Financial Collapse of the John Law System Summary

  • Last updated on November 10, 2022

The fall of Scottish banker John Law’s Banque Générale and the collapse of his Mississippi Company in 1720 brought down France’s first national bank, ended serious attempts to modernize the state’s public financing and tax systems, and indirectly contributed to the massive debts that helped precipitate the French Revolution.

Summary of Event

Between 1716 and 1720, Scottish financier John Law tested a radical restructuring of France’s banking, tax, and colonial structure that came to be known as the Law System. In the space of less than four years, Law created a French central bank, the Banque Générale Banque Générale (France) (1716), introduced true paper currency, assumed responsibility for the state debt and for tax collection (1719), and monopolized the colonial trading companies (1719). The system failed when a speculative Speculation;economic frenzy in shares of Law’s Mississippi Company Mississippi Company led to the creation and collapse of a financial bubble in 1720. Although the system was a dismal failure in the short run, many of Law’s innovations were central to modern financial institutions. [kw]Financial Collapse of the John Law System (1720) [kw]System, Financial Collapse of the John Law (1720) [kw]Law System, Financial Collapse of the John (1720) [kw]John Law System, Financial Collapse of the (1720) [kw]Collapse of the John Law System, Financial (1720) John Law System [g]France;1720: Financial Collapse of the John Law System[0550] [c]Economics;1720: Financial Collapse of the John Law System[0550] [c]Organizations and institutions;1720: Financial Collapse of the John Law System[0550] Law, John Orléans, duc d’ Louis XV

The Law System was an emergency response to decades of mounting state debt National debt;France and currency Currency;devaluation in France manipulation in France. Under Louis XIV (r. 1643-1715), the Crown had regularly devalued the coinage in order to reduce its massive war debts. The state had also issued a wide variety of paper instruments that fulfilled some of the purposes of paper currency. Certificates and bills on the state, some of which carried interest, were tried as a fledgling form of official currency, and by 1704 the government was issuing bills unbacked by bullion. These too were repeatedly devalued by the government, however. By 1715, when the duc d’Orléans became regent for the minor King Louis XV, French finances Financial collapse;France were on the brink of collapse.

The regent, a daring if not very systematic thinker, realized that only radical reforms of the tax and financial system could break the dreary cycle of old-regime currency devaluations, bankruptcies, and show trials of financiers and tax farmers. He turned to John Law as the architect of reform. A charismatic gambler and economic theorist, Law had been trained by his father, a successful Edinburgh goldsmith and banker. Forced to flee London after killing a man in a duel, he used his mathematical skills to support himself at the gaming tables of Europe, where he met the future regent of France.

Law was not merely an adventurer: He ranks among the important preclassical economists who influenced the later eighteenth century economist Adam Smith. Smith, Adam In his treatise Money and Trade Considered with a Proposal for Supplying the Nation with Money Money and Trade Considered with a Proposal for Supplying the Nation with Money (Law) (1705), Law advanced the idea that the money supply should respond to the real needs of merchants for currency. “An addition to the Money,” he explained, “adds to the National Wealth.” His argument flew in the face of mercantilist Mercantilism theories that had been dominant in France since the time of controller general Jean-Baptiste Colbert. Colbert, Jean-Baptiste Mercantilists broadly viewed the wealth of the nation as being founded on a positive trade balance and on reserves of bullion. Law, much like Smith after him, was inclined to believe that wealth Wealth and economies was founded on the prosperity and productivity of the inhabitants and that the money supply could help grease the economic wheels.

With the confidence of Orléans in his proposals, Law swiftly and audaciously constructed the system that was to bear his name. By a royal edict of 1716, Law founded the Banque Générale, which had the privilege of printing banknotes. Banknotes The bank’s currency could be bought with old government notes or coins and quickly became more valuable than silver, since the bank committed to never devaluing its bills. By April, 1717, the regent, impressed with the bank’s success, made its notes legal tender for payment of taxes; this was the true mark of state confidence. Tax payments almost immediately improved, and bank branches flourished in Lyon, La Rochelle, Orléans, Tours, and Amiens.

Almost simultaneously, in August of 1717, Law applied to the Crown for a letter patent to take over management of Louisiana Louisiana Territory;and French economy[French economy] under the name of the Mississippi Company (or Company of the Occident). With exclusive trading privileges, Law proposed to exploit imaginary silver reserves on the banks of the Mississippi River. On the strength of that colonial acquisition, Law now appeared capable of a financial hat trick: creating paper wealth at home, finding silver to back it abroad, and opening the road to a radically new public financing structure for the French state.

Frantic speculators trade shares in John Law’s Mississippi Company.

