by Felix Martin
In August 1719, Law put the final phase of his plan into action. The Company acquired the rights to collect all the indirect taxes in France. It no longer represented only the crown’s foreign interests; its revenues now derived from the French economy as a whole. At the same time, it announced its intention to buy up the entire remaining part of the sovereign debt. To finance these mammoth transactions, it issued huge new tranches of equity. Such was the euphoria surrounding Law’s “System,” as it was now known, that it was more a matter of repelling than attracting investors. The Company’s share price rose from 500 livres in May to over 10,000 livres in December—and the higher it went, the more public debt was absorbed by new equity issues. With the transaction complete, Law had finally achieved an unprecedented and never-to-be-repeated feat: a comprehensive swap of government debt for government equity. Meanwhile, by successive decrees of the sovereign before the end of the year, gold and silver lost their status as legal tender in the Kingdom of France, and the notes of the Royal Bank acquired it. The supremacy of bank money and the fiat standard was complete.
Law had used the window of opportunity provided by the Chamber of Justice to superlative effect. The Royal Bank was solving the monetary crisis, and the economy was booming. The Mississippi Company was reaping the profits, and using them to solve the public debt crisis. And the remaining rigidity in the system—the link between the Bank, with its certain notes, and the Company, with its risky assets—had been solved as well by the greatest innovation of all. The monetary standard was now the exclusive creature of the sovereign—so that if the economy, and thereby the Company, fell on hard times, the value of the Bank’s money could fall to reflect this. Accolades for Law’s spectacular achievements flooded in from all sides. The Regent and his court were entranced. “[T]he construction was admired by everyone in France and was the envy of our neighbours, who were really alarmed by it,” wrote a wistful contemporary two decades afterwards: “It was a type of miracle that posterity will not believe.”13
With all the essentials of the System now in place, Law’s underlying reasoning was becoming clear. The problem with conventional sovereign money was that it consisted of financial claims of certain value backed by revenues whose value was intrinsically uncertain. Sovereigns might promise, and subjects believe, whatever they liked—and these promises and beliefs be solemnly inscribed in bonds and rentes. But there was only one ultimate source of sovereign revenue: the industry and commerce of France. If the economy prospered, the sovereign’s tax revenues grew, his credit improved, and his bonds would pay as promised. If not, the opposite applied. Since this is the reality of public finance, why not be honest about it? asked Law. Rather than pretending to his subjects that he can magic away the uncertainty inherent in economic activity, better for the sovereign to give them access to its proceeds directly—and by the same token, make them bear the risks. With government equity—shares in the Mississippi Company—this could be done directly. With transferable sovereign credit on a fiat standard—notes issued by the Royal Bank—it could be done at one remove.
On 5 January 1720, John Law was appointed Controller-General of the Finances of France. A few weeks later, he crowned his extraordinary ascent to power with the final merger of the Company and the Bank into a single, vast conglomerate. But his moment of triumph was short-lived. Almost immediately, cracks began to appear in the System. The long shadow of the Chamber of Justice had finally begun to fade: the bloodsuckers of the old financial system were beginning to stir again. When Law sent a memorandum to the Regent proposing a drastic simplification of the tax system, the Regent expressed concern that the old financial oligarchy might finally revolt. Law brushed away the Regent’s concerns: “[w]hat will become of the rats that live in my barn if I remove the grain so as to transport it to a safe location?” he coolly responded.14 But Law had underestimated his opponents, and the fragility of his success.
Wily old financiers that they were, Law’s enemies knew that his System—like any monetary system—was vulnerable to a collapse of confidence. With so brief a track record to fall back on, even the slightest suspicions about the value of the Company shares and the Bank’s fiat money might be fatal. The rumour mill was set to work. It had plenty to work with. The laughing colonists who had been seen processing to the docks to cross the Atlantic were not toiling prosperously on their French–American homesteads. Half had died of malaria; the other half had been hired stooges, and never made the crossing. Louisiana was not, as Law had given out, a commercial Promised Land to rival British North America. It was an irretrievable swamp that would never yield a profit. But above all, there were simply too many monetary claims chasing too little real activity. Regardless of whether they were debt or equity, notes of the Bank or liabilities of the Company, the value of the System’s outstanding claims on the cash flow of the French economy were unsustainably large. No matter how optimistic one was about its prospects, they were never going to pay.
The smart money began to sell. Word got out that senior members of the Regent’s court had converted their banknotes to gold the previous December. Panic set in. Law tried to engineer a controlled reduction in the value of the System’s shares and banknotes. New and more draconian measures were introduced to discourage, and finally to outlaw, the ownership of gold and silver. The market crash intensified. At the end of May, with the System disintegrating, Law was arrested. Two days later he was at liberty again, but only because the Regent, one of his councillors reported, had realised that “the only man capable of taking him out of the labyrinth in which he found himself was Mr. Law.”15 In the confusion, Law’s credibility was destroyed. With sage shakes of their heads, the resurrected sangsues regretfully advised the Regent that the only viable policy was retreat, at haste. On 1 June, gold and silver were restored as legal tender. Two days later the old system of annuity finance was relaunched. By October the notes of the Bank had been abolished. By December, Law had fled France in fear of his life.
