Author: Self-Control
Reviewer: Guanfu · Juntian

  In the previous installment, “Financial Crises: The Netherlands—The Temptation of Tulips,” we told the story of the Dutch tulip bubble during capitalism’s infancy. From its birth and expansion to its final collapse, the episode exposed the madness and greed buried in human nature. The crisis brought down the Netherlands, once the “carrier of the seas,” in a single blow. You might think it would have made people more wary of financial alchemy. Yet, as Hegel observed, the only lesson people learn from history is that they learn nothing from history.

  John Law was born into a wealthy family in Edinburgh, Scotland, in 1671. His father was a banker, and Law, the eldest son, began a three-year apprenticeship in his father’s accounting office at fourteen. His remarkable talent for mathematics emerged during those years, perhaps planting the seeds both of the frenzy he would lead decades later and of his lifelong passion for gambling.

  Law’s father died when he was seventeen. Rather than sink into grief, the young man took his enormous inheritance to London and soon immersed himself in the city’s gambling houses. In the usual version of this story, he would quickly have squandered everything. Instead, Law’s exceptional mathematical ability made him a formidable gambler. He was even said to have played cards with Newton, Defoe, and Montesquieu and taken their money with ease.

  Law was as successful in love as he was at the gaming table, but a duel with a romantic rival ended in the other man’s death. To escape prosecution, he fled to continental Europe.

  Let Law spend some time making his way across Europe; his moment had not yet arrived. For now, we turn to France at the end of the seventeenth century and the beginning of the eighteenth. The Enlightenment was flourishing. New ideas met and clashed, and its thinkers placed reason on a pedestal. Yet this intellectual abundance could not hide France’s desperate material circumstances. Louis XIV, the “Sun King,” had a passion for war and reigned for an extraordinary 72 years and 114 days. France became the strongest power on the European continent during his reign, but decades of warfare and the king’s lavish lifestyle left the state deeply in debt. At his death, the government owed three billion livres. Annual tax revenue was only 145 million livres, and after paying the expenses of the state and royal household, a mere five million remained for servicing the debt.

  Government bonds consequently fell far below face value. Louis XIV’s fierce persecution of the Protestant Huguenots late in his reign also drove 200,000 of them abroad. Many played important roles in French commerce and industry, so their departure dealt another heavy blow to the economy.

  In short, France’s economy was already in desperate straits before John Law took the stage. To service the debt, the regent even recalled silver coins and reminted them at a lower weight, pocketing the difference for the state. Against a mountain of government debt, however, this was no more than a drop in the bucket.

  As the regent struggled with this seemingly impossible problem, John Law came to his attention. Law proposed establishing a private bank that would issue paper notes in place of livre coins. He would then create a company and use its shares to absorb the surplus notes in the market. Because paper money could, in principle, be issued without limit, the government appeared to have gained limitless wealth. The regent knew little about economics, but he trusted Law and accepted the proposal.

  On May 5, 1716, the French government issued a decree authorizing Law, who was well versed in monetary and financial theory, to establish a private institution called the General Bank. The bank could administer state tax revenues and use them as reserves for issuing banknotes. Backed by those revenues, the notes initially held their value, were easy to redeem, and were far more convenient to carry. The French public embraced them almost immediately, and they even traded at a premium to coins of the same face value.

  The new paper money also revived French commerce and industry. More money in people’s hands increased purchasing power and domestic demand, bringing business back to life. The ample supply of notes also made bank loans easier for merchants to obtain, allowing them to expand production. As paper replaced gold and silver coins, the precious metal flowed back to the government, which could pay foreign debts and even keep a surplus for royal expenses. If the plan stopped there, however, severe inflation would soon destroy everything and leave the notes worth less than the paper they were printed on.

  Law therefore launched the second step of his plan: create a company to absorb surplus banknotes and keep the money supply under control. The ingredients of the coming storm were quietly gathering. At a time when monetary theory was still in its infancy, Law’s bold attempt to replace coin with paper was like walking a tightrope blindfolded. One misstep could send him into the abyss…