Although John Law's name is now associated
with the 18th century South Sea Bubble, the
problem he wanted to solve was the same that
central banks are struggling with today: "How much
money and credit can be created without bringing
about inflation, destabilizing the economy, or
destabilizing the international financial system?"
Law's proposal then was that a
"land-collateralized" note issue would be the
The crisis we are in and that
Japan has been in for two decades by now, show
that the world repeated Law's mistakes, though
heavily disguised by new
jargons, policies and financial instruments, which
obscured the "land"-based-similarity.
Law's solution at the time was based on
these principles: For money's purchasing
power to be stable, the issuing of credit must be
linked to anticipated "real" trade; Using land as
collateral, there could be no over-expansion of
credit. Law was mistaken, though, because he did
not see how monetary expansion raises land prices,
which then mistakenly rationalizes further credit
expansion. Adam Smith recognized this flaw in this
early version of the "real bills" doctrine, and
First, he said, the
collateral should be commercial paper, rather than
arbitrarily choosing land as collateral. Second,
Smith saw that even commercial paper could not be
sufficient to sustain stability: the price of the
asset backing the "real trade" could be increased
too, leading to credit expansions. For the "real
bills" doctrine to work, he noted, it needed
specie (gold) convertibility to constrain the
undue expansion of credit.
happened first in Japan, then in the events
leading to the present financial crises? After
World War II, Japan passed many laws that biased
investments toward land. Among them: if people
invested in land using borrowed funds, interest on
the borrowing was deducted from their income; and,
for the purpose of inheritance tax, land values
were appraised advantageously lower than cash or
As the competition among Japanese
financial institutions intensified in the latter
half of the '80s, the quality of due diligence
dropped, and lending with land as security
increased. This drove up the price of land, and
credit then expanded further. The central bank
accommodated, with John Law logic, unconstrained
by Smith's reservations. The soaring land prices
affected share prices (as companies had massive
real estate holdings), and both then affected each
other in an upward spiral for a while.
Oblivious to the nature of the problem, by
1988 the Japanese government tried to solve the
monetary problem with fiscal remedies - which will
seem eerily familiar. It imposed a 20% withholding
tax on savings; a capital-gains tax on equity
sales; a security transfer tax; a 3% consumption
tax; a 6% tax on new cars; and a 2.5% surtax on
corporate profits among others. Then, at the end
of 1989, the Basic Land Law was enacted. The law
focused on the "public interest" in land to ensure
appropriate planning and to suppress land
The Bank of Japan raised
the discount rate in May 1989 and introduced
quantitative controls on the total amount of land
related loans from April 1990. The government then
reformed the land taxation system, drastically
raising capital gains taxes. While the changes
were complex, what they meant was that capital
gains taxes on real estate jumped from 20% to 50%
if people or companies sold them within a 10-year
holding period. No wonder real estate prices and
share prices then collapsed.
events leading to the present crises. Never mind
the reasons, Washington decided to increasingly
subsidize housing in increasingly complex ways. In
no particular order, interest rate payments on
mortgages became deductible, mortgage guarantors
Freddie Mac and Fannie Mae were created, which,
combined with securitization, the Fed's disregard
of the expansion of credit through "shadow
banking", lack of supervision of institutions
fulfilling financial intermediary functions and
due diligence, lack of adjustment in rating
agencies' analyses when banks were giving up their
traditional due diligence roles, have all
contributed to the undue expansion of credit.
This took the shape and form of
mortgage-backed loans - in principle "land-backed"
- though misleadingly called "real estate-backed".
Words matter. They are the vehicles of
thinking: while they can shape accurate
perceptions, they can shape misperceptions too. As
it turns out, and not for the first time in
history, there is not much "real" about this asset
class. The question is, what do you do with it?
John Law and followers, who come up with
theories based on "real" estate", or "real" bills"
doctrines (unconstrained by having a "unit of
account" too), make implicit assumptions that they
know what is "real". But as one can readily see,
many things perceived "real" can melt into thin
air in a flash. Perhaps we would be far better
from now on using the French word for "real
estate" - "immobilier".
captures the essence of this asset class, as the
English word does not: it is immobile, you can't
take it away with you. It immobilizes owners to
various degrees, making them easy targets for
taxes. The "immobile" feature of this asset class
brings a better understanding why politicians love
to subsidize this asset class first - realizing
that, push come to shove, they can tax it later.
