When A Stock Bubble Goes Horribly Wrong And Hyperinflation Results

Tyler Durden's picture

Perhaps the most amusing and curious aspect of this entertaining summary of the Mississippi Bubble of 1720, the resulting European debt crisis (the first of many), how bubble frenzies are as old as paper money, the man behind both - convicted murderer and millionaire gambler, John Law, what happens when paper money's linkage to gold is broken, and how everyone loses their wealth and hyperinflation breaks out, is who the source is. The New York Fed. Perhaps the Fed-employed authors fail to grasp just what their institution does, or have a truly demonic sense of humor. In either case, the following "crisis chronicle" highlighting how banking worked then, how it works now, and how it will always "work", is a must read by all.

Crisis Chronicles: The Mississippi Bubble of 1720 and the European Debt Crisis

Convicted murderer and millionaire gambler John Law spotted an opportunity to leverage paper money and credit to finance trade. He first proposed the concept in Scotland in 1705, where it was rejected. But by 1716, Law had found a new audience for his ideas in France, where he proposed to the Duke of Orleans his plan to establish a state bank, at his own expense, that would issue paper money redeemable at face value in gold and silver. At the time, Law’s Banque Generale was one of only six such banks to have issued paper money, joining Sweden, England, Holland, Venice, and Genoa. Things didn’t turn out exactly as Law had hoped, and in this edition of Crisis Chronicles we meet the South Sea’s lesser-known cousin, the Mississippi Bubble.

Who Wants to Be a Millionaire?

John Law was an interesting figure with a colorful past. He was convicted of murder in London but, with the help of friends, escaped to the continent, where he became a millionaire through his skill at gambling. Like South Sea Company Director John Blunt in England, Law believed that a trading company could be leveraged to exchange the monopoly rights of trade for the ability to make low-interest-rate loans to the government. And like Blunt, in 1719 Law formed a trading company—the Mississippi Company—to exploit trade in the Louisiana territory. But unlike Blunt or the South Sea Company, the Mississippi Company made an earnest effort to grow trade with the Louisiana territory.

In 1719, the French government allowed Law to issue 50,000 new shares in the Mississippi Company at 500 livres with just 75 livres down and the rest due in nineteen additional monthly payments of 25 livres each. The share price rose to 1,000 livres before the second installment was even due, and ordinary citizens flocked to Paris to participate. Based on this success, Law offered to pay off the national debt of 1.5 billion livres by issuing an additional 300,000 shares at 500 livres paid in ten monthly installments.

Law also purchased the right to collect taxes for 52 million livres and sought to replace various taxes with a single tax. The tax scheme was a boon to efficiency, and the price of some products fell by a third. The stock price increases and the tax efficiency gains spurred foreigners to Paris to buy stock in the Mississippi Company.

By mid-1719, the Mississippi Company had issued more than 600,000 shares and the par value of the company stood at 300 million livres. That summer, the share price skyrocketed from 1,000 to 5,000 livres and it continued to rise through year-end, ultimately reaching dizzying heights of 15,000 livres per share. The word millionaire was first used, and in January 1720 Law was appointed Controller General.

The Trickle Becomes a Flood

Reminiscent of a handful of florists failing to reinvest in tulip bulbs as we described in a previous post on Tulip Mania, in early 1720 some depositors at Banque Generale began to exchange Mississippi Company shares for gold coin. In response, Law passed edicts in early 1720 to limit the use of coin. Around the same time, to help support the Mississippi Company share price, Law agreed to buy back Mississippi Company stock with banknotes at a premium to market price and, to his surprise, more shareholders than anticipated queued up to do so—a surprise we’ll see repeated at the apex of the Panic of 1907. To support the stock redemptions, Law needed to print more money and broke the link to gold, which quickly led to hyperinflation, as we saw in our post on the Kipper und Wipperzeit.

10-livre-banknote

The spillover to the economy was immediate and most notable in food prices. By May 21, Law was forced to deflate the value of banknotes and cut the stock price. As the public rushed to convert banknotes to coin, Law was forced to close Banque Generale for ten days, then limit the transaction size once the bank reopened. But the queues grew longer, the Mississippi Company stock price continued to fall, and food prices soared by as much as 60 percent.

To make matters worse, there was an outbreak of the plague in September 1720, which further restricted economic activity—in particular, trade with the rest of Europe. By the end of 1720, Law was dismissed as Controller General and he ultimately fled France.

