John Law and Easy Money Quantitative Easing, Then and Now

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“If five
hundred millions of paper had been of such advantage, five hundred
millions additional would be of still greater advantage.” So
Charles Mackay, author of Extraordinary
Popular Delusions and the Madness of Crowds
, described the
“quantitative easing” tactics of the French regent and
his economic adviser, John Law, at the time of the Mississippi bubble
in the early 18th century. The Mississippi scheme was a precursor
of modern attempts to reflate the economy with unorthodox monetary
policies. It is hard not to be struck by parallels with recent events.

Law was a brilliant
mathematician who used his understanding of probability to help
his gambling habit. Escaping from his native Scotland after killing
a rival in a duel, he made friends with the Duke of Orleans, the
regent of the young king Louis XV.

The finances
of the French government were in a terrible mess. Louis XIV had
spent much of his long reign fighting expensive wars. Tax collection
was in the hands of various agents, who were more concerned with
enriching themselves than the state. Not only was the monarchy struggling
to pay the interest on its debt, there was also a credit crunch
in the form of a shortage of the gold and silver coins needed to
fund economic activity.

insight was that economic activity could be boosted by the use of
paper money that was not backed by gold and silver. He was well
ahead of his time.

confidence in a new monetary system was the trickiest part. Law
had the benefit of working for an absolute monarchy which could
decree that taxes should be paid in the form of notes issued by
his new bank, Banque Générale. He also believed, having
observed the success of the Dutch in exploiting the spice trade
in the East Indies, that France could use paper money to develop
its colonial possessions. Hence the Mississippi scheme, under which
Law created the Compagnie d’Occident to exploit trade opportunities
in what is now the United States. The money raised from these share
issues was used to repay the government’s debts; on occasion,
Law’s bank lent investors the money to buy shares.

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18, 2009

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