EPISODES / WEEKLY COMMENTARY

The Biggest Bubble In The 18th Century & The Man Who Got Out In Time

EPISODES / WEEKLY COMMENTARY
Weekly Commentary • Jan 01 2019
The Biggest Bubble In The 18th Century & The Man Who Got Out In Time
David McAlvany Posted on January 1, 2019
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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

THE BIGGEST BUBBLE IN THE 18TH CENTURY,
AND THE MAN WHO GOT OUT IN TIME
January 2, 2018

“What Law has tried to do, and he said this in his writings at the time – he said, ‘It would have been easy for me just to introduce money into France, but that wouldn’t have solved the problem. There was this huge overhang of government debt, and I tried to address this problem.’ Unfortunately, he went at it perhaps too quickly, pushed it too hard, and the system collapsed in the second half of 1720.”

– Antoin Murphy

Kevin:We have a guest today, Dave, who reminds me of what Alex Pollock, a guest that we had about six weeks ago, brought up to us, that the financial world really doesn’t study economic history. When he would go talk to some of the bigwigs in the financial world and in the banking world he was amazed that they really didn’t know anything about financial history.

David: Reading through the biographies that Antoin Murphy has written on Richard Cantillon and John Law, I would say that Antoin Murphy is one of my favorite economic professors. Now, I haven’t sat with him in class, but I can tell you that the reason I am excited about listening to and engaging in conversation with Professor Murphy today is because he is the kind of professor that I would have wanted in my Economics class.

Kevin:He is a biographer at heart. He understands the human behind the economics. If you remember, when we interviewed Adam Fergusson, who wrote a book about the collapse of the German system back in the 1920s, what we loved about his book When Money Dieswas that it didn’t come at it from mathematical point of view. He brought it to the human perspective, which, let’s face it, Dave, we’re humans first.

David:In that sense, Dierdre McCloskey does the same thing where you have a certain approach to economics which is less common today, but is of equal or greater value as it becomes scarcer and scarcer.

Kevin:We live in a day and age when we talk a lot about John Maynard Keynes. We talk also about Milton Friedman. We talk about what we call the new economists, as if these were new ideas, but when we were talking the other night about John Law and his sometimes partner, Richard Cantillon, we realized that John Law was the first John Maynard Keynes 300 years ago.

David:(laughs) And Richard Cantillon, to some degree, was a monetarist.

Kevin:Yes, Milton Friedman.

David:As we launch into our conversation today with Antoin Murphy, there are three things that stand out from the biography on Richard Cantillon which he wrote in 1986. The first was that unconventional monetary policy is not new, it is something that we have seen going back several hundred years, and still have today. We just have a new vocabulary for it today.

The second thing that stood out was the role of money and credit which has always been central to bubble dynamics and always necessary to continue to push prices of assets higher and higher.

I think the third thing that stood out to me is that Shakespeare suggested, and I think Cantillon’s life reflects this, that the past is prologue.

*     *     *

Professor Murphy, several of your interests as an academic in the field of economics deal with the history of monetary thought, with monetary economics, and with macroeconomics as a whole. You have written a number of books highlighting the stories of John Law, and then of Richard Cantillon, as well. Many of our listeners will know John Law from the story of the Mississippi Bubble of 1720. I think fewer will know of the name of Richard Cantillon, and I think fewer knew about him prior to your biography, but he is certainly no less important. Law was from Scotland, Cantillon from Ireland, and they both found themselves in Paris, France. We will talk about them more in a moment.

You have moved from Trinity College, Dublin, to the Center for International Affairs at Harvard, to then the West Coast to teach a seminar in economics there at Stanford University, along with time at the Hoover Institute. I’m sure there is more we could add to your biography to make it exhaustive, but now by coincidence we find another Irishman in France. We’re curious, in your retirement, are you trading wine? And are you banking? Are you speculating on the Paris Exchange? (laughs) Tell us why you’re there, and tell us how Cantillion emerged as that banking figure in Paris from his youth in Kerry, Ireland.

Antoin:Well, it is far more prosaic, my reason for being in Paris. My wife is French and we come over to Paris from Dublin quite frequently. It was on one of my trips from Dublin to Paris that I had been reading a book on The Monetary Approach to the Balance of Paymentsby Harry Johnson and Jacob Frenkel, and I saw a footnote in that. In the footnote it said that Richard Cantillon made a contribution to The Monetary Approach to the Balance of Payments.

I remembered a lecture that I got in University College Dublin in which the lecturer described some of the gruesome details of Cantillon’s murder in 1734. I said to myself, “I’m in Paris, why don’t I go to the Archives Nationale and Bibliotech Nationale and try to find out something about Cantillon?” That started the first ten years of research on Cantillon, which ended up in this book being published in 1986. Incidentally, there is a paperback edition of the book which has just been published by Oxford University Press this year.

