Cyclopædia of Political Science, Political Economy, and the Political History of the United States
LAW'S SYSTEM. This is the name given to the great financial experiment made in France by the government of the duke of Orleans under the direction of John Law.
—Had John Law's financial operations been only a series of expedients devised from day to day to tide over a condition of embarrassment, they would not merit a place in a scientific work. History gives us many examples of means and abuses similar to those adopted or produced in France at the beginning of the past century. But Law's operations were distinguished in more than one way from ordinary expedients: first, they were entered upon as the practical application of a preconceived theory, and in the aggregate they form a system; second, they were the signal for a revolution in the manners and habits of the French, third, they afforded a magnificent example of the combinations and effects of stock-jobbing. On these accounts they are pre-eminently deserving of the consideration of the economist, and it may be useful, while exposing them, to make some little comment upon them also.
—At his death Louis XIV. left the finances of France in a most deplorable condition. The debt in a thousand different forms, payable on demand, made a sum of 785,000,000 livres; 64,000,000 of annuities, perpetual or redeemable at a fixed date and drawn from every branch of the revenue, represented a principal sum of 460,000,000; and finally, the creation of offices, increase of salaries, etc., had involved the state to the extent of about 800,000,000. The public debt amounted thus to a principal sum of about 2,000,000,000 livres, of which about 785,000,000 were payable on demand. "When the king died," says Bailly, "not more than four or five millions could be anticipated from the last three months of the year; and the revenues of the succeeding years were more than half consumed." Complete disorder reigned, besides, in every department of the financial administration, so much so that no one could give, or even know, till much later, the balance-sheet figures of the situation.
—By different measures of a sufficiently suspicious nature the regent's government reduced the debt payable on demand, and embodied it in bonds of uniform description, giving them the name of billets d'état. These were issued to an amount of 250,000,000, and bore interest at the rate of 4 per cent. They were receivable for arrears of taxes, and were to be destroyed as they came in; but as the promises of the state then inspired no confidence, these billets were at a discount of no less than about 80 per cent. of their nominal value. However, some method was introduced into the collection of taxes and the financial administration in general, judicial investigation instituted against the farmers of the revenue, and an alteration of the coinage furnished some little funds, dishonorably obtained and dearly bought. It was at this crisis that Law submitted to the finance council a first scheme which was not adopted; and in order to cause his ideas to prevail he was obliged to adopt indirect means—Letters patent of May 2, 1716, gave to John Law the privilege of establishing a bank. It was constituted under the name of the Banque Générale, with a capital of 6,000,000 livres, in 1,200 shares, of 5,000 livres each, payable in four installments, one-fourth in specie and the remainder in billets d'état. The functions of this bank, which to all appearance was independent of the government, were to be, according to its by-laws, the same as those now fulfilled by the bank of France.
—This establishment was very well received by public opinion. Banks of issue were in all the first vigor of youth. The bank of England had only been in existence since 1694, and that of Scotland since 1695, and they were both giving good results. Commerce highly appreciated an establishment which gave a price current to discount, and which caused its rate to decline, at first to 6 and finally to 4 per cent. It appreciated still more highly the current accounts and the bank credits based on a currency whose weight and standard never varied, however great the alteration undergone by the current coin. It was the first introduction into France on a large scale, or at least with great pretensions of two excellent commercial undertakings, the bank of deposit and the bank of issue. But no one had any definite knowledge of the theory of its working, and the start of the new bank was regarded with that distrust which is so common in France and so closely akin to the blindest credulity.
—The Banque Générale prospered, but it developed but slowly in an environment in which credit had received some rude shocks and in which there was but little business done. Besides, the establishment's own capital was very small: of the 1,500,000 livres payable by the shareholders in specie, one-fourth only, that is to say, less than 400,000 livres, had been paid up. As for the billets d'état they were still at a discount of 70 per cent., and it was impossible, in the then condition of affairs, to derive any advantage from them.
