Author: Zikongli
Reviewer: Guanfu · Juntian

  In the previous installment, “Financial Crises: The Netherlands—The Temptation of Tulips,” we recounted the Dutch tulip bubble during capitalism’s infancy. From its formation and expansion to its final collapse, the episode exposed the madness and greed buried in human nature. The crisis struck down the Netherlands, once the “coachman of the seas,” in a single blow. One 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 as the eldest son, Law began a three-year apprenticeship in his father’s accounting office at fourteen. His remarkable mathematical talent 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 Law was seventeen. Rather than being overwhelmed by grief, the young man took his enormous inheritance to London and soon became absorbed in its gambling houses. In the usual version of such a story, he would quickly have squandered everything. Law’s exceptional mathematical ability instead 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 romance as he was at the gaming table, but a duel with a romantic rival ended in a killing. To escape prosecution, he fled to continental Europe.

  Law would spend some time gaining experience across Europe; his moment had not yet arrived. We turn instead to France at the transition from the seventeenth to the eighteenth century. The Enlightenment was flourishing, new ideas met and clashed, and its thinkers elevated reason to the highest place. This intellectual ferment could not conceal France’s dire material circumstances. The previous king, 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 its finances deeply in debt. At his death, the government owed three billion livres. Annual tax revenue was only 145 million livres, and after the expenses of the state and royal household, a mere five million remained for debt repayment.

  Government bonds consequently depreciated far below face value. Louis XIV’s severe late-reign persecution of the Protestant Huguenots also drove 200,000 of them abroad. Because many were important participants in French commerce and industry, 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 reduced weight, extracting the difference. Against the mountain of government debt, however, this yielded no more than a drop in the ocean.

  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 whose shares would absorb the surplus notes in the market. Because paper money could, in principle, be issued without limit, the government seemed to have gained limitless wealth. Knowing little about economics but trusting Law, the regent 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. It could administer state tax revenues and use them as reserves for issuing banknotes. Backed by those revenues, the notes initially offered stable value, easy redemption, and convenient portability. The French public accepted them almost immediately, and they even traded above equivalent metallic currency.

  The issue of paper money also revived French commerce and industry. More money in people’s hands increased purchasing power and domestic demand, restoring commercial activity. An ample note supply also made bank loans easier for merchants to obtain, allowing them to expand production. As paper replaced gold and silver currency, the metal flowed back to the government, which could pay foreign debts and even retain a surplus for royal expenses. If matters stopped there, however, severe inflation would soon destroy everything and leave the notes worth less than waste paper.

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