Author : John E. Charalambakis
Date : June 23, 2016
“A greater Quantity [of money] employs more People than a lesser Quantity”, said John Law in 1705 in his pamphlet titled “Money and Trade Considered, with a Proposal for Supplying the Nation with Money.” And so started the story of paper money and credit, which according to Law would stimulate trade. Scotland – for whom he wrote the paper – was in Law’s opinion a “very inconsiderate Trade, because she has but a very small part of the money”. Hence, in his opinion, if the stock/quantity of money was increased trade would increase with it too.
Today’s legacy of quantitative easing, bond purchases by central banks, negative yields and the myriad other schemes, such as Outright Monetary Transactions, are intellectual descendants of John Law and his ideas. Law’s ideas found fertile ground in France at a time when its finances and economy were in terrible shape (1715) following disastrous wars and the enormous weight of debt that had converted traders into beggars. Law convinced the French that paper money works, and he used the English case as an example.
Law argued that the establishment of England’s Central Bank was the epitome of its success and that through a system of paper money and credit France’s finances would be fixed. Indeed on June 21st, 1694 the subscription book for the Bank of England (BoE) was opened in Mercers’ Chapel. By July 2nd of that year it had been oversubscribed. The first central bank in the world was a fact. The BoE issued paper money and the show began. Credit over-extension brought euphoria, the shares of the BoE rose substantially, the British crown forced holders of its debt to convert their debt claims into equity in the BoE, and a spirit of speculation as well as a sense of jumping on this bandwagon called prosperity bought on credit prevailed in England.
John Law’s scheme envisioned a bigger debt-for-equity swap. The debts of France would be swapped for equity in the Mississippi System. The latter encompassed all the land from the Great Lakes to the north to the southern border of Louisiana and the Gulf of Mexico. Hence the System would be able to issue shares and swap them for the debt of France. Through manipulation the price of the company’s shares skyrocketed by almost 6000%, and the Company promised high dividends. The more the price of the shares rose the lower the debt of France was projected to be. Magically the debt could disappear and the state could start running wars and deficits again. And then, confidence in the paper scheme was shaken and the scheme collapsed.
The story is the same with any scheme that is based on paper money. The State overspends (several times because it is obsessed for pleasing its clientele, and seeking power through conquer), the central bank monetizes the overspending, paper assets enjoy a good run, and then the collapse takes place because confidence in the system is shaken.
In both the British and the French experience, the idea behind the schemes arose because the governments could not afford high interest rates on their debts. Hence they enacted schemes where debt claims were exchanged for equity in bubble schemes. Nowadays, the governments around the world – including state and city governments – cannot afford the interest on their debts, and therefore schemes emerge so that financial repression through zero and negative rates runs amok.
Market delusions prevail when hopes get exaggerated. The EU represents such exaggerated and inflated hopes. Its bureaucratization and excessive regulation intrudes into personal and collective lives. Instead of focusing on advancing free trade and movement of capital (in all its forms) along with simplifying the way that businesses run, it has overreached and that overreaching (especially through the dysfunctional and delusional Euro project) undermines productivity, sound money, and a functional business environment.
It’s time for a genuine economic and financial reformation whose principles would be deleveraging, capital formation, advancing productivity, and sound money. What are the likely outcomes of the projected Brexit votes and the implications for portfolios?
We will be touching on those issues in the near term, but for now we believe that we need to focus on the following issues:
The potential forthcoming turmoil point to the importance of hedging and anchoring portfolios. As for asset allocation, we prefer assets that represent no one else’s liabilities.