by Felix Martin
The inevitable result of this relegation of money to a passive role was an explosion in its issuance. The engineers were in charge, and there was no incentive to listen to the irrelevant bankers’ whining about financial viability. The bankers might issue periodic pleas for enterprises not to demand so much new money by continually increasing production which they, by law, had to fund; but since it was production and not money that mattered, who cared? One exasperated banker characterised the prevailing attitude of company chiefs as follows: “let’s build our factories, let’s make our goods: victors are not judged, after all.”36 The resulting flood of money increased the need for the second part of the Soviet strategy: the imposition of ever stricter limits on what it could be used for, and when. With the introduction of the first Five Year Plan in 1928 and the related Credit Reform of 1930, money, even in its passive form, was gradually removed from more and more parts of the economy. As Ostap Bender discovered, money became less and less the organising technology: pulling the strings in its place was the Plan, and an ever more elaborate system of vouchers and privileges assigned to particular classes of worker or members of specific unions. Even money’s most basic component—the concept of universal economic value—ceased to exist. A whole plethora of goods and services had no monetary price, since they could not be bought and sold for money; and as for those that could, their prices were administered and access was rationed, so money’s role as a universal comparator was no more than a empty charade.
“The Power of the Dollar” to circumvent all legal constraints and transport the wealthy capitalist up to take control of the political machinery, as illustrated in this Soviet poster: it was this subversive power that Soviet monetary policy was designed to curb.
(illustration credit 10.1)
The Spartan solution of abolishing money and the Soviet solution of attempting to contain it both focus on restraining or eliminating the applicability of money’s core idea: the concept of universal economic value. Whilst advocates of the abolition of money are a rare breed today, the idea of constraining money is undergoing a rebound in popularity: the philosopher Michael Sandel was even invited to address the annual conference of the U.K.’s main opposition party on the subject in September 2012. But practical methods of implementing it remain as elusive as ever.37
Yet there is a third historic strategy for managing money’s contradictions which concentrates not on trying to limit or extinguish the use of money, but on a novel solution to the age-old question of what its standard should be. It is a strategy that is reappearing today not in the visions of revolutionaries or the public outreach lectures of philosophers, but in the discussions of politicians and regulators at the heart of the world’s financial system. It is the strategy of innovation: the structural reform of money.
11 Structural Solutions
THE SCOTSMAN’S SOLUTION
“Some men are born great,” reads Malvolio, the vain antagonist of Shakespeare’s Twelfth Night, “some achieve greatness, and some have greatness thrust upon them.” In the case of the Scotsman John Law, it was most definitely the last of the three. By 1705 and the age of thirty-four, Law had certainly had an exciting career—but not one that could be called conventionally distinguished. The son of a prominent Edinburgh goldsmith, he had a brilliant natural talent for numbers, but his commercial education in the Projectors’ London of the 1690s had been cut short when he was convicted of murder in April 1694 as the result of a duel in Bloomsbury Square.1 Somehow, he had escaped from prison on New Year’s Day, 1695 and fled to the Continent, where he had spent the next eight years deploying his unusual mathematical skills as a professional gambler from Venice to the Low Countries. By 1703, however, he had tired of travelling, and contrived to return to his native Edinburgh—only to discover, to his dismay, that all the talk was of a mooted Union of Scotland with England. Whatever the political and economic merits of this proposal, it was quite obvious that for Law it would be a disaster. While Scotland remained an independent state, Law was a free man—there were no extradition treaties in those days—but Union would almost certainly mean arrest and trial. The trouble was that many enterprising men in the Scottish Parliament were dazzled by the success of England’s financial revolution and ashamed of their own failed efforts to replicate it.2 Joining forces, they believed, was the only way to catch up. Law’s best hope was to convince them they could stand on their own two feet. Scotland’s problem was not that it needed to import the new system of English finance wholesale, but that it needed a proper monetary system of its own. If Law was to save his skin, he had to explain why and how it could get one. The result, published in 1705, was one of the most profound and far-sighted economic treatises of his or any other era: Money and Trade Considered, with a Proposal for Supplying the Nation with Money.3
Law had witnessed at first hand the prodigious effects that modern banking and finance could have, and he had followed assiduously the great dispute between Locke and Lowndes. But Law’s analysis significantly superseded either of these more eminent authorities in both its clarity and its depth. He started from an understanding of money summarised in a concise formula: “[m]oney is not the value for which Goods are exchanged, but the Value by which they are Exchanged.”4 To see the true nature of money—and its true potential for good or ill—one must look beyond tokens to the underlying system of credit and clearing. “Gold, Silver, Copper, Bills, Shells mark’d and strung,” he explained, “are only representative Riches, or the Signs by which real Riches are Transmitted.”5 Even so solid and substantial a thing as a gold coin, one had to remind oneself, is just a “Sign of Transmission”: “I look upon a Crown-Piece it self,” he boldly explained, “as a Bill drawn up in these terms.”6
If money is simply transferable credit, Law reasoned, then the debate between Locke and Lowndes had really been missing the point. They had not in fact been arguing about the nature of money itself, but about what the standard of abstract economic value should be. This, Law believed, was the single most important question in all economic policy, for two reasons. The first was that for an economy to prosper, the choice of standard must be such as to ensure a sufficient supply of money—an objective that had been acknowledged as important by monetary pamphleteers all the way back to Nicolas Oresme.7 The second was that the choice of standard also determines the distribution of wealth and income. This, too, was an old topic in monetary thought, insofar as seigniorage—the ability of monetary policy to redistribute wealth to the sovereign from his subjects—was concerned. But Law realised that in the new world in which money and finance were beginning to pervade the private sector, the economic significance of inflation and deflation was increasingly that it shifted the balance of financial power between private creditors and debtors as well. A healthy commercial economy, he explained, requires the primacy of the entrepreneurial classes. Monetary credit that never circulates, but reverts to a bilateral mortgage of the rentier over the entrepreneur, is a recipe for economic stagnation. One might as well return to the static feudal obligations of traditional society.