What am I doing in Paris at the moment? One of the things that I am trying to do is to sharpen up a play that I have written dealing with Richard Cantillon and John Law called Millionaires. This, I think, could be sort of opposition to the musicalAlexander Hamiltonbecause in the play I try to show the huge internal debate that went on between Cantillon and Law at this rather frenzied time in 1720 when the world’s first stock market boom, and eventually collapse, occurred here in Paris.

David:I think the story of his life is one full of drama, and it is fit well for theater, so when you are near completion I would love to be there for when it opens. It sounds absolutely fantastic.

You had the Jacobin capital flight from Ireland to France, and at one point the amount of money leaving Ireland was equal to 50% of the total Irish money supply. This really cemented the Irish banking community in Paris, of which Richard Cantillon became a member. You discuss in the biography his transition to banking through working with James Bridges, British Paymaster General and war profiteer.

And in this episode it was clear that creative accounting was not invented by Arthur Andersen – this is not a new-fangled thing – and it was not limited to non-GAAP reporting, as corporations use today. Maybe you can tell us a little bit about Bridges and the bridge that relationship became to Cantillon’s banking endeavors.

Antoin:Bridges is an absolutely fascinating character. He was probably the biggest war profiteer of the 18thcentury. He was paymaster general to the forces abroad for the British crown, and in the period in which he was paymaster the British forces were fighting out on the Iberian Peninsula in a war known as The War of the Spanish Succession, and that had been going on for about ten years.

Now, Bridges, who would later become the Earl of Carnarvon, and still later, the Duke of Chandos, as the paymaster general to forces abroad seemed to have his finger in every provisioning pie that was available. For example, the clothing for the soldiers, the gunpowder for the guns, the muskets that they had. All of these contracts, Bridges would have been insisting with the contractors that he had a certain percentage. He would have taken a percentage on the foreign exchange transactions as money was transferred from London to Genoa and from Genoa to the Iberian Peninsula.

All of the time he was making a very, very considerable sum of money, to such an extent that he built a huge house outside London called Cannons, which unfortunately was destroyed later. But remarkable, as well, he was able to employ Handel as his Kapellmeister, as the head of his chapel, and he could click his fingers and ask Handel to perform some musical activity whenever he wanted. So he was fabulously rich. He was fabulously corrupt.

Cantillon, through one of his uncles who was a banker, got involved with Bridges and acted as an accountant to the troops in the Iberian Peninsula, and there I think he really learned double-entry book-keeping because there were books kept for the official files, and then there were books kept on the additional amount of profiteering that was going on. So Cantillon was certainly no saint and he would have been assisting Bridges make a very substantial fortune. When the war ended, Bridges then suggested to Cantillon to come to London and work for him, but Cantillon decided, no, he would go to Paris. His cousin had a bank in Paris, the Chevalier Richard Cantillon, and he decided he would go to Paris and become a banker in Paris.

David:There is a long stretch here where multiple bubbles occur, both in Paris and the London Exchange, and then Amsterdam. And through this, Cantillon makes his own fortune, going from banking to speculating. And after that he is sitting as a wealthy man with a little bit of time on his hands, other than defending a few lawsuits, and he publishes a book.

The first systematic treatise on macro-economics was written by Richard Cantillon in the 1730s, and it followed his practical experience as a goods trader, as a banker, as an accountant, and then again, as we mentioned, a fabulously successful speculator. How would you contrast John Law’s ideas of fiscal and monetary policy management with what we find in Cantillon’s book on economics?

Antoin:Law is also a fascinating character. I sometimes describe Law in terms of a tabloid headline, “Convicted Scottish Murderer Becomes Prime Minister of France and Causes the World’s First Stock Market Boom and Collapse.”

David:(laughs)

Antoin:Now, despite that sort of very jazzy headline, Law was a very serious economic writer. He wrote a work called Money and Tradein 1705. In that he really put forward the viewpoint that trade, economic activity, is driven by money. He didn’t believe in the neutrality of money, he believed that if you expanded the money supply you could expand economic activity, and you could lower interest rates in the process. And that is, essentially, what he did when he took over the French finances after the death of Louis IV in 1715.

Law set up a bank, the General Bank, and started creating bank notes to substitute for gold and silver. And then at a later stage, he set up the Company of the West, and he used this company to take over the French national debt through the issue of shares. Part of the collateral of the shares was the area known as French Louisiana, which was an area stretching from the Gulf of Mexico right up to Canada, bordered by the British and the Carolinas on the East Coast, and by the Spanish and Mexico on the west side. Now, this was the equivalent of half of the United States, so Law ultimately ended up creating a company which had trading rights and concessions over half of what we would know as the United States today if you exclude Alaska. Law’s system was a system in which money would be expanded, the rate of interest would be reduced, and economic activity would be increased.

