MONETARY PERSPECTIVES FROM JOHN LAW AND RICHARD CANTILLON

ANTOIN E. MURPHY – TRINITY COLLEGE DUBLIN

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John Law 1671-1729

• Born in Edinburgh, the son of a goldsmith

• Brilliant mathematician at school• Lives in London in the 1690s where

known as ‘Beau Law’ he becomes a dandy, rake, philanderer…

• Kills Edmund Wilson in a duel in 1694. Convicted of murder. Avoids the gallows by escaping to the Continent.

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A potential 18th centurytabloid headline

• Convicted Scottish murderer becomes Prime Minister of France and causes the world’s first stock market boom and collapse

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John Law’s Economic Theories• Law – the pre-Monetarist• First to introduce the concept of the

demand for money in Essay on a Land Bank

• The demand for money is proportioned to people land or product

• Inflation caused by the money supply expanding excessively out of line with the demand for money

• Law of one price and the distinction between trade and non traded goods

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Law – the pre-Keynesian

• The circular flow of income model

• The influence of money on the real economy

• Money and Trade – Money drives trade

• The money-in-advance requirement

• Policies – Monetary Expansion combined with low interest rates

The Power of Words

• How a change in a preposition can change the definition of money?

• Traditional 17th/18th century definition of money

• Money is the value for which goods are exchanged

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“Money is the measure by which goods are valued, the value by which good[s] are exchanged, in which contracts are made payable and payments are made.” (Essay on a Land Bank)

The Power of Words

• John Law’s definition

• Money is the value by which goods are exchanged

• John Law’s Conclusion

• Money does not need to be intrinsically valuable.

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France’s dual crises in 1716

• Monetary crisis – shortage of money

• Financial crisis – very high level of sovereign debt

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John Law’s Financial Revolution

• A new monetary system aimed at relieving the monetary crisis manifested by a shortage of money

• Debt management involving equity swap for government bonds aimed at relieving financial crisis

• Features:Specie money replaced by paper

moneyShares substituted for government

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John Law The Corporate Financier

• Introduction of paper money into France

• Use of the banking system and the capital market to raise finance

• Sizeable equity and rights issues by the Mississippi Company

• Mergers and takeovers by the Mississippi Company

• Creation of an options market for Mississippi shares

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Law’s Financial System (1716-1720)

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Monetary Crisis Financial Crisis

General/Royal Bank

Company of the West/Mississippi

Company

Expansion of the Money Supply

Issuance ofShares

Low Interest

Rate

Share Support

Debt Manageme

nt

Development of Trading

Companies

Merger of Royal Bank and the Mississippi Company

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The Mississippi Company Bubble

• Standing impassively in this crowd in the rue Quincampoix one observer, who is both a merchant and a banker, is reckoning where he went wrong

• He had bought Mississippi at 170 in 1717 but sold out in July 1719 at just over 2,000

• He believed that Mississippi was a financial bubble and that the market would collapse

• Instead the market had risen to over 10,000 and its creator, John Law, had become the Prime Minister of France

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The Mississippi Company Bubble

• In early 1720 he believed that something had to give. He was more certain than ever that the financial bubble would burst

• He therefore took a strong position against the French currency

• Paralleling these developments in Paris the British were copying the Mississippi System through the re-structuring of the South Sea Company

• Our observer felt there was further money to be made by becoming a bear of the South Sea stock. He would later purchase, in May of 1720, a number of sizeable put options in South Sea shares. 20

The Mississippi Company Bubble

• In the Spring of 1720 he used his economic theory to make a second fortune.

• Our observer believed that it was impossible for the French:

(1)To expand the money supply(2)To lower the interest rate(3)To revalue the paper currency relative to

gold and silver

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The Mississippi Company Bubble

• By the end of 1720 both the Mississippi System and the

• South Sea Bubble had collapsed and our observer had made three fortunes:

(1)Through his earlier purchase and sale of Mississippi shares

(2)By selling the French currency(3)Through his put options in South Sea

stock

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The Mississippi Company Bubble

• A new term, millionaire, had been coined to describe people like him who had made fortunes out of the Mississippi.

• Our observer is the Kerry born entrepreneur and economist, Richard Cantillon, probably the greatest analytical economist of the 18th century.

