Tuesday, August 25, 2015

Easy come, easy go - of a creative Scot and financial bubbles

by Anna Belfrage

Admit it. People start talking about Keynes and Milton, and chances are you, dear reader, will start considering what to cook for supper or how to change the subject. That’s the problem with financial theories, that no one really tends to find them interesting. Given this, it is somewhat ironic that no matter how bored we are with economics, most of us are rather interested in money. After all, money makes the world go round.

Money was not always available in electronic form as it is today. Nor was it available in bills. No, up to the late 17th century, money was mostly available as coins. Rich people, per definition, either had strong biceps or hired people with adequate musculature to lug their riches around. While not wanting to toot the nationalistic horn too much, I am rather proud to inform you that paper money was to a large extent a Swedish invention – the Swedish National Bank (the first ever National Bank, yet another cause for a bashful blush) issued paper money already in the 1650s. Quick to follow on was England – and Scotland, seeing as both these nations were major trading economies, ergo quickly saw the benefit of using paper rather than bags of coin.

Our John
Today, I’d like to introduce you to one of the early promoters of paper money. Not only was this gentleman an extremely skilled mathematician and a successful gambler, he was also to become singlehandedly responsible for one of the more disastrous financial bubbles of the early 18th century. Ladies and gentlemen, I give you John Law of Lauriston.

Our hero was born in Scotland in 1671. His father was a prosperous gold-smith – rich enough to buy a castle, no less, hence the “of Lauriston” – and the expectations were that John as the eldest son would follow in dear Papa’s footsteps. Not to be. Law senior died when John was still young, and anyway, John showed little aptitude for making pretty things out of gold. No, John was in love with mathematics – and gambling.

In the aftermath of the Glorious Revolution our Scotsman decided to try his luck in London. Tall, dark and handsome, possessed of excellent manners, John was something of an immediate success in London society – at least with the ladies. He gambled, lost, gambled, lost some more, gambled and began to win. Capable of extremely complex mental probability calculations, endowed with an excellent memory for cards, over time John achieved quite the reputation at gaming tables. People preferred not to meet him. Well, the sensible ones. There are always those that set out to prove they can win no matter who they’re playing against.

Other than cards, John enjoyed the ladies. Not, I’d hasten to add, in an overtly scandalous manner, but women liked him and he liked women – in particular Catherine Knollys. Catherine was married (as per some sources), which does not seem to have deterred either her or John, maybe because her husband was exiled in Paris together with the former king, James II.

However, our young man was not only a shallow card-playing rake. He had dreams. Odd dreams, his contemporaries thought, not at all understanding what he was on about when he spoke of a new type of banks and paper money. Where other people held on to coins, Law scoffed, saying paper money was the way to the future, having the added benefit of being elastic – i.e. when in need of more money, you could print it, when there was too much money, you could trash it. In Law’s opinion, there was only one financial instrument that was better than paper money: shares. Why? Because shares, as per Law, were essentially monetary equivalents with the added benefit of giving the owners dividends.

While impressed by the young man’s obvious intelligence, the movers and shakers of London’s financial world were not quite as taken by his notions of new banking systems, new money systems. Besides, who did he think he was, this young lad from the back of beyond? After all, the Bank of England had just been chartered, and any day soon, they'd be issuing paper notes - once they'd investigated the issue thoroughly. Not enough, Law attempted to explain. A central bank should control the finances, use the tools at its disposal (such as paper money, which can be printed when the need for money escalates, thrashed when things move the opposite direction). He was met with condescending smiles. A frustrated Law dreamed of truly changing the financial markets, but continued to frequent the elegant salons of London, in between nurturing the growing attraction between him and Catherine.

E Villiers
Enter Elizabeth Villiers. Well, enter and enter: Betty Villiers was very much a part of all those elegant salons, her rumoured role as the king’s mistress making her popular among those who wished to influence their new Dutch leader. Law very much wanted to somehow catch the ear of the king so as to whisper seductively about growth and trade and a bright future – all of it built on Law’s own theories regarding banks and the supply of money. What transpired next is a bit vague, but somewhere along the line John Law felt obliged to call out a certain Edward Wilson – this to safeguard his honour and that of Mrs Villiers.