Cantillon, on the other hand, would be different in his approach. He believed that there was a real economy out there and you needed to be careful about grafting onto the real economy a financial economy, and over-expanding the financial economy relative to the real economy. In his essay, The Nature of Trade in General, published in 1755, Cantillon really stood out from all the other writers of that period in that he showed that the essence of a good economist was to build a model, and he built up a model from what you might call a single command barter economy to a sophisticated market money-using open economy. And he showed how the economy could produce goods and services, how the market system operated, and how at the center of economic activity you have this key individual, the entrepreneur.

In terms of modern day parallels, I think John Law could be regarded as a Keynesian, somebody who believed that monetary and fiscal expansion were good to drive the economy if the economy was at a situation where there was less than full employment. Cantillon, on the other hand, was more of a monetarist. He was saying, “Look, the market can sort out unemployment problems, and you have to be very, very careful in ensuring that you don’t over-expand the money supply relative to the demand for money, and if you do that you are going to get balance of payment problems, you are going to get inflation problems, etc.”

So I think Law could be regarded as sort of a pre-Keynesian and Cantillon could be regarded a pre-monetarist in today’s parlance.

David:Fascinating that it was Cantillon who was seeking for market solutions, and yet he had a different view. I know in our Commentary we have contrasted Adam Smith’s concept of the unseen hand of the market with maybe the seen hand of central planning. Cantillon, I think, had an even more compelling concept than Smith in that the seen hand was not of the central planner, to him it was the entrepreneur as the driving force of economic growth and prosperity.

So when you are talking about market solutions, you could also substitute the entrepreneur in the marketplace taking risks and coming up with solutions. Tell us about Cantillon’s entrepreneur, in some ways, really reflecting his own life as a transition away from a history and heritage of landed gentry in Ireland to needing to find another way, being the second brother in a larger family of boys.

Antoin:You have to remember that Cantillon was forced out of Ireland. They were sort of lords of the estate down in the southwest of Kerry in a placed called Ballyheigue. Then the Williamite invasion took place and a lot of the Catholic Irish were dispossessed. So they had to leave after the Treaty of Limerick, and he would have had to fend for himself. There are stories that he arrived in Paris, and he had no shoes on his feet, and he was relatively poor. That would have been before he went to Spain.

When he comes back from Spain to Paris he is a merchant, he deals in clothing, he deals in wine, but he very quickly finds his feet in the area of banking and he becomes a top class banker. But all the time, as you read the essay you can see that he is very, very interested in the central role of the entrepreneur. And I think this is very refreshing, because in economics we have sort of gotten rid of the entrepreneur. There are very few textbooks in economics in which you will find the writer discussing in great deal the role of the entrepreneur. Schumpeter was one of the few people who recognized the incredible importance of the entrepreneur.

Adam Smith, with the invisible hand, blanks out the entrepreneur, although he plagiarizes an awful lot of Cantillon’s essay in probably his most famous chapter, which is chapter seven of book one of The Wealth of Nations, where he distinguishes between market prices and natural prices. And that is all taken from Cantillon who had the distinction between market prices and intrinsic value. Intrinsic value was just what Smith replaced with natural price.

To Cantillon, the entrepreneur had to be conceptualized. Who is he? What does he do? Here, I think he produces one of the most brilliant one-liners in economics. He said the entrepreneur is somebody who buys at a known price to sell at an unknown price. And I’ve challenged many years of students in Trinity, and indeed, at other universities, to produce a better one-line definition of the entrepreneur – somebody who buys at a known price to sell at an unknown price.

So you buy up the factors of production, you know the cost to produce the good or service with the factors of production, and then you have to sell it. Now, if you get the price right you make profit. If you get it wrong you lose and you go out of business. So the entrepreneur is somebody who has to be very, very close to the market and identify what is going on and be able to work out the price at which he is going to sell the particular good or service that he is producing.

Cantillon, I think, in introducing the entrepreneur to economics, showed economists a way forward. Let’s use the entrepreneur as the central driving force of economic activity. You can see that across the global economy at the moment. China has been transformed. Why? Because there are millions and millions of entrepreneurs that have been unleashed. Incidentally, Cantillon talked about these entrepreneurs in China in the 18thcentury. In the United States, over the centuries, it has been the entrepreneurial drive that has led to the huge progress and prosperity of the United States.

Economics, if you think about it, took an awful turn for the worse in the 19thcentury when Marx came along and classified the socioeconomic difference in society as being between the capitalist and the laborer. The capitalist was the nasty man and the laborer was meant to be the good man who should be benefitting from all of the surplus value created by the capitalist.

