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The Structure and Stability of John Law’s Early Land Bank Proposals

La structure et la stabilité des premières propositions de banque foncière chez John Law
John Berdell
p. 459-479

Résumés

Cela fait désormais deux décennies qu’Antoin Murphy découvrait et publiait Essay on a Land Bank, texte jusqu’alors inconnu de John Law ; cependant, ce texte n’a toujours pas soulevé beaucoup d’intérêt. J’examine ici la nature de la stabilité du système bancaire proposée dans l’Essay. Deux modèles distincts pour la création d’une banque foncière sont proposés et Law leur attribue des propriétés très différentes. La seconde proposition a beaucoup de points communs avec le développement du secteur financier aux États-Unis, avant 2008, dans la mesure où elle suggère de transformer un groupe de crédit hypothécaires en un actif divisible et très liquide. Une analyse attentive de la différence entre les deux propositions contenues dans l’Essay apporte un nouvel éclairage sur un autre texte bien connu de Law, Money and Trade Considered: With a Proposal for Supplying the Nation with Money, texte qui reproduit largement le contenu de l’Essay mais sans distinguer précisément les différentes propriétés dynamiques de deux propositions. Par conséquent, des arguments contradictoires apparaissent les uns à côté des autres. Dans ce cadre, l’Essay peut servir de clé de lecture pour comprendre la logique de Law dans son travail publié, malgré la distance théorique considérable qui existe entre les deux travaux. Enfin, l’Essay suggère que c’est sa conception de l’histoire financière qui aurait poussé Law, en 1719-1720, à fixer comme objectif (insoutenable) un faible taux d’intérêt.

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Texte intégral

1. A New Window into the Genesis of the First Great Bubble?

  • 1 Citations of the form (E, 67-75) are to pages 67-75 of Law, John and Antoin E. Murphy. 1994. John L (...)

1It has now been over two decades, but Antoin Murphy’s discovery and publication of John Law’s hitherto unknown Essay on a Land Bank has elicited little attention.1 Yet since that discovery we have experienced financial turmoil very closely related to the Essay’s intention to transform a pool of mortgages into a divisible and highly liquid asset. This work should also be of considerable interest given that it constitutes Law’s first proposal for financial innovation, and one has to wonder whether this early work contains any conceptual germs that came to fruition in Law’s grand reorganization of French state finances. At first sight the Essay is a remarkably unlikely intellectual point of departure for Law’s financial “System”. The two ever present themes of the Essay are stability and limitation. The Essay is devoted to establishing a bank in such a manner that its money will be reliably stable over time. Stability is emphasized from start to finish, and in between Law considers different constitutional designs for a land bank that would limit its activities in such a way that the stability of its notes would be seen as assured by the public. Law’s Money and Trade has much in common with the unpublished Essay and reproduces the assertions that land backed money can hold its value over time nearly word for word. But Money and Trade gives pride of place to a notion not found in the Essay, namely that an increase in the money supply will increase employment and output. Moreover Money and Trade compresses the discussion of what had been two distinct bank models into one amalgamated discussion with the result that contradictory statements now appear side by side. On these points one has to consult the Essay to grasp what Law presumably meant to argue as he hurried to prepare Money and Trade so that it could generate support for his land bank proposal within the Scots Parliament.

2. The Background

  • 2 See also Murphy (2006, 173).
  • 3 The 1696 failure of the National Land Bank may indicate that an elaborate proposal containing a cle (...)

