John Law, the Outlaw Banker

At the start of the 18th century, a stock market boom was underway in several European countries simultaneously. Today, this episode is best remembered for the spectacular boom and bust of the South Sea Company in Britain. However, it was just one of the companies involved in a larger mania. In France, a bubble in the shares of a firm called the Compagnie d’Occident was gripping the country concurrently with the episode in London. Behind the French firm was an enterprising Scot named John Law. He was a banker, an economist, a gambler, a commercial and political adventurer, and an outlaw. He founded two companies, a bank and a trading firm, at the center of one of financial history’s earliest and most spectacular bubbles.

John Law

One of the most intriguing characters in 18th century finance, John Law, was born in 1671 to wealthy Scottish bankers in Edinburgh. He joined the family banking firm at age fourteen and was distinguished for his ability in mathematics. Of mixed blessing, he was also known by his proclivity for extravagance and thrill. Perhaps it was the combination of both features in the young Law that gave him an appetite for gambling, in which he became experienced after leaving the family firm for London.

Whatever his skill in the gambling houses, Law nonetheless eventually found himself broke. Worse still, Law was challenged to a duel over the affections of Elizabeth Villiers, an earl’s granddaughter and the future courtier and Countess of Orkney. Law killed his adversary in that duel, was charged with murder, and then sentenced to death in 1694 at the age of 23.

There was still some luck left in Law though and he managed to escape from imprisonment by unknown means and fled to Holland. With little more than his experience in banking and gambling in hand, Law appropriately enough dedicated his time in the Netherlands to studying finance. He spent the next two decades travelling across Europe, frequenting gambling houses and speculating in markets all the while discussing the financial news of the day at the card tables.

Monetary Theories

Whatever the state of his life at the turn of the century, Law was an economic theorist of perhaps the first order. In 1705, he published a treatise advocating for the issuance of paper money backed by land as a means of alleviating shortages of credit while maintaining the currency’s purchasing power. Such a currency, he argued, would augment the money available for commerce and would prove to be an economic stimulus. Though this policy suggestion was written explicitly with Scotland in mind, it drew attention in France, which like Scotland was nearly bankrupt at the time.

“Indeed, if lowness of interest were the consequence of a greater quantity of money, the stock applied to trade would be greater, and merchants would trade cheaper, from the easiness of borrowing and the lower interest of money …” – Law’s treatise, Money and Trade Considered, 1705

John Law’s notoriety in France was also on the ascent as he began to frequent the same gambling parties attended by French nobility, including the Duke of Orléans. At the time, France was grappling with its large state indebtedness, accumulated during the reign of Louis XIV, who died in 1715. Because the King’s heir, Louis XV, was still a child, the country was governed by a regency headed by Philippe d’Orléans, the duke with whom Law was acquainted. The duke was responsible for paying down a state debt of three billion livres, a massive sum when compared to the mere 150 million livres in state revenues available to his government. The distress was obvious to all and bills issued by the French government to finance this debt were trading at steep discounts of 30% or more.

Banque Générale

To reinvigorate the French economy after its long involvement in the War of Spanish Succession, Law pitched his idea of paper money to the regent Philippe d’Orléans. What Law envisioned was a central bank that would issue paper money that could be used in lieu of metal coins. Such a concept was not at all new and Law argued that the use of paper money in Britain and Holland provided a positive example for France to follow. The argument was similar to that he had made with respect to Scotland a decade earlier; paper currency would enhance trade which suffered from the scarcity of precious metal coins.

The outlaw banker convinced the duke and in May 1716, the Banque Générale Privée was chartered by royal edict. As the name suggests, this was a private bank, though what Law had proposed would have been a state bank. Rather than state funding, the initial capital was thus to be provided by private investors. The bank was capitalized with six million livres through the issuance of 12,000 shares for five-hundred livres each. Shareholders could pay the offering price not just with payments of cash but by exchanging their existing government bills for shares in the bank.

“The benefits that public banks have conferred upon various European States, sustaining their credit, building up their commerce, and supporting their manufactures, have made it clear to us that our people might secure the like advantages from similar institutions …” – Preamble to the registration of the Banque Générale Privée, 1716

The Banque Générale augmented its capital by issuing banknotes. Notes issued could be exchanged for coins and would be accepted for payment of taxes. With respect to the former feature, the notes were peculiar because they were redeemable for coins of a specific finesses and size, protecting noteholders from any devaluation of the official coinage. Given the protections they offered, the Banque Générale’s notes began to command a premium to both metal coins and the bills issued by the state to finance its debt. This reflected the public’s confidence in the bank, which exceeded its confidence in the state.

However, this confidence was put to nefarious use. Though Law’s theories stressed the need for monetary stability, the bank began to issue notes in excess of the reserves backing them. This would enhance the profitability of the bank, allowing it to put its enlarged balance sheet to use discounting receivables for merchants and in other banking operations. The bank grew rapidly; new branches were established in Lyons, Rochelle, Tours, Amiens, and Orleans. With a short though seemingly impressive track record under its belt, stock in the company was acquired by the regent on behalf of the King. The Banque Générale was accordingly rebranded the Banque Royale in December 1718.