Duels were illegal. A duel in which one of the parties was killed was considered murder. John Law, who had considerable skills outside his beloved numbers, killed Wilson with one thrust. One moment, he was an up-and-coming man, the next he was in Newgate, facing imminent execution. The execution was commuted to a fine, Wilson’s family protested, the death penalty was upheld, and John Law had no option but to flee the country. He would have a price on his head for the coming 23 years…

When John Law escaped to the Continent, Catherine decided to join him. Her husband does not seem to have cared one way or the other, and whatever their other faults, John and Catherine were devoted to each other, a life-long love story that would produce two children. Were they married? Once again, some sources say they lived in sin. Others say they did marry. Does it matter? Not to us, it doesn’t, and John and Catherine don’t seem the type of people who would have cared.

John continued to earn his living at the gaming tables. He became rich – very rich. Women continued to flirt and wink at him, fans waving ecstatically whenever this handsome man walked by. John smiled and bowed, twirled in his splendid clothes, and did quite some flirting back. In the European salons his ideas about banks and companies, about paper money and shares mostly fell on deaf ears, no matter how impressed people were by John’s intellectual prowess. The world was simply not ready for John’s ideas.

But there were exceptions: France, for example, was so mired in debt, the entire economy stagnating after decades of mismanagement, that there were people who listened to Law and nodded in agreement. Not so the Sun King and his advisors.

The boy king
However, no one lives for ever, and in 1715 the Sun King passed away. France’s new king was a child of five, with the Duke d’Orleans acting as the regent. And the duke was rather fond of Law, who was put in charge of revitalising the dying economy. At the time, France was a mess. People starved, people stole, people begged – years of war, years of lavish expenditure by the king on matters close to his heart, had left the state finances precariously close to bankruptcy, plus the social unrest was making people nervous. Specifically, the rich people were getting a tad antsy. What if all these disgruntled desperate people would rebel, raise the standards of revolution and colour the fields red with the blood of their oppressors? (Happened anyway, as we all know)

John Law rubbed his hands. At last an opportunity to test his grand theories. For years, he had advocated the concept of a central bank, one institution in the country responsible for all major credits, for issuing paper money with corresponding securities in land or gold. Taxes, Law argued, should be collected and handled centrally so as to increase control and enable investments for the greater good.

D'Orleans
D’Orleans listened, and in 1716 Law’s bank saw the light of the day. Investors could pay for their shares with gold and with land, and the bank was authorised to issue its own money, which, because of the solid base created by gold and land, did not fluctuate as much as the livre did.

Once the bank was in place, Law implemented a series of measures that can essentially be described as some sort of proto-Keynesian approach, namely he created jobs. How? By investing in roads, in canals, in rebuilding. The national debt rose, but the social unrest faded. Law had done what Roosevelt would do two centuries later, what all desperate governments since have attempted to do: expand a suffering economy by state-financed infrastructural investments.

There was just a teensy, weensy problem in all this: France still lacked money – or rather, the French government was more or less paralysed by lack of funds. The bank in itself created stability rather than development, and for France to rise out of its impoverished state, something had to change. Law mulled this over and came up with the brilliant idea of what was to be known as the Mississippi Company. Here, at last, he would be able to prove just how fantastic shares could be, how easily they could substitute money.

It must be said from the start: Law genuinely believed his idea would work. Being a man of honour and integrity himself, he had no understanding for such base emotions as greed, nor did he understand fully just how people would react when presented with an “easy killing”.

The Mississippi company – or, to be correct, the Companie d’Occident – was founded to exploit the vast natural riches in the French American colonies. Whether the riches were vast yes or no, no one really knew, but everyone expected them to be. Law was not entirely sure, but was confident there’d be enough riches – in land, if nothing else, to guarantee the success of the venture. The company was set up, went on to acquire the monopoly on the lucrative tobacco trade and was awarded the responsibility for all African trade. An exciting new venture was under way, and Law as one of the main shareholders stood to make a fortune.

John Law
Expansion requires money. In 1719, Law was given permission to issue 50 000 shares in the company at a nominal value of 500 livres. To make people more willing to part with their money, only 72 livres had to be paid up-front. The rest was to be paid over five years.

People rushed to buy the shares. The price went up to 1 000 livres, and a further 300 000 shares were issued, with Law expressing this would be enough to more or less wipe out France’s national debt. People screamed for shares. They traded like hot cakes, and bowing to popular pressure – and his own convictions – Law ended up issuing 600 000 shares.

