Transcription
Welcome to the world of money. Bread. Cash. Dosh. Dough. Loot. Lucre. Moolah. The readies. The wherewithal. Call it what you like. Money can break us or it can make us. In the past year, it's certainly broken more than a few of the biggest names on Wall Street and in financial centers around the world.
And while former masters of the universe crash and burn, the rest of us are left worrying if our savings would be safer in a mattress than in a bank. Well, I want to explain to you just how money rose to play such a terrifyingly dominant role in all our lives. What's more, I want to reveal financial history as the essential backstory behind all history.
Banks finance the Renaissance while the bond market decided wars. (rifle shot) Stock markets built empires and monetary meltdowns made revolutions. From ancient Mesopotamia right down to the present day, the ascent of money has been an indispensable part of the ascent of man. But money's rise has never been a smooth upward ride.
As we'll see, financial history has repeatedly been interrupted by gut-wrenching crises, of which today's is just the latest. (dramatic music) (individuals hollering) Imagine a world with no money. (wind blowing)
500 years ago, the most powerful society in South America, the Inca Empire, had no real concept of money. The Incas appreciated the aesthetic qualities of rare metals. Gold was the sweat of the sun. Silver, the tears of the moon. Labor was the unit of value in the Inca Empire just as it was later supposed to be in a Communist society.
But in 1532, the Incas ran into a man whose hunger for money had led him across an ocean. Francisco Pizarro and his fellow Conquistadores had come from Spain to what they called Upper Peru, inspired by the legend of El Dorado, the realm of the gold-covered king. After defeating the Inca army at the Battle of Cajamarca, their quest began in earnest.
At Potosi, in what is now Bolivia, the Spaniards struck it rich. They discovered the Cerro Rico, literally the rich hill. Towering nearly 16,000 feet above sea level, it was a money mountain. In that 250 years of Spanish rule, more than two billion ounces of silver were extracted from mines like this one, 14,000 feet up in the Andes.
What the Incas couldn't grasp was why the Europeans had such an insatiable lust for gold and silver. They couldn't understand that to Pizarro and the Conquistadores, silver was much more than just shiny metal. It could be made into money. A store of value, a unit of account, portable power. (dramatic music)
I'll say, I find this place pretty harrowing. The Spaniards had a system of forced labor, which meant that every able-bodied male in the native population had to do a stint down these mines, and you can see why one in eight of them didn't survive the ordeal. (shovels scraping)
Today, 500 years later, conditions for miners in the Cerro Rico haven't improved much. But at least they get paid for the work they do. In those days, it was a way of making money but verged on genocide. The silver ore was ground up, refined with mercury, and then shipped to Europe as bars and coins.
Empire, it seemed, had made the Spanish crown rich beyond the dreams of avarice. (tribal music) And yet, all the silver in the mines of Potosi couldn't halt the inexorable economic and political decline of Spain's Empire. Why was that when Pizarro seemed to have struck it so incredibly rich?
The answer is that the Spaniards had dug up so much silver to finance their wars of conquest that the metal itself suffered an extraordinary decline in value. More silver coins didn't make Spain richer; it simply made prices higher as an increased quantity of money chased the same amount of goods.
What the Spaniards didn't get was that money is only worth what other people will give in exchange for it. On the back of the $10 bill, it says "In God We Trust," but it's not really God you're trusting in. By swapping your goods or your labor for a fistful of these things, you're trusting the US Treasury Secretary not to repeat Spain's mistake and produce so many of the damn things that by the time you come to spend them, they're worth even less than the paper they're printed on.
(electronic music) That's what the conquistadores got wrong. They failed to see that money is about trust, even faith. Trust in the person paying you the money. Trust in the central bank issuing the money. Trust in the commercial bank that honors the check.
Money isn't metal. It's trust inscribed, and it doesn't much matter what it's inscribed on—paper, silver, clay, or a screen—provided the recipient believes in it. There was one huge possibility created by the emergence of money as a system of mutual trust, a possibility that would revolutionize world history.
It was the idea that you could rely on people to borrow money from you and pay it back at some future date. That's why the root of credit is credo, the Latin for "I believe." Without the invention of credit, the entire economic history of our world would have been impossible.
