Transcript Law and Cantillon Middle Temple 2015x

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 century
tabloid headline
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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
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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
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The circular flow of income model
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The influence of money on the real
economy
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Money and Trade – Money drives trade
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The money-in-advance requirement
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Policies – Monetary Expansion
combined with low interest rates
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The Power of Words
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How a change in a preposition can
change the definition of money?
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Traditional 17th/18th century definition
of money
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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)
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The Power of Words
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John Law’s definition
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Money is the value by which goods are
exchanged
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John Law’s Conclusion
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Money does not need to be intrinsically
valuable.
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France’s dual crises in 1716
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Monetary crisis – shortage of money
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Financial crisis – very high level of
sovereign debt
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John Law’s Financial
Revolution
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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:
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Specie money replaced by paper money
Shares substituted for government debt
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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)
Monetary Crisis
Financial Crisis
General/Royal Bank
Company of the
West/Mississippi
Company
Expansion of the
Money Supply
Issuance of
Shares
Low Interest
Rate
Share
Support
Debt
Management
Development of
Trading Companies
Merger of Royal Bank and the Mississippi Company
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The Mississippi Company Bubble
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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
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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.
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The Mississippi Company
Bubble
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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
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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
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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?
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
(1)
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The Model Building Aproach
Command, Barter and Closed Economy (The Single Landed
Estate)
Market
Market Monetary
Economy
Open Market
Monetary
Economy
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The Key Role of the
Entrepreneur in Markets
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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
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Cantillon:
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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:
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Two groups: Workers and capitalists
Class tension endemic to this classification
with capitalists deemed to be exploiters of
workers.
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‘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.’
Foreign borrowing initially
creates a feel good factor and economic
activity is increased.
‘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.’
Expenditure rises and prices
increase.
‘By means of this increase in
expenditure or consumption resulting from it
the tax revenues arising from consumption are
expanded.’
Tax revenues increase – a
development that encouraged reductions in
income tax and reliance on property taxes in
countries such as Ireland recently.
‘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.’
Despite the benefits there are
costs in the form of external interest
payments.
‘…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 ….’
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
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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
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John Law
Belief in the power
of paper money and
bank credit
Belief in monetary
expansion and low
interest rates
Belief in financial
innovation
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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
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John Law
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Richard Cantillon
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Joseph Schumpeter
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Turgot
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Investment is not
reliant on savings
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Savings needed for
capital formation.
Self-financing model
of investment
Investment financed
through retained
profits
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Investment may be
financed through
monetary creation
and capital markets
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Implications of the
Law/Cantillon Division
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Law followers
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Cantillon followers
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Advocates of
quantitative easing
and low interest
rates
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Concerned about
low savings ratios
and the excesses of
monetary expansion
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