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     Dec 17, '13

Mississippi Bitcoin
By Martin Hutchinson

The excitement over Bitcoin is intense, with the artificial currency soaring to over US$1,200 last week from less than a dollar two years ago. Observers have compared it to the 1999 dot.com mania; more historically minded observers have compared it to the British South Sea Bubble of 1720.

But there is an even closer analogy. Unlike the dot.coms or the South Sea Company, Bitcoin is not a stock. It is a new form of money. It thus resembles the only other bubble involving an entirely new monetary invention: the French Mississippi Scheme of 1718-20. The trajectory of that episode is instructive; surprisingly, it throws light on not only Bitcoin but also today's monetary experimentation as a whole.

Economically and financially, France was in pretty bad shape in

1718. The megalomaniac Louis XIV, who had died in 1715, had kept the country at war for the previous quarter century. Consequently, French credit was poor, and the Regent Philippe II, Duke of Orleans was short of money, in particular short of precious metals, used for coinage. Enter a dodgy Scottish financier called John Law, who in May 1716 set up a private bank, Banque Privee, capitalized largely by government bills.

The following year the Banque Privee bought control of the Mississippi Company, which had been set up to settle the Gulf Coast, and gained a monopoly from the Regent to exploit it and the Mississippi. Law, a good promoter, founded the city of New Orleans near the mouth of the Mississippi and marketed the hell out of Mississippi land concessions. In December 1718, under Law's guidance, Orleans bought out the shareholders of the Banque Privee and converted it into a Banque Royale, thereby providing a royal guarantee for the bank's notes, while Law was appointed Comptroller General of Finances.

Law then expanded the bank's note issue, claiming the notes were backed both by a royal guarantee and the exploitation rights to the Mississippi and Gulf Coast. The notes with such good security traded at par, thereby expanding the French money supply and causing a bubble in the economy, the money and stocks markets (Mississippi Company stock, still publicly held, soared from 150 livres in January 1719 to 18,000 by August 1720), and an inflationary spiral.

Naturally during 1719 and 1720, Law expanded the note issue too far, and the failure of the British South Sea scheme in late 1720 caused confidence in Law's paper to collapse. Attempts to boost public confidence by staging gigantic bonfires of Banque Royale notes proved fruitless, and the bank failed.

Law was stripped of his offices and fled into exile, while the Banque Royale's failure and the collapse of Mississippi Company stock price to 100 livres by September 1721 took French savings with them. Unlike in London after the South Sea scheme's failure, where the state arranged a partial bailout of South Sea Company debt by the Bank of England, there was no such bailout in France. French credit was thereby wrecked for the next 70 years, hampering France severely in her wars against the creditworthy Britain and eventually causing the economic crisis that led to the French Revolution.

Law was thought of as a crook for the next two centuries, but in recent years he has been hailed as a financial genius, having effectively invented paper money (well, if you don't count a reasonably successful attempt in Song Dynasty China, which lasted about 150 years before a Mongol Ben Bernanke caused its collapse into hyperinflation.) In reality, he was a clever financial promoter of limited scruples. His paper money scheme was thoroughly unsound, even by the standards of paper money schemes, and did immense long-term economic damage by destroying the French savings base.

It's the monetarily innovative nature of Bitcoin that makes it resemble the Mississippi Scheme more than the Dutch tulip mania (let's face it, tulips are just tulips, not money) or any of the myriad subsequent stock market bubbles. His Banque Royale notes were used as money, yet they had no intrinsic value and did not resemble anything that had previously been used as money (outside Song Dynasty China, the awareness of which was limited in 1720 France.)

Previous attempts to debase the currency had involved adulterating gold or silver with base metals. In this case, there was no adulteration involved - the money was simply created using a printing press, an assurance of Royal backing and vague promises of untold riches from developing the Mississippi.

Bitcoin is similar to the Mississippi Scheme in that it involves an entirely new form of money; in this case entirely virtual, created by solving computer algorithms and limited in eventual total issue (an important advantage over Banque Royale notes.) Like Banque Royale paper, nobody knows what it's really worth and nobody knows what its eventual fate will be. In 1720, many believed that Banque Royale notes would become the dominant currency of France, taking over from Louis d'or and enabling the embattled Regent to wipe out the national debt by subsuming it in the Banque Royale conglomerate.