If, in fact, some economists hadn’t gone down that Marxian detour, and had emphasized more the role of the entrepreneur rather than the capitalist, you don’t get all this tension that you have between capitalists and labor because the entrepreneur can be a taxi driver living on the same road as somebody who is driving a bus for the public sector. So you don’t have socioeconomic tensions, I think, when you classify your society as being a society of a bunch of entrepreneurs and people who work at a fixed wage rate.

So there is a huge richness to be found in Cantillon’s essay, not only in terms of the way he conceptualized the role of the entrepreneur, but in terms, also, I think, of the socioeconomic classification that society is one in which you have entrepreneurs and people working on fixed wages, rather than a society in which you have nasty capitalists versus laborers.

David:We’ll bounce back and forth between this period of the 1720s and modern times, perhaps borrowing some of the intellectual capital from Cantillon to better understand where we are today. In a conversation that I had with Carmen Reinhart last year, we discussed financial repression, and that is essentially the assignment of losses and the corralling of investors into particular categories so that problems can be sorted out from a fiscal standpoint.

I think if the entrepreneur is one of these key pieces in the market that ensures that the market works, what happens when incentives shift away from the entrepreneur so that now it is no longer just buying at a known price to sell at an unknown price, but it is also dealing with how a central planner may be trying to apportion losses, whether that is through a special tax scheme or debt restructuring? What are you thoughts?

Antoin:I think if you’re trying to give Cantillon a voice in this, he would be saying that once you move toward central planning you are essentially destroying the role of the entrepreneur and you are going to end up with a very, very soft economic structure. It’s going to lose its dynamism. So Cantillon would be saying you have to nurture and progress the entrepreneurs. You have to encourage young people to think of acting as entrepreneurs.

And indeed, there is a good example of this in France at the moment in President Macron who is getting very hostile press, but if you look at it from an economic perspective, he is trying to ensure that there are a lot more young entrepreneurs brought into the French economy. He is trying to reduce taxation on the capital that entrepreneurs are using. And he is really producing a type of Schumpeterian approach to how you can produce almost an economic revolution in France, which is very much needed.

Of course, the time lags always involved in these things, you can introduce the policy and the good effects are going to take 18 months, two years, three years, to manifest themselves in the economy. But I think it is reassuring to see in France that there is at least an attempt now to reduce taxation of entrepreneurs to encourage their activity, and to get them to grow the French economy.

David:We go back to this issue of investing in the youth. You mention early on in the book, quoting Jacques Savary, that advice to parents for budding entrepreneurs is basically, stay away from college. “Experience has taught us that children whose parents send them to college to study Latin, grammar, rhetoric and philosophy up to the age of 17 or 18 are very seldom fit for trade, and of 30, there would not be four who would go into this profession if they were not forced into it by their relatives.”

I think of Cantillon’s life and the hardship which was a precursor to his success. Yes, he earned a fortune, but was Cantillon’s real fortune to emerge at a unique time in history? Right place, right time seems to be a prominent aspect of his biography, along with the hardship that he endured to get where he was.

Antoin:I think he would have made money at any particular phase of history over the last couple of hundred years. I think he was just innately extremely bright. When you have a look at the way in which he got himself involved in the Mississippi system, you can see his intelligence shining through at almost every phase. Here he is in Paris, he meets up with John Law, he listens to what Law is talking about, and he says, “There are a lot of good ideas there.” And he agrees with Law that it might be a good idea to send some colonizers out from France to what would be called New Orleans. Incidentally we are celebrating the third centenary of the establishment of New Orleans this year. It was named after Law’s mentor, Phillippe, Duke of Orleans. Cantillon says, “Right. Law and myself, we’ll send colonizers out, we’ll put the investment up and we’ll send them from La Rochelle to New Orleans.”

He follows Law in the first phase of the Mississippi system, the price of shares rises from $160 in 1717 to $2000 in the early summer of 1719. Cantillon has made a lot of money because he has invested in these shares. But at this stage he starts using his economic theory and he says, “Hey, this is a bubble. This thing is going to blow up.” So he decides to sell all his shares and he retires to Italy.

Now, you can imagine his concern when he is down in Italy and he buys the Gazettes that come from Paris and he sees that he has made a mistake. The price of Mississippi goes up from $2000 to $3000, to $4000, to 5, to 6, to 7, to 8, to 9, to $10,000 within the next six months. And here he is in Italy and he sold out at $2000 so he has missed out on a very strong phase of the Mississippi system.