So unlikely was the rise, and so precipitous the fall, of the System that it has always been easy to dismiss the whole affair as a typical tale of unscrupulous financial chicanery, with Law in the role of an eighteenth-century Bernie Madoff. The English writer Daniel Defoe painted Law’s career sarcastically as an excellent model for a young man seeking his fortune. “The Case is plain,” he advised, “you must put on a Sword, Kill a Beau or two, get into Newgate, be condemned to be hanged, break Prison, IF YOU CAN,—remember that by the Way,—get over to some Strange Country, turn Stock-Jobber, set up a Mississippi Stock, bubble a Nation, and you may soon be a great Man.”16
Such assessments are too superficial. Law’s System was an experiment in harnessing the power of money of major historical significance, the archetype of a third generic strategy for harvesting the benefits of monetary society while avoiding its undesirable drawbacks. The Spartan and the Soviet strategies were fundamentally distrustful of money—and attempted to abolish or restrict its application. John Law, by contrast, believed that money’s capacity to unleash ambition and entrepreneurship was its most valuable quality. The Scotsman’s scepticism was reserved instead for the second leg of money’s promise: its ability to combine this social mobility with the security and stability provided by fixed financial obligations. His strategy therefore aimed not to restrain the use of the concept of universal economic value, but to square the circle instead by making the standard by which is it measured intrinsically flexible. This was the ultimate objective of the System: a new financial settlement in which the risks inherent in money’s contradictory promise were borne fully and explicitly by all money-users, rather than hidden behind the veil of unfulfillable promises by the sovereign to pay.
By merging the single state holding company with the single state bank, Law made explicit what he believed to be obscured in a decentralised system of money and finance. All income and wealth flows in the end from the productive economy—and it is claims on this income alone that money ultimately represe
nts. That income is, however, uncertain, because the world is an uncertain place—so the value of those claims is in reality uncertain too. The simplest way to acknowledge this fact of life is to transform the fixed financial claims that are generally used as money—otherwise known as debt—into variable ones—otherwise known as equity. That required something that did not exist in Holland or England, and has not existed since: a corporation that owns all the assets of the state, including its rights to collect taxes, in which citizens can own shares. This equity-money, of course, would provide much less security than conventional money, since its value could go down, as the System’s investors found out in 1720. But by the same token, it would provide a lot more mobility. For those who could not stomach such thoroughgoing transparency, the System also furnished a less powerful option: the notes issued by the Royal Bank. These had a fixed value in terms of the standard monetary unit. But that standard itself was now flexible, determined by the King’s Council at the level they felt most appropriate from an economic and a fiscal perspective. The only difference, in other words, was that for the notes it was the sovereign, rather than the market, that would set the value of money.
John Law, before his fall (left, front view)—and after it (right, rear view).
(illustration credit 11.1)
Law’s System was ingenious, innovative, and centuries ahead of its time. It was even to prove prophetic two hundred and fifty years later, when the international gold exchange standard finally disintegrated in 1973 and fiat monetary standards became the worldwide norm. Yet it failed spectacularly. Where was the flaw? There were of course plenty of circumstantial problems that bedevilled Law’s ambitious scheme. He overestimated his own abilities, and underestimated the vested interests that his System would disenfranchise. The plan attempted far too much in far too short a time. And Law’s particular idea of offering the public government equity rather than government debt was indeed so far ahead of its time that its like has not been seen again since.17 But far outweighing these incidental challenges, the Scotsman’s solution suffered from a much more fundamental flaw. It was a bug for which another neglected monetary genius had discovered the fix more than two millennia earlier.
THE WISDOM OF SOLON
While Sparta’s reaction to the invention of money might have been the least ambiguous in the ancient Greek world, it was certainly not the only one. In many other Greek city states, money was embraced with enthusiasm—despite the widespread scepticism about its drawbacks.18 Such openness was, according to Aristotle, a particular characteristic of democratic city states, in which “[p]ayment for services, in the assembly, in the law courts, and in the magistracies, is regular for all.”19 Athens was the canonical example and had become, by the fifth century BC, a uniquely monetised society—“a salary-drawing city,” in which virtually every aspect of civic life was mediated by money.20 Somehow or other, the citizens of classical Athens—whose poets, philosophers, and playwrights were the source of so much of the profound scepticism about money—had devised a means of harnessing their precocious and potentially dangerous invention. They owed this priceless discovery to one of their greatest philosophers,poets, and statesmen whose heyday had coincided, as luck would have it, with Athens’ very first financial crisis.
