Lessons for Today with the Past as Prologue: the Mississippi Bubble of the 18th Century
It is human nature to congregate. Over centuries such behavior was reinforced by survival–there is strength in numbers. But over the last few centuries financial markets developed and proved fertile ground from time to time for group activity, for better or worse. It has not been rare that the latter outcome prevailed.
The development of central banks occurred at about the same time. That was coincidental at first, but over time the two ended up as traveling companions in a precarious, and at times, dangerous relationship. Financial market participants, perceiving the intention of central bankers, placed their wagers accordingly. The now-familiar result is that markets overshoot in both directions.
The risk is greatest when central bankers decide to experiment, since without the benefit of experience and history the outcome is purely conjectural. Following the Global Financial Crisis after Lehman Brothers’ insolvency in 2009, the insolvency in 2009, the chairman of the Federal Reserve, Ben Bernanke led a crisis response that included the then-novel Quantitative Easing and a massive expansion in the Fed’s assets. Such unconventional policies continued at various times over the next decade as the trauma of the contraction impaired risk-taking in the private sector. An intentional outcome was zero percent interest rates, which were not intended at first to last so long. But the failure of the private sector to recover fully caused the Fed to extend the policies multiple times.
This is Edward Chancellor’s subject in The Price of Time: The Real Story of Interest, published in 2022. There was a time when the charging of interest at all was in disfavor, but Chancellor relates the evolution of interest charges (interest was legalized in England by Elizabeth I in 1571), the relationship to risk and the now-apparent obviousness of the practice. He discusses at length the relationship of interest rates and speculation, having examined multiple cycles in his previous volume, Devil Take the Hindmost, published in 1999 at the height of the Dot-com boom.
The first of those was the speculation in tulip bulbs in Holland in the 1630s, which apparently broke out at a time when money was abundant. The relationship becomes more evident as central banking practices developed beginning in the 17th century. The Bank of England began in 1694, preceded closely by the Swedish Riksbank.
As it happened, in that year a young man died in London in a duel. His opponent was John Law, who was convicted of murder. Law prevailed on influential people to press for a royal pardon, which did not occur. His companions helped him escape from prison and escape to the Continent . From Chancellor:
Law was twenty-three years old when these events took place. A quarter of a century later, he cut a very different figure. In 1720, the Scotsman (Law) was appointed France’s finance minister. He was also the founder and head of the French central bank, and ran a vast corporate enterprise, known as the Mississippi Company, whose activities encompassed a large share of the French economy…Equally remarkable is the fact that this convicted murderer should later earn a place in the pantheon of great economists…Law has been called the original monetarist—an eighteenth-century forerunner of Milton Friedman. His monetary policy prescriptions form the basis for modern central banking. (p. 46)
Law’s reputation as a brilliant economist rests on some pamphlets he authored a decade or so after his escape to the Continent…Money, he said, does not derive its value from precious metals…Rather, money was simply a yardstick of value…This…amounted to a monetary revolution. In essence, he was saying that since money lacked intrinsic value it need not be backed by gold or other precious metals…In modern language, Law was suggesting that a central bank could reduce interest rates by printing money; that this would alleviate the position of heavily indebted borrowers…create jobs and revive the economy. At the same time, the cost of servicing government debt would fall and deflation come to an end. In the aftermath of the 2008 financial crisis, the world’s central bankers acted with similar intentions. (p.49)
The Mississippi Company was the successor to another company that held monopoly trading rights and land claims to French Louisiana, the size of which was approximately half the current landmass of the United States (excluding Alaska). Chancellor again:
Law subsequently merged this business with France’s other trading monopolies…along with the tobacco monopoly, the contract to farm the royal taxes and the royal mint. To cap it all, in the late summer of 1719 Law arranged for the Mississippi Company to take over’s France’s entire national debt, in exchange for an annual payment. Government creditors were given the opportunity to swap the bonds for shares in Law’s company. In the space of three years, the Scotsman had created ‘the most colossal financial power ever known’. His System, encompassing commercial, debt management and banking operations, was the most ambitious economic experiment prior to the Russian Revolution. (p.50)
The stock of the Company was distributed to the public. The initial offering was priced at 500 livres (the French currency of the day). Law had formed a bank which at first was a fairly conventional structure, but in 1718 it was nationalized and its name changed to the Royal Bank, which suggested Law’s intent:
…The Royal Bank’s notes were denominated in livre tournois, rather than gold. This removed any restriction on the amount of money that could be issued. As soon as the Royal Bank started printing its paper money, Mississippi shares perked up. Over the course of 1719, their price climbed some twentyfold, peaking at close to 10,000 livres. Investors who had bought into the first subscription with depreciated government debt increased their money by more than forty times. The French coined a new term, millionaire, to describe these lucky fellows. A speculative fever enveloped the nation and soon the whole of Europe had caught the bug. (p.50)
This is one of the earliest, and perhaps the most enormous for centuries to come, of speculative bubbles. It is important for at least two reasons. First, unlike tulips in Holland it was the first explicit deployment of a fiat currency without tangible backing by anything other than the issuer. Another reason is that its initial apparent success encouraged the issuer to do progressively more of it.
