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Source link: http://archive.mises.org/10302/john-law-and-the-invention-of-modern-finance/

John Law and the Invention of Modern Finance

July 17, 2009 by

John Law may have died in disgrace after his Mississippi System failed in 1720, but government and its cheerleaders in the economics profession continue to embrace his ideas, believing that the printing of money can lift an economy from the doldrums. They believe enlightened central bankers know just how much money an economy requires, or just how high or low interest rates must be to ensure prosperity. Of course, nothing could be further from the truth. FULL ARTICLE

{ 11 comments }

Richard Ebeling July 17, 2009 at 10:14 am

The Swedish economist, Knut Wicksell, commented in his “Lectures on Political Economy” (Vol. 2, p. 78) on what brought about the great financial crash in France in 1720 that John Law’s money scheme generated. His statement rings as true today for our own situation:

“The chief cause of the crash was, however, as in other countries at this time (and not least in Sweden), the immoderate appetite of Governments for money and the contempt with which they placed themselves above ordinary business morals.”

Richard Ebeling

C July 17, 2009 at 11:36 am

I presume this is the same Richard Cantillon that Mark Thornton referred to in his Skyscrapers article (mentioned yesterday in the blog):

“Cantillon effects are named for their discoverer, Richard Cantillon, who is widely credited as the first economic theorist, and in particular, was the first to show that changes in the money supply and credit have important impacts on the economy by changing relative prices. Cantillon showed that an increase in the supply of money would cause economic expansion, but that ultimately the process would be self-reversing as prices would rise and imports would increase, sending money back out of the economy. Cantillon further showed that monetary inflation does not affect all prices equally or at the same time, but in sequences that depend on the spending behavior of money holders all along the channels of monetary flows.”

Interesting fellow. So he figured this out by watching John Law and profiting from his game.

See http://en.wikipedia.org/wiki/Richard_Cantillon

Mike Sproul July 17, 2009 at 7:19 pm

Law had two valid ideas:
1) Money can be backed by land.
2) Issuing paper money in a cash-starved country can relieve people from the inconvenience of barter and inferior moneys, and thus can stimulate real economic activity.

Law’s downfall resulted from a fall in the value of the Mississippi land, combined with overissue of the company’s paper money.

P.M.Lawrence July 18, 2009 at 7:09 am

It’s also worth reading James Buchan’s Frozen Desire (a history of money), which covers the Law episode in some depth.

Mike Sproul appears not to realise that this sort of thing can only ever be a sort of moving things around, except for the very rare special case in which it brings about new productive capacity which would not otherwise have been there. In France, the only and temporary gain was the recovery of what previous government burdens had set back, and a simple reduction of those burdens would have achieved the same. The Physiocrats had the idea that only agriculture mattered as a base for everything else, and that was in fact an accurate simplification of how things worked in that time and place; and that base was more or less fixed. That would not have been true if Louisiana really had offered new opportunities that could only be brought on stream through government action, or if a state-sponsored industrialisation could have worked (not that it was tried), but that was not the way it was.

Mike Sproul July 18, 2009 at 12:53 pm

PM Lawrence:

There have been many historical instances of ‘moving things around’, but there have also been cases where paper money has relieved a genuine scarcity of money. This appears to have been the case in the American colonies (1685-1710) and in France prior to Law’s arrival. Paper money can stimulate real economic activity in those cases, but unfortunately money can also lose backing in those cases. Thus the issue of paper money often leads to some early success, but people are then tempted to go hog wild and act as if they have discovered the goose that lays the golden eggs.

P.M.Lawrence July 18, 2009 at 6:18 pm

Mike Sproul, you’re missing a “things not seen” thing. Of course the early stages caused genuine growth (since they were repairing a damage or shortage of something useful) – only, as I was careful to point out, it was not growth that would otherwise not have been there. The shortage was of circulating medium, not of physical capacity, and that would have been restored automatically anyway, either by an influx of sound money or by an adjustment of price levels (unless something else kept restoring the imbalance, e.g. taxes storing bullion in war chests etc.).

Mike Sproul July 18, 2009 at 10:41 pm

PM Lawrence:

It sounds like we’re saying the same thing: that when money is scarce, production is inhibited, and so the introduction of paper money can remove the inhibition and stimulate production. Histories of the early 1700′s are full of references to scarcity of money, and there are several cases where the introduction of paper money led to significant economic improvement.

newson July 18, 2009 at 11:52 pm

mike sproul says:
“Histories of the early 1700′s are full of references to scarcity of money…”

a case of grist to the mill. inflation always is championed by special interest groups.

P.M.Lawrence July 19, 2009 at 2:06 am

No, Mike Sproul, we are not saying the same thing. Rather, money never can be truly scarce in a truly free system; either more comes in through outside trade, or Pigou’s Real Balance Effect makes existing money appreciate enough to restore things. However, the symptom of “scarcity” (apparent, not real) occurs if something else caused a dislocation of trade etc. Providing money can then relieve that symptom, and in fact might do no immediate or lasting harm if the underlying cause were cured through some other process (as happened in Guernsey after the Napoleonic Wars, when they tried the printing money thing until they were stopped by the home government). But in any event, those other processes can cure the trouble, and if there were no deeper problem there would never even have been the symptom in the first place.

Ben Ranson July 19, 2009 at 10:09 am

An early, amusing account of the Mississippi bubble can be found in Mackay’s “Extraordinary Popular Delusions and the Madness of Crowds.”

Todd Marshall July 19, 2009 at 1:13 pm

A medium of exchange is governed by the equation:

DEFAULTS = INTEREST + INFLATION

If the managers of the medium of exchange acknowledged and followed this equation INTEREST would equal DEFAULTS and INFLATION would be zero.

You know they don’t have a clue when they can tell you all kinds of things about INTEREST and INFLATION but can’t tell you anything about DEFAULTS.

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