I recently listened to the Great Courses series of lectures, entitled Crashes and Crisis: Lessons form a History of Financial Disasters, hosted by Professor Connel Fullenkamp. Although the lecture series focused on economic disasters, I found many leadership lessons embedded in the lectures. In prior podcasts, host Richard Lummis and myself have considered the Dutch Tulip Bubble from the 1630s and the South Sea Bubble of 1720. Today we consider the leadership lessons and failures which led to the Mississippi Bubble of 1720. The Mississippi Bubble has nothing to do with the state of Mississippi or the great river but rather a French trading company which had been granted an exclusive charter by the King of France to develop France’s territory in the Mississippi territory in the New World.
One cannot understand the Mississippi Company Bubble without understanding John Law. Whoever said that economists are universally dull, drab and dreary never met John Law. A genius with numbers and a profligate gambler because of the card counting he could do; Law fled from England to the Continent after killing a rival in a duel. He studied finance in Amsterdam, Venice and Paris. He was one of the first proponents of removing the gold backing of specie, claiming that, according to Jesse Colombo, “the use of fiat currency would stimulate commerce. Due to these distinct views, Law is often considered to be an early Keynesian-style economist.”
Fullenkamp said of the scandal, “In 1720, a Scotsman named John Law was put in charge of the entire French economy and given free rein to put his ideas about money, banking, and finance into effect. Law did get the French economy moving, but along the way, he also helped create one of history’s most famous, and least understood, financial bubbles: the Mississippi bubble.” It is a prime example of what can happen when governments put radical economic theories into practice on a large scale.
Through royal connections and maneuvering, in 1717 Law acquired the Mississippi Company and the exclusive royal charter. In July 1719 he purchased the right to mint new coinage for the country. In August 1719 the company obtained the right to collect all French indirect taxes and in October 1719 the Compagnie took over the collection of direct taxes. The final step was a plan “launched to restructure most of the national debt, whereby the remainder of existing government debt would be exchanged for Compagnie shares. By this time, John Law had amassed an incredible amount of power as his companies now controlled both France’s foreign trade and its finances.”
To pay for these monopoly rights, the Mississippi Company was allowed to issue stock. First, in June 1719, the company was allowed to issue new shares offered at a price of 550 francs, but a person had to pay only 75 francs up front and the rest in monthly installments. Law repeated this tactic twice, driving up the share price to as high as 5,000 francs. Law used these proceeds to virtually wipe out the French national debt. Law then made one final offering of shares at 5,000 francs and for which buyers only had to put 10% down. It sold out almost immediately and it pushed the Mississippi Company stock price up to 9,000 francs.
But the end was nigh as the bust came when two independent, yet inter-related events occurred. The first was that speculators who had bought in at the original 500-franc subscription amount and now held paper worth 10X that wanted to cash in by redeeming that Mississippi Company stock. Fullenkamp said, “People who had bought shares on credit when the price was 550 were sitting on huge paper profits that they wanted to realize. So, they began to sell the shares, and this started to push the share price down in the market.” This led to Law (in his defacto position as French national Treasurer) to issue enough paper money to meet the redemption calls, swamping the French monetary system with enough money to double the money supply and cause inflation, which was already running high to double in six months. This led eventually to stock price devaluation was the French money was devalued.
What does it all mean? Fullenkamp opined, “The legacy of the Mississippi Bubble is a cautionary tale about what happens when economic theories meet reality. John Law had some good ideas about monetary policy . His proposal to increase the money supply when the economy was in recession eventually became a standard policy prescription, especially among Keynesian economists. But not all of his ideas about money were sound, especially his claim that stocks are exactly equal to money. Worse still, to put his ideas into practice, he had unleashed powerful financial forces that he didn’t truly understand. He needed to solve the French government’s debt problem before he could get the economy going . But to solve the debt problem, he had to start the Mississippi Company and provoke speculation in its shares to raise enough money to buy off the king’s debts.”
This lack of seeming awareness of enhanced risks, is a confounding aspect of this Bubble. If your own company policies, procedures, controls and personnel cannot determine how business is transacted in your organization, you run the risk of a legal violation or something similar to the fall of the Mississippi Company and John Law, who was forced to flee France disguised as a woman.
Join us again next week, when we consider how personal integrity and leadership can work to stop an economic panic as we take a look at the Panic of 1907 and JP Morgan (the man, not the bank).