Law’s Mississippi System

Following the British model?

It was not till the death of Louis XIV and the arrival of Philippe, duc d’Orleans, as regent of France during the minority of the future Louis XV, that Law’s monetary proposals were accepted.

In 1715, France faced two crises, a monetary crisis and a financial crisis - see Faure (1977), Murphy (1997), Velde (2014) and Buat (2015). The first crisis, the monetary crisis, was due to the acute shortage of money.

The question as to how a Scotsman with a dubious reputation was able to move towards the centre of financial power in France is an intriguing one and may be explained by historical circumstances in the form of the Chamber of Justice, established in 1716. This Chamber was set up as a tribunal to judge and penalise the hitherto powerful financiers and others deemed to have exploited the Crown through their financial and trade manipulation.

The Chamber of Justice produced two beneficial outcomes for John Law. First of all, it forced the financiers to adopt a low public profile. This meant that they could not be vocal in their opposition to Law when he started to introduce elements of his System to the Regent, then despairing of improving France’s economic situ­ation. Their enforced silence provided Law with a good opportunity to present his ideas aimed at addressing both the monetary crisis and the financial crisis without meeting any real opposition from them. This initial lack of opposition from the financiers was important particularly as the adoption of Law’s ideas involved the dismantling of the established financial system and the removal of the financiers from their central role in it.

The second beneficial outcome of the Chamber of Justice for John Law was that it forced one of the wealthiest financiers, Antoine Crozat, to abandon his plans for the development of French Louisiana. Crozat, described by Menard as “le Fran- ςais qui possedait l’amerique” (Menard 2017), was forced to give up his trading rights over the French colony of Louisiana as part payment of a fine of 6.6 million livres levied on him by the Chamber of Justice. Crozat’s ceding of these trading rights presented Law with the ideal opportunity to take over these trading rights and launch a further part of his plan aimed at addressing the second crisis, the financial crisis.

In August 1717, Law was given permission to launch the Compagnie d’Occident (Company of the West). It had two major objectives. The first was the development of the trading concession of French Louisiana, a land mass stretching from Canada to the Gulf of Mexico, bounded by the British in the Carolinas and by the Span­ish in Texas. French Louisiana covered almost half of the land mass of the United States (excluding Alaska). The trading concession to such a vast territory created the possibility of a strong income stream from trade there for the Company. The second objective was to use the Company to reduce the burden of the Crown’s debt. This was met by the stipulation that the first issue of shares in the Company could only be acquired with short-term government debt instruments, the billets d’etat. The Company, in return for the Louisiana trading concession, agreed to accept a lower interest payment from the government on the “billets d’etat”. This had the dual advantages for the government of reducing the interest cost on the short-term debt and, secondly, reducing the overhang of this short-term debt on the financial market.

The development of the system

At this stage, Law had closely followed the British models. His Banque Generale (General Bank), established on 2 May 1716, which had been converted into the Royal Bank (Banque Royale) on 1 January 1719, had been influenced in many respects by the Bank of England and the new Company of the West had parallels with trading companies such as the East India and South Sea Companies.

Law would soon distance his Company from its British counterparts through his expansionist policies for the Company. In 1717, on its establishment, the Company was permitted to issue 200,000 shares with a nominal issue price of 500 livres per share. However, as the “billets d’etat” were standing at a very significant discount of 68 to 72%, the real cost of acquiring shares worked out between 140 and 160 livres per share for the initial subscribers. For nearly two years, the progress of the Company was very moderate. This was the result of an initial lack of public enthusiasm for the shares and may also have been due to the fact that Law was busy expanding the business of the Royal Bank. Furthermore, by an arret of 8 July 1719, it was stipulated that the Royal Bank’s banknotes would no longer be guaranteed in terms of “ecus de banque” (that is, redeemable in coins of the same weight and fineness as they were when they were issued), which had been the case for those notes issued by the former General Bank. By this measure, all the banknotes issued by the General Bank were withdrawn from circulation and presumably converted into banknotes of the Royal Bank which had no metallic content guarantee as to their value. This decoupling of the link between the banknotes and a stipulated value of silver meant that there was no guaranteed conversion rate for banknotes into silver, a development consistent with Law’s idea that money should not be intrinsically valuable. This move also gave the Bank carte blanche to issue bank­notes as it wished. Additional to these monetary developments, the banknotes were made legal tender and tax payments had to be made using them.

By the early Summer of 1719, Law needed to generate some momentum in the Compagnie d’Occident whose shares were still at a discount, that is, below their nominal issue price of 500 livres per share. The first action he took was to merge two trading companies, the Compagnie des Indes Orientales (Company of the East Indies) and the Compangie de Chine (China Company), with the Com­pagnie d’Occident. The newly merged group was named the Compagnie des Indes (Company of the Indies). Another trading company, the Compagnie d’Afrique (Company of Africa), was taken over on 4 June 1719. These operations required financing, for both the Compagnie des Indes Orientales and the Compagnie de Chine were heavily in debt. Additionally, fresh funds were required to re-equip existing ships and build up a new fleet to exploit the colonial trade which, as a result of the merger, was now almost completely under the control of the Com- pagnie des Indes.

