mississippi-bubble

What Was The Mississippi bubble? The Mississippi Bubble And The Birth Of Central Banking

The Mississippi bubble occurred when a fraudulent fiat banking system was unleashed in a French economy on the verge of bankruptcy. Happened in the 1700s, the Mississippi bubble was among the most incredible financial bubbles of human history. The scapegoat of this financial bubble was John Law, which introduced the concept of central banking, by convincing King Louis XV to restore France’s prosperity through monetary stimulus, something unprecedented before.

Understanding the Mississippi bubble

The Mississippi bubble is one of the most significant asset bubbles in modern history. 

In 1716, the excessive spending of former king Louis XIV left France on the verge of bankruptcy.

To restore France’s prosperity and revolutionize her monetary systems, regent to the new King Louis XV met with John Law, a Scottish financier and banker.

Law proposed to replace the metallic currency with a paper-based currency based on government debt that had been converted into shares in a company.

Circulating debt, he argued, would provide companies with credit that could be used as equity in commercial ventures and revitalize the French economy.

Desperate for a solution, the regent wholeheartedly endorsed Law’s strategy. He was then appointed Controller General of Finances of France and created the Banque Générale Privée, which accepted metallic currency deposits and issued loans and withdrawals in paper currency.

The new paper notes were immediately popular and had the desired effect of stimulating economic activity in the beleaguered nation.

With governmental support, Law decided to acquire the Mississippi Company and in the process, gained a trading monopoly with then French Louisiana.

The stock price of the Mississippi Company increased further as its power expanded to encompass all trade and tax collection outside of Europe.

Mass hysteria

In early 1719, investor hysteria around the Mississippi Company was high. Rumors abounded of precious metal reserves in Louisiana, while many others invested in the company for the promise of dividends or because of Law’s growing celebrity.

When the regent authorized the issuance of 300,000 shares to finally pay off the French national debt, investors swarmed Law’s residence as commoners jostled with high society for a piece of the company.

Encampments sprung up in the parks nearby, and soldiers were called to clear the streets each night. Thievery of company shares was also common.

Hyperinflation

Hyperinflation reached a peak of 23% in January 1720 as the market price of company shares reached a peak of 10,000 lives.

This was caused by Law’s unending willingness to issue more banknotes to fund purchases of shares in his company.

Soon after, the share price began to fall as investors tried to take profits in gold and silver.

Many of these investors, realizing the share price could not rise indefinitely, liquidated their holdings and sent capital gains abroad.

In response, Law made desperate attempts to arrest the share price decline.

He capped redemption in gold and silver to avoid depleting his reserves and made the paper notes legal tender to legitimize paper currency in the eyes of the public.

This caused hyperinflation to set in as the amount of paper currency circulating in the economy was many times the value of gold and silver reserves.

Share prices continued to decline as Law’s attempts became increasingly comical. In one example, authorities conscripted 6,000 workers to parade through the streets of Paris carrying mining equipment.

This gesture, the authorities hoped, would give the impression that the Mississippi Company had struck gold. 

By the middle of May, inflation was so severe that Law attempted to force deflation by devaluing all paper currency to 50% of its face value

The bursting of the Mississippi bubble

Ultimately, French authorities had to admit that the number of paper notes issued exceeded the value of gold and silver held by the banks.

The company share price crashed to just 1,000 livres by the end of 1720, representing a 1900% decrease since its peak less than a year earlier.

Though the crash was not directly attributable to Law, he was nonetheless made a scapegoat and banished from his post as Controller General.

Amidst a wave of convictions against investors suspected of having made illegal profits, Law was forced to flee France altogether.

The astronomical debt of his former company was taken over by the state, which was forced to raise taxes to retire it.

The Mississippi bubble caused widespread investor revulsion of the stock market in the country, which hampered the development of French capitalism and industry for decades.

It would be another 80 years before France would again introduce paper money into its economy.

Key takeaways:

  • The Mississippi bubble occurred when a fraudulent fiat banking system was unleashed in a French economy on the verge of bankruptcy.
  • Scottish banker John Law proposed that the French transition from gold and silver-based currency to paper currency. Law theorized that he could sell shares in the Mississippi Company to pay off French national debt. When the company secured total control of European trade and tax collection, investor speculation increased to unsustainable levels.
  • The company share price reached its peak in January 1720 as more and more speculative investors entered the fray. Law continued to issue banknotes to fund share purchases, which inevitably caused hyperinflation. Less than twelve months later, shares in the Mississippi Company declined by 1900% and Law had to flee France in disgrace.

