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 livres. 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.

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