To finance such ventures, the Company proposed on 15 May 1719 a second issue of shares, known as the filles (daughters) consisting of 50,000 shares at 550 livres per share, the nominal value of the share remaining at 500 livres. The shares were kept, so to speak, in the family in that they were issued as a rights issue stipu­lating that purchasers needed to be holders of four meres in order to acquire one fille. This measure reinforced the value of the meres and ensured that the shares remained under the control of the first subscribers which included the Regent and his circle. To encourage their uptake, soft payment terms were offered. Subscribers paid 50 livres in down payment and then faced 20 monthly payments of 25 livres. Unlike the first issue, which had been totally subscribed in billets d’etat, all pay­ments were to be made in cash. On making the first payment, subscribers were given a certificate authenticating their purchase of the share. As each future pay­ment was made, the certificate was to be stamped to this effect. Cochrane (2001) has suggested that because of this payment procedure the certificates effectively acted as options with transactors having the option to discard purchasing the share by not making future payments.

Two months later, on 26 July, Law tapped the market again issuing 50,000 shares at a price of 1,000 livres per share payable in 20 monthly instalments of 50 livres. These shares were known as the petites filles (granddaughters). Again, this was a rights issue aimed at keeping the shares closely held amongst the first subscribers because each purchaser had to have four meres and one fllle in order to purchase a petite fille. Again, they could also have been regarded as options in that subscribers could decide to abandon purchasing the shares at any stage during the prescribed payment schedule.

By August 1719, Law had made four share issues. The first involved the Gen­eral Bank, whose shares had been bought back from the original shareholders prior to its transformation into the Royal Bank in December 1718. The other three share issues involved the Company of the West, later called the Company of the Indies, which will now be referred to as the Mississippi Company. In all, the Company had issued 200,000 meres, 50,000 fllles and 50,000 petites filles, a grand total of 300,000 shares. These share issues had been used to acquire 100 million livres of “billets d’etat”, to purchase capital assets for the trading companies, and to acquire the rights to the Mint. Thus, Law could contend that he had mopped up a large part of the floating debt and in the process pushed the remaining “billets d’etat” back to par, that he had injected much-needed funds in the trading companies and that he had added an important revenue-earning source to the Company, namely the Mint. At the same time, the Royal Bank had expanded the money supply, a process which had produced further reductions in the interest rate.

While some extolled the great progress that Law had made, the debt manage­ment issue was still dominating his thought:

the deepest wounds of the State were still not cured and it was necessary to apply even stronger remedies. What had been seen up to this point was more a preparation for the cure rather than a radical cure.

(Law 1934, III, 343-4)

What did this radical cure involve? I believe that the author of the above was refer­ring to Law’s attempt, starting in August 1719, to address in a comprehensive man­ner the problem of France’s national debt.

On Saturday, 26 August 1719, Law produced his master plan which was unveiled by the arret of 27 August. He proposed that the Company would lend 1.2 billion livres at an interest rate of 3% to the King - this sum was later raised to 1.5 billion by an arret of 12 October 1719. This money would be used to repay the long-term state debts, the annuities (“rentes”), the remaining short-term float­ing debt (“billets d’etat”), the cost of offices (“charges”) that had been or would be suppressed, and the shares of the United Tax Farms (la Ferme Generale) that had been taken over by the Company. In this way, Law proposed “the radical cure” for the French economy, namely the conversion of most of the national debt into equity of the Company. Through these operations, Law transformed the Company from a trading company to a trading-cum-financial conglomerate, controlling the State’s finances most notably tax collection and debt management.

On 13 September 1719, there was a new issue of 100,000 shares which were priced at 5,000 livres a share. Within two weeks, on 26 September, a further issue of another 100,000 shares at the same price was made. In the text of the latter arret, it specifically pointed out that the public wanted to use the proceeds of the repay­ment of their annuities and offices to purchase shares. A further issue of 100,000 shares at the same price was authorised on 2 October. There was also a smaller issue of just 24,000 shares on 4 October, though this latter issue was never actually sold to the public. Thus, within a three-week period, the Company issued 324,000 shares, of which 300,000 were sold to the public at 5,000 livres a share, amounting in all to 1.5 billion livres when fully paid up. Purchasers of the September/October soumissions, the cinq-cents as they were called, had only to put up 500 livres to acquire their rights to the shares and then to repay the rest in nine monthly instal­ments. The issue of the extra 324,000 shares between September and early October of 1719 meant that the Company had issued 624,000 shares, not all of which were fully paid up. This means that a variety of shares ranging from those that were fully paid up to the partially paid filles, petites filles and cinq cents were quoted by trad­ers in the frenetic trading that took place in the rue Quincampoix in Paris.

