2007 97 1 Part2 279
Dalmacio Reese
The Rise and Fall of John Law's System: An Analysis of 2007 97 1 Part2 279 by François R. Velde
John Law was a Scottish economist and financier who lived in the 18th century. He is best known for his role in creating and managing the Mississippi Company and the Banque Royale in France, which were part of his ambitious plan to reform the French economy and finance. His plan, known as the System, involved issuing paper money backed by land and shares, expanding trade and colonization, and stimulating economic growth and development. However, his System also led to a massive speculative bubble and a subsequent crash that ruined many investors and caused a financial crisis in France.
In this article, we will analyze 2007 97 1 Part2 279, a paper by François R. Velde that evaluates John Law's System and its impact on the modern economy. Velde is a senior economist and research advisor at the Federal Reserve Bank of Chicago. He has written extensively on monetary history and theory, especially on John Law and his System. His paper was published in the American Economic Review in May 2007.
What are the main features of John Law's System?
John Law's System had three main features: paper money, central banking, and securitization. Let us explain each of them briefly.
- Paper money: Law proposed to replace the existing metallic coins with paper notes that would be issued by his Banque Royale (Royal Bank), which he founded in 1716. The paper notes would be backed by land and shares of the Mississippi Company, which he also founded in 1717. The Mississippi Company was a trading and colonization company that had exclusive rights to exploit the vast territories of Louisiana in North America. Law believed that paper money would increase the money supply, reduce interest rates, and facilitate trade and commerce.
- Central banking: Law's Banque Royale was the first central bank in France. It had the monopoly of issuing paper money and regulating its value. It also acted as a lender of last resort to other banks and financial institutions. It also provided loans to the government and the public at low interest rates. Law hoped that his Banque Royale would stabilize the financial system, support the fiscal policy, and promote economic development.
- Securitization: Law's Mississippi Company was the first securitization scheme in France. It involved issuing shares that represented claims on the future profits of the company's activities in Louisiana. The shares were initially sold at a low price to attract investors, but their value soon soared as more people bought them in anticipation of high returns. Law also encouraged investors to exchange their land, gold, or government bonds for shares of his company. He hoped that his Mississippi Company would increase the wealth of France, reduce its public debt, and expand its trade and colonization.
What are the main achievements of John Law's System?
John Law's System had some remarkable achievements in its initial phase. Some of them are:
- It increased the money supply and reduced interest rates in France, which stimulated economic activity and growth.
- It reduced the public debt of France by converting it into shares of the Mississippi Company, which improved the fiscal situation and creditworthiness of the government.
- It created a stock market boom that enriched many investors and increased their consumption and investment.
- It enhanced the financial innovation and sophistication in France by introducing new instruments and institutions such as paper money, central banking, securitization, portfolio diversification, etc.
- It expanded the trade and colonization of France by establishing new settlements and businesses in Louisiana and other parts of North America.
What are the main failures of John Law's System?
John Law's System also had some disastrous failures in its later phase. Some of them are:
- It created a speculative bubble that inflated the value of paper money and shares beyond their intrinsic worth, which made them vulnerable to sudden shocks and fluctuations.
- It caused inflation and currency depreciation in France, which eroded the purchasing power and confidence of the public.
- It faced political opposition and legal uncertainty from various groups such as nobles, clergy, parliament, courts, etc., who resisted or challenged Law's authority and policies.
- It suffered from asymmetric information and moral hazard problems between Law, his Banque Royale, his Mississippi Company, and their investors and creditors.
- It collapsed in 1720 when a panic ensued among investors who tried to sell their paper money and shares for gold or land, which triggered a bank run, a stock market crash, and a financial crisis in France.
How does John Law's System compare with the modern economy?
John Law's System was a pioneering attempt to create a modern economy based on paper money, central banking, and securitization. It had many similarities and differences with the current economic system. Some of them are:
- Similarities: Both systems use fiat money that is not backed by any commodity, but by the authority and credibility of the issuer. Both systems rely on central banks to regulate the money supply and interest rates, and to act as lenders of last resort in times of crisis. Both systems employ securitization to transform illiquid assets into liquid securities that can be traded in financial markets. Both systems aim to promote economic growth, stability, and development by facilitating trade, investment, and innovation.
- Differences: Law's System was based on a single bank and a single company that had monopolies over money issuance and trade respectively. The modern system is based on a network of multiple banks and financial institutions that compete and cooperate with each other. Law's System was controlled by one person who had absolute power and discretion over monetary and fiscal policy. The modern system is governed by laws, rules, and institutions that limit and balance the power and discretion of policy makers. Law's System was isolated from the rest of the world and had little interaction with other countries or regions. The modern system is integrated and interconnected with the global economy and faces various external shocks and challenges.
