FRENZY #1 | The Story of John Law and the Mississippi Bubble

An account of one of the earliest asset bubbles and psychological principals at play.

If wisdom has a short cut, its history. Within the world of finance, however, the true secrets tend to lie hidden within the subject of psychology. So, it is at this intersection of finance, psychology, and history where one can usually find the answer to the ever-pressing question: What the hell is going on?

Is that cryptic enough for you? Try this. How did the son of a Scottish goldsmith manage to gamble his way through Europe, kill a man, escape from prison, assume the position of “Controller of General Finance” for the nation of France, revolutionize the French financial system, become the wealthiest man in all of Europe, nearly bankrupt the country, and then barely escape with his life; only to die in Venice without a penny to his name. Did I mention he indirectly caused the French Revolution?

This is the story of how desperation turned into delusion, delusion into wealth, and wealth into dust.

Its a tale of frenzy; John Law and The Mississippi Bubble.

Part 1: Fertile Ground

Underneath every instance of mass hysteria lies a circumstantial hot-bed of conditions; all serving as a sort of fertilizer for the eventual bloom into pandemonium. Many things must be in place in order for people to truly lose their minds. The details of such conditions are often different, but the psychological effects they produce are not. As we move through this story I will attempt to point out the various psychological biases that paved the way for events that - in retrospect - seem absolutely insane. So lets roll back the clock and start at the beginning…

Our story starts in 1715 when the people of France learn that King Louis the XIV has died. This news may not have been so badly received, however, as Louis the XIV had left his country deeply in debt - so much debt, in fact, that despite obscenely high tax rates, the national income-tax revenue was still not enough to meet the interest payments on that debt. Thanks to inefficient tax farming, court costs, and (of course) decades of war, France was essentially insolvent. During his reign, King Louis the XIV made many many attempts to rectify cash flow problems by devaluing the "livre” (the French currency at the time). As we all know, devaluing a currency may solve a short term cash problem, but it creates more trouble down the road. So, by the time Louis XIV died, France was financially broken. The many prior attempts to devalue their way out of a money problem had failed; thus leaving France in a state of hopelessness and instability.

To make matters worse, the heir to the throne of King Louis XIV was his five year-old great grandson, Louis XV. Rather than let a five year-old boy rule the kingdom, power fell to the regent, Philippe II: The Duke of O’rleans. France’s new regent and his ministers found themselves in an impossible situation. The social fabric of the nation was strained after years of heavy taxes and coin devaluation, and our Duke of O’rleans needed a solution fast.

France was not the only nation in Europe with these sorts of financial troubles however, and “financial reform” was the talk of the town in Western Europe. England had recently instituted Dutch-inspired financial innovations; establishing the “Bank of England” which issued paper bank notes rather than coins and chartered such companies as the famed “South Sea Company.” France, on the other hand, had lagged behind. No doubt these stories permeated the mind of the new Regent, The Duke of O’rleans, as he desperately searched for a solution to France’s fiscal nightmare.

So our backdrop in this case appears to have three key components: instability, newness, and pressure. These desperate times seemed to call for desperate measures, but those “measures” would inevitably result in still more desperate times. The chaos and pressure of the moment facing Philippe II (Duke of O’rleans) seemed to make him less risk averse and more open to ideas that, in hindsight, are obviously dangerous. It reminds me of the way scammers often target those who are desperate and struggling because they are easier to fool. They need something to be true, and so they are more willing to believe it is. Moreover, the “innovation” happening throughout Europe serves as a sort of “social proof” for Philippe II; making “new ideas” seem like “good ideas.” In other words, “it seems to be working for them, so it’ll probably work for me.”

And so it is in this state of desperation and naive optimism that The Duke of O’rleans finds the solution to all his problems.

Part 2: John Law

In the year 1671 in Edinburgh, Scotland, John Law was born into a family of goldsmiths and bankers. After attending school he joined the family firm at the age of 14. Life at the firm was a bit too dull for the eager young boy, and after his fathers death he set off on his own in pursuit of adventure - funded of course by the estate he had just inherited. And so John Law became known as “Beau Law” for his flamboyant attire as he traveled his way through Europe; making a name for himself as a high-stakes gambler.

