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Law's System

LAW'S SYSTEM

LAW'S SYSTEM. A prophet of a modern credit-based economy, operating free of ties to metal currency, John Law (16711729) was born into a commercial family in Edinburgh, Scotland. After a rakish sojourn in London, where he narrowly escaped the hangman's noose, Law succeeded in Europe as a professional gambler, thanks to his grasp of probability theory. He also studied economics and argued in learned treatises that paper instruments should replace gold and silver as money. Only an economy free to expand its currency and fueled by credit could develop significantly. In Paris he befriended Philippe, duke of Orléans (16741723), himself a gambler as well as the nephew of King Louis XIV (ruled 16431715). When Philippe became regent of France, he turned to Law for help with the financial effects of twenty-six years of war, an empty treasury, and mountainous state debt.

Law perceived that these problems could be solved in association with each other. He planned to turn the debt into equity or shares of stock and to make the shares into paper currency, demonetizing gold and silver coin while simultaneously expanding credit. An economy thus oriented to growth would, in his view, lift itself free of debt.

Between 1716 and 1719, he created France's first national bank, the Royal Bank, and a powerful conglomerate, the Company of the West, or Mississippi Company, merging them in 1720. The former, based in Paris, established branches throughout the realm, taking in tax revenues as deposits and issuing negotiable banknotes. The latter sold shares of stock, also negotiable. It controlled tax revenues, the royal mint, and commerce with Africa, Asia, and the Americas. It assumed the state debt, turning creditors into shareholders and liabilities into assets. To encourage the public to buy company shares, some of which paid dividends of 12 percent, Law dropped interest rates to 2 percent, from 5.55 percent, a blow to fixed annuities. These elements, along with sharp restrictions on the monetary use of gold and silver, became his system.

After initial hesitations, the investing public reacted favorably. In January 1720, a share of company stock, having long since climbed nicely from its initial price of 550 livres, peaked at 10,100 livres, a real stock-market boom. Euphoric buyers, emboldened by easy credit, anticipated a share price of 20,500. Some of them became, if only briefly, "millionaires," a word coined at the time. The system took on the aspects of a Europe-wide miracle. But when Law, deeming shares overvalued, acted to reduce their price, investors turned against him in fury, and the shares tumbled in value, compromising the bank and the company. A rueful John Law left France in December 1720 and died in Venice in 1729.

Amid the ruins of the system, the state emerged as a net gainer, having lightened its debt load: urban workers, victimized by inflation, were the primary losers. The experience turned France against paper money for almost two centuries and gave historians a low opinion of the system, until recently. In the twentieth century, however, the global economy developed in the growth-oriented ways that Law anticipated, with regard to a credit base, the importance of the quantity of money, and its freedom at long last from specie.

See also Banking and Credit .

BIBLIOGRAPHY

Faure, Edgar. La banqueroute de Law, 17 juillet 1720. Paris, 1977.

Hamilton, Earl J. "Prices and Wages at Paris under John Law's System." The Quarterly Journal of Economics 51 (1937): 4270.

Kaiser, Thomas E. "Money, Despotism, and Public Opinion in Early Eighteenth-Century France: John Law and the Debate on Royal Credit." Journal of Modern History 63 (March 1991): 128.

Murphy, Antoin E. John Law: Economic Theorist and Policy-Maker. Oxford and New York, 1997.

John J. Hurt

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