In the Athens of the late seventh century BC, money and its spread was the social problem of the age.21 Until recently, Athens had still been organised along traditional lines with a small class of land-owning aristocrats leasing land to sharecroppers in return for a portion of their harvest. In the days when the aristocrats had supplied the ranks of the army, there had been a compact of mutual aid with their tenants. But in the competitive, atomising world of monetary society, the peasant farmers, with the prospect of social mobility now opened to them and the requirement to fight now imposed on them, resented the aristocrats’ traditional rents. The aristocrats, meanwhile, saw their land-holdings not as hereditary estates to which they owed a duty of care but as potential sources of financial gain. Money was tearing the social fabric apart. “The citizens themselves in their wildness wish to destroy this great city,” lamented the poet Solon, “trusting as they do in wealth.”22
It was a situation ripe for a financial crisis if ever there was one. As the creditor class of aristocrats attempted to maximise their profits, they met with increasing resistance from their insubordinate clients. Disputes multiplied, but there was no such thing as property or contract law to adjudicate them—only customs and taboos that were fast disintegrating. As for a property registry, there were nothing but worn and faded marker stones to settle arguments over ownership. The transition from traditional to monetary society was provoking a messy class war, driven by a debt crisis fuelled by the very shortcomings that the Greeks knew to plague money’s fantastic promise: financial obligations cannot fulfil every role that social obligations can; there is no intrinsic limit to ambition in monetary society; and, left unchecked, the exhilarating independence that money promises becomes destructive isolation. “The leaders of the people … are ripe to suffer many griefs for their great arrogance,” warned Solon, “for they know not how to restrain their greed.”23 Something had to be done to defuse the situation.
As it happened, there was a precedent. The great command economies of Mesopotamia may never have assembled all the components of money—but they did have the institution of interest-bearing debt. As a result, they were no strangers to the crises that this could generate and were as concerned as the Greeks with the potential of debt to disable the martial capacity of their cities by demoralising a vital class of fighting men through foreclosure and therefore disenfranchisement.24 They understood this problem, and therefore its solution, in terms of their traditional and religious cosmology: it was the responsibility of the king, who was heaven’s divine representative on earth, to restore social balance by cancelling some or all of the debts. The earliest known examples of this Mesopotamian practice of proclaiming a clean slate when the burden of debt became socially unsupportable are almost as old as the earliest evidence for interest-bearing debt itself—dating from the reign of Enmetana of Lagash in around 2,400 BC.25 It was a tradition that survived in the Ancient Near East into biblical times, in the form of the institution of the jubilee, which the Book of Leviticus enjoined the Hebrews to declare every fifty years.26
There was, however, a fundamental problem with the application of this tried and tested oriental remedy in Athens at the turn of the sixth century BC. Athens was a society in the throes of scientific enlightenment. The religious cosmology of traditional society no longer cut the mustard as the definitive guide for the distribution of power on earth. “Man controls his destiny” was the spirit of the age.27 So man himself must determine the fair distribution of wealth and power by money. Once again, an oriental practice—this time, the institution of debt cancellation—was imported into Greece. And once again a critical innovation, peculiar to the distinctive political culture of the Greeks, was made. An ulterior ideal of social order would indeed be imposed upon the uncontrolled excesses of monetary society. But this ideal would not be a simulacrum of the divine order in heaven. It would be a human notion of fairness in society hammered out by man. It would be determined, in short, through politics.
The man who introduced this radical idea was none other than the one who had done most to diagnose the problem: the statesmanpoet Solon. Elected chief magistrate of the city in 594 BC, Solon proceeded to enact a series of social reforms known from then on as the “Shaking-off of Burdens.” Chief amongst these was a cancellation of debts—but one which differed fundamentally from the oriental practice of the jubilee. For the central decision of any debt relief—who should gain and who should lose—was a matter of political compromise. The leadership of a gifted politician was of course crucial. “In great matters, it is hard to please all,” wrote Solon in defence of his greatest legacy years later, but “[i]n between the two opposing sides, I stood like a boundary-stone.”28 Poet that Solon was, his choice of
metaphor conveyed brilliantly the essence of the revolution he had wrought. If monetary society was to function, the old system of fixed boundary stones—the system that had regulated traditional society, with its immutable social obligations—would have to go. In its place would be a new system, in which the boundary markers—the standard of social justice—would have to be adaptable to the social change that money by its nature brings. And in the world in which mankind controlled its destiny, there could be only one source of legitimacy for that new standard of fairness: democratic politics.29 The Shaking-off of Burdens did not stop there. Share-cropping was abolished, taxation by economic category rather than class introduced, and the right to trial by jury guaranteed. More than two centuries later, Aristotle argued that this last reform was “said to have been the chief basis of the powers of the multitude … for the people, having control over the courts, thereby have control over the government.”30
But another aspect of Solon’s reforms was more important than any single measure. For the critical role to be played in future by political decisions regarding what was and was not economically fair called for a new and more formal system of recording such decisions and assessing compliance with them. What was required—and what Solon therefore supplied, inscribed on a famous set of rotating wooden tablets—was a comprehensive body of law.31 With Solon’s achievement of a democratic state under the rule of law, the formula for making money work was complete.