John Law and Ben Bernanke

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John Law and Ben Bernanke

Throughout history, economies have been periodically subject to asset price bubbles. These bubbles can be defined as, “pronounced increases in asset prices that depart from fundamental values and eventually crash resoundingly” (Mishkin). One of the most prominent examples of such bubble is John Law’s Mississippi Company in 1715. Essentially this was an experiment in fiat money done by John Law on behalf of the Regent of France. The parallels between the recent financial crisis of 2008 along with the impending events and John Law’s bubble are remarkably similar. Ben Bernanke is only the latest in a long line of economists to believe in Law’s solution to a broken economy- just print more money. I. John Law- Early History

John Law contributed a lot to economic thought but unfortunately is remembered most for his Mississippi Company and the failure of his experiment in paper money. Growing up in Scotland as the son of a goldsmith, there is little wonder as to where Law’s financial theories were shaped. Goldsmiths were the precursors of the early banking system. They performed basic deposit and lending functions; citizens would leave their gold with the goldsmith in exchange for paper certificates which could be redeemed at any time for the amount they represented. No doubt the usefulness of this ad hoc form of currency played a part in developing John Law’s concept of fiat money. Law possessed an advanced grasp of banking and monetary theory, well ahead of his time for that matter. Law realized that paper money was preferable to the common coinage of the time; it was much more portable and convenient to use. Law originally published a proposal for a paper currency in the early 1700’s but did not find a willing supporter until the death of Louis XIV in 1715 (Marietta). Law was successful in convincing the regent of the advantages of paper money and credit. To the Regent of France, who was left with a country deeply in debt due to war and extravagant spending, Law’s theories seemed like the perfect solutions to stimulate France’s economy. Law was granted permission to open a bank (Banque Generale) along with the right to issue paper money (Maloney). Establishing confidence in a new monetary system was the hardest part. Lucky for Law, he had the benefit of working for an absolute monarchy which could declare that taxes had to be paid in the form of notes issued by the new bank. II. The Mississippi Company

Based on his previous success, it was not hard for John Law to convince the regent to support his next venture. Noting the success of the Dutch in exploiting the spice trade in the East Indies, Law believed that France could use the paper money to finance its colonial possessions; the Mississippi Company was thus created. The Louisiana Territory was believed to be rich in gold at the time. The Mississippi Company, with exclusive trading rights in the new territory, quickly exploded. Law “issued 200,000 shares in the company and share price quickly exploded, rising more than 30-fold in a period of months” (Maloney). Originally the proceeds from the shares were used to pay off the government’s debt. The creditors would then take the money and invest it in shares of the company that Law offered to them at less than their value. The advantage for the company was, as Law wrote, “the creditors shall invest the money they receive in the shares which are now offered to them at less than their value. Thus they will be enriched while the State is relieved” (Faber). Despite the fact that paper currency was a new concept the regent responded, like many have governments have since, by asking for more money to be printed. The money supply was expanded by sixteen times its original size (Sizemore). A lot of this new found currency was used to purchase shares of the Mississippi Company. As demand for shares grew so did the demand for paper money with which to buy them so more...
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