2Law’s land bank proposal was only one of many such proposals made in England and Scotland during the last decade of the seventeenth century and first of the next. Law appears to regard Hugh Chamberlen’s land bank proposals as the competition to beat. Chamberlen’s English proposal attracted considerable attention as a possible alternative to the Bank of England between 1690 and 1693, and he then proposed a similar scheme in Scotland that the Essay portrays as an inchoate competitor. Murphy convincingly argues that the Essay predates Law’s 1705 Money and Trade Considered and was most likely written around 1704. Gray was “credibly informed” that Law offered the work to Sidney Godolphin, 1st Earl of Godolphin and the long serving First Lord of the Treasury (Murphy, 1994, 21; Murphy, 2009, 46). If Godolphin did indeed receive the Essay, he should be forgiven for not pushing Law’s proposal forward.2 Godolphin had in fact just backed the failed National Land Bank proposal of 1696. Rubini (1970) maintains that that scheme need not have been seen as a hostile competitor to the Bank of England, but so it was received by the Whig junto ministers of the day. So despite Godolphin’s support and even that of King William, who pledged to invest in the bank, it was firmly opposed by his ministers who were not keen to lessen his dependence on the Bank of England. The land bank bill passed Parliament, but the bank’s commissioners found that its terms of incorporation were immensely more difficult to satisfy than they had anticipated. England had suddenly committed itself to reminting the silver coin while successively devaluing the gold guinea. Consequently it proved very difficult to raise the cash component of the capital subscription in full bodied coin and the bank’s supporters, including the King, found it quite impossible to get any relaxation in the terms of incorporation, such as permission to raise money in clip coin (Rubini, 1970, 708).3 Whether the National Land Bank at the center of Parliamentary conflict in the 1690s deserves to be called a land bank at all has been disputed. A true land bank, it could be argued, shouldn’t need to raise coin. Kleer (2008, 94-95) sees little but “vestiges” of a land bank left in the 1696 Act, because in the end there was no requirement that a substantial portion of the bank’s capital be devoted to mortgages. The Act required a large cash contribution (£2.564 million) to the exchequer. The bank was also committed to attaining and maintaining a 25% reserve of cash. Law’s early Essay carefully avoids any reference to raising, holding, or using cash.

  • 4 Watt (2007, 83) demonstrates that the Scots devoted considerably more of their resources to the Com (...)
  • 5 Law ([1705] 1750, 70) thought that a larger supply of Bank of Scotland notes might have prevented t (...)
  • 6 See Murphy (1997, 50); Robertson (2005, 173).

3We know that the Essay was drafted with an English readership in mind since it suggests naming the new institution the “land mint of England” (E, 68). Yet the parallels between the Essay and Money and Trade show that Law lost no time in applying the ideas to Scotland. In 1704 Scotland faced an even greater scarcity of coin than England had faced during its 1696-1699 recoinage. In an effort to establish an autonomous Scottish colony, the Scottish elite founded the Darien Company, formally the Company of Scotland Trading to Africa and the Indies, raising over £100,000 in cash to fund the venture in 1696. The sums pledged to the Scots company were far higher in proportion to the Scots population, its annual tax revenue, or its money supply than England’s commitments to the Bank of England or the East India Company had been.4 The Company’s attempt to found a trading company in present day Panama quickly succumbed to disease and Spanish resistance; and as a result the destruction of capital and liquidity in Scotland was far-reaching. Liquidity was especially lacking during 1704 when Law was most likely writing the Essay because in December of 1704 the Bank of Scotland, under great strain, ceased payments. Soon thereafter Queen Anne forced the issue of political union with Scotland by passing an Alien Act that threatened to sever trade ties with England should the Scottish Parliament fail to quickly vote for political union.5 Murphy details a host of competing pamphlets and proposals produced by Scotland’s difficult situation. Law felt that his proposal—or perhaps one should say proposals—for a land bank were in particularly direct competition with Hugh Chamberlen’s. An English Physician, Chamberlen had long advocated an English land bank. As Murphy recounts in detail a proposal based on Chamberlen’s advice was submitted to the Scottish Parliament slightly before one following Law’s design was submitted.6

  • 7 See also Neal (2012, 33) on the Scottish Parliament’s discussion of Chamberlen and Law’s proposals.
  • 8 Here Antoin Murphy (1997, 73) quotes William Greg’s correspondence.
  • 9 The idea that parties or the three great “interests” of the day (generally given as land, money and (...)
  • 10 Hugh Chamberlen it should be noted was an avowed supporter of political union spanning not just Eng (...)
  • 11 Anton Murphy traces the fortunes of Law’s proposals in the Scots Parliament. The proposal was intro (...)
  • 12 Archibald Campbell was one of the few investors who subscribed more than a thousand pounds to the C (...)
  • 13 When the £398,085 10s Equivalent arrived in Scotland it was born by a large wagon train under heavy (...)
  • 14 Patterson received £18,241 which Watt (2007, 246) reckons was some £2.5m in present money.

