EDMOND — Depending on your point of view, you may or may not be too happy with Fed Chairman Ben Bernanke and all the money printing going on at the Federal Reserve. Consider the story of John Law, the Scottish adventurer who, as France’s first central banker in the early 1700s, became the most powerful man in international finance — and the wealthiest man in the world — before having to flee penniless into exile and obscurity.

Law was born in 1671 to an Edinburgh goldsmith. Goldsmiths were the foundation of the early European banking system, performing basic deposit and lending functions; they would take deposits of gold and issue paper certificates that could be redeemed at any time for the gold they represented. Learning the basic tricks of the trade from his father, Law was exceptionally well positioned for a career in finance.

Law spent nine years on the run in Continental Europe after escaping England on murder charges, and amassed a small fortune before returning to Scotland. Scotland was in the midst of a financial crisis after a disastrous colonial venture in Panama that wiped out the savings of much of the country’s citizenry.

Law’s proposal to get the Scottish economy moving again — which was defeated by the Scottish parliament — was the issuance of paper money backed by the land owned by the government.

Monetary conditions in the wake of the crisis were extraordinarily tight. Given that there was a shortage of physical gold (as most of it was lost in the Panama debacle), banks and private citizens were hoarding what little cash they did have. The money supply was diminished and the velocity of money was in free fall. (Sound familiar? A collapse in the velocity of money is a common occurrence in nearly all post-bubble crises, and the American housing and debt crisis of 2008 was no exception.)

Law believed that paper money was preferable to gold or silver coinage for several reasons. Paper money is highly portable, making it more convenient than gold or silver as a medium of exchange and facilitator of economic activity. Unfortunately, paper money also can be printed at will, as we are learning all too well lately.

Law soon found a place for his ideas in France. Upon his death, Louis XIV had left France virtually bankrupt. Building Versailles and spending decades at war cost a lot of money — 3 billion livres, to be exact, while annual tax revenues were 145 million livres. Suffice it to say that France was a bad credit risk.

Because Louis XV was only a young boy when his father died, his uncle Philip II, the Duc d’Orleans, became the Regent of France. Philip was in a bind and was willing to try anything to avoid default and collapse. And John Law appeared to have the answer — the creation of new money by a powerful government-chartered bank that would be used to pay off the existing debts.

Law would issue stock in the new bank and would use the proceeds of the IPO to buy back government debt. He also would take deposits in coin but issue loans and withdrawals in paper. How is that for quantitative easing?

The rest of the story is quite complicated and too long for this column, but you can read more of the story in my newsletter on my Web site at www.nickmassey.com.

The short story is basically that the French government declared all taxes must be paid with notes issued by Law’s bank, thus making them legal tender. Law was then able to offer bank share exclusively in exchange for government bonds. Unbeknownst to the buyers, this retired much of the existing government debt, which the French government couldn’t pay anyway, for something of far worse credit quality.

Law built trust in his new paper money by making it redeemable for the full value in gold coin. His rhetoric worked and the French bought into the scheme. Of course, there was this little problem of not having anywhere near the amount of gold necessary to back up the paper, but Law figured nobody would ever call his bluff.

France might have prospered had Law stopped there, gradually paying off its debts through a mixture of economic growth and mild inflation, but he got cocky. To pay off the country’s remaining debts in one grand swoop, Law convinced Philip II to back a trading company with monopoly trading rights over the Mississippi River and France’s land claim in Louisiana.

Shares in the new company would be offered to the public, and investors would only be allowed to buy them with the remaining government bonds. So began the famed Mississippi Company Scheme.

The Mississippi Company was France’s answer to the Dutch East India Company, but with one critical difference: the Dutch company actually had profitable trading routes. (Who knew that you needed a profitable business model?) The French trading company had the mosquito-infested bog we today call Louisiana and little else.

The investors that piled in were buying shares in a company without any real business model, of course. How exactly Law intended to make money in Louisiana — a land of tepid swamps, not mountains of gold — was never fully explained. The Banque Generale proceeded to expand the money supply by 16 times its previous amount — by literally printing money — and later increasing it by even more. Suddenly, Ben Bernanke’s much maligned “QE2” would seem tame by comparison!

The entire scheme began to unravel when Law attempted to deflate the bubble. When French investors attempted to redeem their banknotes for gold, it quickly became obvious that there was not enough gold coinage to back the banknotes in circulation.

The bank stopped payment on the notes, the economy collapsed and Law was forced to flee the country in disgrace. Shares in the Mississippi Company fell all the way back to their issue price, destroying both the newly rich and the established order alike.

What lessons can we learn from this? One point on which nearly all market historians would agree is that the bigger the bubble, the bigger the bust that follows. Bubbles almost always return to the level at which they started. Share prices of the Mississippi Company rose from 500 livres to more than 10,000 livres before collapsing back to 500.

Perhaps the most important lesson would be that credit-fueled bubbles always end badly. Quantitative easing is dangerous and does not “fix” a bad economy. It does, however, generally lead to destabilizing asset bubbles. The quantitative easing following the “dot com” bust helped to create the conditions that made the housing and mortgage bubble possible.

And today, we have incipient bubbles in gold and food prices forming. Again, using history as a guide, the most likely outcome is a prolonged period of deflationary conditions and slow growth. Thanks for reading.



NICK MASSEY is a financial adviser and owner of Householder Group Financial Advisors in Edmond. Massey can be reached at www.nickmassey.com. Securities offered through Securities Service Network Inc., member FINRA/SIPC.