The King of England has a problem.
The British government is teetering on the verge of bankruptcy
England only recently having ended a treasury-depleting war with France, has now entered into the War of Spanish Succession – yet another drain on an increasingly debt-ridden government.
As a result, the new Chancellor of the Exchequer, Robert Harley, has inherited from his successor a mountain of debt, and the immediate problem of having to satisfy creditors, all of whom are anxious to be paid.
Harley does not have a lot of options.
Or cash.
Drastic measures need to be taken.
And drastic measures are taken indeed.
Harley adopts the proposal of a group of merchants from the Sword Blade Company – a company specializing in financial transactions - and incorporates all of the government's short term creditors under a single entity - with the rather unwieldy name of 'the Governor and Company of Merchants of Great Britain Trading to the South Seas and other parts of America and for encouraging the Fishery'.
He then gives this entity a monopoly on trade with a large part of South America in exchange for the cancellation of nine million pounds of government debt.
In one fell swoop, Harley has succeeded in ridding the government of much of it's debt burden.
However the 'South Sea Company' as it is called – is a disappointment.
It sends only a single ship to South America, and fails to sell out all of it's stock.
The Sword Blade merchants – now Directors of the South Sea Company - are more than a little anxious about their investment. They look enviously across the Channel at John Law and his propserous Mississippi scheme and the limitless wealth of his paper money economy...and watch precious capital depart for the continent by the day.
If only they can pump up their share price in a similar fashion....
Now, despite the lack of progress in the Company's business, the actual scheme of exchanging government debt for stock in the South Sea Company has gone quite well...it achieved exactly what it was meant to achieve – the cancellation of a large sum of government debt for little cost to the government.
But there is still so much more government debt to be rid of....
...perhaps....
And just like that....
An idea is formed.
An idea that will generate a mountain of wealth, stop the capital flight to Paris, and cement London's reputation as the financial center of the world.
An idea that has virtually no drawbacks.
Well...
Virtually none.....
Over the past several years, the government has been furiously printing money to pay for the War of Spanish Succession, thereby engendering a mini-boom in the English economy.
And as of today, the War has finally ended, opening the shipping lanes to South America, which will at last allow the Company to begin trading with the boundless wealth of the New World.
The time is ripe.
The savvy Directors calculate that if a boom in stock prices can be engendered, holders of government annuities will quickly exchange this debt for the opportunity to make huge capital gains relatively quickly.
And the South Sea Company is to be given the exclusive rights to convert these annuities to stock.
On April 12, 1720, the plan comes to fruition. Virtually the entire debt of the English Kingdom is taken upon the South Sea Company as government annuity holders exchange their debt for shares in the South Sea Company.
In order to juice stock prices and ensure the success of the plan, Five million pounds – a staggering sum at the time - is injected into an already booming economy - with a simultaneous lowering of interest rates.
The company’s stock, at a hundred and thirty a few days earlier, quickly explodes to over three hundred....
And the race is on....
Over in France, Law is desperately printing money in a futile attempt to prop up his own collapsing share price. Sensing a new opportunity, smart money rapidly flees from the obvious mess in France to the new, improved boom in England.
Seeking to cash in on the unprecedented euphoria and explosion in new capital looking for a home, stock companies pop in and out of existence like....
well...
bubbles....
Nobody seems to know – or care – exactly what these companies do, but no matter. No need to ask silly questions like whether a company has any revenue. Or employees.
Just buy a hundred shares, kick back, wait a few days, and get rich.
And if you're a bit late to the party, no need to fuss. There's plenty of capital to go around.
There always is.
Until there isn't.
Friday, October 23, 2009
Friday, October 16, 2009
Bubbleology Part V - Law's Folly
This is Part V in a continuing Series. For part I please click here.
The first sign that something was amiss came early in 1720.
A wealthy Prince who had quarrelled with Law in a business matter, demanded payment in coin of so enormous a quantity of Law's notes, that three wagons were required for its transport. Law was able to comply. However, sensing the danger of what could happen if others made similar requests, Law complained to the monarchy and had the Prince publicly vilified.
But the public vilification did not prevent others, perhaps sensing what lie ahead, from soon following suit.
Despite the ominous forebodings, the system continued to flourish. Fortunes continued to be made. The population wined and dined with their newfound riches, all the while in complete denial of any trouble ahead. Naysayers were derided as pessimists and boors. After all, what had anyone to fear? The country had never been richer. And business had never been better.
And John Law - next to the King the most powerful man in France - worshipped by an intoxicated population almost as a God, was the architect.
However despite the seeming abundance and good cheer, all was...
well....
not quite as...
healthy...
as it seemed.
The more prices rose, the more notes Law issued. The more notes Law issued, the richer everyone felt. The richer everyone felt, the more prices rose. The country had entered into a state of...
