A:

In 1715, France was essentially insolvent as a nation. Even though taxes were raised to extremely high levels, the hole that warfare had left in the French treasury was too deep. France began to default on its outstanding debt and the value of its gold and silver currency whipsawed as people feared for the future of the nation. France turned to John Law to solve its problems. Law was a Scottish exile – he killed a man in a sword duel – whose talents in both gambling and finance gave him great weight with the government.

Law thought it was the unpredictable supply of gold and silver that was slowing the economy rather than a true economic problem. By switching to paper, he reasoned, more currency could be issued and trade would speed up. He created a bank that took deposits in coin, but issued loans and withdrawals in paper. Law's bank built up its reserves through a stock issue and also made a good profit by handling the government's finance needs.

Law decided to expand by acquiring the Mississippi Company. The company held a government-backed monopoly over trading with French Louisiana. Under Law's influence, the company's charters grew to include tax collection and all trade outside of Europe. The stock price shot up and the amount of cash needed to buy Mississippi shares meant that more money had to be printed.

Unfortunately, people wanted gold and silver when they took profits. Law capped redemption in gold and silver to avoid depleting his reserves. This removed France's paper currency from the gold and silver standard and put it on the Mississippi Company share price standard. The amount of paper currency afloat was now many times the actual reserves of gold and silver and hyperinflation set in.

Realizing the share price was vastly overestimating the wealth of beaver hides and gold in the French colonies, Law attempted a controlled slowdown. He depreciated the currency and the shares by half, but the decision triggered a selling frenzy that drove the share price down sharply. The paper currency became worthless and Law found himself in exile all over again. Since it occurred in the same year as the South Seas bubble, the Mississippi bubble is often confused with its British counterpart. The Mississippi bubble is actually more of a currency blunder than a true speculative bubble. (To learn more, read our feature Market Crashes: What are Crashes and Bubbles?)

This question was answered by Andrew Beattie.

RELATED FAQS
  1. Do negative externalities affect financial markets?

    In economics, a negative externality happens when a decision maker does not pay all the costs for his actions. Economists ... Read Full Answer >>
  2. What is the difference between disposable and discretionary income?

    According to the Bureau of Economic Analysis, or BEA, disposable income is the amount of money an individual takes home after ... Read Full Answer >>
  3. What kinds of costs are included in Free on Board (FOB) shipping?

    Free on board (FOB) shipping is a trade term published by the International Chamber of Commerce or ICC, that indicates which ... Read Full Answer >>
  4. What are the major laws (acts) regulating financial institutions that were created ...

    Presidents George W. Bush and Barack Obama, in conjunction with Congress, signed into law several major legislative responses ... Read Full Answer >>
  5. What are the similarities and differences between the savings and loan (S&L) crisis ...

    The savings and loan crisis and the subprime mortgage crisis both began with banks creating new profit centers following ... Read Full Answer >>
  6. What are the differences between B-shares and H-shares traded on Chinese stock exchanges?

    Equity listings in China generally fall under three primary categories: A shares, B shares and H shares. B shares represent ... Read Full Answer >>
Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI South Africa

    Learn more about the iShares MSCI South Africa fund, which is an NYSE-listed exchange-traded fund offered and managed by BlackRock.
  2. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI EAFE Small-Cap

    Read an in-depth analysis of the iShares MSCI EAFE Small-Cap Fund, a well-managed exchange-traded fund that tracks small-cap international stocks.
  3. Mutual Funds & ETFs

    ETF Analysis: Vanguard Global ex-US Real Estate

    Take an in-depth look at the Vanguard Global ex-U.S. Real Estate ETF, an international property fund tilted toward Asian markets.
  4. Economics

    Is the Yuan a Yawn or a Nightmare for Investors?

    China’s decision to change the method of setting its currency exchange rate caused global shock waves last week.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares International Select Dividend

    Learn how the iShares International Select Dividend ETF provides investors an opportunity to gain exposure to high-quality companies outside the United States.
  6. Professionals

    Holding Out for Capital Gains Could Be a Mistake

    Holding stocks for the sole purpose of avoiding short-term capital gains taxes may be a mistake, especially if all the signs say get out.
  7. Economics

    Signs of a Struggling Economy?

    Last week was another difficult one for stocks, marked by a bruising mid-week selloff triggered by China’s surprise devaluation of its currency. 
  8. Stock Analysis

    Looking to Invest in China's Fast Food Industry? Try KFC

    Read about the fast food industry in China, and learn what makes KFC the dominant brand in a market poised for years of high growth.
  9. Investing

    Is Lenovo an Example of the New China?

    From modest beginnings, Chinese computer firm Lenovo has become the number one provider of personal computers in the world. But does this represent the new China?
  10. Mutual Funds & ETFs

    Top 3 Vanguard Managed ETFs

    Find out which three Vanguard exchange-traded funds made into the list of best Vanguard products for new and established ETF investors.
RELATED TERMS
  1. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China ...
  2. Optimal Currency Area

    The geographic area in which a single currency would create the ...
  3. European Sovereign Debt Crisis

    A period of time in which several European countries faced the ...
  4. Regional Asset Liquidation Agreement (RALA)

    An agreement between an asset manager and the Federal Deposit ...
  5. The New Deal

    A series of domestic programs designed to help the United States ...
  6. Accelerated Resolution Program (ARP)

    A program designed to reduce the time and cost of resolving failed ...

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!