—The secret connection which existed between the Banque Générale and the government was brought to light April 10, 1717. On that date, a decree of the council ordered the receivers of the public revenue, not merely to accept the bank's notes in payment of taxes of all descriptions, but even to pay the value of these notes in hard cash, when asked to do so and if they had the money at their disposal. It does not appear, however, that these privileges had the effect of extending much the circulation of the notes, which, concentrated in Paris and some other large cities, never exceeded 12,000,000. Evidently it was not with such trifling resources that a credit could be obtained sufficient to liquidate the public debt. This was only the first story of the great edifice called the Système.
—Toward the end of August, 1717, a celebrated merchant named Crozat, who had obtained a monopoly of the Louisiana trade, ceded this privilege to a company floated by Law under the name of the Compagnie de l'Occident. The letters patent authorizing the formation of this company gave it a monopoly of the commerce with Louisiana for twenty-five years, and of the trade in furs, arms, munitions and ships in Canada. The privileges given to the company were somewhat justified by the way in which its capital was obtained; it was in amount 100,000,000 livres, in shares of 500 livres, payable in billets d'état, which the government assimilated to life annuities, and the interest of which it guaranteed at the rate of 4 per cent. But it was not necessary to have great experience in business to be able to understand that a capital thus formed could not furnish the necessary resources for commencing an undertaking so vast as the colonization of Louisiana, that is to say, of a tract of country which included the valleys of the Mississippi and the Missouri, and which extended northwest as far as the Pacific ocean. At first, then, the credit of the Compagnie de l'Occident languished. Public opinion was opposed to it, and capitalists hesitated to invest in shares. Affairs were in this condition when, on May 11, 1718, an edict was published ordering the recoining of the coinage. The silver marc had already been carried from twenty-seven to forty livres; the edict of May carried it from forty to sixty livres. "From the order to recoin all money," says Eugène Daire, "arose the obligation to take all the old money to the mints; but it was permitted to join to one's silver two-fifths in billets d'état. It happened, therefore, that when, in the words of the law, a man disseized himself in favor of the fisc of eight écus of five livres each, or, altogether, forty livres, that is, a marc of silver, it was optional with him to add to them sixteen livres in billets d'état, the effect of which was the delivery of fifty-six livres to the profit of the treasury. When the latter had received this value, it returned in exchange nine and one-third of the new écus, denominated six-livre pieces, which also made fifty-six livres. But the intrinsic value of those fifty-six livres, the weight of silver which they contained, was less by one-fifteenth than the weight of silver previously paid into the treasury, and thus the person paying lost, first, that amount of his silver, and, secondly, gave up his paper, his billets d'état, for nothing. In brief, the state gained by this honest operation 6 2/8 per cent. in silver and 26 2/8 per cent. in paper; in all, 33 1/8 per cent. on all sums paid into the mints." Parliament resisted this operation in vain.
—Was the edict of recoinage Law's work? It has been believed to be so, since it had the effect of raising bank silver in the public estimation, that being money of fixed weight and standard, and of encouraging the use of paper among the people. Several writers, on the contrary, have attributed this edict to the minister d'Argenson who had succeeded the council on finance, and is supposed to have devised this simple and summary means of extinguishing the billets d'état, solely with the view of proving himself a financier of greater powers than Law.
—Be that as it may, this minister gave soon a clear proof of the ill-will be bore the Scotchman, by farming out the taxes to the brothers Paris, skillful bankers who had introduced some order into the administration of the finances, on terms usually considered advantageous. With their contract in relation to the taxes as a basis, the brothers Paris established a company of limited liability in June, 1716, with a capital of 100,000,000 livres, in 100,000 shares of 1,000 livres each, payable in rentes or bills. This operation had a much more solid basis than the Compagnie d'Occident, for it was much more probable that the brothers Paris would gain by their contract of the farming of the taxes than it was that the Compagnie d'Occident would gain by the commerce of Louisiana. The shares of the latter company met with a formidable competition in the market when they were brought in collision with the shares of the association gotten up by the Paris brothers, which was called the "Anti-System."
—New financial operations had to be resorted to to impart value to the shares of the Compagnie d'Occident. On Sept 4, 1718, it farmed out the tobacco monopoly; its shares rose a little, for public opinion rightly viewed with favor speculation in the state revenues. But the rise was slow and slight.
