Money (26 page)

Not content with furnishing France with an all-new system of paper money, Law also began to attack the second part of France’s economic problem—its parasitic system of public finances and the unsustainable level of the public debt. The tried and tested solution was to take a scythe to the sovereign’s creditors’ claims by devaluing the monetary unit or announcing an outright default. But Law’s plan was to play not on creditors’ fears, but on their greed. In 1717, with his prestige buoyed by the success of his Bank, he had convinced the Regent to allow him to form a joint-stock company, the Company of the West, and to award it the rights to develop French North America, which had until then been held by the arch-bloodsucker Antoine Crozat. These vast and virgin territories were sure, Law publicly predicted, to yield gigantic profits for the new company—and all of it with the endorsement of the French crown. Holders of sovereign bonds were invited to swap their debt claims on the crown for equity shares in the Company of the West. Instead of government debt, savvy investors could henceforth enjoy a type of government equity.

The response was decisive. Sovereign creditors deluged the new company’s offices hoping to exchange bonds for equity shares, and the new company was heavily oversubscribed. Its business model—or at least, its ability to raise finance—now proven, the Company of the West embarked on an impressive trail of mergers and acquisitions. One by one, the corporations that owned the trading rights in every one of France’s possessions were swallowed up. The Company of Senegal went first; then the Company of the East Indies; then the China Company and the Africa Company as well. Each acquisition
was funded in the same way. Investors turned in their sovereign bonds and bills at Law’s office in the Rue Quincampoix in return for equity shares in the ever-expanding Company. By the middle of 1719—now officially renamed the Company of the Indies, but known popularly after its most glamorous asset as the Mississippi Company—Law’s giant corporation had subsumed every major joint-stock company in France.

In August 1719, Law put the final phase of his plan into action. The Company acquired the rights to collect all the indirect taxes in France. It no longer represented only the crown’s foreign interests; its revenues now derived from the French economy as a whole. At the same time, it announced its intention to buy up the entire remaining part of the sovereign debt. To finance these mammoth transactions, it issued huge new tranches of equity. Such was the euphoria surrounding Law’s “System,” as it was now known, that it was more a matter of repelling than attracting investors. The Company’s share price rose from 500 livres in May to over 10,000 livres in December—and the higher it went, the more public debt was absorbed by new equity issues. With the transaction complete, Law had finally achieved an unprecedented and never-to-be-repeated feat: a comprehensive swap of government debt for government equity. Meanwhile, by successive decrees of the sovereign before the end of the year, gold and silver lost their status as legal tender in the Kingdom of France, and the notes of the Royal Bank acquired it. The supremacy of bank money and the fiat standard was complete.

Law had used the window of opportunity provided by the Chamber of Justice to superlative effect. The Royal Bank was solving the monetary crisis, and the economy was booming. The Mississippi Company was reaping the profits, and using them to solve the public debt crisis. And the remaining rigidity in the system—the link between the Bank, with its certain notes, and the Company, with its risky assets—had been solved as well by the greatest innovation of all. The monetary standard was now the exclusive creature of the sovereign—so that if the economy, and thereby the Company, fell on hard times, the value of the Bank’s money could fall to reflect this.
Accolades for Law’s spectacular achievements flooded in from all sides. The Regent and his court were entranced. “[T]he construction was admired by everyone in France and was the envy of our neighbours, who were really alarmed by it,” wrote a wistful contemporary two decades afterwards: “It was a type of miracle that posterity will not believe.”
¹³

With all the essentials of the System now in place, Law’s underlying reasoning was becoming clear. The problem with conventional sovereign money was that it consisted of financial claims of certain value backed by revenues whose value was intrinsically uncertain. Sovereigns might promise, and subjects believe, whatever they liked—and these promises and beliefs be solemnly inscribed in bonds and
rentes
. But there was only one ultimate source of sovereign revenue: the industry and commerce of France. If the economy prospered, the sovereign’s tax revenues grew, his credit improved, and his bonds would pay as promised. If not, the opposite applied. Since this is the reality of public finance, why not be honest about it? asked Law. Rather than pretending to his subjects that he can magic away the uncertainty inherent in economic activity, better for the sovereign to give them access to its proceeds directly—and by the same token, make them bear the risks. With government equity—shares in the Mississippi Company—this could be done directly. With transferable sovereign credit on a fiat standard—notes issued by the Royal Bank—it could be done at one remove.

On 5 January 1720, John Law was appointed Controller-General of the Finances of France. A few weeks later, he crowned his extraordinary ascent to power with the final merger of the Company and the Bank into a single, vast conglomerate. But his moment of triumph was short-lived. Almost immediately, cracks began to appear in the System. The long shadow of the Chamber of Justice had finally begun to fade: the bloodsuckers of the old financial system were beginning to stir again. When Law sent a memorandum to the Regent proposing a drastic simplification of the tax system, the Regent expressed concern that the old financial oligarchy might finally revolt. Law brushed away the Regent’s concerns: “[w]hat will become of the rats
that live in my barn if I remove the grain so as to transport it to a safe location?” he coolly responded.
¹⁴
But Law had underestimated his opponents, and the fragility of his success.

Wily old financiers that they were, Law’s enemies knew that his System—like any monetary system—was vulnerable to a collapse of confidence. With so brief a track record to fall back on, even the slightest suspicions about the value of the Company shares and the Bank’s fiat money might be fatal. The rumour mill was set to work. It had plenty to work with. The laughing colonists who had been seen processing to the docks to cross the Atlantic were not toiling prosperously on their French–American homesteads. Half had died of malaria; the other half had been hired stooges, and never made the crossing. Louisiana was not, as Law had given out, a commercial Promised Land to rival British North America. It was an irretrievable swamp that would never yield a profit. But above all, there were simply too many monetary claims chasing too little real activity. Regardless of whether they were debt or equity, notes of the Bank or liabilities of the Company, the value of the System’s outstanding claims on the cash flow of the French economy were unsustainably large. No matter how optimistic one was about its prospects, they were never going to pay.