Because we take it for granted, we tend to underestimate the extent to which our entire civilization is based on the borrowing and lending of money. No, it doesn't literally make the world go 'round, but it does make vast quantities of people, goods, and services go around the world from Babylon to Bolivia.
The puzzle is that the early moneylenders got so little thanks for their services. On the contrary, they were widely reviled as pariahs. Why was that? (train metal scraping along tracks)
Welcome to Northern Italy in the year 1200 AD. (railway sounds) A land divided into multiple feuding city-states. A land where trust was in rather short supply. Among the many remnants of the defunct Roman Empire was a numerical system singularly ill-suited to complex mathematical calculation, let alone the needs of commerce.
Nowhere was this more of a handicap than in Pisa, where merchants struggled to do business with seven different forms of coinage in circulation. Even the simplest transaction could be a headache requiring the use of an abacus. By comparison, economic life in the eastern world, in the Muslim caliphate or the Song Chinese Empire, was far more advanced to discover modern finance back when Europe needed to import it.
Enter a young mathematician called Leonardo of Pisa, or Fibonacci. The son of a Pisan customs official based in what is now Algeria, Fibonacci is best remembered today for his sequence of numbers that mimic the properties of nature. But the famous sequence was only one of many eastern mathematical ideas that Fibonacci introduced to Europe with his pathbreaking book, The Liber Abaci, the book of calculation.
Even more important was his demonstration of the superiority of Arabic numerals over Roman numerals and crucially, nearly all Fibonacci's examples related to business. Since Roman times, Europeans had been struggling to do simple arithmetic with these: The Hindu, or Arabic, numerals made all kinds of calculation easier.
In particular, Fibonacci showed how the new methods of calculation could be applied to commercial bookkeeping, to currency conversions, and crucially to the computation of interest. Just imagine trying to work out percentages in Roman numerals. Fibonacci's Liber Abaci made it child's play. This was some of the application of mathematics to making money.
The most fertile soil for such financial seeds proved to be the Italian city-states. Fibonacci's hometown of Pisa was one, but it was above all Venice, more exposed than the others to Oriental influences, that became the great money-lending laboratory.
And the home of literature's most notorious moneylender, Shylock, in William Shakespeare's The Merchant of Venice. May you stead me? Will you pleasure me? Shall I know your answer? Crucially, Shylock's only prepared to lend the money if Bassanio's friend, the merchant Antonio, is providing the security.
3,000 ducats for three months and Antonio bound. Your answer to that? Antonio is a good man. By good, Shylock doesn't mean virtuous; he means good for the money he's about to lend Bassanio. In other words, credit worthy.
Have you heard any imputation to the contrary? Oh no, no, no, no. My reason in saying that he is a good man is to have you understand me that he is sufficient. 3,000 ducats I think I may take his bond. With any loan, things can go wrong. Ships can sink, and that is precisely why anyone who lends money to a merchant, if only for the duration of an ocean voyage, needs to be compensated.
We usually call the compensation interest, the amount paid to the lender over and above the sum lent, or principal. Overseas trade of the sort that Venice depended on couldn't operate without such transactions, and they remain the foundation of international trade to this day.
But why does Shylock turn out to be such a villain, demanding literally a pound of flesh, in effect Antonio's death, if he can't fulfill his obligations? Why is Shakespeare's moneylender so heartless? The original of that blood-sucking financier who recurs time and again in western literature.
One clue is that Shylock is a Jew. And Jews were among history's earliest moneylenders. Jews who stayed in Venice for more than two weeks were supposed to wear a yellow O on their backs, or a yellow hat, and they were confined to a special area which became known as the Ghetto Nuovo.
This is the entrance to the Jewish Ghetto in Venice, where Jews were obliged to live and, indeed, confined at night. Jews were tolerated in Venice, but for a reason. The key was that Jews could provide a service that Christian merchants were forbidden to do. They could charge interest on their loans.
Fibonacci might have figured out the mathematics of lending, but it took Shylock to do the deal. This is where the Venetian Jews used to do business. This building here was the old Banco Rosso, and it was outside here that they used to sit behind their tables, their tavulo, on their benches, their banci, the root of the Italian word for banks.
Now there was a good reason why merchants came here to the Jewish ghetto to borrow money. For Christians, what the Jews were doing, lending money at interest, was a sin. The medieval church's laws against usury, charging interest on loans, were a major obstacle to the development of finance in Europe.