The trouble, Law explained, was that money would not generate healthy conditions by itself. The more people use money to preserve their security, the less that money generates wealth and facilitates mobility. And nothing, Law argued, exacerbates this incipient flaw at the heart of money like the tendency to mistake the representative token for the technology itself. Economic slumps occur, he explained, when “[s]ubjects … hoard up those Signs of Transmission as a real Treasure, being induced to it by some Motive of Fear or Distrust.”8 These psychological urges, nurtured by this conventional misunderstanding of money, “I always call blind,” Law wrote, “because it stops a Circulation that puts a State to a loss, and which is more likely than any Thing else, to bring that Poverty which they fear, both upon others and themselves.”9 Without appropriate intervention, money’s seductive promise is self-defeating.
Here was the problem with money, analysed in detail for the first time. What
was the solution? The answer, Law reasoned, was simple. The sovereign issuer of money must have the ability to vary the supply of money to match the needs of private commerce, public finance, and the balance between private creditors and debtors. The central choice, therefore, is over the monetary standard: it must be one which allows discretion in the issuance of money. This immediately ruled out a precious-metal standard. Indeed, if one lived in a country without significant gold and silver mines, “it would be contrarr to Reason,” Law argued, “to limit the Industry of the People, by making it depend upon a Species [that] is not in our power, but in the power of our Enemies.”10 Law’s economics pointed in a much more radical direction. To achieve both a sufficient supply and a healthy distribution, money must be managed. To be managed it needs a flexible standard. Gold or silver “species” therefore will not do. Fortunately, Law informed the Scottish Parliament, “we have a Species of our own every way more qualified.”11
The world would have to wait another thirteen years to discover exactly what the Scots Projector’s tantalising alternative was. Law failed to convince the Scottish Parliament that independence under his scheme would be better than Union with England. In 1706 he therefore returned to the Continent and resumed his itinerant lifestyle. In addition to his gambling he now had a second vocation, however—the attempt to win political backing for his economic ideas. If Edinburgh would not listen, perhaps Turin, or Venice, or some other less prestigious principality would. Yet despite the Scotsman’s tireless angling, none would bite. As irony would have it, that opportunity finally presented itself a decade later in the largest, wealthiest, and most powerful European country of all: the Kingdom of France.
By the beginning of 1715, France had been embroiled in one major war or another for almost half a century. The cumulative effect on the finances of its long-reigning absolute monarch, Louis XIV—the “Sun King” of Versailles—had been disastrous. Every acre of the royal domain had been mortgaged, and every tax hypothecated. An entire system of public finance and an entire social structure had grown up around the king’s endless campaigns. Some of the wealthy advanced money to the crown in return for long-term bonds—rentes—and lived off the income as rentiers, while others purchased feudal offices which enjoyed the right to collect various fees and duties from a particular population. The masters of this elaborate machine were not the king and his court, but a small club of bankers in Paris—through whose networks private money could be raised and to whose clients sinecures and sovereign paper would flow back in return. These grand financiers were the greatest tycoons in France: men like Samuel Bernard who had funded the War of the Spanish Succession; his friends, the banker brothers Antoine and Claude Paris; and Antoine Crozat, who personally owned the concession over the whole of French North America.
Like most tycoons, and especially those who make their money conspicuously from pilfering the public purse, these men were not universally popular. Indeed, they were known proverbially as sangsues—bloodsuckers—and almost the only feeling common to both the nobles at court and the peasants in the provinces was that these vampires should themselves be periodically subjected to a painful saignée—a bloodletting—in order to relieve their stranglehold on the nation. When complaints reached a sufficiently fevered pitch, the king would typically declare the creation of a special court, the Chamber of Justice, which would proceed to dole out swingeing-sounding punishments. But the host was too heavily dependent on its parasites. Once a little red meat had been tossed to the most disgruntled taxpayers and the bloodsuckers had lain low for a few months, the machine would crank into action again, and the forced transfusions would resume.
