Was Everything as Rosy as it Seemed?

As I previously explained John Law paid for his ‘empire’ by issuing shares in the Compagnie des Indes. These shares could be paid for with bank notes (from his own bank) or with government debt. In January 1719, the shares were selling for 500 livres each, livres being the French currency at the time. The subsequent 12 months saw extraordinary growth, with the shares reaching an unbelievable 10,000 livres per share by December 1719, a 2000% increase! You can read more about the financials in a great article by Dave Smant. He estimates that the Compagnie would have had annual net revenues of 80,500,000 livres! You can read his article here.

Investors were getting slightly over excited by the potential value of trade. This was because of the promise of gold and silver from the French colonies due to the monopoly of trade they had acquired. Investors were not just from France, but from all corners of Europe. It got to the stage that soldiers were needed to maintain order in the financial district of Paris

John Law’s life had been transformed. He went from a broke gambler to one of the wealthiest men in Europe with significant power within the French government. It was not just the well-off that could invest in Compagnie des Indes, but people across all social classes. This caused many off the poorer people in France to become quite rich in a very short space of time. This is where the French word "millionaire" is said to have originated as so many people were becoming rich so quickly.

Source: Garber (1990)

You can access the full article here.

The huge demand for Compagnie des Indes shares resulted in the amount of bank notes increasing by 186% in just one year. This was because the Banque Générale issued as many notes as was demanded by the public. This resulted in serious inflation during which the price of goods doubles in just 18 months from July 1719 and December 1720. This inflation also affected the share price of Compagnie des Indes.

The problems really started by Law’s eagerness to print more paper notes to fund purchases of shares. In no time the Banque Générale far too many notes, well above the equivalent amount of gold and silver-based legal tender they kept in reserve for one who wanted to redeem their notes. Law probably thought he could fill this gold and silver deficit by importing it from the metal rich colonies in North America.

By January 1720, the price of shares began to fall as some investors ‘making a quick buck’ sold off to take profit in the form of gold coins. Law tried to prevent this by limiting payments in gold to more than 100 livres. However this was only the start of John Law’s problems. I will conclude the story in my next post.


Bibliography:

Garber, P.M., (1990) "Famous first bubbles," Journal of Economic Perspectives, vol.4,2.