4Party politics were fast moving affairs during both the Scottish and English land bank periods.7 The difficulty of associating Law’s proposal with either court or country factions is epitomized by George Baillie of Jerviswood. When Baillie introduced the Act containing Law’s Land Bank to Parliament in July of 1705, he met with fierce resistance from Andrew Fletcher of Saltoun, who was greatly angered by Baillie’s recent “apostasy from the Country to the Court party”.8 Baillie’s “apostasy” was not as personal as Fletcher suggested. Baillie was only one member of the newly formed Squadrone Volante parliamentary group that centered on John Hay, 2nd Marquis of Tweeddale. Members of the Squadrone decided to break away from the country (or opposition) party to support union with England. Within the court party Law already had the most influential support possible, that of John and Archibald Campbell, the 2nd Duke of Argyll and Earl of Ilay respectively. Murphy suggests that the Bank of Scotland was suspected of Jacobite leanings in 1705, so the Campbell brothers might have found Law’s land bank an appealing alternative.9 The brothers led Queen Anne’s campaign to forge a political Union between Scotland and England, and had they suspected Law of Jacobite sympathies “they would have abandoned him” (Murphy, 1997, 69).10 As we will see, Law was keenly aware of competing proposals and quickly reformulated the proposals of his Essay as Money and Trade; injecting promises of rapid employment, output and export growth not found in the Essay and obscuring the details of the Essay’s carefully constructed constraints on note issue. Yet the attention of Law’s backers in Parliament was drawn away from banking proposals and became suddenly absorbed in a revived discussion of Union with England.11 The two issues were intimately related. A critical sticking point the negotiations over Union suddenly seemed to have been resolved. It was the payment of an “Equivalent” which has been portrayed as simply a bribe to induce the Scots into union, or as reasonable compensation for Scotland’s increased taxation. Either way, the Equivalent certainly was large. A large part of it was structured as compensation to the proprietors of the failed Scottish African Company, who as a result of the Equivalent suddenly realized 140% on their investment rather than the complete loss they would otherwise have suffered. The influx of almost £400,000 revived the fortunes of a very large number of Scottish Parliamentarians, and in particular the fortunes of the Squadrone Volante as well as court luminaries such as the Campbell brothers.12 It was John Campbell who broke the deadlock in the Scots Parliament and allowed the Queen to nominate pro-Union commissioners. They in turn successfully negotiated the Equivalent, article fifteen of the treaty of Union.13 The very last person to appear in the minute book of the commission charged with disbursing the Equivalent was none other than William Patterson who, after falling out with the other founders of the Bank of England, had devoted his energies to raising funds for the Scots African Company. The commissioners did not grant Patterson’s claim for compensation out of the Equivalent. Undaunted, Patterson successfully petitioned Parliament for very generous compensation.14

  • 15 Neither the Essay nor Money and Trade promise aid to the state. The failed National Land Bank did p (...)

5Financing state expenditure was a necessary feature of all successful corporate flotations in England, but not in Scotland where the Bank of Scotland was founded to support trade rather than the state. Actually none of Hugh Chamberlen’s (unsuccessful) English and Scottish land bank proposals promises state aid.15 Indeed I think one can read Law’s Essay as attempting to put flesh on Chamberlen’s (1700, 20) thin assertion that:

A good Land mortgage is esteemed equally valuable with a like Summ in Money, else none would give Money for it: the bills of Land-Credit are little Land Mortgages as safe, as the greater, and more useful, because small, and therefore may be made by Parliament Current and living… (Chamberlen, 1700, 20).