Mississippi Scheme

Though the Banque Générale may have been the realization of Law’s monetary vision, it was not the most monumental creation of his time in France. The financier also conceived of a firm that would do for France what the South Sea Company was doing for Britain. The latter company was established in London to retire a portion of the national debt by allowing bondholders to exchange their notes for shares in a company with a monopoly on trade with South America. In France, Law organized the creation of the Mississippi Company, officially known as the Compagnie d’Occident. It secured a charter in August 1717 bestowing on the firm a monopoly on trade with France’s territories along the Mississippi River in North America.

This was not a mere giveaway to the friend of the regent. As with the Banque Générale, shares in the new trading company were acquired by exchanging them for government bills at face value. Law agreed to accept a lower interest rate on these contributed bills, thus reducing the government’s debt service costs. Essentially, the company was accepting a below market interest rate on the bonds it held in exchange for the monopoly it was given; this was the same business model pursued by the South Sea Company in Britain. In its initial public offering, the Compagnie d’Occident issued 200,000 shares at five hundred livres each. The share sale thus raised 100 million livres in capital. The offering was immensely popular with the public because the shares could be paid for in state bills then trading at a discount.

Bubble

Shares in the company surged in value, partially due to exaggerated stories of the riches available for exploit in North America, stories never supported by fact. Also supporting the surge in prices was the monetary stimulus provided by the Banque Générale’s liberal issuance of banknotes. Shares in the Compagnie d’Occident rose in value from five hundred livres each to 10,000 livres by the end of 1719. They traded hands at 18,000 livres at the height of the mania.

The inaugural issuance of shares was succeeded by others. This brought the number of shares outstanding to over 600,000, meaning the company’s market value at its peak reached a stunning 11 billion livres. Compare this to the entire French state debt of 3 billion livres at the time of Louis XIV’s death five years earlier. The rising value of shares was so great that it made the banknotes needed to purchase them appreciate relative to coins. A batch of shares offered in 1719 were oversubscribed six times over. All this mania was for a stake in a company that never stood to make a profit from colonial trade.

Regardless, the climbing share prices were enough to make Law look like a genius. He and his companies were soon conferred new privileges. These included a monopoly on the sale of tobacco and monopolies on trade with other regions including in Asia. John Law himself was appointed Contrôleur général des finances, an office from which he continued to support the liberal issuance of paper money. True, Law had skeptics and one notable skeptic in the French government was the Chancelier Henri François d’Aguesseau. He was dismissed however for his opposition to Law’s monetary ideas but the old minister had allies in the courts who continued to challenge Law’s policies. Nonetheless, their warnings and objections fell on deaf ears.

The first signs of trouble actually arrived in the most mundane of ways. It came when a prominent noble, previously a strong supporter of Law, was angered by not being given an allocation of shares he felt he deserved. In anger, this noble, the Prince de Conti, demanded all his notes be redeemed for coins at Law’s bank, a brash but presumably benign move. However, so scarce were the real reserves at the bank that this single large withdrawal would have drained a large portion of the coin available. Fearing imitators, Law convinced the regent Philippe d’Orléans to force the angered aristocrat to greatly reduce the size of his withdrawal.

This move proved heavy handed and rumors of the incident spread. Despite, or rather because of, the intervention, people were uncertain as to whether their banknotes would be redeemed as promised. Demands for withdrawals grew, first to a trickle, then to a torrent. So quickly was the bank’s esteem evaporating, it was nothing less than a run on the Banque Générale. Depositors feared an inadequacy of reserves and the banknotes began to trade at discounts. To stop the run, Law, still Contrôleur général, along with the regent, depreciated the coinage relative to the notes with the idea that this would convince people to keep the latter. When this failed to change the public’s behavior, the pair issued edicts limiting the size of withdrawals and even banning holdings of precious metals of over a certain value.

Amidst the rush into the precious metals, investors were looking to liquidate their shares in the Mississippi Company. Share prices fell from their peak of 18,000 livres to 8,000 by May and 5,000 livres by December 1720. In September of the following year, the shares were once again trading at 500 livres, precisely where they started.

The panic in France foreshadowed the bursting of the South Sea Bubble underway simultaneously in Britain. Law’s plans for the commercial and fiscal recovery of France had failed. The state assumed the debt of his bankrupt companies and was forced to raise taxes to pay off the debt – no more financial engineering. The very word ‘bank’ would arouse suspicion for decades to come. John Law was once again driven out of his country. He fled Paris for Brussels and eventually travelled to Italy; Law died broke in Venice in 1729.

Lesson

This account of the financial mania that gripped France in the second decade of the 18th century is essentially a biography of John Law; such was he always at its center. It may seem difficult to imagine the boom and bust that ended in 1720 without Law but there was certainly more behind it than his ideas and ambitions alone. After all, Law’s bubble was essentially a mirror of speculative events underway in London at the same time. Though the South Sea Bubble in Britain burst a bit later that year, the company and the scheme behind it had actually pre-dated Law’s firm. Indeed, records of share prices in London and Amsterdam show a stock market mania affecting Europe more broadly. Whatever the more general causes, in France, Law’s monetary ideas and his taste for financial adventure no doubt played a part.

More from the Tontine Coffee-House

Read about the setting of 1720’s other great bubble, Exchange Alley. Also, check out what happened to French banking after Law’s bubble had burst, including the meteoric rise and fall of Crédit Mobilier.