After all, what God-fearing Christian merchant wished to risk the torments of hell? This astonishing vision of eternal damnation was painted by Giorgio Vasari and Federico Zuccari on the inside of the great dome of Florence's cathedral, the Duomo.
Down below, there's another fresco by Domenico di Michelino of Florence's greatest poet, Dante Alighieri, holding his masterwork, The Divine Comedy. According to Dante, there was a special part of the seventh circle of hell that was exclusively set aside for usurers. (fast string music)
There, the moneylenders were eternally tortured with scorching earth and freezing snow. Their necks weighed down with bulging purses. Jews too weren't supposed to lend at interest, but there was a convenient get-out clause in the Old Testament Book of Deuteronomy, chapter 23. You weren't supposed to lend to your brother at interest, but to a stranger? Well, that was a different matter.
In other words, a Jew couldn't lend to a Jew, but he could lend to a Christian. The price the Jews paid for performing this service was social exclusion, hence, the ghetto. And, hence, the century's long association between Jews and finance. One of the few forms of economic activity from which Jews were not once excluded.
In the end, of course, Shylock is thwarted. For although the court recognizes his rights to a pound of flesh, the law also prohibits him from shedding Antonio's blood, and because he's a Jew, the law also requires the loss of his goods and life for so much as plotting the death of a Christian. He only escapes by submitting to baptism.
It turns out to be a risky business to be a moneylender. But it was in another Italian city-state, Florence, that the key financial service of providing credit moved out of the ghetto and away from the gates of hell to become the legitimate preserve of banks. This transition was symbolized by the rise of one family, the Medici. (violin music)
With their ascent, credit came of age. Money lending ceased to be disreputable. It became glorious and the foundation of a new kind of power. The dazzling legacy of the Medici family's power still surrounds you in Florence today.
In the space of 400 years, two Medici became queens of France, three became Pope. Appropriately, it was Machiavelli, the supreme theorist of power, who wrote their history. Perhaps, no other family left such an imprint on an age as the Medici left on the Renaissance. You might even say that they paid for the Renaissance.
Their patronage ran the gamut of genius from Michelangelo to Galileo. (violin music) And this in the Uffizi Gallery is the Medici's private art collection. One of the most spectacular ever assembled. (violin music)
What the millions of tourists who flock here generally forget to ask is how the Medici paid for all this? The simple answer is that they were foreign exchange dealers, members of the Arte del Cambio, the money changers guild, who made it big. They were known as banchieri or tavulieri because like the Jews of Venice, they literally did their business sitting on benches behind tables.
Indeed, the original Medici bank or bench was located right here in the Ville dell' Arte della Lana, Wool Guild street. (mellow music) Prior to the 1390s, the Medici were Florence's answer to the Sopranos. A small-time clan notable more for low violence than for high finance.
In a 17-year period, no fewer than five Medici were sentenced to death by the criminal courts for capital crimes. Then came Giovanni di Bicci de' Medici. It was his aim to make the Medici totally legitimate. Part of the secret of his success was an ingenious bit of creative accounting that got the Medici off the hook of the anti-usury laws.
These ledgers of the Medici bank make it clear how important commercial bills for financing foreign trade were to the bank. True, the church prohibited the collection of interest on loans, but there was nothing to prevent a shrewd trader from making money on transactions like these, which involve multiple currencies.
There was no interest and, therefore, no sin. Simply a commission deducted for the conversion of one currency into another. If money was advanced to a particular trader for any length of time, the commission was that bit larger. In the same way, depositors who put their money in the Medici bank were given discrezione to compensate them for risking their money.
This was credit, in other words, but with the interest payments discreetly concealed. Now for the first time, money lending had evolved into banking. The real story of the success of the Medici bank can be found here in the liber secreto, the secret book, of Giovanni di Bicci de' Medici.
The key was not so much size as diversification. Earlier Italian banks had been monolithic and very vulnerable to default by a single bad borrower, but a Medici bank was made up of multiple interlocking partnerships, each in some measure independent of the rest. It was this decentralization that was the key to their astonishing profits.
Under Giovanni's guidance, the Medici banking network extended from Florence to Venice to Rome. The scale and diversity of the Medici's operations was the key to reducing the risks of money lending and therefore also the costs to borrowers. That's the essential difference between loan sharks and banks, between Shylock and the Medici.