So what does he do? He comes back to Paris, he has another look at the system, and he says, “There is something wrong with this. I thought it was a bubble in the summer of 1719. Now in the spring of 1720 I think it is a massive bubble and it is certainly going to blow up.” So what do you do? Well, you take a bear approach to investment behavior. You just sell your shares and you speculate against the French currency. That’s what he did and he did it extremely successfully.

And then in the summer of 1720, John Law realizes that Cantillon is speculating like mad against his system, brings him in and says, “Look if we were in Britain together we could be buddies with respect to what is happening, but we’re in France, I’m the Prime Minister, and you’re speculating against my system so you’d better get out.” So he kicks Cantillon out of Paris. Cantillon continues to speculate against Law’s system.

Law then realizes that perhaps one of the few people with sufficient intelligence to shore up his system, because the Mississippi system is starting to collapse at this stage, is Cantillon. He writes a letter to him and he says, “Please come back and help me restructure the Mississippi system so that we can make it successful.” It would have been very strange, a Scottish man and an Irish man running the French economy.

Cantillon is too clever, though. He realizes the Mississippi system is in a collapse phase, and it is not going to recover. If he goes back he will lose the fortune he has made. So he stays in Amsterdam and in London. Then what happens? He sees the South Sea bubble developing, and he says, “Well, this is another opportunity. It is exactly the same thing that was going on in France.” And he gets involved in all sorts of option deals with call options with Dutch financial traders and he makes a further fortune.

So I think the way in which he used his amazing intelligence at different stages of the Mississippi system, and of the South Sea bubble, shows that no matter what period of history he could have lived in he would have made a very substantial fortune. He was just very, very bright, and that is what you see coming through in his one known economic work,Essay on the Nature of Trade In General.

David:You also see that his intelligence is not limited to numbers. He has the sense, after selling out on the first round from $160 to $2000 in the Mississippi bubble, to move to Italy to get out of the way of any political ramifications which may come if, in fact, the system does collapse, knowing that there will be further ramifications. So he understood social, political, economic trends, as well as accounting and economic theory, so he really is an interesting guy to study.

Cantillon’s view – I want to compare him, perhaps, with Jacques Rueff. Imagine a conversation with Jacques Rueff, financial attaché to the British in the early 1900s, and he was advisor to de Gaulle to begin to change the relationship between the U.S. and the United States. Cantillon’s view of the increase in the money supply leading to a balance of payments deficit – how do you think Cantillon, again, hypothetically, would have discussed that issue with Jacques Rueff? We have the U.S. running a deficit. Rueff called that “the deficit without tears.” Cantillon assumed that, if I were to put words in his mouth, there would always be tears. How do you think that conversation would go?

Antoin:Oh yes, I think Cantillon would have said to him (laughs), “Look, these things always end up with tears – always – because if you are expanding the money supply relative to the demand for money, there are a number of transmission mechanisms whereby the expanded money supply can manifest itself. It can happen in the bond market, it can happen in the goods market and various types of asset markets, in consumer goods markets, etc. But you are going to have increased expenditure in these areas and then it all depends on the extent to which the economy is fully employed or not, and if the economy is fairly fully employed, Cantillon would say, “Hey, this money is going to flow through increased expenditure in these markets and generate a balance of payments deficit.”

Now, in the early stages of the balance of payments deficit, you may be able to cope, but you can’t cope with a continuous and increasing balance of payments deficit over time. You just run out of money. The United States is in the privileged position that it has a reserve currency. But how does it maintain its position as a reserve currency? Well, it maintains its position by not abusing it, and by not over-expanding the overall amount of dollars created.

But once you have balance of payments deficits, that is a manifestation that there is an excessive amount of dollars in circulation, and if the balance of payments deficit gets worse and worse, then the exchange rate can come under pressure, you have interest rate effects, and then further down the line you have something the Cantillon writes brilliantly about – capital flight. People say, “Hey, this is no longer a reserve currency, this is a currency that I don’t want to hold.” And you suddenly have capital flight out of the U.S. currency, and that can be very, very dangerous.

David:To some degree then, it would have been an agreement. Rueff would have said, “On this basis, that is why I am advising the French to take gold instead of greenbacks,” going back to the Bretton Woods period, because it can’t last and there will be a consequence and the dollar will decline. So Rueff ultimately would have agreed with him, it sounds like.

Antoin:Yes. And I suppose de Gaulle could give himself a pat on the back for identifying the weakness in the reserve currency status of the dollar at the time as a result of the flow of funds out of the dollar the Americans had to go off the last vestige of the gold standard, which was guaranteeing gold at $35 an ounce. It was a great period to be able to buy gold in those days. Now you’re paying $1200 an ounce.

David:(laughs) It’s a little bit more. But what can we apply from Cantillon’s views on velocity, to issues such as asset price or goods inflation? Is this what has been called, or come to be known as, the Cantillon effect?

