STORIES WE TELL OURSELVES - PART II – THE MISSISSIPPI SCHEME 1716-1721 (A TALE IN FIVE CHAPTERS)
In a podcast interview [Link], fund manager Rajiv Lapasia talked about the investment business. Rajiv’s background is unusual. He was a medical doctor before becoming a fund manager. He says that much of the information in medicine has become outdated by new technologies in the last 30 years. In contrast, there is nothing new in investing. To his point, I am sharing a story that is 300 years old, but as timely as today. It is one of my favorites, and I hope it will be one of yours.
“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one.” Charles MacKay
Charles MacKay wrote a classic book in 1841, Extraordinary Popular Delusions and the Madness Of Crowds. Financier Bernard Baruch said it was the most important investment book he ever read. A madness seized all of France in 1719. This is the abridged story without MacKay’s wit.
THE MISSISSIPPI SCHEME CHAPTER ONE – EASY MONEY
The Scot Economist
John Law was born at Edinburgh in 1671. He had an exceptional mind for mathematics and understood monetary and credit principles better than anyone in his day. He failed to persuade Scotland to try a paper money system. Then, following a murder charge, he fled to the Continent and studied the monetary policies of European countries.
The Duke of Orleans in Paris befriended him. In 1708, Law tried to convince the Duke to issue paper money along with gold and silver coinage. But the French currency comptroller rejected the idea. When Louis XIV died in 1715, leaving a seven-year-old heir, the Duke became, as regent to the young king, head of government.
Louis XIV had been extravagant and corrupt. France’s finances were on the verge of collapse. Officials considered bankruptcy, but soon realized this would be ruinous, so they settled on “recoinage,” reducing the size of coins. Thus, they depreciated the currency 20%. This did not solve the problem.
A Royal Public Offering
Law’s fortunes had suddenly turned. His friend, the Duke of Orange, already acquainted with Law’s paper money theory, would try anything to restore France’s credit. Unfortunately, he knew little about finance and totally trusted to others’ judgement.
The royal court cordially received Law. He asserted that metal currency, without paper money, was inadequate for a great country. He proposed a bank to manage royal revenues. Persuasive, the court soon agreed, expecting great things of him. So, in May 1716, a royal edict authorized Law to open a bank, Law & Co. Ready to issue paper money, he declared, “A banker deserves death if he has not sufficient collateral to answer all demands (for withdrawals).” A statement he would regret.
Law’s bank issued notes that immediately traded at a 1% premium to metal coinage. Public confidence returned, and the economy revived. In a year, Law’s notes rose to a 15% premium, while the government notes issued for Louis XIV’s debts sold at a 78% discount. Law’s policy appeared sound, and France entered the early stage of a speculative frenzy, believing anything Law promised.
The Duke of Orange came to believe that paper money could completely replace coins. Law & Co., renamed Royal Bank of France, was awarded a monopoly on tobacco sales and the sole right to handle gold and silver. As soon as the bank became a government institution, the regent issued new notes for a billion livres,[i] exceeding anything Law ever dreamed. He had only issued notes for 60 million livres. Thus, the paper money supply increased 17-fold. Some in parliament were critical, but the regent dismissed them. The criticism alarmed Law, but the regent quieted things down.
Law had created a second venture, the Mississippi Company to mine the supposed precious metals in France’s Mississippi-Louisiana lands. He issued 200,000 shares. When the bank criticism faded, Law breathed easier and turned to his Mississippi project. Early in 1719, the Mississippi Co. gained exclusive trading in the East Indies, China, and the South Seas. The share price rose rapidly. The Company now took a new name, Company of the Indies. Law proposed a secondary stock issue of 50,000 shares. He promised magnificent prospects, a yearly dividend of 200 livres. A share was valued at only 166 livres, so a 120% yield.
The Story Develops
With such promise, the stock did not long stay at this price. The “herd” grew more enthusiastic. Applications flooded in for 300,000 shares. Making a list of buyers took several weeks, and the public mood rose to a frenzy. Eager buyers milled around Law’s house. Noblemen waited for hours before his door. To avoid the thousands of commoners who also wanted shares, the wealthy rented nearby houses to be near the man who could bestow great wealth on them. Every day the share price increased, and Law raised his secondary offering to 300,000 shares at 5,000 livres a share. Demand would have supported 900,000 shares.
Law’s prosperity and the people’s infatuation were approaching the zenith. Everyone had visions of boundless wealth. The aristocracy were buying stock, and people of every age and class speculated. Law’s street, the grand marketplace of the brokers, was narrow and accidents continually occurred in the milling crowd. Houses that had rented for 1,000 livres a year, now rented for 12-16,000. A cobbler, who had a stall on the street made 200 livres a day by renting it to brokers. A hunchbacked man made a good income by lending his hump as a writing-desk to eager speculators! These traders and spectators drew all the thieves and rogues in Paris. Riots were common, and at nightfall, a troop of soldiers often had to clear the street.
Law moved to the larger Place Vendôme, and the crowd followed. That spacious square soon became as crowded as his former street. From morning to night, it looked like a fair. Booths and tents for business and the sale of refreshments and gamblers with roulette tables filled the middle of the Place. Public gardens were empty; people preferred to stroll in the Place Vendôme.
One old soldier was totally vexed at his countrymen’s folly. Passing through the Place Vendôme in his carriage, he ordered his coachman to stop. He put his head out the window and cursed them for half an hour on their “disgusting avarice,” Not a wise move! He got back hisses, shouts, laughter, and jokes. When rocks began to fly, the old marshal drove on. He never repeated the experiment
The noise was so loud that the local court complained that cases could not be heard. Law solved the problem, buying from a Prince at an enormous price the Hôtel de Soissons, and moving there. The Hotel had acres of gardens in the rear, and the Prince wisely kept them. An edict forbade stock trading anywhere but in that garden. Brokers put up 500 small tents and pavilions. Their colors and bright banners, the crowds, the noise, and the music gave an enchanting air that enraptured the Parisians. Each tent rented for 500 livres a month. The Prince profited enormously ($3 million - 2023, annually).
Two sober, quiet, and philosophic men of letters congratulated each other, that they, at least, were not infatuated. A few days after, as one was coming out of the Hôtel de Soissons, where he had been buying shares, he saw his friend entering to also buy shares. They passed quickly, embarrassed. And for a long time, they did not talk about the stock incident.
[i] To appreciate the magnitude of the wealth in this bubble, we need a modern reference. It is difficult to calculate the current buying power of a 1720 French livre, but the best guess (going from Livre to British Sterling to $US is that the 1720 French livre is about $12 in 2023.