And here's the proof that it worked. Page after page of Giovanni's assets declared for tax purposes, culminating in the grand total of 91,089 florins. In those days, that was serious money. (thunder)
When Giovanni died in 1429, his last words were an exhortation to his heirs to maintain his standards of financial acumen. His funeral was attended by 26 men of the name Medici, all paying homage to the man who had made the business of banking respectable and profitable as it had never been before.
For his son Cosimo, the accumulation of wealth combined seamlessly with the accumulation of power. Within 20 years of his father's death, Cosimo de' Medici was the Florentine state. As the Pope himself put it, "Political questions are settled at his house. The man he chooses holds office. He it is who decides peace and war and controls the laws. He is king in everything but name."
This Botticelli is mainly famous for the beauty of its young subject, but it's actually intended as a tribute to a dead banker, Cosimo de' Medici. That's him there on the medallion, and you can just make out the inscription, "Pater Patriae," the father of his country.
In 150 years, the Medici had transformed themselves from backstreet moneylenders to the most powerful financial force in Europe. (bells tolling) Nothing could better illustrate the extraordinary ascent of money. For what the Medici had achieved was nothing less than the birth of modern banking.
Others had tried before, but the Medici were the first bankers to hit the political big time, and they did it by learning one crucial lesson: in finance, small is seldom beautiful. By making their bank bigger and more diversified, the Medici had found a way of spreading their risks, and by focusing on currency trading rather than just lending, they'd reduced their exposure to defaults by borrowers.
For Cosimo and his family, it was a truly beautiful business model. (train horn blowing) Yet banking was only one of Italy's contributions to the ascent of money. Of equal importance was the bond market. As a general rule, banks financed commerce. The bond market arose to finance war.
The ancient Greek philosopher, Heraclitus, had declared that war is the father of all things. It was certainly the father of the bond market. For much of the 14th and 15th centuries, the medieval city-states of Tuscany, Florence, Pisa, and Sienna were at war with each other.
This was war waged as much by money as by men. In Pieter van der Heyden's Battle of the Moneybags and the Strongboxes, piggy banks, treasure chests, and barrels full of coins lay into one another with lances and swords in a chaotic free-for-all. The Dutch verses inscribed at the bottom read, "It's all for money and goods, this fighting and quarreling."
But what they might just as easily have said is that war is impossible if you don't have the money to pay for it. (bells tolling) And the way to do that, the ability to finance war through the bond market, was like the Medici banking revolution, an invention of the Italian Renaissance.
Rather than require their own citizens to do the dirty work of fighting, each city hired military contractors, condottieri, who raised armies to next land and loot treasure from the others. Among the condottieri of the 1360s and 1370s, one stood head and shoulders above the others. (snare drum)
This is his portrait in Florence's Duomo, a thank you from a grateful public. Unlikely though it may seem, this master mercenary was an Essex boy. So skillfully did he wage war that the Italians called Sir John Hawkwood, Giovanni Acuto, John the Acute.
This castle was one of many pieces of prime real estate the Florentines gave him as a reward for his services. But Hawkwood was a mercenary who was willing to fight for anyone who'd pay him—Milan, Padua, Pisa, or the Pope.
These dazzling frescoes in Florence's Palazzo Vecchio show the armies of Pisa and Florence clashing in 1364. At that time, Hawkwood was fighting on the side of Pisa, but 15 years later he'd switch sides. Why? Because Florence was where the money was.
The cost of these incessant wars plunged Italy's city-states into crisis. Expenditures, even in years of peace, were running at double or more tax revenues. To pay the likes of Sir John Hawkwood, Florence was drowning in deficits.
This wonderful document in the Florentine State archive shows how the city's debt had exploded from around 50,000 florins at the beginning of the 14th century to five million by 1427. It was quite literally a mountain of debt, hence the name, the Monte Commune.
But from whom could the Florentines possibly have borrowed such a vast sum? The answer is right here. From themselves. (violin music) It was a revolutionary idea that would change the world of money forever. Rather than paying direct tax, citizens were now effectively obliged to lend money to their own government, and the fact that they were forced to lend the money meant that the interest payments they earned were not deemed to be usury by the church.
