Looking back over the past year its hard not to try and look for parallels in history of the economic remedies Ben Bernanke and the Obama administration have taken thus far. Many see Zimbabwe or Argentina as examples of the risks of Quantitative easing. Even some see Japan as a good comparison. Although all three have unique differences that make it difficult to compare with the United States. Looking back even further into history we should take a look at the policies taken by the French some 300 years ago.
Charles Mackay, “IF 500 millions of paper had been of advantage, 500 millions additional would be of greater advantage.” This 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 bubble was a precursor of current attempts to reflate the economy with unordinary monetary policies.
Law was a very bright mathematician who had a bad gambling habit. Leaving Scotland after killing a rival in a duel he quickly became friends with the Duke of Orleans, regent of the young King Louis XV.
French government finances like the United States currently were in a terrible mess. Louis XIV had spent much money on fighting long and exotic wars that had exhausted the treasury. Not only was the monarchy struggling to pay interest on its debt, there was also a credit crunch in the form of a shortage in gold and silver coins needed to fund economic activity (like todays credit crunch in which bank loans are needed to fuel economic expansion).
Law came up with the idea of using a fiat – paper currency ( backed only by the Monarchies good faith). Law needless to say was ahead of his time.
Blessed with having an absolute monarchy, enforcing a paper currency backed by nothing wasn’t too difficult. Now taxes would be paid in the form of notes issued by his new bank, Banque Generale. After observing the Dutch exploiting the spice trade in the East Indies, he believed that France could use paper money to develop its colonial possessions… i.e Mississippi. Law created Compagnie d’Occident to exploit trade opportunities. Money raised from these share issues was used to repay the governments debts. On occasions Law went as far to lend investors money to buy shares.
Nowadays this type of scheme could be seen as a French stimulus package for economic activity. Rather then rescuing now dying car-making industries like the U.S. has done, Law was a bit of a venture capitalist financing the awesome potential of the Mississippi delta.
Problems eventually arose from the Mississippi delta operations, being that it was a infested mosquito swamp, generating enough income from the area become impossible. Paying back dividends Law had promised become futile.
So then a vicious cycle was created, in which growing money supply was needed to bolster the share price of the Mississippi company to maintain confidence in the system of paper money…. sound familiar?? Money was lent on the back of rising asset prices, and higher prices gave banks confidence to lend more and more. This was a game of confidence in was in no way sustainable.
When this scheme finally fell under its own weight, Law resorted to a number of then rescue packages. One was a guarantee by the bank to buy shares in the Mississippi company at a set price (like todays various asset purchase schemes). Eventually the company took over the bank ( like Fannie and Freddie blank check to treasury/taxpayer money) and finally there was a restriction on the amount of Gold and Silver people could own (like in 1930’s America)
All this eventually failed and collapsed. Law was then exiled and eventually died in poverty. French finances would continue to stay in a wreck until the 1789 revolution. This all only took four years to collapse, which unlike todays extend and pretend policies taken by our government are much easier to extend when having a much larger and diversified economy.
The broad message from this failed scheme was that maintaining asset prices above market values is doomed from the start.
One other question arises from this problem of a credit fueled economy. That is, how long can it last? Over the past few decades we have seen credit expansion be the main driving force to fueling economic growth. Small businesses use credit to expand and to eventually use future profits to pay back the principle with interest. Though while doing so we exhaust demand for the ever increasing supply of business. Commercials try and get the American public to spend spend spend to keep this going. Savings is discouraged and being a speculator/gambler is rewarded along with consuming perishable products.
This in turn leaves me and others with many more questions on what solutions are there to these problems. More on this later….