There were a lot of problems. The first, obviously, was that the bubble was not real. The Mississippi Company was consuming resources, not producing them. People and supplies went west, nothing valuable came back. The number of ships involved in French export went from sixteen to three hundred. Secondarily, nobody wants to let go of the boom that they artificially created. The game, once begun, is difficult to end. Initial success removes the last traces of self-restraint. People want to believe that the good times will last forever, and that was what John Law promised. Unearned wealth is the world's oldest seduction, whether through gambling or war. With wealth comes a sense of superiority and invincibility. They were enjoying a self-fulfilling prophesy. The same as on a battlefield, an early victory does not mean that the war is won. The costs will rise as time passes.
The French financial experiment collapsed in 1720, just a few years after it began. The economy experienced a tremendous boom before the tremendous bust. All the world took notice of the boom.
The Problem with Gold
The system was wobbly the moment it started, and steps were taken to prevent a collapse. To sustain growth, more money was constantly needed. Just as today, the solution was to create more debt to cover the old debt, aka "prime the pump.' The stocks were frequently recalled and reissued. The investors faith in the value of a piece of paper was constantly assured. Every change was characterized as an adjustment yielding a new profit opportunity. The few people asking probing questions were ignored. John Law was regarded as a genius and a hero. He made France, society, and individuals significantly richer. The was no way to argue against the buzz of activity and the productive wealth being created. Waste, pollution, illness and inequality were not a pressing problem.
The paper money that purchased the stocks was supposed to be backed by hard currency (gold, silver, jewels). Buyers were guaranteed that at anytime they could be redeem their notes for gold. As the price of the stocks went up, that was materially impossible, unless the value of the gold went up just as fast. The first solution was to change the rules. Notes could only be cashed for gold in a limited amount, but eventually that was not enough. The increase in the stocks value created a problem with the amount of money in circulation. The shortage of money issue had returned.
By definition, borrowed money is immediately spent, otherwise there is no need to borrow. It is impossible to repay the lender, without re-borrowing or extracting money from someone else. Time is required for the inflationary spiral of buy-low sell-high to shift the burden onto someone else. Therefore, it was impossible to guarantee to return what was borrowed within a narrow time frame. The "backing' of a bank or business was the ability to borrow more money at will, which led to the need for a central bank. A problem occurs whenever people expect their money returned or sell their stocks. The "run on the bank' can be from a lack of trust or another economic condition, but the results are equally volatile, and cascade. The hedge fund collapse of 2008 was a reenactment of the simple math of 1720. Once one person cannot borrow to pay a bill, the entire system collapses. The only reason a nation can stay afloat is because of its capacity to increase its debt. Doing so does not increase the amount of gold it has, however. The value of the gold must rise.
The gold the Mississippi Company received was spent purchasing supplies for the expeditions. That was the real boom. Gold formally held in vaults was spent and recirculated. If one ignores inflation, and the future bust, the prime the pump model of Keynesian economics does work temporarily. Money greases the wheels of progress. However, there can never be as much money in the system as the values imply. Debt must correspond to the size of the boom. The gold in the vaults of the rich was lent, not spent, within a casino-like structure. The consequences of this subtlety between spending and lending eventually appear. The structure of modern finance and a ponzi scheme are exactly the same. The system can only continue with a perpetual supply of new money masking the mathematical truth. Any interruption of revenue, for any reason (like a natural disaster, illness, mistakes), and the whole thing collapses. Inflation makes sustaining overhead difficult, and losses can quickly become fatal.
To deal with the gold-to-paper exchange problem, France made the ownership of gold illegal. The original gold backing paper agreement had collapsed under the weight of its own contradiction. It was claimed that centralizing ownership of gold would solve the problem and prevent the old money from competing with the new money. Everything would be paid in paper, which the government could regulate and create at will.
The prohibition of gold ownership obliterated any sense of decency in what was already a heady society. A ransom was to be paid to anyone who reported illegal hoarding. The expanding society of the rich people turned from joy to fear. Their pride combined with anger and paranoia. Corruption by the police took every form: accepting a bribe, demanding a bribe or planting evidence. A friend would turn in a friend, a spouse would turn in a spouse, competitors or enemies could use the prohibition to seek an advantage or revenge. It turned their society into a fascist hell, resembling the totalitarian societies of the twentieth century. Paris became a police state. Everybody was afraid. Just like the prohibition on alcohol in America, the cure was worse than the disease.
The government's zeal was salt in an open wound. Old money was lost, new money was lost, and those cautious souls who sat out the boom were now targeted for having precious metals. Why would anyone want to turn gold into paper, based on what they just witnessed? Fascism is the climax of many small steps of folly. The birth of modern finance destroyed the social fabric. It is easy to understand the brutality of the French Revolution sixty-nine years later in the context of these events. The caste system was increasingly anachronistic, and the problems with money were only going to get worse.
Just as with the Monopoly game, the boom was imprinted on everybody's psyche. The French treasury got rich, allowing the settling of war debts and expansion of government. Other nations witnessed their early success and copied this public financing solution.
The new export industry of colonization increased the material wealth for everyone. It seemed like the perfect solution. Goods went out, and profits were generated. The collapse was not blamed on contradictions within the system, it was blamed on the decisions of specific people. John Law received a lot of the blame. He zigged when he should have zagged. Collapse was viewed as a management problem, not a systemic failure.
Two dramatic intellectual shifts had occurred. First, paper money was real. Second, profit was the new panacea for the financing of society. The government would be sustained by taxes, and the private sector would be sustained by profits. The chit had eclipsed the product. Increasingly, taxes would be paid with money, not harvests.
Nobody was questioning whether the experiment with paper money and stocks had failed. Despite the results, the experiment was regarded as a success. "Everything that fails brings you closer to what works." Like the game Monopoly, one person winning, and three people losing, was regarded as acceptable. Under monarchy, only the royals won. It was a marked improvement to be able to compete as equals, regardless of the terrible odds.
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