Unsustainable Ecstasy.
Soon, there was no longer even the semblance of a relation between the amount of notes in circulation and the amount of gold coin which backed them.
Inflation, which at first had been but a minor bugaboo for the country's nouveau riche, suddenly became a significant, systemic threat. Prices could rise 20% in a matter of hours.
Some of the more astute among the wealthy noted this situation and sensed that a crisis was imminent. They began to redeem their notes for valuable coin, hoarding the coins in their homes or sending them abroad for safety. As a result, a scarcity of gold and silver coin rapidly became alarmingly apparent.
Soon the trickle of coin out of the country became a flood. Confidence in Law's notes began to deteriorate as it dawned on a stunned population - seemingly all at once - that there was not enough coin to go around. In February of 1720, in a futile attempt to support public confidence in the notes, an edict was passed forbidding any person to hold more than 500 livres worth of coin in his or her possession.
Almost overnight, the country turned on the brink of revolution.
Business came to a standstill. Shares in business stocks, including Law's own venture in Mississippi – crashed.
Redemption requests for Law's notes began to flow in like a tidal wave. There was not nearly enough hard currency available to cover them all. Something had to be done.
And Something was.
On the 27th of May, 1720 Law's bank halted the redemption of his notes for coin.
The Bubble had Burst.
Law's grand experiment in paper money, an experiment which promised a riskless explosion of free wealth for all, had instead caused the abrupt and total collapse of the French economy, leaving the population utterly penniless and hopelessly embittered.
Law, once among the richest and most powerful men on Earth, was ruined, and fled the country in disgrace. The collapse was so catastrophic, so disastrous, that the economy would never fully recover, and the devastating after-effects led directly to the violent overthrow of the French monarchy over half a century later.
But not before another country -
a little island just across the English channel from John Law's France -
would experience a Bubble of it's own.
A Bubble that would mark the beginning of the modern economic era.
And set the standard by which all future Bubbles would be judged.
To be Continued.
The first sign that something was amiss came early in 1720.
A wealthy Prince who had quarrelled with Law in a business matter, demanded payment in coin of so enormous a quantity of Law's notes, that three wagons were required for its transport. Law was able to comply. However, sensing the danger of what could happen if others made similar requests, Law complained to the monarchy and had the Prince publicly vilified.
But the public vilification did not prevent others, perhaps sensing what lie ahead, from soon following suit.
Despite the ominous forebodings, the system continued to flourish. Fortunes continued to be made. The population wined and dined with their newfound riches, all the while in complete denial of any trouble ahead. Naysayers were derided as pessimists and boors. After all, what had anyone to fear? The country had never been richer. And business had never been better.
And John Law - next to the King the most powerful man in France - worshipped by an intoxicated population almost as a God, was the architect.
However despite the seeming abundance and good cheer, all was...
well....
not quite as...
healthy...
as it seemed.
The more prices rose, the more notes Law issued. The more notes Law issued, the richer everyone felt. The richer everyone felt, the more prices rose. The country had entered into a state of...
Unsustainable Ecstasy.
Soon, there was no longer even the semblance of a relation between the amount of notes in circulation and the amount of gold coin which backed them.
Inflation, which at first had been but a minor bugaboo for the country's nouveau riche, suddenly became a significant, systemic threat. Prices could rise 20% in a matter of hours.
Some of the more astute among the wealthy noted this situation and sensed that a crisis was imminent. They began to redeem their notes for valuable coin, hoarding the coins in their homes or sending them abroad for safety. As a result, a scarcity of gold and silver coin rapidly became alarmingly apparent.
Soon the trickle of coin out of the country became a flood. Confidence in Law's notes began to deteriorate as it dawned on a stunned population - seemingly all at once - that there was not enough coin to go around. In February of 1720, in a futile attempt to support public confidence in the notes, an edict was passed forbidding any person to hold more than 500 livres worth of coin in his or her possession.
Almost overnight, the country turned on the brink of revolution.
Business came to a standstill. Shares in business stocks, including Law's own venture in Mississippi – crashed.
Redemption requests for Law's notes began to flow in like a tidal wave. There was not nearly enough hard currency available to cover them all. Something had to be done.
And Something was.
On the 27th of May, 1720 Law's bank halted the redemption of his notes for coin.
The Bubble had Burst.
Law's grand experiment in paper money, an experiment which promised a riskless explosion of free wealth for all, had instead caused the abrupt and total collapse of the French economy, leaving the population utterly penniless and hopelessly embittered.
Law, once among the richest and most powerful men on Earth, was ruined, and fled the country in disgrace. The collapse was so catastrophic, so disastrous, that the economy would never fully recover, and the devastating after-effects led directly to the violent overthrow of the French monarchy over half a century later.
