The History of Paper Money – Part 4: Lay Down the Law
Last we left off, paper money doctrine was just starting to be established with people like Nicholas Barbon beginning to explore the radical idea that gold and silver didn’t have any inherent value, only the value we gave them. Which leads inevitably to the argument that in using gold and silver, we tied ourselves to a system that has all the disadvantages of a commodity currency without really securing for ourselves anything more tangible than what we get with paper bills. Today we get to watch what happens the first time someone really tries to put paper money doctrine into practice.
John Law, the son of wealthy Scottish goldsmiths turned bankers. Until his 17th year he followed the family trade, but when his father died he decided that banking was too honest of an employment for him and moved to the seedier side of London. There, he rapidly found that women and cards were far more to his liking than ledgers and receipt. He lived it up as the rake and rogue of lower London. But between the fast women, the high fashion and the low cards, he more than once ended up having to run home and ask mom for a loan just to get by. But it all came to a head one foggy evening in Bloomsbury Square. Law had a rival for one of his lady loves, a drunken quarrel turned into a duel. Blades were drawn, a step, a thrust, one man fell, red between the pavers. Before he could flee, Law was apprehended. He was hauled before the famous hanging judge, Salathiel Lovell, and sentenced to death.
As he awaited the gallows though, his friends and benefactors got his sentence commuted to manslaughter and he was slapped with a fine and released. But the family of his rival was pulling strings too, and they appealed the decision. This time Law knew to flee, he hightailed it to the Dutch Republic enjoying the coffeehouses, the gambling and perhaps most of all; the stock market of Amsterdam. While he had always been of an intellectual bent, it here he started to really refine his ideas; both about gambling and finance. Watching this small republic with none of the natural resources of the other great countries of Europe, dominate the world’s economic landscape galvanized his thoughts. He reasoned that if he could just understand what had created such an economic revolution there, he could export it to nations with more natural advantages. So he spent half a decade considering the problem and all this reasoning led him to one conclusion – it was the supply of money and the availability of credit that made the Dutch Republic such a powerhouse, and where did he see the bottleneck in the availability of money and thus the availability of credit?
The supply of gold and silver.
If you’re only going to lend out gold and silver, you have to have the gold and silver to lend, and that puts a ceiling on the size of your economy which while not absolute is a lot more rigid than paper. And so he began to formulate his treaties; money and trade considered, with a proposal for supplying the nation with money with the aim of getting his native Scotland to create a national bank. Unfortunately Scotland was destitute from risky Central American ventures and the failed harvest. The Scots were in no mood to take a risk on some theory. To cap the whole thing off, the act of the Union in 1707 not only crushed any chance Law had of convincing the Scottish Parliament of his plan, but also made him an outlaw in Scotland as well as England. So once more our ironically named hero fled back to the continent.
For the next 10 years he moved between France and the Dutch Republic, speculating, gambling and socializing. But Law was always one to learn from his mistakes, he no longer gambled simply as a gamble. Now it was a system; he put into practice the many ideas that translated from the financial world. He deconstructed the games he played and worked out great tables of outcomes. He was renowned for being able to calculate precise odds on the fly and hold them all in his head and soon it paid off. This time instead of gambling his way to the poor house, he became one of the richest men in Europe amassing what today would probably be hundreds of millions of dollars just from cards and market speculation. But his gambling did one other thing for him, it opened doors. He was affable, charming and very well-dressed. As he gambled across Europe, he worked his way up to playing at private very high-stakes games in Paris. Games which included some of the most powerful men of the land, and in these smoky rooms he had far more opportunity to persuade them of his ideas than he’d had in Scotland. And the truth is those men were primed to be persuaded.
The wars of Louis XIV had left the French treasury empty and the state burdened with insurmountable debt. The new regions and his counsel were looking for a way out. So when Law said that he had a plan, they listened, the plan was ambitious. He would form a central bank which would take over many of the economic functions of the state right down to issuing money, which of course would take the form of his beloved banknotes. Most importantly though, his plan to bankroll it was genius. He allowed people to buy stock at the bank paying only one sixth of the stock’s value in cash and paying the rest by trading in their government bonds, the debts the government owed them. This scheme was genius, because the population of France knew that these government bonds were currently worthless because the government was too broke to repay them. Yet, at the same time much of the debt which the government had been crippled trying to service was the very debt the people of France held. So in having everybody trade it in, this debt magically disappeared and people who previously thought that they had been ruined by purchasing worthless government bonds, now had something of worth that they can sell or trade (stock in the new bank), because everybody was confident in the new bank – genius.
And as John’s bank began to take away, it all seems to work. The paper currency was far more stable than the old silver currency. Nobody could clip its edges and forgeries were, well punishable by death. Now with this first part of his economic system in hand, Law initiated the second part of his plan; he would form a trading company. With complete control of the economy, he established a monopoly on trade with the French territory of Louisiana and gave that monopoly to a company he established called ”the Company of the West”. The plan here was simple, he issue shares at 500 Livres a share, taking 15% down payment and the rest in installments, and sell enough of these shares to pay off the remainder of the government’s debt. Soon buoyed by some of Law’s own investing in the company, the stock price began to grow and word got out. This opportunity in Louisiana was too good to miss.
Law was made the Duke of Arkansas and soon the stock jumped 100%, then 1000%, then 3000%. The problem was there wasn’t any wealth coming out of Louisiana. When this all started, there were a mere 800 Europeans living in the whole territory and soon Law had to resort to the expedient of offering criminals a pardon if they would marry a prostitute and move to Louisiana. Meanwhile, the stock price had created even more demand for paper currency. As people borrowed and spent against their stock, that was now worth 30 times what they had paid for it, inflation ran rampant. Now if this all sounds kind of familiar for some reason, you’re not wrong. Something very similar was happening right across the channel. Soon Law’s system which he had thought incorruptible was forced to bend; he had to recall some of the paper money, slash the value of the currency and outlaw the sale or possession of large quantities of gold. But all this did was to let people know just how bad a shape the Company of the West and by extension the bank was in; soon it would not hold, mobs formed.
There were rushes on the bank and Law found himself yet again in a carriage in the night fleeing yet another country. But unlike his counterparts across the channel, Law wasn’t operating out of greed, but rather out of a desire to prove the idea that he had burning within him. And while his bank and his trading company were a disaster from which France barely recovered, they were a failure in execution more than in concept. And so despite such a catastrophic misfortune, there were those in Europe who heeded what was perhaps his most famous conjecture ”that money is the value by which goods are exchanged and not the value for which goods are exchanged”.
Join us next time as we take the final step toward modern money by getting off of the gold standard.