—On Dec. 4, 1718, a royal edict changed the Banqus Générale into the Banque Royale. The 1,200 shares of the Banque Générale, only the fourth part of which had been paid in, were bought at a price of 5,000 livres, their nominal value, and were redeemable in écus. Never had shareholders made so much in so short a time. What might not be the intrinsic value of an enterprise that the public treasury, completely involved in debt as it was, thought fit to purchase at that price. Men's imaginations were possessed, and little attention was paid to the radical changes that the by-laws of the bank underwent.
—The notes of the Banque Générale were payable in bank money, the weight and standard of which were defined; those of the Banque Royale were payable in livres of tours currency (livres tournois), that is to say, in nominal money the weight and standard of which was not exactly settled. The notes of the Banque Générale could not be made and issued except against securities in hand; an order in council was sufficient to authorize the Banque Royale to issue notes to the profit of the government. The Banque Royale had branches in which were exchanged notes for écus and écus for notes, and in the cities in which they were established the use of specie was restricted to payments of 600 livres and under. It was clear that liberty was distrusted and that there was an intention of outraging public opinion; in short, on April 22, 1719, a decree of the council forbade all transport of coin by private persons into the cities where the bank had offices; it ordered the public officers in those cities to keep their cash in notes, under penalty of bearing the loss on specie in the event of a depreciation of the currency; it authorized creditors in these cities to refuse as worthless the offers of their debtors, unless made in notes, and only to receive the precious metals in payment of small change. It was attempted to demonetize, as far as possible, the precious metals, and to give the paper of the Banque Royale the properties of money. However, those measures decreed by a government which had already made a bad use of its paper, could not inspire much confidence; it was necessary to captivate men's minds by a bold stroke which should disarm suspicion, upset all calculations and raise the value of the shares of the Compagnie d'Occident, then at a discount of about 40 per cent. Law bought 200 shares at par, at six months date, paying 40,000 livres on the price of the 100,000 livres which those shares represented, with the stipulation that he should lose the 40,000 livres if the shares did not reach at least par. The premium market was then unknown in France and the confidence felt in Law's personal ability was so great that in a short time the shares of the Compagnie d'Occident rose to par. Rumors skillfully set afloat, all tending to enhance the idea of the company's probable future prosperity, also contributed to this result.
—The most difficult step had been taken: however little observation may have been bestowed on the course of such speculations, it is well known that it is sufficient to establish an upward movement in the price of shares in order even with moderate ability to push that advance in due course to a considerable extent. Now Law's ability was very great; he was backed by all the power of public authority; and he dealt in titles whose intrinsic value was little known, and was therefore all the more easily exaggerated. What golden dreams was it not easy to have about the resources afforded by the commerce of an immense, new, unknown and uninhabited country. For the rest, Law did not leave men's imaginations idle; like a skillful gambler, he caused frequent changes of luck. In May, 1719, all the great commercial companies which still existed, were acquired by the Compagnie d'Occident. It took the name of the Compagnie des Indes and was authorized to issue 25,000 new shares of 300 livres each, payable in specie and by twentieths (vingtiémes) monthly: only fifty livres had to be paid immediately, and a decree of June 20, 1719, permitted only those to subscribe for the new certificates who already possessed an amount four times greater of the old certificates. Already fortunes had been made by the rise in the first certificates; they were in still greater demand as soon as it became necessary to possess a certain amount of them in order to obtain the new shares, which on this account were called the "filles" (daughters), and rose rapidly.
—This rise was maintained by new schemes. On June 25 the state ceded to the Compagnie des Indes all the profit it might make by the coinage of money, in consideration of a sum of 50,000,000, payable monthly in fifteen equal sums. The company issued 25,000 new shares at a nominal value of 500 livres, but at an actual price of 1,000 livres, at which the first shares were selling. It was necessary, before being permitted to subscribe for the new certificates, to qualify by holding five shares of the old to obtain one share of the last issue. These were named the "petites filles" (grand-daughters) and had the same success as the preceding ones. The company had guaranteed its shareholders a dividend of 12 per cent., dating from Jan. 1, 1720. At the beginning of September all the shares were placed and were selling at a price of 5,000 livres, those which had been subscribed for in billets d'état, as well as those the amount of which had been furnished in specie.