The rapid movements in the share price in the late Summer of 1719 had created the favourable environment for Law to introduce his plan for the overall conversion of the government’s debt into equity of the Company. On 1 August, the original shares, the meres, which, as has been shown, could have been bought for between 160 and 180 livres in 1717 stood at 2,750 livres. By 30 August, they had risen to 4,100 and by 4 September they were at 5,000 livres, with the filles and petites filles, rising pari-passu. The debt holders recognising the prospect of a capital gain were quite happy to transfer their debt into shares. Their difficulty in fact became one of converting quickly enough into the shares of the Company as the price of the shares rose very sharply during September. To activate further interest in the new issues, Law provided further soft instalment payment terms giving subscrib­ers nine months to complete the payment of the shares. Such instalment payment terms were one of Law’s favourite marketing ploys to increase the marketability of the shares to the general populace. Even when the approaching monthly payment dates caused problems for investors, and perhaps, more importantly, for the price of shares, Law softened the repayment terms by changing them from monthly to quarterly repayments. Small down payments and an ever-increasing demand for shares pushed the price of fully paid-up shares to over 9,000 livres in the Autumn of 1719. On 2 December, the share price peaked at 10,025 for the year.

These monetary and debt management innovations in France that initially had been modelled in part on the Bank of England and the East India Company were perceived to be so successful that the British, belatedly, attempted to copy part of them with the South Sea Company in 1720. In Britain, there was a further develop­ment in that the debt management initiative of the South Sea Company spawned a wide range of new issues by fledgling “bubble” companies, some with serious objectives such as insurance and others the creation of confidence tricksters. All of these new companies formed part of the phenomenon that came to be known as the South Sea Bubble.

In France, there were no bubble companies. The Mississippi Company/Royal Bank centralised all the trading companies under its control and reigned supreme. News coming through from France in the first weeks of January 1720 would have greatly encouraged the directors of the South Sea Company for, as the New Year started, the Mississippi-dominated stock market boom gathered further momentum and went to a new high in the second week of January. This second week produced one of the most intense bouts of speculative purchases during the System charac­terised by a huge upsurge in demand for newly created options, called “les primes”.

Law, in an effort to destroy the private derivatives markets that had been set up in Mississippi shares, proposed a scheme whereby subscribers by paying 1,000 livres would have an option to purchase Mississippi shares at a guaranteed price of 10,000 livres over the next six months. Some members of the public believ­ing that the share price would move even higher sold their old shares to purchase the “primes”. By selling a share for 10,000 livres, it was possible to acquire ten “primes” worth 10,000 livres each when all the future payments would be made on them. In the early days of the issue of these “primes”, they sold at a premium. The quantity of them sold in the second week of January indicates that this was the period that the Mississippi share price peaked. Ironically, Law’s attempt to dampen the future price of the Mississippi shares led to the most intensive bout of specu­lation in them through these sizeable sales of the “primes”. According to Law, 300 million livres of “primes” were sold to the public indicating a commitment by transactors to purchase another 300,000 shares.

The collapse of the system

The objective of the narrative up to this point is to show the extent to which Law initially succeeded in addressing France’s dual crises, those relating to the mon­etary shortage and debt management. His initial choreography of the French econ­omy, between 1716 and the first half of 1720, seemed to have been almost perfect. He appeared to have solved the monetary crisis by substituting banknotes for spe­cie and he had addressed the financial crisis through the conversion of France’s state debt into equity of the Mississippi Company. Both policies were deemed ini­tially to be highly successful so much so that Law was made Controller General of Finances on 5 January 1720 and the British authorities, imitating Law, decided to use the South Sea Company to convert government debt into equity.

So, Law had both the ideas and the opportunities to implement a financial revo­lution. For a brief period, he had introduced one, but it was not to last. Why did he fail? At a political level, the maintenance of his financial revolution would always prove difficult once the financiers, bereft of their control of the finances, regrouped and waited for an opportunity, like that of 21 May 1720, to attack Law. Du Tot, a man at the centre of the Royal Bank’s operations continually criticised the financi­ers for their opposition to Law.