Balancing Dispersed Debt Issuance against Central Monetary Policy

One might argue that Law suffered a self-inflicted loss of control over monetary policy once the link between paper money issuance and the underlying value of gold holdings was broken—a lesson that monetary authorities have learned over time. (ZH: they have? where?)  But what if you don’t have direct sovereign authority over banknote issuance or, in more modern times, monetary policy? A challenge that’s perhaps most visible in the Eurozone is how best to balance dispersed, country-specific debt issuance against more centralized authority over monetary policy. In an upcoming post on the Continental Currency Crisis, we’ll see why a united fiscal policy was needed along with the united currency and monetary policies. Could the same be true of Europe? And if so, would a united fiscal policy include Eurozone debt as well as centralized fiscal transfers, or perhaps even collection of taxes? Tell us what you think.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Boris Alatovkrap's picture

John Law Mississippi Bubble Redux.

Itch's picture

Is Boris do Russian joke again?

Boris Alatovkrap's picture

Q: How many Russian in Soviet Era to screw incandescent bulb?

A: First must get in line to acquire of bulb.

Itch's picture

Is same for luminous Chernobyl people? 

Boris Alatovkrap's picture

You are suggest Chernobyl (or Nukushima) is not screw incandescent bulb because is screw people?

CrazyCooter's picture

Ralph Foster's "Fiat Paper Money" book does a really good job going over the whole French fiat bubble (and the US colonial money printing escapades). Curiously, he writes that the Chinese were the first to blow up a fiat, almost a 1000 years ago IIRC.

Regards,

Cooter

pavman's picture

The first to discover America... the first to blow up fiat currency.  China is so always the first... they're probably the first historical revisionists.

Soul Glow's picture

China is doing everything that everyone else is doing - printing yuan out of thin air based on future revenue, making bad loans, etc - except they're buying gold.

It's because of their gold purchases that will keep them at the top of the trash heap.  Europe has 14k tonnes but they haven't added much if any over the last five years.  The US has 14k tonnes but the running meme is "gold is bad" (thanks Bernanke).  So now China, the USA, and Europe all have about the same amount of gold.

When the respected treasuries fail to auction their debt, the fiat currency system will fail and gold will be ushered back into the limelight to save the system.

HoofHearted's picture

The US claims 8k tons of gold, but it has never been audited. If the US has 14k tons, it is likely because it is not returning Geramny's gold to the Germans...

Wile-E-Coyote's picture

Chernobyl light buld does not need a filament.

Boris Alatovkrap's picture

Q: What is length 200 meter and is eat potato?

A: Citizenry in Moscow wait in line to buy meat. 

spinone's picture

Boris, I look forward to your Russian shtick.  Having a few good Russian friends, I have to say you're dead on.

Peter Pan's picture

Woman in line in Moscow waiting to buy bread when she hears someone break wind 100 metres further back. She leaves her place in the line and goes up to the man, looks at him in the eyes and asks, "where did you buy the beans?"

HoofHearted's picture

A friend of mine lived in Moscow during Soviet times. We were in Paris, and a line was forming someplace. Pavel went to join the line, then hesitated. I asked why he went to get in a line when he didn't know what it was about. He told me, "In the Soviet times you always got in a line because there just might be something at the head of the line that you could spend your rubles on."

I got a better understanding of bubbles that day.

Boris Alatovkrap's picture

They are to sell bubbles in Paris!? Soap bubble or maybe champagne bubble? Even stupid Russian is not fool to spend good money on bubble.

Confundido's picture

No bubble redux, Boris. Unlike John Law, the Fed has drones and algos to stabilize shocks.

Buck Johnson's picture

Very much so, and we will see it.

Itch's picture

Why aren't there more feminist articles on ZH? 

Boris Alatovkrap's picture

Woman is like shrub... ZH is for hater of shrub.

Itch's picture

Woman is shrub because she is survivor no?

Boris Alatovkrap's picture

? Zerohedge is website for fellowship of male bonding (in manly way) of mutual dislike for shrubbery, no?

Itch's picture

No! Russian pig! Zh should be feminist news source. 

NIHILIST CIPHER's picture

Itch       Well, I have been waiting for this for a while now, the  onslaught of the feminist blathering. Hitlery's big chance to be overlord is almost upon us and we will be hit with a shitstorm of loud mouth feminazi's saying it's TIME for a woman to wreck the country. (what's left after the darkman is finished) Please go back to Huffpoo and keep that chatter over on a site that will listen to you. 