(violin music) These debt instruments, simple lines in a ledger, were the original government bonds, and the wonderful thing about them was that if you needed your money in a hurry, you could sell your bonds to other citizens. They were liquid assets.
What this record tells us is how Florence turned its citizens into its biggest investors. (calm serene music) This wartime expedient marked the birth of the modern bond market. Everyone was a winner. Bonds had saved the city-state from bankruptcy. The citizens were happy earning their interest, and the bond market let them buy or sell as they saw fit.
It seemed as if the problem of public debt had been solved, allowing the citizens of Florence to turn their minds to higher things. But there was just one problem with this brilliant idea. There was a limit to how many more or less unproductive wars could be waged.
The larger the debts of the Italian cities became, the more bonds they had to issue, and the more bonds were issued, the less valuable they looked to investors. And that was exactly the sequence of events in Venice. By the early 16th century, the city had suffered a series of military reverses, and the value of Venetian bonds had taken a hammering.
At the nadir, between 1509 and 1529, Venetian monte nuovo bonds were trading at just 10% of their face value. Now, if you buy a bond when war is raging, you're taking a risk—the risk that the city won't pay you back or pay your interest.
On the other hand, remember that the interest is paid on the face value of the bond, so if you can buy it at just 10% of its face value, you're earning a handsome return of maybe 50%. That is how the bond market works. In a sense, you get return for the risk you're prepared to take.
At the same time, it's the bond market that sets interest rates for the economy as a whole. If the state has in effect to pay 50%, then so do all the other borrowers. The bond market had been invented to help pay for Italy's wars, but now it was setting interest rates for everyone. Its rise to power had begun.
Over the next two centuries, bonds would come to rule the world. If the 15th and 16th centuries had seen a revolution in money and credit and the birth of the bond market, then the next step in the story of the ascent of money was the rise of the joint stock, limited liability company.
But the ability of the company to transform our lives would depend on another innovation, the stock market. The price that people are prepared to pay for a company's shares in the market tells you how much money they think it'll make in the future.
But as we've discovered in recent months of financial turmoil, stock markets can also be shock markets. The future is always uncertain, but we human beings are prone to over-optimism. When prices here on the New York Stock Exchange surge upwards in sync, it's as if investors are gripped by a kind of collective euphoria, what the former Chairman of the Federal Reserve, Alan Greenspan, once famously called irrational exuberance.
So stock markets really can be like soap bubbles. We never quite know when they're gonna burst. Nothing illustrates more clearly than the history of stock market bubbles how hard human beings find it to learn from history. (rushing water)
Hidden away among the many splendors of Venice is a small clue to one of the most astonishing tales of adventure in all financial history. To the honor and memory of John Law of Edinburgh, most distinguished controller of the treasury of the kings of the French.
This is the final resting place of the man who invented the stock market bubble. An ambitious Scot, a convicted murderer, a compulsive gambler, and a flawed financial genius, he not only caused the first true boom and bust in asset prices, he also indirectly caused the French Revolution.
There was a time when John Law owned a quarter of what is now the United States, only to lose it all in history's first great crash. From Edinburgh to Amsterdam to Paris, all the way here to New Orleans and finally to Venice, Law's story is a classic tale of boom and bust. It's also very much a story for our own times.
Hidden away here in the warehouse of the Louisiana State Museum is the only known painting of John Law. Here he is. With that lean and hungry look, he really is for all the world a Scotsman on the make. The path that led Law from obscurity to celebrity to notoriety is a path that many of the great stock market players have followed since.
Law was born here in Edinburgh in 1671, the son of a successful goldsmith and heir to the Estate of Lauriston. In 1694, while living in London, Law killed a man in a duel over a woman and was sentenced to death. Somehow, Law managed to escape from prison and fled to Amsterdam.
He couldn't have picked a better town to lie low in. By the 1690s, Amsterdam was the world capital of financial innovation. To help finance their war against Spain, the Dutch had introduced one of the world's first national lotteries. To protect their merchants from dodgy coinage, they created the world's first central bank.
But the one that had the biggest impact on Law was the single greatest Dutch invention of them all, the Company. The story of the Company had begun a hundred years before Law's arrival as Dutch traders spread out all over the world from Manhattan Island to the Cape of Good Hope, but it was Asia that became the primary target of Dutch commercial expansion.
