Mississippi Mania

The Mississippi Mania – usually referred to as the Mississippi Bubble – is a classic example of a Currency Crisis. It was a financial crisis in the early 18^th century that occurred in parallel to the South Sea Bubble in Britain.

In the early 1700s, the French economy was undergoing a period of depression. The War of Spanish Succession had plunged the government into heavy debt. The national debt was 3000 million livres, the revenue was limited to 145 million livres, and the expenses of the government were almost 142 million livres. This meant the country had only 3 million livres to pay the interest on their debt of 3000 million livres.

The state, in order to revive the economy, first ordered a re-coinage. The currency was devalued by one-fifth; those who took a thousand pieces of gold to the mint got four-fifth of the weight of the metal back. The government also repudiated parts of its debt, forced a reduction in its interest payments, and hiked taxes.

But all these measures plunged the French economy deeper into depression.  

France was in absolute chaos when John Law appeared upon the scene.

John William Law, often regarded as the gambler who revolutionized French finance, is the man responsible for the Mississippi Mania. He was an exile (killing a man in a duel might have led to this), a passionate gambler, and oh yes, the Scot behind France’s first central bank.

The Duke of Orleans, the Regent of France, held Law in high regard. He sought his advice to save the economy.

At the time, the French used precious metals – gold and silver – as currency. Law recognised the scarcity of these metals and blamed this scarcity for the economic slowdown.

He proposed setting up a bank that would manage royal revenue and issue notes – essentially a Central Bank. The bank would back these notes with precious metals.

On 5^th May 1716, a royal order was published which gave permission to Law to set up a bank, the Banque Generale, the notes of which should be used to pay taxes. The masterstroke of his policy was making the notes payable at sight. This removed the risk of devaluation which the metal currency still possessed. The notes were deemed sacrosanct by the public and considered more valuable than precious metals. He also declared that a banker deserved death if he issued notes without having sufficient security. The notes advanced in the public and French trade and commerce felt the benefits of it.

It was now that the frenzy began to seize the nation. Anything Law proposed was readily accepted by the regent and the public. The bank got a monopoly on the sale of tobacco, the sole right of refining gold and silver, and was finally set up as the Royal Bank of France. As soon as the bank was made a public institution, there was a fabrication of notes amounting to 1000 million livres. This was the first time the bank departed from Law’s vision. Until then every note issued by the bank had security to back it. The actions of the bank, once it was brought under the royal structure, defied Law’s earlier proclamation that any banker who issued more notes than he has to back with reserves, deserved death.

Law acquired the struggling Mississippi Company next. In early 1719 an edict was issued granting the company monopoly on trade in East Indies, China, and the South Seas. The shares of the company were issued to the public. Law promised a dividend of 200 livres on each share of 500 livres. The optimistic sentiment of the public, mainly driven by their perception of Law and their trust in the Royal Bank of France, could not resist an offer so splendid. Around 300,000 applications were received for the issue of 50,000 shares.

The aristocracy of France – the dukes, marquis, barons, and counts – waited in the streets for hours, at Law’s door to know who was getting the allotments.

The prices of the shares rose every day and were up by 1900% in less than a year. The prices were overvalued to a level that can only be regarded as absurd and were far off from their intrinsic worth.

France was now reaching the zenith of its craze All classes of the society were captured by images of boundless wealth.

Extrapolation and sentiments had completely taken over the market and driven logic and rationality out the window.

The Banque Generale was issuing as many notes as the public demanded. The amount of paper money in circulation had increased by 186% and which led to hyper-inflation.

Law did not see the financial crisis on the horizon. His judgment was clouded by the incredible amount of wealth created and a confirmation bias.

It was a house of cards just waiting to collapse.

In January 1720, the company’s share price began to fall when some investors decided to take their profits in form of gold and not paper currency. This triggered a sell-off. Law, in an attempt to curb this, put a cap on payment in gold of more than 100 livres. This further aggravated the panic.

In May 1720, Law decided that the company’s shares were overvalued and began devaluing them along with the notes of the Banque Generale. This caused a massive public uproar which resulted in the restoration of the value of the banknotes but, payments in gold and silver were stopped. The French public was outraged by the worthless paper notes. The share prices of the Mississippi Company tanked, and many previous “millionaires” were paupers by the end of 1720. Law was left with no option but to flee France.

The debts of his company and bank were taken over by the government, which raised taxes to retire it.

The collapse of the Banque Generale and the Mississippi company, which coincided with Britain’s South Sea bubble, plunged France into a severe recession and laid the groundwork for the French Revolution.

The epitaph below was written for Law at the time:

Ci gît cet Ecossais célébre,

Ce calculateur sans égal,

Qui, par les régles de l’algébre,

A mis la France à l’hôpital.

It translates into:

Here lies this celebrated Scottish, 

This calculator without equal, 

which, by the rules of the algebra, 

Put France in the Hospital.

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