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Richard Cantillon

• Cantillon was born in Ballyheigue, County Kerry, Ireland, most probably between 1680-1690. Forced from his ancestral lands by the Williamite confiscations he became an accountant to James Brydges, later the Duke of Chandos, the Paymaster General to the Forces Aboard during the War of the Spanish Succession.

• Working in Spain, Cantillon helped Chandos to become the biggest war profiteer of the age – so much so that he was able to employ Handel as his keppelmeister.

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Essai: the greatest analytical book of economics of the 18th century?(1) Model building approach(2) Allocative mechanism of the

market – extensively adapted by Adam Smith

(3) Central role of the entrepreneur(4) Circular flow of income(5) Elaboration of the black box of the

monetary transmission mechanism

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The Model Building Aproach

Command, Barter and Closed Economy (The Single Landed Estate)

Market

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Market Monetary Economy

Open Market Monetary Economy

The Key Role of the Entrepreneur in Markets

• The entrepreneurs ‘pay a certain price…to resell at an uncertain price (Essai: 1755, 65)

• Shopkeepers and retailers of every kind are ‘Entrepreneurs who buy at a certain price and sell in their shops or the market at an uncertain price.’ (Ibid. 67)

• Uncertainty at the centre of entrepreneurial activity

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The Contrast between Cantillon and Marx’s Socio-Economic Classifications Cantillon:

Two groups: Workers on fixed income and entrepreneurs

They can live on the same street and move without tension between jobs. The civil servant (fixed income) can become a taxi driver (entrepreneur), the taxi driver can become an automobile worker (fixed income), etc.

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The Contrast between Cantillon and Marx’s Socio-Economic Classifications

Marx:Two groups: Workers and capitalistsClass tension endemic to this

classification with capitalists deemed to be exploiters of workers.

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A Deconstruction of Cantillon’s Analysis on the Dangers of Foreign

Borrowing…

Quote 1 : ‘This money enables the state’s entrepreneurs to borrow more easily, to have people make articles and to establish manufactures in the hope of profiting from them.’

Implication: Foreign borrowing initially creates a feel good factor and economic activity is increased.

Quote 2: ‘The craftsmen and all through whose hands this money passes will consume more than they would have done if they had not been employed by means of this money, which consequently raises the prices of all things as if it belonged to the state.’

Implication: Expenditure rises and prices increase.

Quote 3 : ‘By means of this increase in expenditure or consumption resulting from it the tax revenues arising from consumption are expanded.’

Implication: Tax revenues increase – a development that encouraged reductions in income tax and reliance on property taxes in countries such as Ireland recently.

Quote 4 : ‘The sums lent to the state in this way produce many benefits from it, but their consequences are always onerous and inconvenient. The state has to pay an annual interest to the foreigners.’

Implication: Despite the benefits there are costs in the form of external interest payments.

Quote 5 : ‘…aside from this loss [external interest payments], the state finds itself at the mercy of foreigners who can drive it into poverty when it takes their fancy to withdraw their funds. It will certainly happen that they will wish to withdraw them at the very time that the state will have most need of them ….’

Implication: There is potentially an even greater cost namely the possibility of capital flight at a time when the state is most in need of support.

Conclusion

• Cantillon provided a template which if read by politicians, bankers, central bankers and regulators could have saved Eurozone countries a considerable amount of grief in recent years.

• Excessive external borrowing has now created a significant time bomb for the European taxpayers.

The contrasts between Law and Cantillon on monetary issues

• John Law• Belief in the

power of paper money and bank credit

• Belief in monetary expansion and low interest rates

• Belief in financial innovation

• Richard Cantillon• A monetary

conservative• A strong metallist• Belief in the

control of the growth of the money supply

• Concerned with excessive financial innovation

• Against external borrowing

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Intellectual lineages and the financing of capital expenditure

• John Law

• Joseph Schumpeter

• Investment is not reliant on savings

• Investment may be financed through monetary creation and capital markets

• Richard Cantillon

• Turgot

• Savings needed for capital formation.

• Self-financing model of investment

• Investment financed through retained profits

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Implications of the Law/Cantillon Division • Law followers

• Advocates of quantitative easing and low interest rates

• Cantillon followers

• Concerned about low savings ratios and the excesses of monetary expansion

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