The Mississippi company bubble is another important bubble in history. However, it isn’t only of the speculative type like is normally seen. It is considered more of currency blunder. The concept of currency and what exactly is money is fundamentally important to understanding how finances work.
France’s situation
In the early 1700s, France was not in the best financial situation. The war of Spanish succession was concluding, and France was essentially insolvent and had to give up some of their territories. This was a symptom of the country beginning to default on their debts, also causing the value of their currency to whipsaw. In finance, a whipsaw is a sudden reversal in the price or value in something, whether it be a security, commodity, or something else.
John Law
At this time, King Louis XIV had passed away, and his nephew, the Duke of Orleans, was acting as regent. This Duke had a friend named John Law, a Scottish financier (and gambler), who he called on to aid in the repair of France’s financial situation.
Law believed that the problem for France’s economy was its use of gold and silver in the money supply. So, he created a bank, the Banque Générale, that would take deposits in precious metals, but would issue paper currency that was 50% back by government debt. The idea was that issuing more currency into the economy via paper, the amount of trade would increase.
The 50% backing by government bonds was done at a low interest rate to help prevent the government from defaulting on all their debt. This marked a change from a specie-based system in which the currency was backed by physical gold and silver, to a credit-based system where the currency is backed by loans. In this case, the bank loaning money to the government by buying their bonds.
The Mississippi Company
Law expanded his business by buying the Mississippi company which controlled trade in French Louisiana. The company grew and obtained control of companies trading tobacco in Africa and in other countries such as China and the East Indies. Essentially, Law controlled all of France’s foreign trade.
Among having exclusive trading privileges with many foreign countries, the company gained duties to collect most of the country’s taxes and eventually bought the right to mint the country’s new coins.
As the amount of actions the company could take grew, their stock price began to soar. On source states the share price in 1719 went from 500 livres in January to 10,000 in December of the same year. An increase of 1900%.
Total Control
Keep in mind that Law also owned the bank that issued the country’s currency. So, to support the ever-increasing share price of his company, he would print more and more currency. The shares of the Mississippi company could be bought with the bank notes from his bank or traded for with government bonds, which backed his bank notes.
As you can imagine, people wanted to cash in their capital gains with the 1900% increase. There was only one problem for Law, the people wanted to cash in their Mississippi company shares for gold. However, at this point in early 1720, the amount of paper currency in France’s economy was many times the amount of gold and silver reserves held at the bank.
Calling Law’s Bluff?
There is one major problem with this. What happens when the money supply is many times the amount of precious metal reserves and the people want those reserves? They realize the currency is worth significantly less then they thought, and they lose faith in the currency. When faith in a currency is lost, history has shown time and time again that hyperinflation is soon to follow.
The Collapse
However, remember that John Law was a financier, so he at least understood some finance and monetary concepts (to what degree? I don’t know). He realized that he was in a situation that could lead to hyperinflation, so he placed a cap on the amount of gold that could be redeemed (100 livres), the bank notes were made legal tender, and the shares of the Mississippi company could be accepted by the bank for new bank notes. The cap on the gold redemption also prevent the banks reserves from being depleted.
Basically, as investors sold their shares in the company, they increased the money supply. This would cause inflation to increase, inducing more investors to sell and continue the downward spiral. The share price of the Mississippi company, the currency, and Laws reputation plummeted. Soon after, Law was dismissed from all his positions and fled France.
Conclusions
This event is interesting because it is seen as a financial bubble, but it is not a bubble in the traditional sense. Generally, a financial bubble is when the price of something increases well beyond the value of the thing it represents. The bubble bursting or the “crash” is when the price is brought back down to the same level as the value of the item it represents.
In the case of the Mississippi company, it makes sense that the price would increase to such an altitude so quickly. Considering the company essentially controlled France’s foreign trade, taxes, coinage, and currency, a price of such magnitude probably represents the value of such economic power accurately.
In this case, it was the fault of the currency that caused everything to collapse, not a divergence of the price from the value. This “bubble” gives just one scenario that can occur when a country issues and messes with fiat currency. It can also give valid reasons why so much power should not be centralized to such an extent, whether in the form of a public or private entity.
To your wealth and future,
James Forsythe
References
https://www.britannica.com/event/Mississippi-Bubble
https://www.investopedia.com/ask/answers/09/mississippi-bubble.asp
http://www.mshistorynow.mdah.ms.gov/articles/70/john-law-and-the-mississippi-bubble-1718-1720