—On Sept. 2 the Compagnie des Indes undertook a new enterprise, which was in some sort the crowning of all. It had secured the rescision of the contract with the brothers Paris for the farming of the taxes; it took upon itself the collection of the taxes at 52,000,000, and in addition the payment of 1,500,000,000 of the king's debts. The creditors of the state were paid by orders on the cashier of the Compagnie des Indes, payable in notes or specie. In order to provide the funds needed for the repayment, the company was authorized to issue transferable shares bearing 3 per cent. interest, payable half yearly; it was itself to receive 3 per cent. on the 1,500,000,000 which it furnished to the government.
—In reality there was nothing more in this transaction than a conversion of annuities. The state, instead of paying 4 per cent. now only paid 3 per cent., thereby making an annual saving of 15,000,000. The company borrowing and lending at 3 per cent. seemed to be performing a disinterested speculation; but it is easy to comprehend that in a transfer of 1,500,000,000 of capital for the repayment of which the choice was given between a bond of definite amount and the shares of a company whose brilliant success was everywhere prophesied, many capitalists would choose the shares. The company issued 324,000 shares, nominally for 500 livres, payable in tenths monthly, but which, if sold at the market price of the day, would bring it a gain of 1,620,000,000, with which sum it could easily meet all its requirements.
—The "Systéme" was complete. Law, sharing a delusion which still finds defenders, confounded price with value; he believed that it was sufficient to raise prices to increase a nation's capital; he attributed to the augmented quantity of paper money, of the "sign," to use the language of the time, the property of creating value, which belongs only to labor. It was with this object that several decrees had been issued with the view of discouraging the use of metallic currency and that stock-jobbing was over-stimulated. A decree of Sept. 26 having settled that the company's shares could only be paid in notes, gold and silver lost in a moment 10 per cent. in exchange with paper. The shares sold in the open market were bought up eagerly, and their price rose constantly for several months. There is no need to seek far for the cause of this rise; foreseeing that the payment of the second tenth would embarrass the holders and would occasion a fall, an order of the council made the payments quarterly, and postponed till the month of December, 1719, the payment which fell due at the end of October, the following till March, and the third till June, 1720. On the other hand, the Banque Royale, which, in accordance with the decree of Dec. 4, 1718, was forbidden to issue notes for a greater amount than 100,000,000 livres, had issued them to the extent of 520,000,000 at the end of October, 1719; of 640,000,000 at the end of November, and on Dec. 29 it was decided that the amount of notes should be raised to 1,000,000,000. The sophism on which Law's system was founded became a gigantic illusion. But this illusion created facts which were very real. Specie in its two common uses was replaced by paper. The sums amassed and hoarded up for future consumption took the shape of shares; the sum for present use became bank notes.
—What was the nature of the real values represented by the shares of the Compagnie des Indes and the billets or notes of the Banque Royale and what was the disposable capital operated with? We do not know exactly what the operations of the bank were, but it is likely that discounting commercial paper was the least important. Perhaps it made advances on shares deposited with it; probably it simply met the financial wants of the government by its notes, so that its paper was based upon no actual value; it was merely a state debt bearing no interest.
