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wars float financial
bubbles
When new
money is printed, its effect is not felt instantaneously.
The
effect moves from a networked individual to another networked individual and
thus from a networked market to another networked market.
Monetary
pumping generates bubble activities across all market sectors.
When the bank tightens its monetary
stance by reducing monetary pumping bubble activities are undermined and
those bubbles burst.
Since monetary pumping generates bubble activities
across all markets, obviously the eventual bursting of the bubbles will
permeate all markets.
"A Satire of Tulip Mania" by Jan Brueghel the
Younger (ca. 1640)
depicts speculators as brainless monkeys in contemporary
upper-class dress.
tulip mania bubble February 1637 At the peak of tulip mania
tulip futures contracts are selling for more than 10 times the annual income of
a skilled craftsman.
Tulip mania or tulipomania (Dutch: tulpenmanie,
tulpomanie, tulpenwoede, tulpengekte, and bollengekte) was a period in the
Dutch Golden Age during which contract prices for bulbs of the recently
introduced tulip reached extraordinarily high levels and then suddenly
collapsed.
The Mosaic virus created beautifully varigated blooms spread
only through buds, not seeds, and so cultivating the most appealing varieties
takes years.
But propagation is greatly slowed down by the Mosaic
virus.
Tulips bloom in April and May for only about a week, and the
secondary buds appear shortly thereafter.
Bulbs can be uprooted and
moved about from June to September, and thus actual purchases (in the spot
market) occurred during these months.
During the rest of the year,
traders signed futures
contracts before a notary to purchase tulips at the end of the
season.
The futures contract
promises to guarantee
delivery of specificied assets, in this case tulip bulbs, on a specific
date for an agreed upon fixed price.
Short selling is banned by an edict of 1610,
which is reiterated or strengthened in 1621 and 1630, and again in
1636.
Short sellers were not prosecuted
under these edicts, but their contracts are deemed unenforceable.
1636 Dutch create a type of formal
futures market where contracts to buy
bulbs at the end of the season are bought and sold.
Traders met in
"colleges" at taverns and buyers were required to pay a 2.5% "wine money" fee,
up to a maximum of three florins, per trade.
Neither party paid an
initial margin nor a mark-to-market margin, and all
contracts were with individual counterparties rather than the exchange.
No deliveries were ever made to fulfill these contracts because of the
market collapse in February 1637.
On February 24, 1637, the
self-regulating guild
of Dutch florists, in a decision
that was later ratified by the Dutch Parliament, announced that all
futures contracts written
after November 30, 1636 and before the re-opening of the cash market in the
early Spring, were to be interpreted as
call option contracts,
or options to purchase in the
future.
This change of law was done at the behest of major Dutch
tulip investors who were trying to recoup lost money because of a German
setback in the
Thirty Years' War.
They simply relieved the futures
purchaser of the requirment to purchase if they paid a small fixed percentage
of the contract price as a default on the failure to purchase.
An option
contract purchases the right to buy an asset at a date in the future at an
agreed upon price.
This trade was centered in Haarlem during the height
of a bubonic plague epidemic, which
may have contributed to a culture of fatalistic risk taking.
the Mississippi bubble
"Imagine the following: a collection of debts owed
by a highly leveraged borrower with
a bad credit record is magically transformed into
marketable securities with triple-A yields.
How is this miracle performed?
It is through the power of
financial innovation and free capital markets!
It could be the story of
subprime mortgages in the US; but it is not.
It is the story of government debt in France in the early 18th century.
In 1719-20, a
financial whirlwind swept through France.
Shares in the Compagnie
d'Occident, or the Mississippi Company, rose 1,000 per cent and then fell by 90
per cent in less than two years.
The story illuminates current events."
- James Macdonald, Financial Times (London) March 6, 2008 HOW THE FRENCH INVENTED SUBPRIME IN
1719
By the end of the War of Spanish
Succession in 1714 public debt had risen to over 100 per cent of national
income and was subjected to forced reductions of interest and principal.
Confidence collapsed.
Government bonds sold for discounts of up
to 75 per cent.
Louis XIV, the "Sun King," had consolidated French
power in Europe but the Nine Year War and the War of Spanish Succession had
effectively bankrupt France by 1715 the year of Louis XIV's death.
France defaulted on its debt, high taxes burdened the country and the
value of gold and silver currency fluctuated wildly.
Louis XV turned to
the Duke of Orleans who hired John Law, a Scottish adventurer, economic
theorist, and financial wizard/engineer.
The
charismatic John Law
lived by his wits at the gambling
table and had never held any post related to public finance.
The
government would issue a new series of bonds, paying only 3 per cent in
exchange for its old debts which paid 4-5 per cent, in exchange for shares in
the Mississippi Trading Company, which held monopoly trading rights to the
French colonies.