Poor people scraped together everything they had to invest in this golden opportunity, widows gambled their pensions, orphans their inheritance. By the end of 1719, the shares had risen to the intoxicating price of 15 000 livres each. A new term, millionaire, saw the light of the day. People were rich – stinkingly rich – in shares.

And here, dear people, was the rub. No matter Law’s insistence that shares could be used as money, should, in fact, be accepted as payment for goods and services, most people preferred gold. When, as a consequence of all this heady economic development, prices began to rise markedly, shareholders started to sell. Those who had invested early on wanted to recoup and make that killing. Some of them did, but like any pyramid game it was those who entered first and exited first who were the winners – all the rest were losers.

Law – who as the newly appointed Controller General managed France’s entire finances, from the national debt to the collection of taxes, to the issuing of money, to the Mississippi company – attempted to control the price by setting a limit on how much actual gold the seller of a share should receive. Did not go down well.

More people insisted on selling, and, as Adam Smith (yet another Scotsman with a love for finance and economy) was to demonstrate some years later, price is affected by supply and demand. When supply exceeds demand, prices fall. Where before, everyone wanted shares in the Mississippi company, now everyone wanted to sell their shares, and accordingly, the prices plummeted. The Mississippi bubble had burst, so to say, and people who until recently were rich – on paper – now faced destitution.

Law was appalled. One desperate measure after the other was attempted to save the company and safeguard France’s fragile economy. Nothing worked, and by the summer of 1720, angry mobs were forming outside Law’s private residence. He had lost just as much as anyone else, but people didn’t care. This was all his fault, with his new-fangled ideas. Law had to flee France, reduced to virtual poverty. For the rest of his life, he was to live like an itinerant, moving from city to city, reduced to yet again making his living at the gambling tables.

In 1729, John Law died, alone and poor, in Venice. But, as he would now and then say, once he, a simple commoner, controlled all of France. At the time of his death, his reputation was in tatters, this rather brilliant man vilified as nothing but a con-man. Over the years, he has been vindicated – many of his theories were sound, a lot of his measures were the right thing to do. Had Law been less of a mathematician and more of a psychologist, chances are he’d have realised that his grand scheme had one major flaw: human nature, which rarely conforms to other theories than that of rampant self-interest.

~~~~~~~~~~~~~

Anna Belfrage is the successful author of eight published books, all of them part of The Graham Saga. Set in 17th century Scotland, Virginia and Maryland, this is the story of Matthew Graham and his wife, Alex Lind - two people who should never have met, not when she was born three centuries after him.

Anna's books have won several awards - recently, one of her books won the HNS Indie Book of the Year Award -  and are available on Amazon, or wherever else good books are sold.

Presently, Anna is working on a new series set in 14th century England - the first installment will be published in November 2015.
For more information about Anna and her books, please visit her website. If not on her website, Anna can mostly be found on her blog.

9 comments:

  1. Excellent post, Anna. What a remarkable man. Thanks for sharing.

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    1. THank you. Yes, a truly remarkable man, although I'm not so sure he qualifies as devastatingly handsome in this day and age. Maybe it's the wig...

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  2. Indeed. Absolutely fascinating, and I'd never heard of him. Thank you!

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  3. When I researched money in the middle ages I learned that gold was used primarily by the rulers, silver and coins of lesser value were used by everyday people. Also gold tended to gravitate to China (where they also invented paper money) in return for silk and silver gravitated to England in return for wool. Hmm, people who controlled clothing ended up with most of the money. Regarding weight, one author writing about the ancient world said that a wagon load of gold was not exactly how it sounds. One could load only so much on the boards above the axels to keep the wagon from breaking down. I suspect large amounts of money was moved by boat or pack horses (in loads of 400 pounds).

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    1. I suspect very few had enough gold to worry about the axles...But yes, silver it was, with the pennies being cut into halves (ha'pennies) or fourths (farthings). And absolutely, China most definitely had paper Money - an early version of the promissory note - long Before us Europeans had even figured out how to use an abacus...

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  4. Absolutely fascinating. I'd never heard of him either. What happened to Catherine if he died alone and poor in Venice?

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    1. She actually retired to a convent. Their son took a commission and their daughter married a lord.

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  5. I believe Isaac Newton was running the Mint for William III ... what did Newton Make of John Law and paper money?

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