this
continued, but he also knew it would be suicidal not to honor his
redemption promise. Share prices fell, and attempts to convert paper into
gold or jewels accelerated.
At Law's urging, the government introduced a series of edicts aimed at
forcing the public to use paper instead of metal. On Feb. 27, 1720, the
government ordered that no person "of whatever estate or condition"
should have more than 500 livres in coins or ingots. The authorities
commenced so-called domiciliary visits, resulting in widespread
confiscations. In the cellars of an ex-chancellor named Pontchartrain were
found 57,000 gold coins. On March 11, the government announced that
gold and silver could no longer be used to pay debts. This made France
the first country in the civilized world where a commercial transaction
couldn't be conducted with gold and silver.
The public was incensed. Law was given a detachment of Swiss Guards to
protect him from enraged crowds. Once when his empty carriage was
recognized on the street, an angry mob tore it to pieces. The windows of
his house were smashed. Yet he still had the ear of the regent. He was,
after all, the only person in the world who understood the system.
On May 21, the government issued the edict that broke the system. It
devalued all the company's notes and shares and fixed their prices. The
value of the company's shares was reduced by almost half. The public
outcry was so vociferous that the edict was repealed a week after its
publication, but the damage was done. Law submitted his resignation as
comptroller general.
The rush on the bank was so great that it closed for 10 days; it opened
again on June 10, but so many people tried to get in that some suffocated
or were crushed to death. On July 17, the crowd arrived at the bank to
find barricades around it. This so incited them that they rushed the barriers;
12 were killed, many others injured.
Meanwhile the price of food was rising, and shopkeepers would accept
paper currency only at discounts as high as 90% and sometimes not at all.
The government began to withdraw paper from circulation by announcing
that all notes of 1,000 livres or more were canceled unless they were used
to buy government annuities or for opening accounts at Law's bank.
Another edict soon did the same for all other notes. A few months later,
the use of gold and silver was resumed in all commercial transactions.
On Nov. 27, the bank closed its doors for the last time. John Law's
experiment with paper money had lasted less than two years. He left
France in December. All his property, except a small amount of cash he
carried, was confiscated by the government. He returned to England,
where he asked for and was granted a formal pardon for his 30-year-old
murder conviction.
In 1725, Law moved to Venice, where he made a modest living by
gambling. He died of pneumonia in a lodging house four years later at the
age of 58. An inventory of his wealth noted 488 paintings, including works
by Titian, Raphael, Michelangelo and Leonardo da Vinci. A satirical
epitaph published in France after his death read, "Here lies that celebrated
Scotsman, that peerless mathematician who, by the rules of algebra, sent
France to the poorhouse."
***
John Law's experiment, like many experiments, was a failure, even a
tragedy for some. But his ideas were like smoke from a bottle: Once out,
they could not be put back. He had proved that the value of money is an
agreement among people, not an objective standard measurable in nuggets
or ingots, a distinction that fostered future stages of wealth creation. |
