Worlds Financial Crisis (The Mississippi Bubble)

The Mississippi Bubble
In 1720, at the same time as England’s South Sea Bubble, France experienced its very own financial crisis. The Mississippi Bubble shares a striking similarity to the South Sea Bubble.
The crisis began in 1715, when France was bankrupt from war. It had defaulted on its debt as well as cut back on interest payments. High taxes quickly burdened the economy and the value of gold and silver currency fluctuated wildly. Eventually the youthful King Louis XV turned to his trusty advisor, the Duke of Orleans. In turn, the Duke of Orleans sought the help of his friend John Law, a Scottish financier.
John Law was born in Edinburgh, Scotland in 1671 to a goldsmith who lent money on the side. Law became his father’s apprentice and became well versed on the principles of banking. Tragically, Law became involved in a duel, killing his opponent and was convicted of murder. Law eventually managed to escape prison and quickly left England to travel Europe. Due to his keen mathematical abilities, Law earned much of his wages from gambling. John frequented destinations such as Amsterdam, Venice and Genoa. It was in these financial centers that John Law renewed his fascination for high finance. In 1705, Law published a monetary theory that argued against the use of metallic money and favored paper money, in true Keynesian style. Law favored paper money from his belief that its use would stimulate commerce (Smant).
With the desperate Duke of Orleans looking for John Law’s help, Law quickly devised a strategy to stabilize the French economy। In May 1716 Law established the Banque Generale, designed after the successful Wisselbank of Amsterdam (Smant). Banque General took deposits of gold and silver and issued paper money in return. These banknotes were payable in the value of the metallic currency at the time the banknotes were issued. Banque Generale gained equity through the conventional selling of shares as well as converting government debt. To John Law’s credit, the economy had begun to stabilize, helping to increase his rapport and influence within the French government.
Pursuing a new venture in August 1717, John Law acquired the ailing Mississippi Company and merged it with Banque Generale. France had granted the Mississippi Company a trading monopoly with the French colonies, commonly called “French Louisiana.” The trading monopoly carried a high-perceived value as speculation arose over the prospect of the beaver skin trade and of finding precious metals, with Indian slaves to mine them. France was looking to profit enormously, as Spain did with Mexico and Peru.
The Mississippi Company raised capital by selling shares to investors looking to take part in the “spoils of the Indies.” Shares were bought and paid for with bank notes or with government debt. The Mississippi Company increased its authority when it “Expanded to monopolize all French trade outside Europe. In July 1719 the Compagnie purchased the right to mint new coinage. In August 1719 the Compagnie bought the right to collect all French indirect taxes and in October 1719 the Compagnie took over the collection of direct taxes. Finally, a plan was launched to restructure most of the national debt, whereby the remainder of existing government debt would be exchanged for Compagnie shares.” (Smant)
Shares started trading at 500 livres (French currency of the time) in January 1719. The French public gained an insatiable desire for Mississippi Company shares and prices hit 10,000 livres by December 1719, a gain of 190 percent. People of all social classes became investors, and many became millionaires just from their holdings of Company shares. Interestingly, the French word millionaire originated as a result of the Mississippi Bubble speculation. (Moen)
The Mississippi Company gained 80,500,000 livres in revenue from interest paid by the King on loans and by profits from tobacco, the mint and trading (Smant), further bolstering investors’ confidence.
Profit taking started in January 1720, with investors receiving payment in the form of gold coins. John Law tried to curb the sell-off by limiting payments in gold of more than 100 livres (Moen).
The amount of bank notes in circulation had increased 186% in one year, due to the rampant issuance of notes to fund share purchases. As a result, hyperinflation ensued with the prices of goods doubling between July 1719 and December 1720. Much of Mississippi Company share price gains were due to inflation as well, rather than from sheer investor demand (Smant). The majority of Banque Generale notes were no longer backed by precious metals, essentially rendering them worthless.
A scandal struck in May 1720 when John Law decided that Company stock prices were exorbitantly high, causing him to start devaluing shares. Additionally, Banque Generale notes were devalued by 50%. Intense protest resulted in a compromise in which the bank notes’ value was restored but payment in precious metals was stopped. The public was outraged against the Company and the near worthless paper money.
Under intense selling pressure and Law’s devaluation, shares had collapsed from 10,000 livres to 1,000 by December 1720. At the end of 1720, John Law’s enemies confiscated two-thirds of shares, giving them control of the company. Share prices further deflated to 500 livres in 1721 (Moen). Investors were financially devastated and many former millionaires lost their entire fortunes.
The collapse of the Mississippi Company plunged France and Europe into a severe economic depression, laying the groundwork for the upcoming French Revolution. John Law was viewed as a scam-artist and was exiled from France. Law returned to his gambling roots and died in poverty.
Although traditionally called a bubble, the Mississippi Bubble wasn’t actually a bubble, in technical terms. A bubble is caused by widespread mania and speculation, followed by a brutal collapse in asset values. In contrast, the Mississippi Bubble was a failure in monetary policy, which caused excessive growth in money supply and inflation