—The paper issued in the shape of shares by the Compagnie des Indes amounted to a nominal principal sum of 312,000,000, issued at a price of 1,797,000,000. But, out of this enormous amount what had been the real payments into the company's treasury? The official documents do not give it exactly, and besides they are not particularly worthy of credence. The company's resources in revenue may be better estimated. They were, first, 49,000,000, due annually by the state; second, the company's profit on the tobacco monopoly, on the tax farming, on the rentes and salt tax of Alsace, and on the coinage of money; and third, the gain on the commercial profits of the company, estimated at 8,000,000. The estimate of the company's profits was singularly exaggerated; for it is at least doubtful if a commercial company constituted without real capital, or, if it be preferred, with a capital of 50,000,000, could realize immediate and considerable profits by the commerce and colonization of Louisiana and Canada, and even by that of the coast of Africa and China. Besides, all its income consisted of an annuity due by the state, the profits on the farming of the public revenue, and the very uncertain gain to be obtained from a monopoly granted by the state. Finally, admitting that the company's revenues reached the exaggerated total of 82,000,000, it could only pay a very moderate interest on a capital of 1,797,000,000, ill calculated to keep up the inflated price of the shares, whatever might be the depreciation of the currency owing to the multiplication of bank notes, since, after all, this depreciation would also reduce the real value of the revenue. It is evident, then, that Law's system could not live, not only on account of the faulty constitution of the bank, but also of that of the Compagnie des Indes itself. By exhausting all the resources of stock jobbing, an edifice of opinion and credit, whose lease of life could not be a long one, had been erected on very slender foundations. It remained to be seen who should be the victim of the illusion, who should give solid and real value in exchange for new paper.
—It is well known that the success of Law's system was beyond all expectation. The factitious fortunes made by the rise in value of the first shares had fired men's imaginations; all who had any disposable capital hurried to the market with it. Those who had not, sold lands, houses, government bonds, etc., and stock-jobbing soon raised the price of the different securities issued by Law to the enormous sum of 12,000,000,000. Certainly if the style of reasoning employed by the publicists of our day be adopted, such signs of prosperity had never before been seen, and, to use the language of the present, business was never as brisk as it was then. The documents of the day are filled with incredible stories of the magnificence of the houses, the furniture and the retinues of the nouveaux riches of that time and the court people, who, in that ephemeral prosperity, had the chief share after the lackeys. The state was not less munificent than private persons; it remitted 80,000,000 of taxes in arrear, did away with vexations burdens, studied new systems of imposts, and even brought to a successful close a short war with Spain without increasing the burdens which pressed on the people. Every one was intoxicated with his dream of wealth. What was the real cause of all this wealth? The consumption in a few months of almost the entire value of the metallic money of the country, both that which had for long been kept as a treasure or reserve and that which served for the purposes of exchange and circulation. The same phenomena were produced as would have been produced had a treasure trove of two or three thousand millions suddenly been discovered and spout productively or unproductively in a few months.
—It was not the Compagnie des Indes itself which gathered the fruit of this movement; nor was it the creditors of the state, for but a small number of them had been paid in time to convert their bonds into shares; it was the people of the court, with the regent himself at their head, who benefited equally by the unlimited issue of the bank's notes and the jobbing in shares. If stock-jobbing was not the sole object of Law's system, it can not be denied that it filled a very large place in it, and it is difficult to understand in what other interest the decrees of the council postponed the payment of the amounts about to fall due on the shares. Would this have been done if the genuine success of the unique commercial monopoly which had been created had been the only end in view? Certainly not. Besides, without having recourse to conjecture, it is sufficient to glance at the documents of the day to see that Law had imported into France or brought to light every means by which a factitious price may be given to securities of doubtful and uncertain value. Since that time the art of appropriating another's property by stock gambling has made no advance; there is but a repetition of the same tricks.
—A catastrophe was inevitable, but Law did not see it. He was fully persuaded that it was possible to sustain the currency of money which was wholly imaginary, by exchanging it for securities whose value was hypothetical; and when the crisis overtook him, he did not even have recourse to the means which might have lessened the effect of the catastrophe. It must be recognized, too, that the want of morality in the government of the time and the extravagant habits which Law himself had encouraged, would scarcely have permitted him to use the means suitable, even had he himself wished to do so.