Itch's picture

We're comming for ya! You're going to respect women, whether you like it or not. If you dont like it we're going to cut your ball sack off and feed it to your kids. 

AG BCN's picture

Shrubbery is respected gift and and skill it takes to make so in land of my brith. It is problem to find man to maketh shrubbery. One that looks nice, and not too expensive.  

spinone's picture

I like a well trimmed bush.  Did everyone stop at the bar ont he way home, or just me?

A Nanny Moose's picture

ekki-ekki-ekki-pitang-zoom-boing!

Say What Again's picture

I groom the shrubbery in my household on a regular basis.  I like to see where I'm going -or...

... never mind.

GVB's picture

SWA, thanks for posting the exponential function link. Few months ago. Needed to thank you one time or another...

FrankDrakman's picture

'cause in English, articles are gender-free. If you want feminist articles, you can go get one of the European and/or Communist langwiches.

Itch's picture

But dont you think ZH has a duty to address the gender inbalance of it's readership? What does this say about American women if you point them towards Europe for an alternative news source? 

Boris Alatovkrap's picture

Itchy, you are miss smart funny linguistic humor! In many latin language, article must to match noun in "gender".

Exit question, if same sex is marriage, which article is use for which spouse?

Itch's picture

Boris wear cape of jelly, impenetrable is question.

Boris Alatovkrap's picture

You are refer to Boris back "nipple" problem?! Boris is not cover, but is expose proudly, even is shave for better visibility!

Terp's picture

The correct articles are designated according to who is "top" and who is "bottom" in fag marriage.

hth

Boris Alatovkrap's picture

TMI - "Too many informing"

In Russia, there is no gay man (maybe gay woman is sometime okay).

Fuh Querada's picture

of course you know the Russian word for "relaxation":

" AT DICK " !

Itch's picture

There is no gay man because there is no toilet roll. If you let the west introduce toilet roll into your country the place will be full of latent homosexuals, like Putin.

Boris Alatovkrap's picture

You are too much mix metaphor, but greater offense is libel talk of manly Putin. You are draw line!

dynomutt's picture

Statements like that have caused some in the past to be served VERY spicy soup.

 

Journalists learn to be careful what is Putin.

blindman's picture

more too many informed in home russia protested
.
“I Was My Own Person Again”
By Masha Gessen
The women of Pussy Riot made meaning out of a horrific
experience in prison. Now, they’re launching another
protest movement in Russia.
.
http://www.slate.com/articles/news_and_politics/foreigners/2014/01/pussy...
.
"“Every correctional institution is a totalitarian state in miniature.”
Maria Alyokhina"

Boris Alatovkrap's picture

Pussy Riot is not support of Russian Citizenry, but is offensive in religious scents. You are attack church, you are attack religious belief, you are no better than Stalin and Mao. Maybe little jail time is good for member of Pussy Riot. There are difference between legitimate and sophomore protest.

blindman's picture

what is boris think of journalist in dual
citizen camping russia and usa with gay marriage
and adoption child leaving russia to fear from
'going to prisons for lifestyle when olmypics
to be ended soon, not mentioning homeland
to be taking children for retraining fear.
http://en.wikipedia.org/wiki/Masha_Gessen
.
As a gay parent I must flee Russia or lose my children
Draconian new laws brand homosexuals second-class citizens in Putin's regime
http://www.theguardian.com/commentisfree/2013/aug/11/anti-gay-laws-russia
.
does boris see her in a spy uniform?

Boris Alatovkrap's picture

Dear Mr. Man,

You are write exceeding long sentence, so please patiently wait Boris:)

Before Boris is answer, you are explain how gay man is become parent. This is medical miracle and maybe Russia is must rethink gayety if can produce offspring. 

Joke to the side, Boris is not desire violence on gay people, or forcibly removal, but proliferation of gay style of family is problematic in Russia Society. Great Republican president Bill Clinton is make smart policy when "don't ask is don't tell" and then citizenry can to make own decision. Boris is not anti-gay, but is anti-coercive-government, gay or strait.

... but what is Boris know!?

Sincerely,

Boris

blindman's picture

mr. man means no disrespect to boris
thinking and ways. gayety style can
import babies into family all over
the world. some fill up dumpster with
swaddled young one then live anyway and
need gayety parent of some kind.
maybe in russia?

CharlieSDT's picture

Those chicks are so lucky to be let out.  They should probably shut the fuck up now.

 

http://www.singledudetravel.com/2012/08/pussy-riot-had-it-coming-to-them/