Like many gamblers, Law had a “system” which kept the odds always in his favor. His interest in the mathematics of probability made it such that John Law often played the role of the “bank.” You may think of all gamblers as fools, but Law did often manage to stay on the winning side of the table thanks to his superior grasp of the odds. Nevertheless, ‘Beau Law’ lived an extravagant lifestyle which perpetually outpaced his means.

As you might imagine, John Law was a bit of “rich bad-boy” type; much enthralled by both money and women. One of these women with whom he found himself enamored went by the name “Wilson.” Her husband, Mr. Wilson, was none too pleased with the flirtation, and so challenged the gambler to a duel. John Law accepted the terms and ended up shooting his challenger dead. And so our Scottish gambler friend found himself imprisoned and sentenced to death.

Employing the use of his considerable wealth and keen whit, John Law managed to escape his fate and flee from London to mainland Europe. When he arrived in the Dutch city of Amsterdam, he became fascinated with the many financial advances made by the Dutch in those years. These innovations included things like a central bank that exchanged coin for paper notes, joint stock ownership of “companies,” and a liquid public market where certificates of ownership (stock) in those companies could be bought and sold. Interestingly, all of these ideas still exist today (minus the ability to exchange fiat currency for a constant weight of gold/silver). In fact, while John Law is often regarded as a somewhat unscrupulous trickster, many also believe him to be a genius. I would argue that the Dutch deserve that credit.

Still, John Law believed in this new system. He spent his days reading and learning about the paper money system and his evenings in the gambling halls of Amsterdam. In 1700 it is believed he returned to Edinburgh to write “Proposals and Reasons for Constituting a Council of Trade.” This pamphlet, a culmination of his observations about the Dutch financial system, was largely ignored by his countrymen and the rulers of Great Britain.

Soon afterward, Law proposed the concept of a “land bank.” His idea was simple: the bank would issue paper notes, but the total value of notes could never be higher than the total value of all the land in Scotland. Each note would be backed by land at normal interest rates, and holders could even claim the land after a set period. The plan sparked spirited debates in the Scottish Parliament. A centrist faction known as the “Squadrone,” which Law had previously won over, put the proposal to a vote. In the end, Parliament rejected his idea, deciding that any scheme forcing the public to accept paper money was a bad move for the country. Law had failed yet again, and so he returned to mainland Europe to continue his life of gambling. He traveled all throughout Europe this time, and as he became more deeply acquainted with the trade and monetary structures of each nation, he became utterly convinced that no country could thrive without a paper money system.

John Law continued his romp through the continent, proposing his idea of a “land bank” to anyone who would listen. Time and time again he was denied. But in 1715, upon the death of Louis XIV of France, John Law saw his chance.

A few observation about Law. While he may have been a gambler and a convicted criminal, John Law was not stupid. He was highly intelligent, and most historians agree that he truly believed in his own ideas - at first anyway. Had I met him myself, I probably would have been impressed with his vast knowledge of fiscal reforms throughout Europe. Still, he found himself rejected from every throne room he walked into - until he arrived in France. The Kings of other nations were perhaps intrigued with his ideas, but foresaw the inherent risks of a paper money system which involved the public of all people being allowed to buy and sell assets at a whim. Still, John Law commanded a modest amount of credibility for his knowledge. Just enough credibility, as it happens, to earn him an audience with an old friend, Philippe II, Duke of O’rleans, who has just assumed the throne of France.

Part 3: Man with a Hammer

To a man with a hammer, every problem looks pretty much like a nail. So, I guess to an 18th century Scotsman with a self-published pamphlet on fiscal reform, every financial woe appeared to be solvable by some new “land bank” style innovation. And such was John Law’s frame of mind when he appeared on the scene in France amid the swirling chaos of 1715.

Philippe II, on the other hand, was miserable. The author Charles Mackay writes,

“No man felt more deeply than the regent the deplorable state of the country, but no man could be more averse from putting his shoulders manfully to the wheel. He disliked business; he signed official documents without proper examination, and trusted to others what he should have undertaken himself.”