Like South Sea Company shares, but unlike Banque Royale notes, the value of Bitcoin fluctuates wildly according to short-term supply and demand. Its use as money is thus at present much more limited than that of Banque Royale notes, because its fluctuations make it a very inefficient store of value. However, with Fidelity now allowing investors to put Bitcoins into their individual retirement accounts, their usage is broadening rapidly.

Banque Royale had one enormous advantage over both Bitcoin and the contemporary South Sea Company: there was only one of it, since it was a Royal monopoly. Thus demand for its paper was forced into one channel, supporting its value. There are now over 60 virtual currencies along the same lines as Bitcoin, including one to be created by JP Morgan under a new patent, according to last Tuesday's Financial Times. That's even more than the number of bubble companies floated to take advantage of the South Sea Company's popularity.

The South Sea Company had bought off a number of tame politicians; hence it was able to pass a Bubble Act in June 1720, before its peak, preventing other companies from siphoning off demand for its shares (this Act was to bedevil British company formation and industrial progress for over a century, until it was finally repealed by the enlightened Lord Liverpool in 1825).

Bitcoin has one other advantage over the Banque Royale. It is still quite small, with a market capitalization of only $20 billion, around 0.1% of US gross domestic product (GDP). The Banque Royale, in contrast, ended up issuing 2.7 billion livres of notes, around five times France's 1720 GDP, while the South Sea Company's market capitalization (admittedly in partly paid shares) at its peak exceeded 10 times Britain's GDP.

Bitcoin can therefore grow a lot bigger than its current size before it threatens to sink the US economy as the Banque Royale sank the French one. However, the existence of 60 similar virtual currencies, the lack of any backing for the currency, not even Mississippi lands or the right to send one slave ship per annum to Latin America, makes its eventual demise all the more certain.

Bubbles are bubbles, and their value is determined by "Extraordinary Popular Delusions and the Madness of Crowds" in Scottish writer Charles Mackay's famous phrase. When the crowds revert to sanity, the bubble's value vanishes.

There is however another disturbing parallel to Banque Royale notes, in which the issue is unlimited with the central bank printing over $1 trillion extra a year, and that is US dollars themselves.

Just as with Banque Royale notes in the first half of 1720, public confidence in the dollar is undiminished. They have state backing, although alas no New World riches in the Mississippi Valley to support their value. However like Law, Federal Reserve chairman Ben Bernanke knows no measure in the amount of paper he issues, surpassing all previous benchmarks in his attempt to keep money pouring into overvalued stocks, whose 27% rise this year is as unjustified as the Mississippi Company's 12,000% rise in 1719-20.

During 2014, it's likely we will reach the stage at which Bernanke's successor Janet Yellen will hold gigantic bonfires of $100 bills on the National Mall to convince holders that the supply of dollars is limited. Like Law's last desperate efforts these, too will fail.

These things move fast, even in our much larger economy. In 2014 or at latest 2015, it's likely the Bitcoin empire will flame out. However, it's also likely, probably not much later, that the granddaddy of all paper money schemes, the US dollar and its companion scams in Britain, Japan and the European Union, will meet the same fate as Banque Royale notes. Like France after 1720, the world will thereafter see many decades of economic stagnation, with colonies lost and wealth dissipated in fatuous public spending and ostentatious displays of vulgar wealth, before finally the revolution arrives and sweeps away the old regime.

At that point, one can only hope that our new rulers have more economic sense than the 1790s Jacobins, and restore a soundly based metallic currency, rather than destroying our wealth further in a blizzard of assignats.

Martin Hutchinson is the author of Great Conservatives (Academica Press, 2005) - details can be found on the website www.greatconservatives.com - and co-author with Professor Kevin Dowd of Alchemists of Loss (Wiley, 2010). Both are now available on Amazon.com, Great Conservatives only in a Kindle edition, Alchemists of Loss in both Kindle and print editions.

(Republished with permission from PrudentBear.com. Copyright 2005-13 David W Tice & Associates.)




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