6Law’s Essay notably does not hold out the prospect of a dramatic increase in manufacturing and exports. This is something that Chamberlen had long promised. One of Chamberlen’s English broadsheets from 1693 ends with a final point: “Lastly, This must Infinitely increase Trade, enrich the Nation, Employ the Poor, and produce too many benefits too tedious to be here enumerated” (Chamberlen, 1693). Law would counter these promises in Money and Trade, but not in the Essay which is relentlessly focused on monetary stability.

7Antoin Murphy has aptly likened the transition from the Essay to Money and Trade to Keynes’ transformation between the Treatise and the General Theory in that it is only in the General Theory that reviving employment from a low level comes to the fore. I believe that Law’s Essay can also be likened to the Tract on Monetary Reform, because in that work (as in the Treatise) it is the stability of the value of the currency that comes to the fore. Inflation and deflation are both evils to be avoided. That is exactly the spirit of Law’s Essay which, like the Tract, was written in the wake of a financially dislocating war and seeks stability first and foremost. Despite Law’s starring role in setting Europe’s first international financial bubble in motion, the Essay should be regarded as a truly classic statement of the benefits of monetary stability and the critical role of good institutional design for maintaining that stability. Watt (2007) argues that the rise and collapse of the Scottish African company should be recognized as an important precursor bubble to that of the Mississippi and South Sea Company even though there was little in the way of an active secondary market in which shares could be traded. It seems that Law was powerfully impressed by it, but in the Essay he does not seek to encourage and harness speculative enthusiasm to his cause. To the contrary the Essay is rife with limiting and stabilizing mechanisms that clearly betray a disinclination to trust the prudence of the bank’s management. These mechanisms seek to prevent, or at least limit, bubbles in land prices. Note holders are empowered with rights and opportunities to check excessive note issue and credit creation by the bank that we will now examine in detail. Given the financial and political turmoil of the times in which it was written, the steadfastness with which the Essay focuses on the long view is remarkable.

3. The Essay: Structure and Strictures

8The Essay contains two different modalities or mechanisms according to which a land bank might emit money. Either modality might be privately or publicly owned. In the first mode the land bank owns land outright. Notes are issued to purchase land and only to purchase land. The second mode has the land bank purchasing (or providing) mortgages rather than land. In the first mode the value of money will rise against silver while in the second the value of money will be stable against silver. By the value of money Law often means its purchasing power against consumption goods, though it may refer to its strength against silver money. In the first mode land money increases in purchasing power while in the second mode it shares silver’s diminishing purchasing power.

3.1 The Bank Buys Land

9In the first modality (E, 67-75) a land bank purchases land with land notes. There is a special role for “standard” land which is supposed to be identified by Parliament at the establishment of the bank. I assume that this means that Parliament would have identified a swath of (contiguous?) terrain that constitutes this standard, but exactly how the designated land is to be rendered homogeneous is not explained. The initial price (in land notes) of this standard land is supposed to anchor prices. The bank may purchase this standard land at its initial legislated price but not at a higher price. Exactly how non-standard land will be valued vis-à-vis standard land is not spelled out, but even if the non-standard land price rose considerably against the standard (due to the land bank’s land purchases), the presence of the standard land ought to limit land price inflation through a second aspect of this system. That is that land-note holders may purchase any parcel of land from the land bank’s portfolio at the original land note price that the bank paid for it. This applies to any parcel of land whether standard land or not. Excessive note issue would increase the price of land (denominated in land notes). This would create an incentive to purchase land from the bank. If there were no provision for standard lands, an inflationary cycle could easily ensue in which parcels of land are repeatedly sold to—and then purchased from—the land bank at rising prices while the volume of notes increases. Standard lands would not be able to participate in this inflationary cycle as the land bank could only purchase them (and would also be required to sell them) at the initial price established at the inception of the bank. In the event of land price inflation the standard lands would necessarily fall in relative price and standard land would be purchased from the bank reducing the volume of land notes in circulation.

