CHAPTER XXIV

THE FIRST GREAT SPECULATIVE CRISES ¹

We have recognized as characteristics and pre-requisites of capitalistic enterprise the following: appropriation of the physical means of production by the entrepreneur, freedom of the market, rational technology, rational law, free labor, and finally the commercialization of economic life. A further motif is speculation, which becomes important from the moment when property can be represented by freely negotiable paper. Its early development is marked by the great economic crises which it called forth.

The great tulip craze of Holland in the 1630’s is often numbered among the great speculative crises, but it should not be so included. Tulips had become an article of luxury among the patricians who had grown rich in colonial trade, and suddenly commanded fantastic prices. The public was misled by the wish to make easy profits until with equal suddenness the whole craze collapsed and many individuals were ruined. But all of that had no significance for the economic development of Holland; in all periods it has happened that objects connected with gaming have become subject to speculation and led to crises. It is quite otherwise with John Law and the great speculation in France and the contemporary South Sea speculation in England, in the second decade of the 18th century.

In the financial practice of the large states it had long been customary to anticipate revenues by the issue of certificates, to be redeemed later. In consequence of the War of the Spanish Succession, the financial requirements of the government rose to an extraordinary height in England as well as in France. The founding of the Bank of England supplied the financial needs of that country, but in France the state was already hopelessly in debt, and on the death of Louis XIV no one knew how the excessive debt was to be taken care of. Under the regency came forward the Scotchman, John Law, who thought he had learned something from the founding of the Bank of England, and had a theory of his own regarding financial affairs, although he had had no luck with it in England. He saw in inflation, that is the utmost possible increase in the medium of circulation, a stimulus to production.

In 1716, Law received a concession for a private bank which at first presented no exceptional character. It was merely specified that the credit obligations of the state must be received in payment for the capital, while the notes of the bank were to be accepted in the payment of taxes. In contrast with the Bank of England there was no clear plan as to the manner in which the bank was to have a regular and secure income so as to maintain the liquid character of its issues. In connection with this bank Law founded the Mississippi Company. The Louisiana territory was to be financed to the extent of a hundred million livres; the company accepted the same amount of obligations of the state as payment for stock and received in exchange the monopoly of the trade in a territory to be determined. If one examines the Louisiana plan it will be observed that a century would have been required before Louisiana would have yielded sufficient revenue to make possible the repayment of the capital. To begin with, Law intended to carry out an undertaking similar to the East India Company, entirely overlooking the fact that Louisiana was not, like India, an ancient civilized country, but a forest waste inhabited by Indians.

When, in 1718, he saw himself threatened by the competition of a stock company which wished to lease the indirect taxes, he combined the Mississippi Company with the Compagnie des Indes. The new company was to carry on the trade with India and China, but the political power was not available to secure for France the share in the Asiatic trade which England already possessed. However, the regency was induced to give to Law the right of coinage and the lease on all the taxes, involving power of life and death over the state, in exchange for a loan at 3% by means of which the gigantic floating debt was to be taken care of. At this point the public embarked on an insane course of speculation. The first year a 200 % dividend was declared and the price of shares rose from 500 to 9,000. This phase of the development can be explained only by the fact that short selling was impracticable since there was as yet no systematic exchange mechanism.

In 1720 Law succeeded in getting himself appointed Comptroller General of Finances. But the whole enterprise quickly disintegrated. In vain the state decreed that only John-Law-notes should be legal money; in vain it sought to sustain them by drastic restriction on the trade in precious metals. Law’s fall was inevitable simply because neither Louisiana nor the Chinese or East India trade had yielded sufficient profit to pay interest on even a fraction of his capital. It is true that the bank had received deposits, but it possessed no liquid external resources for repayment. The end was a complete bankruptcy and the declaration that the notes were of no value. A result was an enduring discouragement on the part of the French public, but at the same time freely transferable share certificates, made to bearer, had been popularized.

In the same years a parallel phenomenon was exhibited by England, except that the course of development was not so wild as that in France. Soon after founding of the Bank of England, the idea of a competing institution became current (1696). This was the land bank project resting on the same ideas later presented in the proposals of the German agrarians, namely, of using land credit instead of bills of exchange as a cover for bank notes. But this project was not carried out because in England it was well understood that the necessary liquidity would be absent. This, however, did not prevent the occurrence that in 1711, after the fall of the Whig government, the Tories adopted a course similar to that followed a few years later by John Law.

The English nobility wished to create a centralized power in opposition to the specifically Puritan basis of the Bank of England, and at the same time the gigantic public debt was to be paid off. For this purpose was founded the South Sea Company, which made considerable advances to the state and in return received a monopoly of the South Pacific trade. The Bank of England was not shrewd enough to keep aloof from the project; it even outbid the founders and it was due only to the Tories, who on the ground of political repugnance refused it participation, that its offer was not accepted.

The course of events was similar to that of John Law’s institution. Here also bankruptcy was unavoidable because the South Sea trade was not sufficient to pay interest on the sums advanced. Yet prior to this eventuality, just as in France, speculation gave rise to transferable certificates. The result was that enormous property was dissipated while many adventurers came out of it smiling, and the state—in a way none too honorable—achieved a substantial lightening of its burden of interest. The Bank of England remained standing in all its former prestige, being the only financial institution based on the rational discounting of exchange and hence possessing the requisite current liquidity. The explanation is that exchange represents nothing but goods already sold, and such a regular and sufficient turnover of goods no place in the world except London at that time could provide.

Speculative crises of a similar sort have taken place from that time forward, but never since on the same scale. The first crises in rational speculation began a full hundred years later, after the conclusion of the Wars of Liberation, and since that time they have recurred almost regularly at intervals of about 10 years—1815, 1825, 1835, 1847 etc. It was these which Karl Marx had in view when in the Communist Manifesto he prophesied the downfall of capitalism. The first of these crises and their periodic recurrence were based on the possibility of speculation and the resultant participation of outside interests in large business undertakings.

The collapse has resulted from the fact that in consequence of over-speculation, means of production, though not production itself, grew faster than the need for consumption of goods. In 1815 the prospect of the lifting of the continental blockade had led to a regular rage for founding factories; but the war had destroyed the buying power of the continent and it could no longer take the English products. This crisis was barely overcome, and the continent had begun to develop buying power, when in 1825 a new crisis set in because means of production, though not goods, had been speculatively produced on a scale never known before and out of correspondence with the needs.

That it was possible to create means of production to such an extent is due to the fact that with the 19th century the age of iron had begun. The discovery of the coking process, the blast furnace, and the carrying of mining operations to unprecedented depths, introduced iron as the basis of creating means of production, where the machines of the 18th century were built only of wood. Thus production was freed from the organic limitations in which nature had held it confined. At the same time, however, crises became an imminent factor of the economic order. Crises in the broader sense of chronic unemployment, destitution, glutting of the market and political disturbances which destroy all industrial life, have existed always and everywhere. But there is great difference between the fact that a Chinese or Japanese peasant is hungry and knows the while that the Deity is unfavorable to him or the spirits are disturbed and consequently nature does not give rain or sunshine at the right time, and the fact that the social order itself may be held responsible for the crisis, even to the poorest laborer. In the first case, men turn to religion; in the second, the work of men is held at fault and the laboring man draws the conclusion that it must be changed. Rational socialism would never have originated in the absence of crises.