On 1 September 1715, everything changed. Louis XIV, by then the longest-reigning monarch in France’s history, died after seventy-two years on the throne, and his nephew, Philip, Duke of Orleans, was confirmed as Regent. France’s new ruler’s first priority was to consolidate his power and gain control of the calamitous state of the public finances. An essential first step was an unequivocal show of strength. A gala version of the Chamber of Justice was therefore announced in March 1716 and put in charge of an orgy of recrimination. Tax evasion was to be investigated as far back as 1689. Anyone unable to prove correct payment was to be subject to the most extreme punishments—the galleys, exile, seizure of assets, even public execution. Generous inducements were offered to informers. France’s commercial class, and her commerce, was petrified. Law saw his chance.
France, in Law’s eyes, was a special case—the greatest policy challenge, but also the greatest policy opportunity, in Europe. Like Scotland, he believed, France was in the grip of a chronic monetary crisis. Simply put, it had a shortage of money, as a result of its medieval reliance on the worst possible combination of a precious-metal monetary standard and an almost exclusive reliance on coins. But France also had a public debt problem, driven by decades of war expenditure. In theory, an innovation like the Bank of England might have served to meet both challenges, as it was doing across the Channel. But the situation in France, Law believed, was well past that point. The accumulated debt of the crown was simply unsustainable with the tax base represented by the existing economy. What was needed therefore was both a monetary revolution and a radical reordering of the public debt. Fortunately, Law’s theories equipped him with a plan that could achieve both.
The first part of his plan was designed to address France’s lack of a money supply sufficient to the needs of its economic potential. Barely had the Chamber of Justice put the old financial interests to flight than Law persuaded the Regent to allow him to establish a General Bank—the first in France’s history with the power to issue notes. Initially, the General Bank adopted a conventional, precious-metal standard, and its notes were convertible to specie on demand.12 Law activated a network of foreign correspondent banks so that the General Bank’s notes could be used to settle foreign trade, and the Regent announced that taxes would be payable using its notes. The Bank proved a conspicuous success—its notes began to circulate widely and to stimulate trade, as Law had predicted. But this initial stage was only a warm-up act. No one familiar with Law’s fierce invective against the restrictive effects of a precious-metal monetary standard just over a decade previously could have doubted that. Sure enough, in December 1718 the Bank was nationalised: the General Bank became the Royal Bank, with all the added authority that this implied. Far more consequentially, it was announced that the number of banknotes it could issue was to be delinked from its holdings of gold and silver. Henceforth, the rate of note issue was to be regulated by decision of the King’s Council alone. Law’s alternative standard had been unveiled. France’s monetary standard now consisted of nothing other than the sovereign’s own judgement. If money-users trusted the King’s Council to issue prudently, all would be well; and better by far, according to Law’s theory, than under a restrictive metallic standard. There was no safety net if they did not: no guarantee from now on that notes could be exchanged for a standard quantity of precious metal. Just in time for Christmas 1718, John Law had introduced France and the world to “fiat” money.
Not content with furnishing France with an all-new system of paper money, Law also began to attack the second part of France’s economic problem—its parasitic system of public finances and the unsustainable level of the public debt. The tried and tested solution was to take a scythe to the sovereign’s creditors’ claims by devaluing the monetary unit or announcing an outright default. But Law’s plan was to play not on creditors’ fears, but on their greed. In 1717, with his prestige buoyed by the success of his Bank, he had convinced the Regent to allow him to form a joint-stock company, the Company of the West, and to award it the rights to develop French North America, which had until then been held by the arch-bloodsucker Antoine Crozat. These vast and virgin territories were sure, Law publicly predicted, to yield gigantic profits for the new company—and all of it with the endorsement of the French crown. Holders of sovereign bonds were invited to swap their debt cla
ims on the crown for equity shares in the Company of the West. Instead of government debt, savvy investors could henceforth enjoy a type of government equity.
The response was decisive. Sovereign creditors deluged the new company’s offices hoping to exchange bonds for equity shares, and the new company was heavily oversubscribed. Its business model—or at least, its ability to raise finance—now proven, the Company of the West embarked on an impressive trail of mergers and acquisitions. One by one, the corporations that owned the trading rights in every one of France’s possessions were swallowed up. The Company of Senegal went first; then the Company of the East Indies; then the China Company and the Africa Company as well. Each acquisition was funded in the same way. Investors turned in their sovereign bonds and bills at Law’s office in the Rue Quincampoix in return for equity shares in the ever-expanding Company. By the middle of 1719—now officially renamed the Company of the Indies, but known popularly after its most glamorous asset as the Mississippi Company—Law’s giant corporation had subsumed every major joint-stock company in France.