Antoin:I think the Cantillon effect is, really, Cantillon looking at the various transmission mechanisms whereby you can have an increase in the money supply affecting prices. And I think what he is doing is looking at it in such a way, saying, “It’s not a crude relationship. You don’t suddenly have an expanded money supply creating an exact proportionate increase in prices. If you look at the transmission mechanism, the black box, between the change in the money supply and the ultimate change in economic activity as manifested by prices, by GDP, and by the balance of payments deficit, if you look at the black box, you’re dealing with a variety of different goods, assets, etc.

So for example, Cantillon introduces a very important distinction between traded goods and non-traded goods. A lot of goods can be traded goods that are traded over international boundaries and frontiers, and the price of traded goods is not necessarily going to be influenced by what is happening to the money supply in the domestic economy. The prices of traded goods are going to be determined in international markets.

That was quite a sophisticated element for Cantillon to introduce into economic discourse, that if you expand the money supply by X percent, it doesn’t necessarily mean prices are going to increase by X percent, because there is a whole range of different markets and different economic settings in which the changed money supply is permeating through the economy.

David:Cantillon learned, as we discussed earlier, some practical trading skills, and it would seem that in the real economy, this is where he was mentored first. Then he transitions to making a fortune in the monetary economy, in the financial universe and in banking. Contrast those for us and tell us if you think there is a point at which the monetary economy eclipses the real economy in a detrimental way.

Antoin:I would say more the financial economy, rather than the monetary economy, because Cantillon believes money has to be there. You have to have a monetary economy for economic activity to function properly. Now, what he is very much against is, if you like, financial graft on the economy. This is the type of financial graft that John Law had introduced. Law is suddenly transforming government debt into shares of the Mississippi Company, and he is monetizing these shares by guaranteeing them as $9000 livre a share.

Cantillon is looking at this and saying, “Hold on, Law, by this financial manipulation, by the financial graft of converting debt into a highly monetized financial instrument, has created a financial economy which is way out of line with the real economy.” Cantillon had spent a lot of his intellectual powers in trying to show how the real economy is built up. It is this economy in which you have entrepreneurs producing goods and services, etc. But now suddenly you have this added dimension, this graft, this financial innovation of John Law, and he feels this is putting things out of kilter. He knows it has been wrong because he has made a fortune out of backing against the consequences of Law’s system.

I think after the collapse of the Mississippi system he sits back and says, “Where did Law go wrong? What was wrong with Law’s system?” And I think his view is, “Hold on, you can have a certain amount of financial innovation, but when you have an excessive amount of financial innovation, and the financial economy goes out of line with the real economy, be prepared for the worst. Stock markets are going to collapse, and you are going to get into all sorts of difficulties.

David:And he is putting these things together in real time because, frankly, the South Seas bubble was almost immediately following the Mississippi bubble, and stock market capitalization at that point reached over seven times total British GDP – seven times GDP – which was just massive – massive. The Mississippi system began to change the French financial system when Law moved into the management of national debt. I am curious if there are lessons that you would draw from that timeframe that might be instructive to contemporary central bankers who are attempting to keep the world afloat on top of massive central bank balance sheets today.

Antoin:I think we have to give a somewhat considerate assessment of Law because when he takes over the monetary system in France and substitutes paper money for gold and silver, that is very much consistent with the period that he has put forward in money and trade in 1705. He believes money drives economic activity, etc. But then Law says, “Look, after I did this I realized that there was a major, major problem and France was almost bankrupt.” Interest rates were at excessively high rates, if you could actually borrow money. A lot of the time the crown couldn’t actually borrow money.

So the French debt structure was all wrong, and something had to be done about it. The policy he introduced was to say, “We will convert the government debt held by French contractors. We will convert that into shares of the Mississippi Company.” And for a period, this worked outstandingly well. It worked so well that the French appoint Law as the equivalent of the Prime Minister of France. In January of 1720 it has reached its apogee.

But then Law realizes, “Hold on, maybe I’ve pushed the system too hard and too fast.” He tries to restructure it and cut back at the rate of financial growth that has taken place. But the problem then for him is that the political supporters of Law don’t want this. They don’t want anything that is going to reduce the value of their shares or the value of the bank notes that they are dealing in. So Law is stuck, and he can’t really introduce the type of measures that he feels are needed to bring some order, some equilibrium, back into the system. And that is his fate, really. Between January of 1720 and May of 1720 he tries all sorts of policies to correct the imbalance which he has created, but to no effect, and eventually in May 1720 when he is allowed to reduce the value of bank notes and shares, there is a huge market reaction against him and he is forced to resign as the prime minister. And then from May 1720 to December 1720 the system is weakening progressively from month to month.