Why? The East Indies were so alluring because of these—spices. Pepper, cloves, nutmeg, ginger. Europeans craved them to flavor their food but also to preserve it. Traditionally, they'd come over land by the Spice Road, but the Dutch plan was to fetch them the longer but quicker way by sea, and that pungent aroma was the smell of money to be made.
This painting shows the return of one of the first Dutch fleets from the east. The inscription reads, "Four ships sailed to go and get the spices towards Bantam and also establish trading posts and came back richly laden to the pulls of Amsterdam. Departed 1st May 1598. Returned 19th July 1599."
The Asian spice trade was so profitable that just one return trip could pay for the construction costs of a ship like this. But so prolonged was the journey around the Cape of Good Hope to the east and so hazardous that merchants had to pool their resources and their risk.
The result was around six fledgling East India enterprises. In 1602, at the instigation of the Dutch government, these various companies came together to form the United Dutch East India Chartered Company, or Vereenigde Oostindische Compagnie for short, and this is its original charter, which spells out that the company was to enjoy a monopoly on all trade from the Cape of Good Hope all the way east to the Straits of Magellan.
Pretty much half the world. The structure of the new entity was novel. The capital of the company was divided unequally between all the major dock cities. Citizens were invited to participate in the new venture by investing. It was the form of this investment that was the real novelty.
This rather wonderful painting is of the family of one of the founders of the Dutch East India Company, Dirck Bass. For 6,000 guilders, he and 16 other so-called participants became the firm's managing directors, the bewindhebbers. After 1606, however, anyone who put his money into the East India Company received an actien, literally an action, or as we would say, a piece of the action, a share in the company's future profits, and here is it.
The world's very first share certificate issued by the world's very first multinational company, almost exactly four centuries ago. Three years later, Bass and his fellow directors declared that any shareholders who wanted their cash back could not have it refunded but would have to sell their shares to another investor.
Overnight, a market for the company shares was born. The world's first true stock market. This invention was to change the face of finance forever because it created a mechanism whereby the price of shares was determined by the laws of supply and demand by sellers and buyers, and as the renegade Scotsman, John Law, couldn't help but notice, the trading of these company stocks was making the world's first shareholders very rich indeed.
(dramatic music) By 1610, the world's first joint stock company, the Dutch East India Company, was ready to conquer the world. It had a new charter, new shareholders, and a burgeoning trade in these shares. But it had to fight to survive. Literally.
Having established a string of factories and warehouses across South Asia from Java to India, the company had to struggle to keep the Spaniards and their English competitors at bay. With 40 warships and a private army of 10,000 soldiers, the directors of the East India Company were the original corporate raiders.
For the Dutch East India Company, firepower and foreign trade went hand-in-hand, but the key to the company's success wasn't just its cannons like these ones aboard the Batavia, the pride of its fleet. Like all big companies, it was able to combine economies of scale with reduced transaction costs and what economists call network externalities, the ability to pool information between multiple employees and agents.
The Batavia was part man of war, part multinational corporation. The big net worth company was simply more efficient. That was why, by the 1620s, it had established a virtual monopoly on spice exports from Asia to Europe. The world's first multinational was making its shareholders enormously wealthy.
I'm looking here at the original shareholders register of the Dutch East India Company, and literally every name in here was a winner. If you'd put a thousand guilders into the company at its very inception, by 1736 your investment would have been worth 7,000. Over its entire lifetime, the company paid an average annual dividend of 16.5%. Virtually all its profits were paid back to the shareholders.
Dirck Bass's original shareholding of 6,000 guilders had been transformed into a 500,000 guilder fortune. To John Law, lying low in Amsterdam, having escaped the gallows in London, the workings of the Dutch East India Company came as a revelation.
Law was living off his winnings at the gambling table, but he was fascinated by the relationships between the Company, with its splendid offices in the hooks-thrat, the nearby stock exchange where dealers busily traded the company shares, and the Bank of Amsterdam. Yet this Dutch financial system struck Law as not quite complete.
To Law's financially supercharged mind, the Dutch were missing a trick or two. For one thing, it seemed completely nuts to restrict the number of East India Company shares when the markets were so clearly enamored of them. Law was also puzzled by the conservatism of the Bank of Amsterdam.
