The Mississippi bubble is one of the biggest asset bubbles known to the modern world. This bubble first led France out of bankruptcy and straight into prosperity. Then this same bubble caused the opposite to happen, bankrupted France and gave an impetus to the revolution.
This bubble was created when John Law, a renegade Scotsman unleashed a fraudulent fiat banking system on an unsuspecting economy. Since the world had been on a gold standard, they were unaware of the devastation that fiat money could cause if it was left uncontrolled. In this article, we will cover the story of the remarkable rise and fall of the Mississippi bubble.
Louis the XIV: The story starts with King Louis the XIV. He was known for his opulent lifestyle. He had built several magnificent castles all over France. However, there was a problem with these castles. They were all made using borrowed money. When Louis the XIV died, he left the throne of France extremely indebted and with no source of income to pay off the debt. France was technically bankrupt and the king succeeding Louis the XIV was a 5 year old boy leaving the matters in the hands of one of the royals, the Duke of Orleans who was acting as the regent advisor for the young king.
An unknown person back then, John Law presented an idea to the Duke of Orleans that would help them get rid of the debt almost overnight. This idea which would later lead to the demise of the French economy had two major steps. They are explained below.
- Fiat Currency Introduced: Firstly, John Law convinced the Duke of Orleans to introduce fiat currency in the system. This meant establishing a state-owned bank that would take in gold and give out paper receipts. The receipts could technically be redeemed for gold on demand. However, such a situation would seldom arise. John Law convinced the Duke that such a system would enable the state to make loans to the budding entrepreneurs with money that they did not have, collect interest on such nonexistent loans and pay off the debt owed. The Duke of Orleans seemed to like the plan, and fiat currency was introduced in France.
- Mississippi Company: The second step was to create a excited company called the Mississippi Company. This company would be given a royal charter which provided them with the exclusive privileges of conducting trade with Louisiana region of the United States which was then a French colony. Because trade with the East Indies had brought riches to Europe, the public opinion was that trade with the United States would result in similar riches. Hence there was considerable hype around the Mississippi Company, and when people were given the option to exchange their debt for shares in this company, most people grabbed the offer with both hands.
Prices Inflated With Fiat Currency
One of the benefits of the co-existence of Fiat money and newly created shares was that John Law could just inflate the stock prices at will. Whenever the stock prices started cooling down, John Law would create more fiat money. A significant portion of this newly created money would reach the shares of the Mississippi Company thereby raising its price and creating the illusion of a successful company. In reality, the company was performing badly. The Louisiana colony in the United States was nothing except a swamp, and there was no way that it would lead to riches. However, John Law used the Louisiana illusion to keep the prices of the Mississippi Company inflated.
Paper Money Withdrawal
The Mississippi bubble was then based on the existence of fiat money that would prop up the prices which would cause the people to buy more shares propping up the prices even further. However, some people got wind of the fact that the government�s bank was giving out more receipts than there was gold in the system. Hence they turned up to make withdrawals. As the banks could not come up with payments easily, lot of people started demanding their gold and bank runs started taking place. This led to a fall in the belief of the strength of the paper money system in France, and people went back to trading with gold as the standard currency. The Duke of Orleans even tried to outlaw the usage of gold at the behest of John Law. However, the economic system failed to expose the inherent duplicity and insolvency that it was made up of.
Collapse of Mississippi Company
Once the government could not create money out of thin air to raise the stock prices of Mississippi Company, the shares started collapsing. John Law had also become a much-hated figure. As a result of this, the Mississippi Company�s lies stood exposed in front of the public. Once the population realized that the most profitable entity in France was bankrupt, they started dumping their shares turning them worthless almost overnight. Many fortunes were lost as a result of the blatant duplicity that John Law had proposed.
The Mississippi bubble was, therefore, an earlier version of the get rich quick schemes that we see today. It ended up causing one of the biggest rags to riches and back to rags story that the world has known.