  • 16 Instead the Trustees overseeing the operations of the bank are charged with judging whether “the la (...)
  • 17 Law’s discussion of the mechanism limiting monetary over expansion is not entirely free of contradi (...)

10It is possible that the land notes in circulation could still rise, but only if the land bank’s purchases of non-standard land exceeded its sales of standard land. Such a situation suggests increasing sales of standard land, which leads to a situation in which eventually the land bank has sold all its standard lands (which might then be bought and sold by the non-bank public at inflated prices). The standard land could prevent an inflationary cycle if the bank was required to maintain a minimum portfolio of such lands, in which case it would have to reduce its note issue to a point where it was able to purchase standard lands at the initial (legislated) price.16 Alternatively the complete absence of any standard land in the land bank’s portfolio might invoke a clause limiting note issue and/or intervening in the governance of the bank. These are really quibbles as Law clearly intends and assumes that standard lands continue to be held in considerable volume by the bank. Other small objections can be raised that would be easily deal with by using index numbers that allowed the land bank to target a land price index rather than committing it to selling specific parcels of land at its purchase price.17

11Although one can raise minor objections to the first modality of Law’s land bank, it certainly appears to be adequately inoculated against an inflationary cycles such as that created by the assignats. Law never clearly addresses whether his anti-inflation mechanism would render the bank unprofitable. He does not seem to allow the bank to add any sort of fee to the price of the land when note holders demand a parcel of land from the bank: it must be sold for exactly the price the bank paid for it. Interestingly this version of Law’s bank would have also created a price system in which goods would be denominated in a land standard. That is to say, and with some irony, that Law proposes creating a price system in which mirrors the value system of his great critic, Richard Cantillon.

12Thayer’s account of American colonial land banks suggests that mortgage providing land banks could deliver a stable currency. Thayer (1953) finds that land banks in the middle colonies (Delaware, New Jersey, New York, Pennsylvania) successfully issued notes that were sufficiently stable in value that they garnered support from the merchant community. Their moderate note issues were backed by lands that were more valuable than that of New England where land banks issued in excess and inflated away the real value of debts.

  • 18 A point made by many observers recently, see for example Richter (2015).

13From a current perspective (2017) the fact that Law’s first proposal aims at stabilizing an asset price is particularly interesting as the creation of high powered money by central banks in the wake of the 2007-2008 collapse has imparted little or no momentum to inflation in final goods prices but has been accompanied by a recovery and further extension of equity prices in the US, as well as a partial recovery of land prices.18 Despite the prominent role of asset price bubbles in recent downturns and the clear evidence that central banks can affect asset prices more easily than goods prices, I know of only one prominent economist today—Roger Farmer at UCLA—who argues that the Federal Reserve Bank should target asset prices, in Farmer’s case the stock market.

3.2 The Land Bank Buys Mortgages

14In the second mode the land bank issues its notes against land “redeemable in a term of years” or against mortgages. So this second mode has two distinct variants. The second mode begins with: “A land money may be given out upon lands sold redeemable in a term of years, or upon lands mortgaged to repay the sum lent with the legal interest” (E, 75). In the former case the land bank must hold the loan to maturity at which time the borrower may pay off the loan (using land notes presumably) or if the borrower is unable to pay off the loan the bank sells the land (again presumably for land notes). Because the bank holds these mortgages to maturity the inflation checking mechanism used in the first mode (in which the non-bank public could retire notes by purchasing land that had risen in price) is not available. Law mandates that if the land bank sells land for more than the redemption price, the excess should go to the original borrower. This presumably removes a clear incentive for inflating land prices. But it also limits, indeed threatens the profitability of the bank. As Law passes quickly over this variant I don’t think much can be said about just how it was to be managed.

  • 19 Note holders can also exchange their low denomination notes for interest bearing large notes or equ (...)