For the government, the cost of servicing the debt
would fall sharply and the budget would look rosier.
The trading rights
to the French colonies were largely worthless, for there were no profits at the
time and the Mississippi Company had existed for a while without exciting
public interest.
The market for government debts was moribund.
John Law's aim was to make Mississippi shares as actively traded as
possible.
This provided an incentive
to swap - to get a more liquid security and the prospect of speculative
gains.
John Law repackaged a collection of "subprime" debts as
marketable securities under a different name and thereby increased their
investor appeal.
Law claimed that Mississippi shares would be so
actively traded that they would constitute "a new form of money."
For
this governmnet debt reduction plan to succeed a new bank must be founded to
provide a massive monetary stimulus of easy money to get bond holding creditors
to convert government bonds into Mississippi trading company shares.
1716 John Law established the Banque
Générale, a bank with the authority to issue fiat bank notes.
In 1717 John Law established the Compagnie d'Occident ("Company of the
West") and obtained a 25-year monopoly to develop the vast French territories
in the Mississippi River valley of North America.
Compagnie d'Occident
soon monopolized the French tobacco and African slave trades, and by 1719 the
Compagnie des Indes ("Company of the Indies"), as it had been renamed, held
a complete monopoly of
France's colonial trade.
John Law took over the collection of French
taxes and the minting of money.
In effect, John Law controlled both the
country's foreign trade and its finances.
An effective marketing scheme
was developed describing the Compagnie des Indes as a future profit generator
due to its monopolistic controls of the exaggerated wealth of Louisiana.
This marketing scheme sent the price for a share from 500 to 10,000
livres , completely out of all proportion to earnings.
The debt was
exchanged and became worth many times its previous value as Mississippi shares
continued their dizzying ascent.
The economy recovered and everyone was happy -- even though the
underlying reality was an unsustainable credit-driven boom.
1719 John Law had issued approximately 625,000 stock shares,
and he soon afterward merged the Banque Générale with the
Compagnie des Indes.
The Compagnie bought the right to collect all
French indirect taxes, took over the collection of direct taxes, purchased the
right to mint new coinage.
The center piece of this financial plan was
the retirement of Louis XIV's debt.
Shares of the Compagnie des Indes
were exchanged for state-issued public securities, or billets d'état,
which consequently also rose sharply in value.
The French government
debt, 1,000% of the annual budget, became property of the Compagnie des Indes.
The French government takes advantage of this situation by printing
increased amounts of paper money, which was readily accepted by the state's
creditors because it could be used to buy more shares of the Compagnie.
The underlying assets of the Mississippi Company were still
questionable royal debts that did not provide enough income to pay its promised
dividends.
Excessive issue of paper
money stimulated galloping inflation, and both the
paper money and the billets
d'état began to lose their value.
Moreover, like many
holders of collateralized debt obligations,
speculators in Paris relied heavily on borrowed money.
The rise in
Mississippi shares is reversed.
Shareholders find themselves holding
toxic debt.
1720 The value of the shares of the Compagnie plummeted,
causing a general stock market crash in France and other countries.
Financial engineer John Law is forced to flee France.
The
debts of his company and bank were consolidated and made good by the state
which raised taxes in order to retire the debt.
South Sea
bubble 1711
South Sea Company, a joint stock incorporation is granted a monopoly to trade
in the South American colonial possessions of Spain as part of a treaty during
the War of Spanish Succession.
The South Sea Company assumes the
bonded debt England
incurred during the war in return for the monoploy.
The primary trading
business of the South Sea Company was transporting slaves from Africa to
America.
South Sea Company proposed a scheme by which it would assume
half the bonded debt of
Britain (£30,981,712) with new shares and contractually promises to the
government that the debt will be converted to a lower interest rate, 5% until
1727 and 4% per year thereafter.
The purpose of this is to allow
a conversion of high-interest bonded debt into low-interest marketable debt
as shares of the South Sea Company.
The South Sea Company market the
stock with "the most extravagant rumours" of the value of its potential trade
in the New World.
A frenzy
of wild speculation ensues leading to the South Sea Bubble.
1720 The share price rises from £128 in January to
£890 in early June even though trade with Spanish colonies is limited to
one ship carrying not more than 500 tons of cargo and the slave trade.
When the speculative adventure collapsed the estates of the directors
of the incorporation are confiscated and used to repay some creditors, and the
stock of the South Sea Company is divided between the major creditors - the
Bank of England and
British East India
Company.
In summation all three
of these speculative run-ups in the value of tulip bulbs or 'stock' was caused
directly by war.
Tulip investors were trying to recoup loses from
betting on Germany winning the Thirty Years War while both the South Sea and
Mississippi bubbles were designed to retire onerous government debt due
primarily to the expenses involved in the War of Spanish Succession.
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