What are the main lessons of John Law's System for the modern economy?
John Law's System was a remarkable experiment that had both positive and negative outcomes for the French economy and society. It also had a lasting impact on the history of economics and finance. It offers some valuable lessons for the modern economy, such as:
- The benefits and risks of paper money: Paper money can be a useful tool to increase the money supply, reduce interest rates, and facilitate trade and commerce. However, paper money can also cause inflation, currency depreciation, and loss of confidence if it is issued excessively or without proper regulation.
- The importance and challenges of central banking: Central banking can be an effective instrument to stabilize the financial system, support the fiscal policy, and promote economic development. However, central banking also faces various difficulties and dilemmas such as maintaining its independence, credibility, and accountability; balancing its multiple objectives and functions; and coordinating its actions with other policy makers.
- The potential and pitfalls of securitization: Securitization can be a beneficial technique to increase the liquidity, efficiency, and diversity of financial markets. However, securitization can also create problems such as asymmetric information, moral hazard, market manipulation, and systemic risk if it is not transparent, regulated, or supervised adequately.
What are the main sources and references for John Law's System?
John Law's System is a fascinating and complex topic that has attracted the attention and interest of many historians, economists, and scholars. There are many sources and references that can provide more information and insights on John Law's System. Some of them are:
- Primary sources: The most important primary source for John Law's System is Law's own writings, especially his Money and Trade Considered: With a Proposal for Supplying the Nation with Money (1705), which outlines his economic theory and policy. Other primary sources include Law's letters, reports, edicts, and pamphlets; contemporary accounts, memoirs, and chronicles by witnesses, participants, and critics of Law's System; official documents, records, and statistics from the French government, the Banque Royale, and the Mississippi Company; newspapers, journals, and gazettes that reported on Law's System; and artistic representations such as paintings, prints, medals, and caricatures that depicted Law's System.
- Secondary sources: There are many secondary sources that analyze and evaluate John Law's System from various perspectives and disciplines. Some of the most influential and authoritative works are: Antoin E. Murphy, John Law: Economic Theorist and Policy-Maker (1997), which provides a comprehensive and balanced biography of Law and his System; François R. Velde, John Law's System (2007), which uses modern economic theory and evidence to assess Law's System and its performance; Larry Neal, The Rise of Financial Capitalism: International Capital Markets in the Age of Reason (1990), which places Law's System in the European context of 1720 and traces its links with other financial schemes and bubbles; Charles P. Kindleberger and Robert Z. Aliber, Manias, Panics, and Crashes: A History of Financial Crises (2005), which compares Law's System with other episodes of financial instability and crisis; William H. Goetzmann et al., eds., The Origins of Value: The Financial Innovations that Created Modern Capital Markets (2005), which explores the financial innovations and institutions that emerged from Law's System.
Conclusion
John Law's System was a radical and visionary experiment in monetary policy and finance that anticipated many modern concepts and practices. It involved issuing paper money backed by land and shares, creating a central bank and a trading company, and securitizing assets and debts. It aimed to reform the French economy and finance, reduce the public debt, and expand the trade and colonization. It had some remarkable achievements in its initial phase, such as increasing the money supply, reducing interest rates, stimulating economic growth, reducing the public debt, creating a stock market boom, and enhancing financial innovation. However, it also had some disastrous failures in its later phase, such as creating a speculative bubble, causing inflation and currency depreciation, facing political opposition and legal uncertainty, suffering from asymmetric information and moral hazard problems, and collapsing in 1720 when a panic ensued among investors who tried to sell their paper money and shares for gold or land.
John Law's System had a significant impact on the French economy and society, as well as on other countries and regions. It also had a lasting influence on the history of economics and finance. It offers some valuable lessons for the modern economy, such as the benefits and risks of paper money, the importance and challenges of central banking, and the potential and pitfalls of securitization. It also raises some interesting questions for further research, such as what would have happened if Law had adopted a different strategy or policy or if he had faced a different environment or situation.
In this article, we have analyzed 2007 97 1 Part2 279, a paper by François R. Velde that evaluates John Law's System and its impact on the modern economy. We have also provided some sources and references for more information and insights on John Law's System. We hope this article has helped you to understand the main features, achievements, failures, implications, and lessons of John Law's System.
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