Was a scam carried out by the government of France? Oops!
The first famous pyramid scheme occurred in the early eighteenth century in France. What you’re about to read goes down as one of the greatest deceptions in history.
Near the end of King Louis’ XIV reign (1643 to 1715) the economy of France was on a steep decline. The country was 3 billion livres in debt. Officials debated whether the government should just declare bankruptcy and start from scratch, but the politicians of the time feared revolution and looked instead for a more expedient solution.
Their first attempt to remedy the problem was to devalue the currency through recoinage (the making of new coins). New gold and silver coins were issued weighing 20% less than coins already in circulation but with the same face value, and the public was ordered by law to make the exchange. The government planned to use the extra gold and silver they saved from the new coins to pay off the nation’s debt.
But the people of France weren’t to be fooled by devalued coins. They refused to exchange their gold and silver for currency that was intrinsically less valuable. This foiled scheme greatly discredited the government of France and worsened the economic depression.
After King Louis’ XIV death, the Regent Duc d’Orleans appointed Scottish economist John Law as Controller General of France.. (A Regent is someone who rules a country temporarily due to the absence of a Monarch.) Together the Regent and Law formulated a brilliant scheme to pay off the national debt.
First, the Regent of France authorized Law to establish a central bank under the name of Law and Company. (A central bank is a nation’s principal monetary authority: in the United States it’s known as the Federal Reserve, while in the United Kingdom it’s called the Bank of England.)
Second, the Regent authorized Law’s bank to issue bank notes (paper money) INSTEAD of real gold and silver coins and decreed that the paper money would be accepted for the payment of taxes. This gave Law and his bank notes a measure of credibility.
Third, Law knew he had to gain public confidence in his bank notes for the entire scheme to work. He immediately announced that all notes from his bank were payable in coin, meaning that his bank notes could be exchanged for their face value in gold or silver.
This gave the appearance that the paper money was the same value of the gold coin! This was perhaps the greatest deception of the 18th century.
Because of the discomfort of carrying coins around in their pocket, people preferred to carry the paper currency. Therefore, the public would deposit their gold and silver into the bank in exchange for a piece of paper. This practice is just as common today, people put their coins in a jar because the coins are too heavy to carry around. Once the jar gets full, they take it to the bank (or even the local grocery store) and cash in their coins for paper money.
The entire scheme required people to believe in the credibility of Law’s bank and his ability to redeem his notes in coins. Once that belief was established, the paper money was literally “as good as gold.”
As more and more people cashed in their gold in exchange for paper, the bank’s vault filled with gold.
Now I need to explain how banking began in order to complete this explanation.
In the early days, there was no such thing as credit. If you wanted to buy something, you carried your gold or silver coins to the store and paid in coin. People didn’t want to have their coins in their home or on their person when traveling for fear of being robbed, so they would keep their coins in a bank’s
vault. As more and more people put their coins in banks, the bank’s vault would fill up.
vault. As more and more people put their coins in banks, the bank’s vault would fill up.
Banks recognized that at no time did EVERYONE pull ALL their gold out of the bank simultaneously, so they loaned out depositors’ gold for short periods of time. This was the birth of “credit & loans.”
John Law learned of “credit & loans” working in his father’s bank. Now, for the first time we have “credit” as a financial tool.
This is where the pyramid concept comes into play. Because of my divergence into banking and credit, let me recap to ensure you’re still following all of this…
The Law and Company’s bank received enormous sums of gold to store in its vault. With all that gold in the vault the bank could issue loans…. but the loans would be made in paper money rather than in coin.
This was the magician’s act. The real product, gold and silver, vanished and the fake product, paper money, was now in the spotlight. This seems a lot like current times, doesn’t it?
THE BANK BECOMES A PYRAMID SCHEME
The Regent made Law’s bank a publicly-traded company and declared it the Royal Bank of France. Now people could buy stock in the government’s bank as well as receive credit in the form of bank loans. Over the course of a few years, the bank issued over one billion livres in paper currency to the public.
Keep in mind that all of these paper loans and paper stocks were based on the real product of gold and silver coins in the vault. You see, once the magician got you to believe that the paper was as good as gold, he didn’t need to show you the gold any more.
Businesses rushed to the Royal Bank of France to secure loans, with which they expanded commerce both at home and abroad. Foreign countries could not cash the paper money from France, so they required payment in gold and silver. Slowly but surely, the gold and silver that backed the paper-money loans began to drain out of France and into other countries. With the bank issuing so many loans, the people of France began to suspect that the gold and silver backing their paper money was disappearing. Depositors quietly began converting their paper money to coins and transporting the coins to foreign banks. By 1720 the scarcity of coin began to increase. The vaults, once filled with gold and silver, were becoming empty, but the paper money was still being loaned out.
In an effort to stop people from converting their paper money into gold and silver coins, the government depreciated the coin’s value to 10% below the paper, and the bank continued to limit the amount of coins any one person could receive. The limit was 100 livres in gold and 10 livres in silver. The government was now claiming that gold and silver was worth less than the paper!
In February of 1720 John Law made a fatal error. At his suggestion to the Regent, a decree was issued forbidding anyone to hold more than 500 livres in coin and prohibiting people from buying up precious stones, jewelry, silver settings, and so forth. The penalty was a heavy fine and confiscation of the
holdings. The government was desperate to hold onto the gold and silver that backed the currency loaned out and sold as stock. This enraged the public. In May of 1720 the bank was out of gold and silver in the vaults and was forced to stop making payments in coin. The bubble burst and the pyramid collapsed. John Law, once a national hero, became the scapegoat for the entire crisis. The government of France blamed him for the whole debacle and he was nearly murdered by angry crowds.