So, a man with a problem is about to meet a man with a hammer.

When John Law entered the court of the Regent, Philippe II, he was well acquainted with the many problems facing France and its financial system. Most rational people could clearly see that the real problem had little to do with medium of exchange (coins over paper), but instead that France’s plight was entirely related to the previous King’s complete abuse of debt and devaluation. Still, no government official wants to hear that. So John Law - hammer in hand - presented the Duke of O’rleans and his ministers with a convenient alternate reality. The fault, he said, lay in a lack of paper currency and financial innovation; the very type of innovation he had spent a decade proselytizing throughout Europe.

To a man with a hammer, every problem looks pretty much like a nail.

Two other biases exist here. The first obvious bias is that of the Duke and his ministers. They want - or perhaps even need - a painless and blameless solution to their problem, and so they are far more willing to believe one exists. The second bias is on the part of John Law himself. This man has been going on and on about his brilliant ideas of financial reform for so many years that he has begun to see no potential fault in them at all. There exists in all of us a tendency toward commitment and repetition bias. The more we say something, the more we believe it ourselves. Charlie Munger explains this “commitment tendency” in his Psychology of Human Misjudgment lecture at Harvard. He puts fourth that the most effective method of brain-washing is that of the Chinese; whereby they get their subject to make a series of small but escalating commitments towards one larger idea. I think of this phenomena like a game of one-man telephone; where one good idea slowly but surely morphs into a crazy one. The more we say something the more we believe it ourselves, and the less inclined we are to question the real merits of those ideas.

Part 4: Death to Other Bankers! Banque Générale and the Paper Premium

While he was impressed with John Law’s many ideas, Philippe II still proceeded with some caution. Rather than implement all of Law’s innovations at once, in 1716 the Duke of O’rleans published a royal edict which authorized John and his brother to establish the Banque Générale. This was a new type of bank which would issue paper notes. These notes could be exchanged at par value (equal value) to their original value in metal rather than livre.

See, the government of France would regularly engage in “recoinage” (i.e re-minting the livre to contain less and less gold and silver); a practice which left its citizens poorer and poorer each year. The Banque Générale, by contrast, issued paper notes which possessed a fixed value. Moreover, John Law proclaimed publicly that his new bank would always possess enough gold and silver in its coffers to meet all of its potential withdrawals at any given moment, and any banker who did otherwise should be put to death.

This dramatic promotion of the mere stability of his bank notes spread like wildfire in a country where the people’s wealth had been melting away for decades. John Law’s new bank and its paper notes became so popular that branches began popping up all over the country. In fact, by simply offering folks a store of wealth, John Law’s bank notes sold for a premium over their par value. So fearful were the people of France of yet another “re-coinage” that they happily paid 1% over the real metal value of their notes. A few years later this premium would reach 15%! This reminds me of the premiums paid by the people of Argentina to simply possess U.S dollars instead of Argentinian Pesos. The damage from devaluation is so painful to those who experience it, that they would rather pay a premium to own money that doesn’t dissolve in their pockets.

Thanks to this ground breaking innovation of a stable currency which the Government couldn’t destroy at a whim, the French economy began to bounce back. Taxes collections became easier, debt payments were made, and commerce resumed. It seemed that the veins of the previously lifeless French economy were once again pumping full of blood. John Law had earned himself quite a reputation.

Now, while a paper money system may be somewhat more convenient than a system involving coins, John Law’s real innovation had less to do with the medium of exchange, and more to do with the constant value of that medium. In short, by offering people an alternative to a currency controlled by the Government, John Law was more or less just giving people something they should have had in the first place; a stable currency. Governments are notoriously poor money managers. When King Louis would reach the end of his fiscal rope, he would simply de-value the livre and extend it a bit further. Like a frog slowly heating up in a pot of water, the nation of France had been slowly boiled alive - just a few percentage points at a time. To his credit, John Law’s bank managed to right the sinking ship by simply removing power from the Government and offering people a convenient and stable alternative. Clever? Maybe. But I would argue this is the root of yet another cognitive bias.

