The eighteenth century was decisive for the history of the economy in the West, the first general bank that would operate in France was created; based on a business system implemented in the Netherlands. But just as the French economy grew thanks to this structure, they also knew what a crisis was, thanks to the Mississippi Company, that would turn into what we know today as the Mississippi bubble.

What is the Mississippi bubble?

The Mississippi Company became one of the biggest asset bubbles of modern times which led a country out of its bankruptcy to prosperity, only to return it to the state of bankruptcy in which it had started. 

Historical Context of the Mississippi Bubble

John Law was a great economist but also a gambler who gambled his life away on many occasions. He spent his days running away from debts and problems caused by his gambling addiction, thus traveling through several European countries.

In the Netherlands he got to know the Dutch East India Company and the first central bank; there he observed how coins were exchanged for credit certificates that proposed a commercial system different from what had been seen so far. Law was fascinated with the procedure and soon realized that the system could be improved.

The year 1715 arrived, and in France Louis XIV had just died. The state finances were bankrupt, the royal debts were 3,000 million pounds (for the wars caused by Louis XIV), the annual income 145 million, and the expenditure 142 million, and the country was close to its third bankruptcy in less than a century. 

The Duke of Orleans had been appointed regent of the seven-year-old Louis XV. 

Meanwhile, in the Netherlands they were creating the first central bank, paper money was being used and they had created the national lottery. 

It could be said that it was the country with the new economic vanguard and they had maritime companies that brought a great number of spices from Asia and America, it was a very profitable business but very risky and the population was already investing in these companies by means of shares in a stock market.

John Law

Law arrived in France amid this context and upon his arrival, he realized that the French currency was very depreciated. In 1713 they had just depreciated it to its fifth part and they were thinking of doing it again. Taxes were impossible to collect and even if they fined the population, the citizens no longer cared. 

Law presented himself to the Duke of Orleans in 1716 to help the country economically, saying that the problem was that there was not enough currency in circulation. 

From that moment of the French crisis, the Private General Bank of France was created in 1716, directed by Law and who developed paper money for its coffers; three-quarters of the capital came from government bills and the rest from interested individuals. 

This money was backed by the gold and silver standard that was circulating in France at the time.

So the population went to their bank to hand over their coins and in exchange, they were given paper money. In this way, the government collected the currency to pay its debt and the paper money would really reactivate the nation's economy. 

In April 1717 he succeeded in getting his paper money accepted to pay taxes and state revenues in bank bills, of which Law was the sole issuer. The bills were raised at a nominal premium of 15% over coins in one year.

The problem was that there was no limit to the printing of this paper money, at this time everything was healthy because only paper money was printed with the counter value of the coinage, but with Law's second plan, this began to get out of control. 

Creation of the Mississippi Company

In 1717 Law created the Company of the West or the Mississippi Company, with which the French state gave him control of the existing business with the colony of Louisiana. Soon the word spread that this region had a lot of potential with the exploitation of its metals; a fact that led to the sale of shares and state bonds by the Company. In this way, the State would be refinanced and Law would become a millionaire.

In 1718 the Company acquired the tobacco trade monopoly with Africa, which Law used to increase the capital flow of his company and extend the empire he was creating. Sometime later, he obtained financial control of the business done with China and the East Indies; that is why he changed its name to Company of the Indies and was appointed director of the company Compagnie de la Louisiane ou d'Occident. 

How the Mississippi bubble formed

Having this empire built, Law could not contain his ambition for money; so he promoted the Company very well. Investors saw in that publicity an opportunity to make huge profits in a short time, thanks to mining.

The shares were initially priced at 500 livres, but soon after they had reached 18,000 pounds, producing an increase of 3,500% per year. By 1720 the Mississippi Company had merged commercially with the General Bank of France; printing a larger quantity of bills and coins than the backing granted. 

How much was the Mississippi Company Worth?

There was a time when the Mississippi Company was worth more than the entire French GPD. 

Law controlled the printing of bills to make his company's stock go up. The shipping company was not creating any wealth, it was on the verge of bankruptcy as a business in Mississippi was challenging because of the deadly diseases there and the land was swampy, not fertile. His workers were dying on those lands, running out of labor and product. 

How the Mississippi Bubble Popped

By December 1719 when the shares were already worth 10,000 pounds many shareholders thought to return the shares to enjoy the 10% return but Law had no money. The first thing he did was to create a dividend for these shares with a value of 200 pounds. 

This stopped a massive sale but some shareholders decided to return the shares to receive the 10%, Law then used the money of the new investors to pay them, this is known as a ponzi scheme, then created new shares to have new capital and get out of trouble.

In what year did the Mississippi Bubble Burst?

The Mississippi Company's bubble burst at the end of 1720; when the stock began to fall, its investors decided to exchange their bonds for gold. To control capital flight, John Law limited payments in gold to a maximum exchange amount of 100 pounds and converted the paper money into legal tender; with it, the holders could pay taxes and settle debts. 

Faced with the difficulty of acceptance, the Royale Bank (so called after its merger) promised to exchange the bills for shares in the Company; at a price of 10,000 pounds. This decision resulted in an increase of money in circulation in France and runaway inflation; with a monthly rate of 23%. During several stages, Law devalued the currency down to 50% of its nominal value. 

How long did the Mississippi bubble last?

The Mississippi bubble had risen and fallen in just two years, from 1718 to 1720. 

Why did the company fail?

Faced with this debacle, Law fled France and his detractors took over the Company by seizing his shares.  He had been too ambitious. His aim to replace gold and silver with paper currency led to the titanic failure of the company. In 1722, after a severe reorganization, the company was functional and operational again.