But not before another country -
a little island just across the English channel from John Law's France -
would experience a Bubble of it's own.
A Bubble that would mark the beginning of the modern economic era.
And set the standard by which all future Bubbles would be judged.
To be Continued.
Friday, October 9, 2009
Bubbleology Part IV - The Kickoff
This is part four of a multipart series beginning here
John Law was born in Edinburgh in 1671, and amassed considerable wealth as a goldsmith and banker. Unbeknownst to him or anyone else in the world, this obscure man would play the key role in the most incredible reign of excess and stock market hyperbola the world had ever seen.
Louis XIV of France died in 1715, and the heir to the throne being an infant only seven years of age, the Duke of Orleans assumed the reins of a government that was incredibly deep in debt from the overt excesses of the previous three decades.
In the midst of this financial wreckage Law appeared upon the scene with a scheme he had concocted several years prior, and had been shopping around various European monarchs with little to no success. Law asserted that a metallic currency – then the standard in France -, was inadequate for the wants of a commercial country. Law proposed that he should be allowed to set up a bank, which should have the management of the royal revenues, and issue paper notes on behalf of the Royal Treasury.
Law was apparently quite persuasive, and on the 5th of May, 1716, a royal edict was published, by which Law was authorised, in conjunction with his brother, to establish a bank under the name of Law and Company, for the purpose of issuing paper notes.
Law made a fortune. He made all his paper payable at sight, and in the coin current at the time they were issued. This was a master-stroke of policy, and immediately rendered his notes more valuable than the precious metals. The government-issued coins were constantly being depreciated by the tampering of the government. A thousand livres of silver might be worth their nominal value one day, and be reduced one-sixth the next, but a note of Law’s bank retained its original value.
In the course of a year, Law’s notes rose to fifteen per cent premium.
The Duke of Orleans was astonished at Law's success, and conceived the brilliant idea that paper could not only aid a metallic currency, but entirely supersede it.
The Great Wave of speculative, paper-based Finance had begun.
A frenzy of speculation ensued. Law become one of the wealthiest and most powerful men in France. Amid the speculative fervor, Law, with the active encouragement of the regent, soon forgot the sound money policies which had made his notes so popular in the first place and fell into the trap that would soon become the hallmark of despotic governments throughout the world -
his bank began to print far more notes than it had the ability to repay in coin.
And thus began the winding road down a slippery slope which would carry civilization to undreamed of heights in wealth and splendor....
a road towards consequences unforetold and from which, once chosen, there could be no return.
Ever.
To Be continued...
John Law was born in Edinburgh in 1671, and amassed considerable wealth as a goldsmith and banker. Unbeknownst to him or anyone else in the world, this obscure man would play the key role in the most incredible reign of excess and stock market hyperbola the world had ever seen.
Louis XIV of France died in 1715, and the heir to the throne being an infant only seven years of age, the Duke of Orleans assumed the reins of a government that was incredibly deep in debt from the overt excesses of the previous three decades.
In the midst of this financial wreckage Law appeared upon the scene with a scheme he had concocted several years prior, and had been shopping around various European monarchs with little to no success. Law asserted that a metallic currency – then the standard in France -, was inadequate for the wants of a commercial country. Law proposed that he should be allowed to set up a bank, which should have the management of the royal revenues, and issue paper notes on behalf of the Royal Treasury.
Law was apparently quite persuasive, and on the 5th of May, 1716, a royal edict was published, by which Law was authorised, in conjunction with his brother, to establish a bank under the name of Law and Company, for the purpose of issuing paper notes.
Law made a fortune. He made all his paper payable at sight, and in the coin current at the time they were issued. This was a master-stroke of policy, and immediately rendered his notes more valuable than the precious metals. The government-issued coins were constantly being depreciated by the tampering of the government. A thousand livres of silver might be worth their nominal value one day, and be reduced one-sixth the next, but a note of Law’s bank retained its original value.
In the course of a year, Law’s notes rose to fifteen per cent premium.
The Duke of Orleans was astonished at Law's success, and conceived the brilliant idea that paper could not only aid a metallic currency, but entirely supersede it.
The Great Wave of speculative, paper-based Finance had begun.
A frenzy of speculation ensued. Law become one of the wealthiest and most powerful men in France. Amid the speculative fervor, Law, with the active encouragement of the regent, soon forgot the sound money policies which had made his notes so popular in the first place and fell into the trap that would soon become the hallmark of despotic governments throughout the world -
his bank began to print far more notes than it had the ability to repay in coin.
And thus began the winding road down a slippery slope which would carry civilization to undreamed of heights in wealth and splendor....
a road towards consequences unforetold and from which, once chosen, there could be no return.
Ever.
To Be continued...
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