But what Law has tried to do, and he says this in his writings at the time, “Look, it would have been easy for me just to introduce money into France, but that wouldn’t have solved the problem. There was this huge overhang of government debt and I tried to address this problem.” Unfortunately, he went at it perhaps too quickly, pushed it too hard, and the system collapsed in the second half of 1720.

David:This is a period of time when they were experimenting with what is money?Gold and silver were considered money, and then this experiment pushing gold and silver out of the way is a part of the process. You then had the collapse of the paper experiments. Specie, gold and silver are brought back in to regain confidence in the monetary system. But at the same time this experiment is happening, you do, if you are a global player, if you are an investor beyond your borders, provincially, you can choose the sterling, you can choose the gilder, you can choose other currencies which have real substantive metallic backing. As a historian of monetary policy, which you are, can you see the current fiat system that we have, post 1971, post Bretton Woods, enduring?

Antoin:Oh, I think so, very much so. The problem is that if it doesn’t endure, do you go back to the gold standard? The gold standard, as we saw in the 1930s, and I would say even before then, acted as a terrible anchor to economic growth and economic prosperity. I think, as you look at history, you can see something happening between Britain and France from 1720 onward. In Britain, the Bank of England survived the crash of the South Sea bubble. It continued.

In France, the banking system collapsed with the collapse of the Mississippi Company. The French didn’t want anything to do with credit creation, bank notes, financial innovation, etc. Right through the 18thcentury, the French return to a specie system. All they want to do is use gold and silver. So the potential for credit creation disappears, to a very significant extent, in France.

And on top of that, the bubble acts, in both Britain and in France, to prevent IPOs being made by companies. But in Britain the Bank of England, and the Scottish banks, the Bank of Scotland, the Royal Bank of Scotland, the British [unclear] Bank, and so on, these are the banks that now suddenly move away from a fully-backed metallic money standard, and start expanding credit. And I think the reason why the British progressed to a far greater extent in the 18thcentury than the French, even though France was more populous and had a lot more basic economic resources, was that Britain had a far more sophisticated financial system, and Britain introduced things like overdrafts, which enabled money to flow through the economy.

So I would think anything that moved the global economy away from fiat monetary system back to one linked up, or anchored to a metallic monetary system, would be very much counter-productive. I think what we have to understand is that we have a lot of financial innovation going on, and financial innovation, at times, can be incredibly important and incredibly good for the economy. Overdrafts are a good example of that, that enabled banks to expand credit and finance investment. But there is always a tension between financial innovation and financial prudence, and that is the balance that central banks have to maintain. You can have an excessive amount of financial innovation, and you get into all sorts of trouble. But you can also have an awful lot of financial innovation, which we have seen over the last couple of centuries of the banking system developing and financing an awful lot of the capital investment that took place in the global economy.

So I think once you balance financial innovation and financial prudence, and you ensure that financial innovation is not excessive on the lines of what happened in the United States in 2008 or what happened in France in 1720, as long as you can introduce some balance there and ensure that financial innovation is not massively excessive relative to what is needed in the economy, you can get a prosperous economy, too.

David:Let me give you an alternative read on the Bank of England and the Royal Bank of Scotland, and perhaps you can offer some critique on this. Certainly the depth of the credit markets was necessary for the English to do all that they did in the 18thcentury. Underscoring depth in the credit markets and willingness to innovate then was confidence.

If we assume that confidence has been tied to a stable monetary system through time, and that is, in fact, what the French were looking for as they went back to the specie system, maybe the difference between the French and what they experienced after the bubble with the Mississippi system – which was really pervasive, it went to the core of the system because it went to the heart of money and credit at the governmental level – it did not do that with the South sea bubble in the sense that the Bank of England had the opportunity to step in and bail out the players in the South Sea Company. They did not – they sidestepped a significant issue which probably would have bankrupted the Bank of England. Yes, gold and silver were still a part of the monetary system, but you have this issue of confidence.

I wonder if perhaps that is what we are dealing with, when, today, we have a system in which, very appropriately, confidence is meted out to hundreds of Ph.D.s at the Federal Reserve, and I don’t know how many are sitting on the Board and directing the European Central Bank and the Bank of England and the Bank of Japan today, but this is a Ph.D. standard, very different than what we had prior to the Bretton Woods system, prior to what we had – Cantillon’s preference – a self-equilibrating real money system based on gold and silver. I guess what I am asking is, is this issue of confidence tied to gold and silver maybe underappreciated, as things played out in the Bank of England and how their credit markets developed in the 18thcentury?

