Galbraith on John Law and the Mississippi Bubble

Reposted as single post 10-7. Already posted in Notes 03-26

When Banks Will Be Banks

Name the event -- 9-11, terrorism, the Chinese economy, global warming, one banking crisis or another -- each motivates its own little publishing industry. uthors write and publishers publish, eager to meet the demands for new knowledge. The financial crisis got people thinking about recessions, depressions, credit default swaps, mortgages, and financial markets, and we now can chose among all the best sellers, "The Subprime Solution..", and "The New Paradigm for Financial Markets..", "The Trillion Dollar Meltdown..","The Forgotten Man", "The Ascent of Money..", "The Return of Depression Economics.." -- more titles everyday. These new books are intriguing and fun, and they'll hopefully help the floundering publishing industry keep its head above water.

But really, when it comes to banking, you don't have to buy a new book, you can just as well read an older one, such as John Galbraith's 1975 "Money: Whence it Came and Where it Went". The book works its way from the Mississippi Bubble to the Bank of England, through the history of the American monetary system up until 1971, with plenty of insights for today's banking woes. Many people have heard of the Mississippi Bubble and its architect, John Law, but I especially like Galbraith's telling.

John Law moved to France in 1716, fleeing a murder charge after dominating a duel in England. Law had inherited a fortune and won even more as a gambler. In France, Law set up a bank and began to issue guaranteed notes, something that France appreciated. The country found Law's entrepreneurial effort a great solution to its fiscal insolvency, having gone broke under the reign of Louis XXVI. With Law's notes, which he instituted in lieu of the gold, standard, France paid its bills and Law's bank flourished. His bank issued more and more notes.

Law then decided to issue notes for a land bank in what was the large land mass of Louisiana. Rumor had it that America's southern swamps were filled with gold. Buoyed by the fame his bank brought him, Law also turned his efforts to economic and social reform. He lobbied to get rid of tolls and tariffs and rallied the clergy to give unused land to peasants.

Wrote Galbraith (28):

"The miracle of money creation by a bank, as John Law showed in 1719, could stimulate industry and trade, gave almost everyone a warm feeling of well-being. Parisians had never felt more prosperous than in that wonderful year."

Law's economic plan began to unravel along with the first bank, when one day one of his note-holders decided they wanted their gold. They cashed in their notes. Then others cashed theirs. Then more and more people got nervous about whether the bank had enough gold to meet all its obligations.

To restore confidence, the government recruited slum-dwellers to march through the streets of Paris with picks and shovels, as if gold really had been found in Mississippi and France was dispatching miners to ships that would sail off to America and cart gold home. No sooner were folks were paraded through the town to the docks, however, when villagers found them back at home in the ghettos -- people got wise to the ruse. The giant scheme caved, leaving note-holders with nothing but songs and bitter ditties to sing. As Galbraith writes (p28):

"...Here, in the briefest form, was framed the problem that was to occupy men of financial genius or cupidity for the next two centuries: How to have the wonder without the reckoning?"

Some people think this version of Law's story is too harsh, and modern bibliographies are much more flattering to John Law's legacy then John Galbraith. Calling Law a forward thinking economist, Antoin E. Murphy wrote in a recent book, "John Law: Economic Theorist and Policy-Maker":

"just as Napoleon cannot be judged by his defeat at Waterloo, so also the theory and policy of Law should not be judged by the financial crash of 1720."

Napoleon historians would no doubt dispute the comparison too.

Galbraith was a Keynesian, and it's not clear that his opinion of John Law, that fit his opinion of bankers in general, would have been changed by the recent, more favorable bibliographical accounts. Here's his 1970's impression of the banker community (p302):

"[I]n money matters as in diplomacy, a nicely conformist nature, a good tailor and the ability to articulate the currently fashionable financial cliche have usually been better for personal success than an inquiring mind....failure is often a more rewarding personal strategy than success."

His judgement derived from the belief, simply, that economic and monetary systems can be well managed.

"There is reluctance in our time to attribute great consequences to human inadequacy -- to what, in a semantically less cautious era, was called stupidity. We wish to believe that deeper social forces control all human action....But we had better be aware that inadequacy --- obtuseness combined with inertness --- is a problem..."

How would he have felt about the current crop of bankers (p303)?

"It will be no easier in the future than in the past for layman or the lay politician to distinguish between the adequate individual and the others. But there is not difficulty whatever in distinguishing between success and failure. Henceforth it should be the simple rule in all economic and monetary matters that anyone who has to explain failure has failed. We should be kind to those whose performance has been poor. But we must never be so gracious as to keep them in office."

He would most likely not have been any more charitable to those who architected our current economic mess then he was to the bankers of his day. There's no substitute for his insights though.

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