At an economic level, Law made the mistake of too closely interlinking the activities of the Royal Bank with those of the Company. He had already won two important battles in substituting banknotes for silver and shares for government debt. These were highly significant achievements in such a short space of time. But then he used the printing presses of the Royal Bank to prop up the Company’s share price at an artificially high level. Nicolas Du Tot was the under-treasurer of the Royal Bank for most of 1720 and his detailed analysis of the System (2000) provides a fascinating insight into the tensions created by Law’s policy of using the Royal Bank’s note issue to support the Mississippi Company’s share price. Du Tot showed that Law used the Royal Bank’s note issue to support the price of shares from as early as 6 October 1719 when the Company provided money to those

shareholders who needed it by purchasing their old shares at 5,000 livres each. Du Tot explained that this strategy was implemented to ensure that the share price did not fall and expressed surprise that the Company, at the very time that it was issu­ing 300,000 new shares, was also buying back its own shares. His wry comment on this was “A merchant who buys and sells at the same price does not gain the public’s confidence” (Du Tot 2000, f. 231).

The share support operation had been further accentuated by the provision of soft loans to existing shareholders. Du Tot explained that one of the reasons for the success of the Company in the closing months of 1719 was its policy of lending 2,500 livres per share at an interest rate of 2% to shareholders (Du Tot 2000, f.252). Soft loans of this nature enabled shareholders to leverage up their holdings of new shares by making down payments of 500 livres. It is quite clear from Du Tot’s account that Law was using the Bank - expanding the banknote issue - to provide loans to shareholders who wished to acquire more of the Company’s shares.

The share support operation became a more important element of the Com­pany’s strategy in 1720. At the AGM of the Company on 30 December 1719, two agencies (“les bureaux d’achat et de vente”) were established, one to purchase shares and the other to sell them. Du Tot expressed considerable reservations about the wisdom of the Company purchasing its own shares though he admitted that the sale of shares by the Company might be regarded as useful in that it reduced the quantity of banknotes in circulation - “this was the good aspect of this operation” (Du Tot 2000, f.304).

Between 30 December 1719, when the bureaux were established, and 22 Feb­ruary 1720, the Company bought back 800 million livres of its shares. Taking an average price for the stock during this period as 9,300 livres, Du Tot estimated that this involved the “bureaux d’achat et de vente” purchasing around 85,000 shares (Du Tot 2000, f. 347). These statistics show that the “bureaux” had been exten­sively used to prop up the share price at a high level. As a result, the printing presses of the Royal Bank had been working overtime. Belatedly, Law realised that he had over-expanded excessively the financial circuit, comprising banknotes and shares, relative to the real capacity of the economy. Perhaps, if he had been able to introduce the intended deflationary 21 May measures at an earlier stage in late Feb­ruary 1720, he might have been successful in dampening the excessive optimism in the System. The Regent’s reluctance to allow him to do so meant that the attempted resuscitation came too late in May of 1720.

One also suspects that Law’s Achilles Heel was his excessive confidence in his improvisational skills to buttress the System rather than asking questions as to whether such improvisation was covering up a deeper issue. For example, in January 1720, when some pressures emerged as the public attempted to cash in their Mississippi gains by purchasing specie and bullion, Law counter-attacked by prohibiting the use of specie for all but very small transactions and by criminalising the holding of specie and bullion above a stipulated amount. In a further effort to increase the attractiveness of banknotes, he produced a demonetisation of gold and a phased devaluation of silver. These were attempts to keep transactors within the financial circuit, trading shares for banknotes and vice versa, thereby preventing them from moving outside this financial circuit. If Law had analysed this desire to exit the financial circuit, instead of designing ways to keep transactors within it, he would have realised that there was a fundamental flaw in his System namely an over-issue of paper money in the form of banknotes and monetised shares. That realisation would have provided an early warning of the need to deflate the Sys­tem. Instead, his improvisations diverted his attention from the main issue to be addressed.

Then, when he eventually realised the inevitable necessity of deflating the Sys­tem in March 1720, political factors prevented him from doing so in that the Regent and his circle were not prepared to see the value of their paper holdings of shares and banknotes reduced in value. Eventually, when he succeeded in having an arret introduced on 21 May stipulating phased reductions in the value of both banknotes and shares, confidence in the System abruptly collapsed. For a short period, Law’s life was in danger as he was put under house arrest. He was sacked as Controller General of Finances but quickly reinstated to run the Company when the Regent realised that Law was probably the only man capable of managing it. However, the public’s confidence system had been badly eroded and despite some Herculean efforts to resuscitate the System it collapsed in the latter months of 1720. Law’s enemies, the powerful Paris brothers, were brought in to restructure the Company and return France to the old financial system. With the assistance of the Regent, Law fled from France, and, after a stay in Brussels moved to London where he was pardoned for his crime of killing Wilson by George 1. During his stay in London, the Regent attempted to entice Law back to Paris - an indication of the esteem that the Regent had for Law. Law prepared for this return but then the news came through that the Regent had died and that the new Regent, the Duc de Bourbon, for­bade Law’s return. Notwithstanding the failure of Law’s System, there were other leaders such as the Serbian finance minister and Czar Peter the Great who were keen to invite Law to address their financial problems. In both cases, he refused these invitations. He moved from London to Venice and died in that city in 1729.

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