The smart money began to sell. Word got out that senior members of the Regent’s court had converted their banknotes to gold the previous December. Panic set in. Law tried to engineer a controlled reduction in the value of the System’s shares and banknotes. New and more draconian measures were introduced to discourage, and finally to outlaw, the ownership of gold and silver. The market crash intensified. At the end of May, with the System disintegrating, Law was arrested. Two days later he was at liberty again, but only because the Regent, one of his councillors reported, had realised that “the only man capable of taking him out of the labyrinth in which he found himself was Mr. Law.”
¹⁵
In the confusion, Law’s credibility was destroyed. With sage shakes of their heads, the resurrected
sangsues
regretfully advised the Regent that the only viable policy was retreat, at haste. On 1 June, gold and silver were restored as legal tender.
Two days later the old system of annuity finance was relaunched. By October the notes of the Bank had been abolished. By December, Law had fled France in fear of his life.

So unlikely was the rise, and so precipitous the fall, of the System that it has always been easy to dismiss the whole affair as a typical tale of unscrupulous financial chicanery, with Law in the role of an eighteenth-century Bernie Madoff. The English writer Daniel Defoe painted Law’s career sarcastically as an excellent model for a young man seeking his fortune. “The Case is plain,” he advised, “you must put on a Sword, Kill a Beau or two, get into Newgate, be condemned to be hanged, break Prison,
IF YOU
C
AN,—
remember that by the Way
,—get over to some Strange Country, turn Stock-Jobber, set up a Mississippi Stock, bubble a Nation, and you may soon be a great Man.”
¹⁶

Such assessments are too superficial. Law’s System was an experiment in harnessing the power of money of major historical significance, the archetype of a third generic strategy for harvesting the benefits of monetary society while avoiding its undesirable drawbacks. The Spartan and the Soviet strategies were fundamentally distrustful of money—and attempted to abolish or restrict its application. John Law, by contrast, believed that money’s capacity to unleash ambition and entrepreneurship was its most valuable quality. The Scotsman’s scepticism was reserved instead for the second leg of money’s promise: its ability to combine this social mobility with the security and stability provided by fixed financial obligations. His strategy therefore aimed not to restrain the use of the concept of universal economic value, but to square the circle instead by making the standard by which is it measured intrinsically flexible. This was the ultimate objective of the System: a new financial settlement in which the risks inherent in money’s contradictory promise were borne fully and explicitly by all money-users, rather than hidden behind the veil of unfulfillable promises by the sovereign to pay.

By merging the single state holding company with the single state bank, Law made explicit what he believed to be obscured in a decentralised system of money and finance. All income and wealth flows in the end from the productive economy—and it is claims on
this income alone that money ultimately represents. That income is, however, uncertain, because the world is an uncertain place—so the value of those claims is in reality uncertain too. The simplest way to acknowledge this fact of life is to transform the fixed financial claims that are generally used as money—otherwise known as debt—into variable ones—otherwise known as equity. That required something that did not exist in Holland or England, and has not existed since: a corporation that owns all the assets of the state, including its rights to collect taxes, in which citizens can own shares. This equity-money, of course, would provide much less security than conventional money, since its value could go down, as the System’s investors found out in 1720. But by the same token, it would provide a lot more mobility. For those who could not stomach such thoroughgoing transparency, the System also furnished a less powerful option: the notes issued by the Royal Bank. These had a fixed value in terms of the standard monetary unit. But that standard itself was now flexible, determined by the King’s Council at the level they felt most appropriate from an economic and a fiscal perspective. The only difference, in other
words, was that for the notes it was the sovereign, rather than the market, that would set the value of money.

John Law, before his fall (left, front view)—and after it (right, rear view).

(
illustration credit 11.1
)

Law’s System was ingenious, innovative, and centuries ahead of its time. It was even to prove prophetic two hundred and fifty years later, when the international gold exchange standard finally disintegrated in 1973 and fiat monetary standards became the worldwide norm. Yet it failed spectacularly. Where was the flaw? There were of course plenty of circumstantial problems that bedevilled Law’s ambitious scheme. He overestimated his own abilities, and underestimated the vested interests that his System would disenfranchise. The plan attempted far too much in far too short a time. And Law’s particular idea of offering the public government equity rather than government debt was indeed so far ahead of its time that its like has not been seen again since.
¹⁷
But far outweighing these incidental challenges, the Scotsman’s solution suffered from a much more fundamental flaw. It was a bug for which another neglected monetary genius had discovered the fix more than two millennia earlier.

While Sparta’s reaction to the invention of money might have been the least ambiguous in the ancient Greek world, it was certainly not the only one. In many other Greek city states, money was embraced with enthusiasm—despite the widespread scepticism about its drawbacks.
¹⁸
Such openness was, according to Aristotle, a particular characteristic of democratic city states, in which “[p]ayment for services, in the assembly, in the law courts, and in the magistracies, is regular for all.”
¹⁹
Athens was the canonical example and had become, by the fifth century
BC
, a uniquely monetised society—“a salary-drawing city,” in which virtually every aspect of civic life was mediated by money.
²⁰
Somehow or other, the citizens of classical Athens—whose poets, philosophers, and playwrights were the source of so much of the profound scepticism about money—had devised a means of harnessing their precocious and potentially dangerous invention. They owed this priceless discovery to one of their greatest philosophers,
poets, and statesmen whose heyday had coincided, as luck would have it, with Athens’ very first financial crisis.