(Francis R. Niglutsch)

Like magnets, the bank and the trading company swiftly pulled the rest of the French financial system into their orbit. In 1718, Law’s private Bank Générale became the Banque Royale, Banque Royale (France) the official Crown bank. In 1719, Law was granted sole monopoly for coining money, then shortly bought out the remaining French indirect tax farms from private hands, a feat that had seemed all but impossible for generations. By year’s end, Law absorbed the old Compagnie des Indes (French East India Company) French East India Company into the Mississippi Company. He now enjoyed a massive monopoly over trade Trade;banking Banking;and trade[trade] in China, the South Seas, and the East Indies. Flush with success, the bank assumed total responsibility for the state debt, buying out old loans and issuing new loans at 4 percent interest. By October, 1719, the last piece of the puzzle fell into place: The company took over collection of the direct taxes, Tax collection (France) or taille. When Law was elevated to controller general of France in 1720, the overthrow of the old system of public finance seemed complete.

Already by 1718, however, with the creation of the Banque Royale, the seeds of disaster had been planted. The duc d’Orléans, heedless of the dangers of inflation and eager to eliminate the state debt, commanded that both banknotes of the Banque Générale and shares in the Mississippi Company be issued far in excess of what Law had projected. Law had proposed the creation of 50,000 shares in the new Compagnie Française des Indes; the regent insisted on 300,000, as a frenzied public demanded more shares. Law’s private Banque Générale had issued 60 million livres in notes; in 1718, the regent ordered the printing of 1 billion livres in banknotes. France’s old elites swiftly arose in protest. The Parlement of Paris, the chancellor of France, and the general tax farmers and financiers who had traditionally collected revenues and made loans to the state united in opposition.

The collapse in 1720 was swift. As share prices for the company rose into the stratosphere, more banknotes were issued to keep pace with the price. Investors suddenly realized that there was neither bullion in France nor silver in Mississippi to back the currency, and prices collapsed. Law was allowed to go into exile in December, 1720, virtually penniless. The usual suspects were put on trial, and the regent, suffering perhaps the best fate, died in the company of his mistress in 1723. Although many lost money, there were winners, especially France’s small debtors, who had paid off mortgages and other debts with the inflated currency before it became worthless. By far the largest winner in the very short term was the French government, which was able to write off massive amounts of debt and to reduce interest rates during the debacle.

Significance

France’s lack of a national bank and of British-style public financing in the eighteenth century was a major source of political and international weakness. Throughout most of the period, the British government borrowed money at 4 percent or less, while the Dutch government could borrow at interest rates as low as 2 percent. By contrast, the French state was forced to borrow at often double those rates, topping out well beyond 7 percent. With the staggering war debts of more than 2 billion livres that France accumulated during the Seven Years’ War and the American Revolutionary War, the government was forced to spend ever-larger portions of annual revenue on interest payments. By the 1780’s, well over half of the state’s annual revenues were going to service the national debt, leaving the government without enough cash to cover its annual operating expenses.

The spectacular failure of Law’s system created such strong opposition to modern financial institutions that reforms were impossible until the French Revolution. Indeed, the French refused to use the discredited name banque for most financial institutions until the late twentieth century, preferring the term crédit. The government was forced to continue borrowing through powerful corporations, including the parlements, the provincial estates, and the guilds—groups that thus remained key stakeholders and opponents of any attempts at fiscal reform. Although farsighted in many of its ideas, the failure of Law’s system helped lock the French state into a debt spiral that ended in insolvency. The bankruptcy of Louis XVI’s government became one of the most crucial steps on the road to the French Revolution in 1789.

Further Reading
  • citation-type="booksimple"

    xlink:type="simple">Collins, James B. The State in Early Modern France. New York: Cambridge University Press, 1995. Illuminates seventeenth and eighteenth century French financial institutions in the context of statebuilding.
  • citation-type="booksimple"

    xlink:type="simple">Law, John. Money and Trade Considered with a Proposal for Supplying the Nation with Money. London: 1705. Law’s most readable treatise on the real value of money and the importance of the money supply.
  • citation-type="booksimple"

    xlink:type="simple">Marion, Marcel. Histoire financière de la France depuis 1715. Paris: Rousseau et Cie, 1927. An early but authoritative source on the financial details of the Law System.
  • citation-type="booksimple"

    xlink:type="simple">Murphy, Antoin E. John Law: Economic Theorist and Policy Maker. New York: Oxford University Press, 1997. The best intellectual history of Law’s economic theories, placed in historical context.
  • citation-type="booksimple"

    xlink:type="simple">Treasure, Geoffrey. The Making of Modern Europe, 1648-1780. London: Methuen, 1985. Considers the Law experiment in the context of European central banks, stock exchanges, and colonial enterprises.

Collapse of the South Sea Bubble

Seven Years’ War

Adam Smith Publishes The Wealth of Nations

France Supports the American Revolution

Franco-American Treaties

Louis XVI Calls the Estates-General

Related Articles in <i>Great Lives from History: The Eighteenth Century</i>

Louis XV; Adam Smith. John Law System

Categories: History Content