After all, politicians get more power the
more their population is immobilized: they can
regulate them, tax and bewitch them with slogans
more easily. Real estate, farming, language laws
(prohibiting learning other languages - see
Quebec, whose laws make it illegal for their
French and immigrant population to go to English
schools, and require businesses employing more
than 26 people to communicate internally in
French) - are all great immobilizers.
wonder governments, since antiquity, have favored
such policies, praised "immobile professions" to
the sky and held "mobile professions" (trade,
finance, science) suspect. Was there ever a time
when importers were praised? Never mind that they
would roam the world for better and cheaper
products to benefit locals. No government built
statues to immortalize importers.
other hand, they subsidized every "land-based"
ideology and practice, praising and subsidizing
exporters among them. After all, exporting
manufacturers are married to land, depend on the
local government, and are in their grasp - whereas
the "cosmopolitan" scientists, traders, importers
can escape them.
Moreover, when unwilling
to make domestic political, regulatory and fiscal
changes needed - better rely on demands from other
countries to cover for the persistent domestic
mistakes. That this may end up in currency wars -
as we may be heading today - politicians are very
good in using gobbledygook economic theories and
using gullible economists to rationalize
devaluations, subsidized exports, and tariffs.
Ludwig Wittgenstein, the philosopher, was
right when he stated that: "Philosophy is a battle
against the bewitchment of our intelligence by
means of language." Indeed, "real estate" "QE,"
"bubbles" ( attributed to random variations in
people's mood rather than any concrete laws and
regulations), erecting statues to heroes of
subsidized "immobility" (unread, unwatched, not
listened to statistical "cultures" being a good
example) have all "bewitched" many for centuries,
though "bothered and bewildered" a few.
What are the most immobile professions,
after all? Politics, local culture, government
bureaucracy, law - much of their expansion being
created with relative ease - as long as
governments have access to credit.
Briefly, the recent financial crises
rhymes strongly with the one John Law and the
Japanese government managed to engineer. Though in
different ways, they were all "land-based",
drawing on the misperception that there is
necessarily something "real" about increases in
prices of immobile assets.
Just as Law and
the Japanese government forgot, so did the Federal
Reserve and the US Treasury, when letting
financial institutions accommodate large
expansions of credit - based on "real estates".
It's here that the distinction lies
between this past "bubble" and what was labelled
as the Internet-related one, and why the recent
one will take much longer to correct. Whereas
Internet shares could not be collateralized and
leveraged through bank loans and government
guarantees, "real-estate" was - and banks and
governments fueled the folly. This is why the
paper loss with Internet shares, though amounting
to trillions, had no significant effect, whereas
the present one will be taking long years to
By looking at the crisis of
sovereign debts through the "immobile" versus
"mobile" prism, we get a better insight too. After
all, such debt is "land-based" too, backed by
national governments' ability to tax people living
in its territory (mother- and father-"lands", take
your pick). But what happens if the talent from
these lands - what I often call "the vital fews" -
move, be it abroad or through evasions?
The "land" stayed the same, but the
ability and incentives to create wealth, and the
part of such wealth that would be taxable - has
diminished, as Italy, Greece, Spain - and now
France - show.
How does one verse in the
famous Lorenz Hart Bewitched, Bothered and
Bewildered lyric go?
Burned a lot, but learned a
lot, And now you are broke, so you earned a
lot Bewitched, bothered and bewildered - no
Indeed, it appears that
the "immobility" prism and its language bewitched
the world for far too long. Perhaps by shifting to
the "mobility" prism, the choices we face today
could come in far sharper focus.
Brenner holds the Repap Chair at McGill
University's Desautels Faculty of Management, and
serves on the Board and the Investment Committee
of McGill's Pension Fund. The article draws on his
books, Force of Finance (2002) and
World of Chance (2008), with A Brown and G A
Brenner, and "Unsettled
civilizations: How the US can handle Iraq",
Asia Times Online, June 23, 2004.