development of the Mississippi Bubble

In January1719, Banque Generale was renamed to the Banque Royale and taken over by the Regent, with a note issue guaranteed by the crown. Law was named chairman. He issued huge amounts of paper while expanding business. He converted the massive government debt into company equity, promising high dividend. Therefore, business promoted the credit and the credit in turn boosted the business, which led to sharp increase in the share price.

In July 1719, Law’s company bought the right to produce the country’s legal tender for fifty million livers. To cover this expanditure, Law issued fifty thousand new shares (1000 livers per share). Share price rose to 1800 livers. In August 1719, Compagnie purchased the right to collect all French indirect taxes. Two month later, Law got the right to collect direct taxes which made the share price increase to 3000 livers. He pulled off three enormous share offerings in September and October 1719 (ten thousand shares in each offering and five thousand livers per share) to repay the national debt for the government. The share price rose to 10,000 livers. Suppose you were a French at that time, according to the following picture what would you forecast the stock price in March?

figure1: the share price of Law's company from April 1719 to October 1720
note: this picture is from Garber (1990).But the prices after February 1720
 were cut by me to show the sharp rise in price.                               

Law reached the apex of the power in January 1720: he was appointed as finance minister; he managed the Mississippi Company which controlled France’s overseas trade and the development of its colonies; he owned the right to collect France’s taxes; he possessed the right to mint coins; he held huge amount of the national debt. To the public, it was obvious that the future of Compagnie would be promising. In other words, its share price would keep increasing. As a result, the share price temporarily maintained at a high level. The rapid rise in the stock price was partly due to the cash flow from the rest of the Europe. But more importantly, it was attributed to the currency issuing. Every time shares were issued along with the currency. In turn, it was a flood of currency (or credit expansion) that supported the further increase in stock price.

It seemed that France stepped into a flourish time. If Compagnie did discover the gold mine, perhaps everything would be different. However, the French were so optimistic that a negative shock destroyed the whole economy.

In next post, we will talk about the burst of the bubble. What cause the collapse of France economy? What is the weakness of Law’s plan? Please stay tuned!