Thus, the reason for studying Law’s pioneering venture is its contribution to the foundations of today’s monetary policies. The shape of it was formed in now-familiar fashion by a national bank, which are now referred to as central banks:
The main stimulus for the bubble came from the Royal Bank’s printing press. Over the course of 1719, the amount of paper money in circulation increased by an estimated billion livres. The bank employed eight printers around the clock to crank out notes in large denominations…The money-printing became so furious that the handwritten signature of the bank’s cashier had to be replaced by a printed impression (as on modern banknotes). An observer claimed that ‘the printing of shares and banknotes was actually delayed because the manufacturers could not supply paper fast enough!’ By May 1720, the total circulation of notes exceeded 2 billion—an increase or fifty times on the earlier issuance…and roughly twice the quantity of gold and silver coins in circulation. (p.52)
The Mississippi bubble’s greatest result may be as an early lesson in the outcomes of egregious investment error. In this there are stark parallels with our time:
The decline in interest rates, together with the increase in dividends, appeared to justify the rapid climb in the Mississippi share price. At the market peak in late 1719, the yield on government debt stood at 2 per cent and loans for share purchases (margin loans) cost the same amount, while Mississippi shares traded at close to fifty times earnings and paid a dividend equal to 2 percent of the market price (admittedly, the dividend was not quite covered by earnings) … Nicholas Dutot, a treasurer to the Company, observed that falling interest rates had ‘carried the value of lands to 80 and 100 years purchase (i.e. a rental yield of around 1 per cent)’. (p.53)
These were among the lowest yields in history. In the nineteenth century the economist Walter Bagehot was to make the now-famous observation that “John Bull can stand many things, but he cannot stand two percent”, referring to English money markets and their effect on excessive behavior in asset prices. Chancellor puts the Mississippi episode in historical context:
The Mississippi Company dominated France’s economy and overwhelmed its nascent stock market. ‘No company before or since has had a greater share of the world’s investment capital than the Compagnie des Indes in the autumn of 1719 … In comparison, Apple Inc is a rag-and-bone shop,’ writes Law’s biographer James Buchan. (p. 54)
The outcome is unsurprising:
Yet no sooner had Law’s great edifice been put together than it started to collapse. The reasons for this failure are complex. (p. 55)
Chancellor goes on to enumerate the multiple and complex flaws in the structure and then concludes:
In the last analysis, the (Mississippi) System was simply too ambitious…(Law’s) System would still have foundered because its monetary foundations were unstable. Towards the end of 1719, the massive issue of banknotes had produced a ‘wild inflation’, evidenced by the near doubling of an index of commodity prices since the start of the year. As confidence in the paper currency began to evaporate, money flowed out of the country…Mississippi shares fell sharply in February 1720 after the Company’s office the purchase and sale of shares closed… (p. 56)
Law flailed for a time, trying to reverse his inflationary system with deflationary policies. Those had the predictable negative results:
The following month, a little more than a year since his appointment as finance minister, Law slipped out of France, leaving his dreams, fortune and wife and daughter behind. His great monetary experiment had failed…After the bubble burst, Mississippi Company shares lost around 90 per cent of their value, falling back to the level they had traded at in 1718. (p. 57)
All of this will sound perhaps astonishingly familiar to current-day observers. The Dot-com boom that ended in 1999-2000 seemed to be a page out of history at the time. Little did we know that 20 years later, we would experience what has been termed the Everything Bubble, when it was not one asset class but many that would see valuations of multiple asset classes, including many of the important ones, at valuations that seemed inconceivable before. In our next piece we will review that episode, including what was perhaps the zenith of excessive valuation—cryptocurrencies.
Reference: Chancellor, Edward, The Price of Time: The Real Story of Interest (First Grove Atlantic, 2022).
John is a Senior Research Consultant and whose primary responsibilities include contributing differentiated macroeconomic perspectives as well as providing industry and company research.
In addition, he writes investment commentary, which is published on our website.
John has worked in the investment industry for over 45 years. He was formerly our Director of Research. Prior to joining BFS, he was the Chief Investment Officer at New England Asset Management, Inc.
John has achieved the designations of Chartered Financial Analyst® and Certified Public Accountant.
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