Blood from Turnips; T. Elniff

372 1972 BLOOD FROM TURNIPS 373 "land bank" had an unsound money based on anticipated royal rev enues and landed securities. (What Law was to do later would have destroyed even a bank with a sound money base.) Concerning Law's banking methods and poli cies, one historian of modern bank ing wrote: "If the bank had con tinued upon the sound basis of a bank discounting commercial paper and acting as the fiscal agent of the Treasury, France would have been under a great debt of grati tude to Law for introducing into her commercial relations the methods of the modern business world."6 A period of recovery and great prosperity followed. But the bank did not continue on that sound basis. Law's next step was to organize the Company of the West and combine into it sev eral other small French trading companies, as well as negotiating with the Regent, d'Orleans, for the# farming of taxes, money coinage, the tobacco monopoly, and the as sumption of the entire .national debt. 7 On December 27, 1718, his Banque Generale was made a pub lic institution - the Banque Royale - and payment of notes in bank crowns (which required specie) was stopped, making the banknotes of the Banque Royale legal tender.

When in May, 1719, the Company of the West was reorganized into the Company of the Indies, the speculation began and the new shares were bid up and up - and the boom was on~ The price on the shares was 500 livres par, but they brought a premium of 5000 livres. By the end of November they were selling for 10,000 livres. By year's end, they brought up to 12,000 livres, and by January 6, they were up to 18,000 livres. 8 But then the tide began to turn. As the mar ket began to drop, "the more pru dent speculators were endeavoring to convert their gains into more solid property by the purchase of real estate or by shipping gold abroad."9 On May 1, 1720, a decree from Law announced that by De cember 1st all shares in the com pany would be· scaled down to 5500 livres per share and that all bank notes would be reduced fifty per cent in value. A commission ap pointed by the Regent to examine the bank found that it had less than ten per cent assets against its three billion livres of circu lating banknotes and only 49 mil lion of that was in gold or silver .10 On July 16th there was a run on the bank, people demanding gold or silver for their banknotes. Ten women were killed in the confu sion. "Repeated riots expressed the feeling of the public that it had been deceived· by financial tricks, and that the upper classes had profited at the expense of the com munity."l1 374 THE FREEMAN June What John Law was trying to do for France has been succinctly summarized by Will Durant: His central conception was to in crease the employment of men and materials by issuing paper money, on the credit of the state, to twice the value of the national reserves in silver, gold, and land; and by lower ing the rate of interest, so encour aging businessmen to borrow money for new enterprises and methods in industry and commerce. In this way money would create business, busi ness would increase. employment and production, the national revenues and reserves would rise, more money could be issued, and the beneficient spiral would expand. If the public, instead of hoarding the precious metal, could be induced, by interest payment, to deposit its savings in a national bank, these savings could be added to the reserves, and additional currency could be issued; idle money would be put to work, and the pros perity of the country would be ad vanced,1~ This was John Law's "system."

Law himself summarized it even more succinctly when he said, "Money is the blood of the State and must circulate. Credit is to business what the brain is to the human body."13 When the same idea was proposed at the beginning of the French Revolution, Jacques Necker, the minister of finance, observed that "They had only to provide themselves with a paper mill and a printing press to make the nation solvent."14 Two Basic Errors Led to failure of John Lawls System Why did John Law's "system" fail? We cannot blame his failure on his motives: there is every in dication that he was sincerely bent on benefiting France. Even his enemy, Duc de Saint-Simon, ad mitted there " was neither avarice nor roguery in his composition."I;) It is common to blame the specu lators whose speculative frenzy both made and broke Law's sys tem: "The principles upon which he had established his bank were theoretically sound; they would have made France solvent and prosperous had it not been for the incredible avidity of speculators and the extravagance of the Re gent."lG But why did they specu late? If Law's system was basi cally sound, why did it cause a situation in which speculation would be expedient? Why, to put the issue in its starkest form, did John Law think he could get blood out of turnips? Did the rules of algebra fail? Or did Law misapply them?

Involved in Law's system are two logically separable, though closely intertwined, economic fal lacies: (1) that money must cir culate, and (2) that successive 1972 BLOOD FROM TURNIPS 375 credit expansions will lead to a spiral of economic prosperity. The error concerning the circu lation of money is one of mistak ing effect for cause. Money is a medium of exchange, as Law be lieved, but it is also a market com modity which takes on value in exchange.I 7 Therefore if people do not circulate their money, it can only be because they anticipate that it will be worth more in ex change at a later time. On the other hand, if people believe that their money will lose value in the future, they will circulate it in the present. 18 Thus circulation is neither an index of prosperity, nor of adversity: it is not wise to cir culate money in a deflating mar ket, and the circulation of money in an inflating economy is not' a sign of prosperity, but rather of sickness. There are times when money must not circulate.

The second error is an extension of the first: that successive credit expansions (i.e., lowering the in terest rate and loaning more money) will lead to a spiral of economic prosperity: that money can create business, which would increase production, which would result in greater tax revenues and foster a new credit expansion, which would create new business, and so on. Law's error may be pointed out with two observations: (a) If the old debt is paid off before the new credit expansion takes place, there has been no net gain for the economy. Consump tion must be curtailed and savings invested in order to finance such progress. It is only a question of when one is going to curtail con sumption and invest savings - now or later. (b) If the old debt is not paid off, and a new credit expan sion is made, the net result is a higher price level for everyone as prices are bid up with the extra money available. This bidding up of prices, however, does not affect everyone equally: While the process is under way, some people enjoy the. benefit of higher prices for the goods or serv ices they sell, while the prices of the things they buy have not yet risen or have not risen to the same extent.

On the other hand, there are people who are in the unhappy situation of selling commodities and services whose prices have not yet risen or not in the same degree as the prices of the goods they must buy for their daily consumption. For the former the progressive rise in prices is a boon, for the latter a calamity. Be sides, the debtors are favored at the expense of the creditors. 19 This process may continue for a longer or shorter period of time. How long it lasts depends on psy chological factors. It will last as long as the people maintain con376 THE FREEMAN June fidence in the relative soundness of the money or faith in the bank or government: Let Ludwig von Mises finish the story: But then finally the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against "real"

goods, no matter whether he needs them or not, no matter how much he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as lTIOney are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.~o The result of such a breakdown is that people return to barter or develop a new kind of money. The result in France was that the bank was closed, the legal tender was suspended, the company's contracts were cancelled, and the stock was readjusted.: n There was an at tempt to restore both public and private obligations and fortunes to the levels which existed before the inflation. But "those who had fled the country with their win nings transmuted into gold, those . who could command the royal fa VOl", and those who were a,ble to keep their gains in hiding were the only ones who escaped.":.!:.!