—Toward the end of December, 1719, discerning foreigners, and those of the French who had a calculating turn of mind, saw that it was time to withdraw from the speculation. After having themselves operated a rise in which the shares reached the value for a moment of 20,000 livres, they sold out, and, with the price obtained, bought real estate, bullion, merchandise—in a word, real wealth. This was called realizing. It will be understood that the sale of a number of the shares soon ran down the price. At the same time the presentation of notes to be exchanged depleted the bank of specie, even although an edict forbade the use of silver in payments of above forty livres, and of gold in payments of over 300 livres, and although, on Jan. 28, 1740, another edict gave compulsory circulation to the notes throughout France, and the edict ordering the reminting of money was carried out vigorously. In February it became necessary to forbid private persons, under pain of confiscation, to have in their possession more than 500 livres in specie, and in March gold and silver were demonetized completely. On Feb. 22, with an end in view which it is not easy to determine, the Banque Royale was united to the Compagnie des Indes. The value of shares was at that time far above the price of issue. A declaration of March 11 fixed the exchange between notes and shares at a settled rate of 9,000 livres the share. Law imagined that by this means he could control the issue of notes; but to succeed it would have been necessary that one of the two objects exchanged should have possessed some intrinsic value. Now the value of the share was not much more real than that of the note, and, however it might be counted, it was impossible to maintain the share at a price of 9,000 livres. On May 21, then, the share was reduced to 5,000 livres. The rate of exchange established by the declaration of March 1 only served to increase still more the issue of notes, which was, according to report, carried to three thousand millions. It is well known that the destruction of notes which had come back, promised by edict, was not honestly carried out, and that M. de Trudaine, provost of the merchants' guild, was removed from office because he refused to become a party to the government's frauds—It is useless to recall the events which marked the fall of Law's system: the creation of annuities payable in billets de banque, the repeated edicts which altered continually the metallic currency, the indictments filed, the confiscations made; how the bank was besieged and reduced to the redemption of one note only of ten livres for each person; the want of specie for the purposes of exchange; the reduction of wages, the engrossing of merchandise, the riots, and the terrible distress which succeeded one of the most extraordinary revolutions of fortunes which history tells of. After having, in the space of six months, promulgated about forty financial edicts, the government was reduced to yielding to public opinion and the force of circumstances. On Nov. 1, 1720, it declared that the notes should be receivable according to private agreement, and as, in spite of the compulsory circulation, they were at a discount of about 90 per cent., they ceased to possess any sort of value. Some time previous to this. Law had been obliged to escape by flight the vengeance of those whom his system had ruined. About two years were needed to prepare the system, and about the same length of time sufficed to develop it and to see its fall. In his speculations, founded on an erroneous conception of the creation of wealth, Law had succeeded, at first, by the importation into France of new and good commercial processes; and because of circumstances entirely unconnected with his theory, from the moment that his ideas were confronted with facts, Law's system crumbled.
—It was not, as has been said and repeated often, because Law's system was carried to excess that it failed. If operations had been confined to the Banque Générale, if that had been allowed to develop within the limits of its by-laws without resorting to rash or adventurous speculations, it might have rendered great services; but this bank was only a decoy, meant to accustom the people to the use of paper; it was in no way a part of the system; Law's writings and the edicts leave no doubt of this. His theories on the subject of paper money were like a story in the Arabian Nights, and the system was only the practical application of those theories.
—In spite of the financial difficulties resulting from the downfall of Law's system, it would have been easy to reap some advantage from the impulse imparted to business and from the state of men's minds at the time, from the custom of the association of small amounts of capital into one whole to accomplish any great purpose, and from the bank of issue. Nothing of the kind was done: the winding up of the affairs of the system, which was confided to Law's bitterest enemies, was conducted with a fury of reaction too frequent in France. The object seemed to be to destroy every trace of the great financial events that had just taken place, in such a way as to leave nothing of them but their ruins. All Barême's arithmetic was put under contribution to prove that Law had been a spendthrift and a knave, who had not only ruined private persons, but involved the state in debt, and people affected to speak with horror of paper. The system became the object of the declamations of philosophers and the epigrams of wits.
—The history of Law's experiments, not yet completed from an economic point of view, would be a curious and very instructive study in examining the theories based on paper money and stock-jobbing. All that has been dreamed of or tried of this kind since 1720 had been conceived and tried by the fertile genius of Law. The study of the system would be the more curious inasmuch as the author of it had at his disposal, at least with respect to the mass of the people, absolute power, that he used this power to its utmost extent, and that he lived in a society accustomed to this power, as to all other monopolies. After this great lesson which confirms so thoroughly the teaching of science, the demonstration of the sterility of paper money and stock jobbing is complete.
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