Related Financial Bubbles

Tulip Mania

tulip-mania
Tulip mania was a period during the 17th century where contract prices for tulip bulbs reached extremely high levels before crashing in 1637. The causes of tulip mania have perhaps been distorted over the centuries, with many assuming it was one of the first examples of a market bubble bursting. However, the proliferation of once rare tulip bulbs probably lead to them becoming less desirable. Tulip mania remains a popular term to describe markets where high prices are associated with low value or low utility items, including baseball cards, Beanie Babies, and NFTs.

South Sea Bubble

south-sea-bubble
The South Sea Bubble describes the financial collapse of the South Sea Company in 1720, which was formed to supply slaves to Spanish America and reduce Britain’s national debt. Investors saw the potential for the South Sea Company to collect interest on the loan in addition to collecting profits from its gold, silver, and slave interests. Positive sentiment was also driven by the actions of the government. Lucrative trade profits never materialized, which caused the share price to become dangerously overvalued. Instead, the South Sea Company operated more like a bank and less like a shipping business. Capital invested from waves of new investors was redistributed to older investors in an early Ponzi scheme. The share price crashed in December 1720, with many South Sea Company directors impeached or imprisoned.

Mississippi Bubble

mississippi-bubble
The Mississippi bubble occurred when a fraudulent fiat banking system was unleashed in a French economy on the verge of bankruptcy. Scottish banker John Law proposed that the French transition from gold and silver-based currency to paper currency. Law theorized that he could sell shares in the Mississippi Company to pay off French national debt. When the company secured total control of European trade and tax collection, investor speculation increased to unsustainable levels. The company share price reached its peak in January 1720 as more and more speculative investors entered the fray. Law continued to issue banknotes to fund share purchases, which inevitably caused hyperinflation. Less than twelve months later, shares in the Mississippi Company declined by 1900% and Law had to flee France in disgrace.

Stock Market Crash of 1929

stock-market-crash-of-1929
The Stock Market Crash of 1929 was a major American stock market crash in October 1929 that precipitated the beginning of the Great Depression. Black Friday, Black Monday, and Black Tuesday are terms used to describe the calamitous fall of the Dow Jones Industrial Average over three days. The index would slide further in the following years and would not recapture its pre-crash value until November 1954. The Stock Market Crash of 1929 was caused by complacency during the economic prosperity of the 1920s with many new investors buying stocks on margin. Government mismanagement and company share prices that did not reflect their true value were also contributing factors.

Japanese Lost Decade

japan-lost-decade
The Japanese asset price bubble resulted in greatly inflated real estate and stock market prices between 1986 and 1991. During the late 1980s, the Japanese economy was booming as a result of exuberance in equity markets and skyrocketing real estate prices. The Nikkei stock market index reached a peak of 38,916 on December 29, 1989. The bubble burst soon after as the Bank of Japan raised bank lending rates to try to keep inflation and speculation in check. The economy lost over $2 trillion in value over the next twelve months. The Japanese asset price bubble was primarily caused by bank deregulation and expansionary monetary policy. Japanese banks who had lost their corporate clients instead lent to riskier small and medium enterprises. The 1985 Plaza Accord trade agreement also caused a sharp appreciation in the yen, which caused massive speculation that the Bank of Japan was happy to ride for years.

Dot-com Bubble

dot-com-bubble
The dot-com bubble describes a rapid rise in technology stock equity valuations during the bull market of the late 1990s. The stock market bubble was caused by rampant speculation of internet-related companies. At the height of the dot-com bubble, instances of private investors quitting their day jobs to trade on the financial market were common. Thousands of companies held profitable IPOs despite earning no profit or even revenue in some cases. The dot-com bubble began to burst after interest rates were raised five times between 1999 and 2000. Wall Street analysts, perhaps seeing the writing on the wall, advised investors to lower their exposure to dot-com stocks. The NASDAQ peaked in March 2000 and had lost 80% of its value by October 2002.

Global Financial Crisis

global-financial-crisis
The global financial crisis (GFC) refers to a period of extreme stress in global financial markets and banking systems between 2007 and 2009. The global financial crisis was precipitated by changes to legislation in the 1970s. The changes created the subprime mortgage industry and forced banks to loosen their lending criteria for lower-income borrowers. When the subprime market collapsed in 2008, one-fifth of homes in the United States had been purchased with subprime loans. Bear Stearns and Lehman Brothers collapsed because of their excessive exposure to toxic debt, while consumers were left with mortgages far exceeding the value of their homes. In the aftermath of the GFC, interest rates were reduced to near zero and there was sweeping financial reform.

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