Bitcoin vs Banking [infographic]
This article was first published in Issue 16 of the print edition of Bitcoin Magazine.
Today, John Law is often hailed as one of the greatest financial innovators of all time. What would he say about Bitcoin and other digital currencies? Let’s take a look at this enigmatic man to discover how yesterday’s financial innovations shed light on our own times.
Before there were MIT graduates counting cards in casinos, there was John Law. He was naturally gifted with numbers and loved gambling. It was only natural that we would learn to calculate the odds. Before there were stock markets, gambling was a preferred pastime of Europe’s elites. As they idled away their time, John Law took their money. When he was gambling, John Law liked to be the bank. He made more money that way. Later on, he was able to create his own “national bank,” effectively printing his own fiat currency and using it to boost his own stock market.
This was France in the late days of the ancient regime, in which monarchs and their regents reigned supreme. Through his friendship with the regent, the man appointed to rule as proxy for a child king, John Law became central banker, stock market overseer, and chief tax collector. When he was successful, eliminating the national debt and bringing riches to the nation, he was loved. When there was a run on the banks and the value of his paper plummeted, love turned to hate. He lost everything.
He was a charming man. Beloved by women, he was also gallant in the old way. He took on mistresses and defended them with the sword.
One sad day, he engaged in a duel with an irate challenger. His sword was sharper and faster; the other man died. Among Europe’s elites, dueling was an acceptable way of settling disputes. But in England, where the Scot now found himself, the tide was changing against such gallantry. He soon found himself accused of murder with all the mustered venom of an aggrieved family. He believed he would be reprieved. Instead he was forced to escape.
Some years later he found himself in France. He had already failed in his attempt to convince Scotland to adopt a land-backed currency. Later, sharing women and wine, he became friends with the regent of France. What was needed to solve the problems of the nation, he soon convinced this eager student of finance, was a new kind of money. This would come in the form of a paper currency.
The citizens of France were not eager to give up their metal coinage for little pieces of paper. Rather strong encouragement was used. Certain types of transactions could only be performed on paper. There was also the advantage of instant and free transfers among branches around the country, a capability that had never existed before. New technology advantage was combined with coercive measures.
Slowly, steadily, the country was convinced to use paper instead of coins, although not without ups and downs. One such down was that the paper was supposed to be metal backed. You could always get back your coins. Prominent individuals who were afraid of losing money due to John Law’s plans attempted to create a run on his bank. He was only able to save it via an emergency loan, borrowing the coins he needed to remain solvent.
After that, growth continued quickly. It was never clear if the paper was truly metal backed or not. This problem was aggravated by another idea of Law’s, the Mississippi company. Americans will probably remember Jefferson’s great Louisiana Purchase from Napoleon, which effectively doubled the landmass of what now is the US, allowing the country to obtain all that is now west of the Mississippi.
John Law had a very different idea almost a century earlier. The vast amount of land west of the Mississippi should be settled by the French. The creation of a dividend bearing stock would do the trick. The stocks would raise money for a company that would go and settle the area, bringing back the great riches of the New World.
Law’s primary flaw was that he was too successful. New paper money went into his stocks, boosting their value a thousandfold. The boost in value drew many people into the markets. Peasants became rich overnight. France paid off its national debt. The country was the envy of Europe. Foreigners flocked to the Parisian streets and demanded their own shares.
At the same time, the new rich were predictably hated by the old Parisian elite. Even more so, Law was hated because his more efficient tax collection had deprived many of a substantial revenue stream. It was too much innovation, too quickly. The stock shot up to the stratosphere. It would come down in the same way, like a rock falling from the sky.
Law was saved several times from aggrieved elites by the intervention of the regent. But, when the magic started to unravel, he could not be saved. The main problem was that just as upward growth of the stock could not be controlled, neither could the decline. Many ships had gone West, but the time to settle and build profitable ventures required decades, not months. People were expecting too much, too soon.
Some systems can soften the impact of a downward fall, but Law failed to. Though opposed in principle, he used all of the aggressive state powers that he had available to preserve his system, suspending convertibility, even outlawing gold. The people saw that the supposed riches of the new world were not on hand, and panicked even more. The glorious French system had gone to shambles and, declared the elites, John Law had to go.
It did not have to be this way. Law later reflected that slower growth could have prevented the precipitous decline. The rush to the top would have not been followed by such a steep descent. Perhaps France would have kept part of her great Western colonies if enthusiasm was not separated from reason.
It was a fascinating lesson of what is possible in the context of a centralized system. The elites did not want this type of financial innovation, but the regent demanded it and defended it. It rescued the ruined credit of a nation, but this success was not enough. Icarus to rose to the sun on paper wings, burning brighter and brighter, until the paper burst into flame. Soon enough, the monarchy itself would fall.
Several lessons present themselves within the current digital currency space, both from Law’s own perspective and the lessons he learned the hard way. First, elites often rally to block helpful innovation in finance, but this can be overcome by having the right friends. Second, financial innovation correctly applied can solve a lot of economic problems, particularly in depressed areas. Third, innovation in a new area has its share of warts. Fourth, it is easy for things to overheat; it is somewhat harder to cool off things off once they overheat.
It should be clear that Law would see digital money as the future. Paper money and coins clearly are not. With Bitcoin, it is clear that it serves as a counterbalance to a bank that prints too much. This is a problem Law saw clearly, as he helped to create such an unstable situation himself. He would see tremendous possibility in the certain upward rise of Bitcoin. He would probably worry that it could overheat.
Law would also certainly be gambling with Bitcoin, probably running his own site that plays the role of the bank and taking a good margin. But that wouldn’t be enough for him. He would most certainly also have some other bold idea relating to cryptocurrency. He would almost certainly be running the circuit talking to central bankers, looking for a nation with a financial crisis ready to take a risk for an even larger reward.
Would he succeed this time? Denied a major success, Law’s attempts did not exactly end in failure. There were bumps along the way. There was even chaos. Ultimately his attempts resulted in a greater good for the nation he tried them in, eliminating debt, and establishing a funding vehicle for Westward expansion. It is quite likely, using the lessons of his past attempts, that this time would succeed on a much larger scale.
Cryptocurrency is the future. It just calls for a bit of vision and boldness to pull it off on the scale needed. It needs another John Law.
Image: Petrafler @ shutterstock
Related story: Does Bitcoin Need a John Law?
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