Mississippi Bubble
The Mississippi Bubble refers to a significant economic crisis that occurred in France during the early 1700s, closely paralleling Britain’s South Sea Bubble. The crisis was primarily orchestrated by John Law, a Scottish financier who advised the French government amid its financial turmoil following the War of the Spanish Succession. Law established the Banque Générale, issuing paper currency to stimulate the economy and later acquired the Mississippi Company, which held a monopoly over trade in the lucrative Mississippi territory in North America. As investors speculated wildly on the company's prospects, the price of its shares escalated dramatically, leading to rampant hyperinflation when the money supply far exceeded the value of gold and silver reserves.
By 1720, the overinflated stock collapsed, and the value of the paper currency plummeted, resulting in a severe economic depression in France. This downturn exacerbated existing financial issues, leading the government to increase taxes to manage the debts incurred from the company's failure. The economic distress contributed to widespread discontent, setting the stage for the social unrest that culminated in the French Revolution. The Mississippi Bubble remains a cautionary tale about the risks of speculative investment and the dangers of unregulated monetary policy.
Mississippi Bubble
The Mississippi Bubble was an economic crisis that struck France in the early 1700s. The crisis developed around the same time as Britain's South Sea Bubble. The mastermind behind the Mississippi Bubble was John Law, a Scottish financier who became the French government's primary financial advisor. Law used his power to purchase the Mississippi Company, which was granted a monopoly on the development of France's vast Mississippi territory in North America. Investors bid shares of the company up to great heights hoping to get a big return on their investments from what they were told was an immense amount of resources in the territory, including gold and silver. Ultimately, the company's prospects in North America ended up being little more than empty promises and the shares crashed, taking France's stock market and public finances down as well.
Background
In 1715, France was in the midst of serious financial troubles. The nation was on the verge of becoming insolvent, meaning it could no longer meet its financial obligations or pay lenders when loans came due. Debts incurred during the War of the Spanish Succession between 1701 and 1714 were putting a burden on the nation. To help dig itself out of its financial crisis, the French government, then led by a group of regents because King Louis XV was only five years old, defaulted on a portion of the country's debt, lowered interest payments, and raised taxes to very high levels. This combination resulted in a depressed economy in France and caused the value of its currency, which was backed by gold and silver, to fluctuate wildly. To address the growing financial crisis, the leader of the group of regents, the Duke of Orleans, sought the council of his friend John Law.
Law had a checkered past in his personal and professional lives. He was born in Fife, Scotland, to an affluent family of bankers and goldsmiths. He became his father's apprentice at age fourteen and learned about the banking business until his father's death when Law was seventeen. Law then went to London, and with his mathematical background, earned a living as a gambler. At age twenty-three, Law became involved in a duel over a woman in London in which he killed his opponent. He was charged with murder and sentenced to death, but he spent only a short time in prison before escaping to mainland Europe, where he studied finance. Law was a proponent of using paper or fiat currency—which is money declared by a government to be legal tender—over currency backed by precious metals, arguing the use of paper currency would stimulate commerce.
When Orleans asked Law for help in addressing France's financial and economic troubles, Law saw this as an opportunity to put his theory in the value of paper money to the test. In 1716, he established a state bank called Banque Générale that would issue paper money redeemable at face value in gold and silver. Although the bank took deposits in coin, it issued loans and withdrawals in paper. Law's bank built up its reserves through stocks and turned a profit by handling the French government's financial needs.
With his bank doing so well, Law soon decided to expand by acquiring the Mississippi Company, which held a government-backed monopoly over trading in France's North American territory. With Law in control, the company soon expanded into tax collection and gained the rights to all of France's trade outside of Europe. The company's stock price shot up and the amount of cash needed to buy shares meant more money had to be printed. When investors looked to collect their profits, however, they wanted it in gold and silver. To avoid depleting his reserves, Law capped redemption in gold and silver, thus removing France's paper currency from a metals-backed standard to the Mississippi Company share price standard. Hyperinflation—rapid, out-of-control inflation—soon set in, as the amount of paper currency out in the market was many times the actual reserves of gold and silver.
Law realized the price of a share in the Mississippi Company was vastly overestimated in comparison to the amount of gold, silver, and other commodities in the North American territory. He attempted a controlled slowdown by depreciating currency and the shares by half, but this triggered a selling frenzy that drove the price down rapidly. By 1720, the paper currency created by Law became worthless and caused the French economy to crash, ultimately sending Law back into exile.
Overview
Although it was given the name the Mississippi Bubble, France's financial crisis in 1720 was not technically a bubble. Traditionally, financial bubbles are caused by widespread hysteria and speculation, followed by a sharp collapse in asset values. The Mississippi Bubble, however, was the result of failed monetary policies that caused excessive money supply growth and rapid inflation. Nevertheless, the collapse of the Banque Générale and the Mississippi Company, which Law had renamed the Compagnie des Indes, plunged France into a severe economic depression.
Around the same time, other European countries were also feeling economic hardships thanks to Britain's South Sea Bubble, which was a speculative bubble involving shares of the South Sea Company. The economic depression in France and other European nations laid the groundwork for the French Revolution that took place later in the 1700s. After the Mississippi Company collapsed, its enormous debts were soon consolidated and taken over by the French government. Because the government needed to pay these debts somehow, they again greatly raised and developed new taxes. Added to other issues, this series of taxation schemes angered many in France who later banded together to overthrow the French monarchy during what became known as the French Revolution.
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