Money: Why understanding its origin is important today – 3

Banking

(extracts from Glyn Davies: A history of money from ancient times to the present day)

The invention of banking preceded that of coinage. Banking originated in Ancient Mesopotamia where the royal palaces and temples provided secure places for the safe-keeping of grain and other commodities. Receipts came to be used for transfers not only to the original depositors but also to third parties.

…After the fall of the Roman Empire banking was forgotten and had to be re-invented much later.

…Banking re-emerged in Europe at about the time of the Crusades. In Italian city states such as Rome, Venice and Genoa, and in the fairs of medieval France, the need to transfer sums of money for trading purposes led to the development of financial services including bills of exchange. Although it is possible that such bills had been used by the Arabs in the eighth century and the Jews in the tenth, the first for which definite evidence exists was a contract issued in Genoa in 1156.

The Crusades gave a great stimulus to banking because payments for supplies, equipment, allies, ransoms etc. required safe and speedy means of transferring vast resources of cash. Consequently the Knights of the Temple and the Hospitallers began to provide some banking services such as those already being developed in some of the Italian city states.

Paper Money

The first proper European banknotes were issued by Stockholms Banco, a predecessor of the Bank of Sweden, in 1660, although the bank ran out of coins to redeem its notes in 1664 and ceased operating in that year.

Until Louis XIV, banknotes were issued by small creditors, had limited circulation, and were not backed by the authority of the state. Economist John Law helped establish banknotes as formal currency, backed by capital consisting of French government bills and government accepted notes.

John Law

(from the Wiki article on John Law)

John Law (usually pronounced Jean Lass by contemporary French) (bap. 21 April 1671 – 21 March 1729) was a Scottish economist who believed that money was only a means of exchange that did not constitute wealth in itself, and that national wealth depended on trade. He is said to be the father of finance, responsible for the adoption or use of paper money or bills in the world today.

Law was a gambler and a brilliant mental calculator, and was known to win card games by mentally calculating the odds. An expert in statistics, he was the originator of economic theories, including two major ideas: the ‘Scarcity Theory of Value‘ and the ‘Real bills doctrine‘.

On 9 April 1694 John Law fought a duel.. over the affections of Elizabeth Villiers.. was tried and found guilty of murder and sentenced to death.. but he managed to escape to the continent.

….Law urged the establishment of a national bank to create and increase instruments of credit, and the issue of banknotes backed by land, gold, or silver.

In May 1716 the Banque Générale Privée (“General Private Bank”), which developed the use of paper money was set up by Law. It was a private bank, but three quarters of the capital consisted of government bills and government accepted notes. In August 1717, he bought the Mississippi Company, to help the French colony in Louisiana…In the same year Law floated the Mississippi Company as a joint stock trading company called the Compagnie d’Occident which was granted a trade monopoly of the West Indies and North America…

The system however encouraged speculation in shares in ‘The Company of the Indies’ (the shares becoming a sort of paper currency) and inflation. The system was based on Law trading shares in the Mississippi Company in return for government debt. The Banque Royale was created by default as a result of Law attaining the majority of the government issued notes (debt). It effectively became the Central bank of France. In 1720 the bank and company were united and Law was appointed Controller General of Finances to attract capital.

Law’s pioneering note-issuing bank was extremely successful until it collapsed and caused an economic crisis in France and across Europe.

Law exaggerated the wealth of Louisiana with an effective marketing scheme, which led to wild speculation on the shares of the company in 1719. In February 1720 it was valued for a very high future cash flow at 10,000 livres. Shares rose from 500 livres in 1719 to as much as 18,000 livres in the first half of 1720, but by the summer of 1720, there was a sudden decline in confidence, leading to a 97 per cent decline in market capitalization by 1721. Predictably, the ‘bubble’ burst at the end of 1720, when opponents of the financier attempted en masse to convert their notes into specie.

By that time, creditors were “counseled the application of Law’s notes to the most ignoble purpose paper can be put to.”

By the end of 1720 Orleans dismissed Law, who then fled from France.