Since we’re on the subject of frogs and water, consider this: if you put one hand in a pot of cold water, and another in a pot of room-temperature water, the second pot would feel hot. The same is true the other way; one hand in a pot of hot water and the other in a pot of room temperature water would make the room temp water feel cold. And so it was with John Law’s reasonable idea of a stable currency. For decades France had its hand in a pot of water full of reprehensible financial management and painful, ineffective solutions. One day they dropped their hand into the “lukewarm pot” - a reasonable system with a stable currency. Because of their relativity bias, the people of France didn’t merely applaud John Law for what he really was; a reasonable man among irresponsible morons. Instead, they thought he was a genius. Suddenly, John Law was both loved and admired. Having won the trust of the Regent, Philippe II, as well as that of the people of France, John Law finally found himself in a position to forge the monstrous system he had long since only dreamed of.

Part 5: The Mississippi Company

In its infancy, the United States consisted primarily of 13 British colonies, many of which were located in the North-Eastern part of the North American continent - still commonly referred to today as “New England.” The rest of this gigantic landmass had been essentially divided up by various European powers during the days of colonialism. The modern day continental U.S was “owned” by the British in the East, by the Spanish in the South-West, and by France in the center. Remember our recently deceased French King - named “Louis” - who’s massive debts drove France to near ruin? Well, it is after King Louis that the French territories in this “new world” were named; “Louisiana.” Today, Louisiana is merely one of 50 states, but back in this period of the early 1700’s, the Louisiana territory was massive. Its borders made up about a third of the country - roughly 530,000,000 acres; stretching from the Gulf of Mexico up into Canada. Below is a map showing the massive size of the Louisiana territory (dated a bit later in history in 1800 after the succession of Texas).

To this day, the Mississippi river remains one of the most important waterways in the U.S, and its after the river (not the state or territory) that John Law’s company will be named: The “Mississippi Company”

Back in France, John Law has proven himself as a shrewd financier and begins to persuade the Duke of O’rleans (Philippe II) of his grand visions for France’s economy. The idea is to create one giant system that is part tax collector, part trade monopoly, part land owner, and part bank; all feeding into one another to create a self propelling machine that would pay the nations debts, make investors rich, and develop the Louisiana territory into a profitable colony. Even when compared to the efforts of the Dutch at the time, John Law’s ideas are bold - if not reckless.

With the help of Philippe II, John Law’s Mississippi Company is founded in 1717, and its shares trade for a par value of 500 livre/share. First, the company acquires the charter to develop the colony itself. The Duke then grants the Mississippi Company a 25 year monopoly on Louisiana’s trade; including exclusive rights to import African slaves to the colony to exploit its natural resources. Moreover, Law has the right to make land grants, appoint governors, and establish an army in the Louisiana territory. Essentially, the royal decrees more or less make John Law the king of Louisiana - answerable only to the King of France; thereby the Regent of France, Philippe II. With all this newfound power, Law’s ambitions grow ever larger.

Next, the Mississippi Company gains a monopoly on the tobacco trade, acquires the African-Company (which is basically just modern day Senegal), and purchases the French East India Company (which has exclusive trading rights in China and south-east Asia). John Law’s already massive “company” has now grown into a mega-cooperation, controlling vast amounts of the globe. By late 1718 and 1719, Law’s company has monopolized virtually all of France’s trade outside Europe - from North America to Africa to Asia. More incredible still, by late 1719 the company has also purchased the right to collect French taxes and to coin new money. And by 1720, John Law is named Controller of General Finance to the nation of France. He is not only the wealthiest man in Europe, but also one of the most powerful men in the world. Meanwhile….

Part 6: FRENZY

Throughout this period of rapid expansion for the Mississippi Company, its shares were sold to both the wealthy and the public; the paper stock certificates becoming yet another form of paper-wealth. These shares were often purchased with bank notes from Law’s own bank which - early on - still kept enough gold and silver reserves to meet all of its withdraws. As word of Law’s new magical Mississippi Company spread throughout the country, demand for the shares began to rise. Since there was no 18th century S.E.C to regulate the promises made to investors by the Mississippi Company, word began to spread of 40% dividends and “mountains of gold” in Louisiana. Whatever grand promises were made by the Mississippi Company became multiplied 10-fold by the newspapers of the day.

