wars float financial
"When new money is created, its effect is not felt
instantaneously across all market sectors. The effect moves from one individual
to another individual and thus from one market to another market. Monetary
pumping generates bubble activities across all markets as time goes by. Once,
however, the bank tightens its monetary stance, i.e. reduces monetary pumping,
this undermines various bubble activities. The bubble bursts. Since monetary
pumping generates bubble activities across all markets, obviously the eventual
bursting of the bubbles will permeate all markets." - Frank Shostak
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.
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, in fact, the story of government debt
in France in the early 18th century.
a financial whirlwind even
more dramatic than anything witnessed today 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.
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 and
government paper sold for discounts of up to 75 per cent and the economy was in
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 economy and the value of gold and silver currency
fluctuated wildly. Louis XV turned to, the Duke of Orleans who turned to John
Law, a Scottish adventurer, economic theorist, and financial wizard/engineer.
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. In other words, 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
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. John Law's company 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 the 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
1719 John Law had issued
approximately 625,000 stock shares, and he soon afterward merged the Banque
Générale with the Compagnie des Indes. In 1719 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.
A frenzy of
wild speculation ensued that led to a general stock-market boom across
Europe. The French government took 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
debt obligations, speculators in Paris relied heavily on borrowed money.
The rise in Mississippi shares in 1719 was reversed in 1720 and the bewildered
French found themselves still holding subprime paper, merely relabelled toxic
1720 The value of the shares of the
Compagnie plummeted, causing a general stock market crash in France and other
countries. The financial engineer John Law was made the
scapegoat and was forced to flee
France. The enormous debts of his company and bank were soon afterward
consolidated and taken over by the state, which raised taxes in order to retire
the 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.
Speculation in corporate stock led
to a great economic bubble known as the South Sea Bubble in 1720.
primary trading business of the South Sea Company was transporting slaves from
Africa to America.
1719 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 then set to
marketing the stock with "the most extravagant rumours" of the value of its
potential trade in the New World which was followed by a wave of "speculating
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 were confiscated and used to
repay some creditors, and the stock of the South Sea Company was divided
between the major creditors - the
England and British East India
"A Satire of Tulip Mania" by Jan Brueghel the
Younger (ca. 1640)
depicts speculators as brainless monkeys in contemporary
tulipomania (Dutch names include 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.
At the peak of
tulip mania in
February 1637, tulip contracts sold for more than 10 times the annual income of
a skilled craftsman.
The mosaic virus spreads only through buds, not
seeds, and so cultivating the most appealing varieties takes years. Propagation
is greatly slowed down by the 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 contracts before a notary to purchase tulips at the end of the
season (effectively futures contracts).
Short selling was banned by an
edict of 1610, which was reiterated or strengthened in 1621 and 1630, and again
in 1636. Short sellers were not prosecuted under these edicts, but their
contracts were deemed unenforceable. In 1636, the Dutch created a type of
formal futures markets where contracts to buy bulbs at the end of the season
were 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
Neither party paid an initial margin nor a mark-to-market
margin, and all contracts were with the individual counterparties rather than
with 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 option contracts.
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
did this by simply relieving the futures buyers of the obligation to buy the
future tulips, forcing them merely to compensate the sellers with a small fixed
percentage of the contract 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
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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