Antoin:I think it obviously helped, but there was still this understanding that quite an amount of the credit that the British banks were expanding was backed by gold and silver, but as you move through time that becomes less and less so. The banks are starting to be more modern-style credit-creating banks with pretty low metallic money reserves. What happened in France – you’re right about the confidence element. Confidence was just absolutely destroyed in the monetary system in France by the collapse of both the Royal Bank and the Mississippi Company. As a result of that, the French did not want to innovate.

The British, I think, were lucky in that the Bank of England stayed out of the South Sea bubble, although in the early stages it tried, actually, to win the contract for running the national debt, and it was bidding against the South Sea Company on this. But fortunately for the Bank of England it didn’t get it. And then when the South Sea Company collapsed, the Bank of England sort of restructured a bit and continued its activities. So confidence in Britain wasn’t destroyed to the same extent that it was in France. But for some reason, in France, there was just this absolute, absolute reluctance to financially innovate, right up to the French Revolution.

But then the French Revolution comes along in 1789, and as one knows, in order for a revolution to be successful it has to be financed. And how do they finance it? They finance it through the issue of paper money known as the assignat, which initially were backed through all of the confiscated ecclesiastical property and land that the revolutionaries had taken over.

But then, once again, the bank notes, the assignat, were over-issued. They financed the first three years of the French Revolution, but coming into 1794 they were massively over-issued, you had massive hyperinflation in France, and the whole system breaks down again. The French lose confidence once again, and they are back to talking about a specie monetary system. And again, I think that makes the French banking system far more conservative, and far less innovative relative to the British banking system as you move through the 19thcentury.

David:As we get to the end of your book and the end of Cantillon’s life, it is shrouded in mystery. Again, we go back to where our conversation began, which is, you are working on a play dealing with the millionaires, and Cantillon and John Law feature prominently here. Well, Cantillon’s life – he accumulated great wealth through his speculations in Paris and in London and in Amsterdam, operating as a financier through that time. Several other speculators took aim at him, tied him up in court, and in 1734 he dies in a house fire. Was it an accident, was it murder, or did he intentionally just want to disappear?

Antoin:That is the intriguing element of the end of Cantillon’s life. He was living in London in a street called Albemarle Street which runs parallel to Bond Street in the center of London. He was living in a very exclusive type of residence. One of the famous politicians, Bolingbrook, was living beside him. Now, if you believe the official accounts, it looks as if he was murdered by his French chef, with some other members of the household involved in this, that they killed him and set fire to the house and the house was burnt to ashes.

Six months after Cantillon’s demise in London, there was a very mysterious individual called the Chevalier de Louvigny who arrives in the Dutch colony of Surinam in South America. The Dutch authorities don’t know who this Chevalier de Louvigny is. He goes into the jungle and he sets up camp there. They send in the troops to locate him. He disappears. Then they relocate him in another area in the jungle. Again, troops are sent in to question him. He disappears again. But this time they find some freshly dug earth, they dig it up again and they find a very large box of documents relating to one Richard Cantillon, Esquire, of Albemarle Street, London.

Now, the question arises, if this Chevalier de Louvigny was the man who murdered Cantillon, why was he pulling a very large box with documentation relating to Cantillon, which would have been highly incriminating, through the jungle of Surinam? Why had he taken it from Europe to South America? Unfortunately, we don’t know who this Chevalier de Louvigny was. Was it Richard Cantillon who had arranged his demise in Albemarle Street, because remember, his body was burnt to ashes? Or was it the French chef who had stolen documents and brought them to Surinam?

Very difficult to know – I would think it was about 85% chance that Cantillon was murdered in Albemarle Street, perhaps 15% chance that he arranged his own demise. Remember, at the time he was subject to a lot of civil and criminal lawsuits, both in Paris and London, and that may have given him an incentive to want to get out. One way or the other, it is quite mysterious. And then, almost 21 years to the day of Cantillon’s murder, in 1755 this Essai Sur la Nature du Commerce en Generalis published in Paris. There is no offer given, but very quickly people say this was written by the former banker, Richard Cantillon, who lived there in the 1720s.

David:Twenty-one years to the day, his work is published. The day that he is murdered, if he is murdered, he withdraws 10,000 pounds, not an insignificant sum in that day, from his bank. Again, these are all at the edge of being real evidence. They are circumstantial at best, but it makes for a very interesting story.

I would suggest that anyone interested in, not only economic history, but a solid tale of wealth, its accumulation, and ultimately, the demise of the man, at a relatively young age, who procured it. It is an excellent book, and fascinating that so few people have written on the life of Richard Cantillon. I think you chose well, Professor Murphy. Oxford University Press offers the book that you put together. They also offer the biography, John Law: Economic Theorist and Policy-Maker, also by Antoin Murphy. I would encourage all of our listeners to order them and engage with them.

Thank you, Professor Murphy, for joining us today on the Commentary.

Antoin:Thank you very, very much.

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