As the price for shares of John Law’s company began to rise, a typical speculative fervor took hold. People saw prices for the new Mississippi Company stock climbing and assumed it would continue to do so. They then purchased shares of their own which of course pushed that price up even further. This in and of itself created a sort of feedback loop. Moreover, the public knew of John Law’s “genius” as well as his endorsement from the Philippe II, and a sort of authority bias kicked in. When authority figures begin to support new ideas, the public usually follows suit. This reaffirms the credibility of the company or asset class in the minds of most people.

Furthermore, as people watched their neighbors double or triple their money in this “magical” company, they began to want in on the party themselves. Naturally, as this trend began to explode, so did the reports of common-folk transformed into wealthy lords overnight. It was actually during this very craze that the term “millionaire” was coined in France.

But common people weren’t the only ones transfixed with this fresh sensation. It became a thing of fashion among the Bourgeoisie to own shares in the new French enterprise, and this further stamp of approval only added to the authority bias swaying the minds of public. As shares rose in price, more people bought them. As more people bought them, the shares rose in price. This effect was only multiplied by the sensationalist news reports of overnight millionaires and the hidden fortunes of the Louisiana territory. The Mississippi Company’s stock rose from 500 livre/share to 1,000/share to 3,000/share, and all the while the public certainty in their new investment grew. As the price of our assets rise, so does the estimation of our own intelligence.

Adding still more fire to the flames, Law’s ‘Banque Générale’ eventually became absorbed by the state and renamed, “Banque Royale.” This might be a minor detail if not for the fact that this bank would now offer credit - rather than a simple “cash for coin” guarantee. People would use their existing shares in the Mississippi company as collateral for a loan which they would then turn around and use to purchase more shares of the Mississippi Company. These loans often only required 10% down payments, and so the liquidity of the new national bank was now intrinsically linked to the stock price of John Law’s company. The sick irony is that Law’s Bank, once an institution who’s sole function was to offer people a stable means of exchange, was now controlled by the very people who abused the currency to begin with. Law had solved the French currency problem by removing the power to essentially “print money” from the hands of the Government. With the Banque Royale now in the hands of the state, the regent began to do precisely what the bank was designed to protect against; he printed money.

Yes, the Regent, Philippe II, Duke of O’rleans proceeded to then issue new “notes” to the public - notes which of course were not backed by metal, but instead relied entirely on the ever-rising price of the Mississippi Company’s stock to guarantee their value. Did everyone finally stop and realize that the firm banking system Law had created only a few years earlier was now bunk? Nope! They saw the stock price rise and continued buying. Stories of Emerald mountains and gold mines in Louisiana Territory began to circulate. Tales of fertile plantations and profitable trade were whispered throughout the courts and brothels of Paris. Any information to the contrary was quickly refuted, since by now everyone was thoroughly convinced that this new Mississippi Company was a sure thing. We people are fundamentally opposed to any information which disproves or challenges our pre-existing beliefs. When met with disconfirming evidence of their newfound glory, the people of France were quick to shrug it off. After all they had every reason in the world to want to believe what they already did, that they were rich and would become still richer.

By 1720, the price of one share in the Mississippi Company was valued at 10,000 livre - a 20x increase from its par value. John Law had become the richest man in all of Europe. He is given the title and position of “Controller of General Finance” of France. And then the selling began….

Part 7: The Great Unwinding

In January of 1720, a few investors began converting their Mississippi Stock back into paper notes, and those paper notes back into gold. The Prince de Conti famously sent wagonloads of banknotes to redeem for gold, nearly emptying the bank’s coffers. To curb this outflow, Law (who was now essentially running France’s treasury) banned any large gold payments, and even outlawed the use of gold and silver altogether; thus forcing people to use paper. As you might imagine, these draconian measures started eroding trust. People started worrying that they would never be able to cash out. As the desire to sell Mississippi stock began to reach a fevered pitch, Law attempted stabilize the price by forcing the Banque Royale to print even more money and buy shares. These attempts failed. Word was out, and the mania to buy transformed into a desperation to sell. To make matters worse, inflation in France had already begun accelerating wildly (23% monthly in January 1720). The inflation was due to the over-issuance of paper money - money used to buy Mississippi Stock, which was now in a tailspin.