It had created an internal system which allowed merchants to settle their accounts by direct cashless transfers, but it hadn't issued any real bank notes to the public. The idea was already taking shape of a breathtaking modification of the institutions that Law had first encountered here in Amsterdam.
Only combine the properties of a monopoly trading company and a public bank, and the sky really would be the limit. Law was preparing to unleash a whole new system of finance on an unsuspecting nation. In 1716, John Law arrived in Paris.
He had identified France as the ideal laboratory for what would be the biggest experiment in the history of the stock market. But why did the French give him his chance? The answer is that France's fiscal problems were exceptionally desperate. The country was saddled with enormous public debts as a result of the wars of Louis the Fourteenth.
When the Sun King died in 1715, the Duke of Orleans, who was acting as Regent for the underage King Louis the Fifteenth, faced a country on the brink of its third bankruptcy in less than a century. It was the perfect opportunity for Law. The maverick, self-taught economist who developed his theories somewhere between the casino and the stock market.
Law's ambition was to revive economic confidence in France by establishing a bank on the Dutch model, but with the difference that this bank would issue paper money, like this 100 livres note. As money was invested in the bank, the government's huge debt would be consolidated, but at the same time—and this was the really important part of Law's system—paper money would revive French trade and with it, French economic power.
The royal government gained doubly. Consolidation simply meant that its onerous debts were magically transformed into shares in Law's bank. At the same point, the monarch gained the ability to print as much money as he liked. As Law wrote, "I maintain that an absolute prince who knows how to govern can extend his credit further and find immediate funds at a lower interest rate than a prince who is limited in his authority. In credit, supreme power must reside in only one person."
That absolute power was in the hands of the Duke of Orleans, who lived here in the Palais Royal, just a short step from Law's apartment in the Place Vendome. It was to him that Law now unfolded his scheme. The prize was nothing less than the revival of French power through financial engineering, but that was only half of Law's ingenious plan.
As Law wrote, "The bank is not the only nor the grandest of my ideas. I will produce a work which will surprise Europe by changes more powerful than were produced by the discovery of the Indies." The second part of Law's idea was that a huge monopoly trading company should be established. The Compagnie d'Occident, the Company of the West.
As he put it, the whole nation would become a body of traders, and Law himself, named here as the company's Chief Director, would be at its head. The focus for this wildly ambitious scheme would be in America, where the French laid claim to a vast tract of land either side of the Mississippi, Louisiana.
The Regent gave Law's company, what was to become the Mississippi Company, a monopoly on trade with the new colony. Frenchmen, regardless of rank, were encouraged to buy shares in the company. Law's name headed the list of directors. (playful music)
In modern parlance, what these documents tell us is that Law was attempting a reflation, and why not? France in 1716 was in a depression, and Law's bank notes helped stimulate a recovery. At the same time, what he was doing was effectively transforming a burdensome and badly managed public debt into shares in what was a privatized tax-gathering and trade company.
Well, what was not to like about that? In a fever of mass speculation, the Mississippi Company's share price soared from the original price of 500 livres to 5,000 on September the 4th. By December 1719, it had reached 10,000.
And this is where it all happened. This was where Law's share issuing office was located, the Rue Quincampoix. You can imagine the scenes of frenzy here as half of Paris descended on this narrow alleyway, all desperate for a piece of the action. The higher the share price went, the more they wanted to buy.
It was a classic stock market feedback loop. It was in these heady times that the word millionaire was first coined. Yes, millionaires like entrepreneurs were invented in France. And by January 1720, John Law was the richest of them all.
Louis the Fourteenth had said, "L'etat c'est moi." "I am the State." Now the renegade Scotsman, John Law, was able to say, "L'economie, c'est moi." "I am the Economy." Only when the Mississippi bubble burst would the French realize the dangers of Law's economic experiment.
Next time, on The Ascent of Money, we'll see how what began as a revolution in finance, the first stock market bubble, ended as a full-blown political revolution in which royal heads would roll. Next time on The Ascent of Money, before Charles Ponzi and Bernie Madoff, the story of John Law.
Like all Ponzi schemes, the effects of Law's system was to generate an unsustainable bubble. His bubble was about to go pop. And the British aristocracy learns that what goes up must come down. This house belonged to the principal victim of the first modern property crash.
The Ascent of Money, a financial history of the world. (electronic music)