In May of 1720, Law tried to let some air out of the bubble gently. He said the value of paper money would be cut in half, and the price of Mississippi shares would be eased down from 9,000 to 5,000 over time. As you might imagine, this plan backfired spectacularly. Riots erupted and Law was removed from his position in an attempt to mollify the angry masses. But it was too late. Public trust in this new system had vanished and a full on run began.

The Government, now in full control, attempted to support the stock price again when it hit ~1500/share, but once again this proved useless. People wanted out. In October, key privileges of the Company were officially revoked and its banknotes declared nearly worthless. John Law, now widely blamed for this nightmare, fled France in December 1720. As the legend goes he did so disguised as a woman.

By the end of the year, any remaining interest in the new “stock market” had vanished. In early 1721, control of what was left of the Mississippi Company passed to a government commission. By September 1721 the stock price had sunk back to its original par value of 500/share. The bubble had fully burst, impoverishing thousands. France’s economy began to slip into a severe recession - made worse still by a plague outbreak that killed 100,000 people. It would be 80 years before France attempted to issue paper money again. John Law would die 9 years later in Venice; impoverished after gambling away what little money he had left.

Most of the pain from this frenzy would be felt by the masses who have now begun to lose all faith in the monarchy. Years later this hatred for the crown will lead France to bloody revolution. A Corsican man, Napoleon Bonaparte, will become Emperor of France and drag all of Europe into years of disastrous war. To pay for these wars, Napoleon will finally sell the Louisiana territory to a budding new Democracy: The United States of America. The price? $15 Million (500 Million in today’s dollars). At its peak, John Law’s Mississippi Company was valued at $6.5 trillion.

Oh and Louisiana? Yeah…it was a swamp the whole time.

Part 8: From Scotland to Venice

John Law may have been the architect and the scapegoat, but I’m not sure he was truly the villain. I’m tempted to talk about how dangerous seemingly any Government can become when they’re given the power to print money. In the U.S we are fortunate to have a central bank which is fundamentally independent of the President, and even still we have issues with money printing - although we call it “quantitative easing”. Its interesting to note that there were at least a few French court officials who warned Philippe II of issuing new banknotes; trying to steer the Regent away from the bubble, rather than into it. Naturally, these men were dismissed from the court (fired).

At its height, this corporation was an octopus entwining the entire French economy. It held the government’s debt, ran the central bank, controlled colonial commerce, and collected the king’s taxes. From a nation building standpoint I think we can all agree this sort of concentration of power is absolutely insane and should never exist in a modern civilization.

But no one likes it when I moralize too much, so i’ll allow for you all to reflect on your own without any more of my input. The interesting bit to me is the parallels which seem to exist in all of these sort of occurrences. The Mississippi Bubble is like Bitcoin plus the 2008 Housing Bubble all wrapped into one ravenous feeding frenzy of fiat mania, and concluded with what amounted to a depression style bank-run. We make the same mistakes over and over and we will continue to do so. People will blindly trust authority. They’ll believe what they need to believe. They will become seduced by newness and overweight mediocre ideas as if they are fantastic ones - simply because whats been happening until recently has been so terrible. They will put their faith in those who have recently succeeded and make the largest promises. They’ll find evidence which confirms existing beliefs, just as they will discard that which disproves those beliefs. They will find even more certainty in the knowledge that their friends, family, and neighbors are doing the same things as them. They’ll be caught in these same self-reinforcing loops that have driven us humans into collective madness for centuries. All I know is that whatever happened on John Law’s journey from Scotland to Venice could not have occurred without the help of an entire country and the eager permission of its leaders.

Anyway, thats the story of how an outlaw Scotsman turn a fucking swamp into 6.5 trillion dollars. Peace.

P.s

This is the first in what I hope to be a series. If you liked it then for God’s sake give it a restack or a like or something because it took forever. I want to dive more and more into the psychology of this stuff. The history alone is tricky to get right, but I hope I can more effectively interweave further psychological tendencies into the stories.