15The second variant of this second model is discussed at greater length so it is where we should focus our attention. It has the land bank purchasing pre-existing mortgages using its special notes. Here the value of notes is to be maintained by rendering the volume of notes circulating endogenous, as in the first mode, but with some necessary modifications. Instead of having the right to purchase any plot of land held by the land bank, as in the first mode, note holders can purchase any mortgage held by the bank.19 This means that the “land notes” are exchangeable against a stream of silver money payments. In this case Law very consciously seeks to establish the stability of land notes against silver money rather than land.

16The logic he uses to establish this stability of land notes against silver money is a two-fold supply and demand analogy (E, 76-77). He considers the relative price of wine in terms of oats. The relative price reflects the supply and demand in both markets. If in either market there are offsetting changes in the supply and demand the relative price will remain constant. Since he believes he has a system in which the supply of land money will respond endogenously to its demand, this seems to suggest that any change in the relative price must originate within the market for silver money, and that the land money supply can and will change to offset any change within the market for silver money.

17An interesting aspect of this two market discussion of monies is that Law regards the price of each type of money as its interest rate. The convertibility of land notes into interest bearing securities or monies ensures that the land-money interest rate remains constant. Here Law appears to take the interest rate on lending silver money as constant, presumably due to usury laws. Frankly the two-fold supply and demand analysis is rather awkward, and to my mind Law presents a far clearer discussion why the land money should maintain parity with silver money several pages later when he discusses the shortcomings of previous land bank proposals which had overlooked the necessity of equating interest rates across land and silver money.

18It is in his criticism of Chamberlen’s preceding land bank proposal that Law more clearly discusses of the parity of land notes with silver money by explicitly linking that parity to the equality of interest rates between the new land money and the interest rate available to lenders of silver money. “Land of £100 rent at 20 year’s purchase is worth £2,000… So this land may be made money equal to £2,000…” He then notes that if the land note interest rate (or years purchase) were half that of the silver money, the land money which the land (or as I would prefer to say the stream of sterling payments) is “coined” into would be worth £1,000 (E, 81-82). The example clearly reflects Law’s assumption that land money would remain a subsidiary, or secondary, form of money that circulates alongside the dominant silver money that is used for rent payment. Hence land money is a claim upon a stream of silver money payments, and so long as the interest rate remains constant the relative value of the two monies remains constant.

  • 20 On Keynes and covered interest rate parity see Keynes ([1924] 2000, 115-139) , Dimand (2006, 176) a (...)

19If we are allowed to engage in prolepsis we can retrospectively examine Law’s discussion using covered interest rate parity (CIP), a very well-known way of discussing the movement of exchange rates over time. Interestingly covered interest rate parity was introduced to the economics literature by Keynes in the Tract on Monetary Reform. Keynes emphasizes monetary stability rather than the output determination.20 Any differences in the interest rate paid on two currencies must be reflected in the forward premium which is the ratio between the forward exchange rate F and the current spot exchange rate S (Taylor, 1989, 378).

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  • 21 In Law’s discussion ownership of the land (or a mortgage) entitles the holder to a pre-determined s (...)

20The essence of CIP lies with the certainty of the forward exchange rate, that currencies can without risk be exchanged in the future at a predetermined rate. This is the forward rate F.21 Clearly stability of land money against silver money (which pays i*) requires F = S. CIP tells us that in order for F = S we must have i = i*. The CIP statement simply clarifies the stability of the exchange rate: if the two interest rates are the same then F = E and the currencies neither appreciate nor depreciate against each other. However we do not find a commonly made CIP observation in Law’s discussion, namely that a currency with a lower interest rate must appreciate over time. Perhaps that is because Law was (rightly) not inclined to assume the existence of riskless arbitrage at known future values between an ill designed land money and silver. Banks provided exactly such contracts in Keynes’ day.

  • 22 Had a land bank been established on the first mode then its notes would have risen in value (agains (...)

21Law considers how prices would have evolved had a land bank been in place over the previous 200 years. He explicitly considers each of the two modes separately. He maintains that land money established in the second mode “could not be more or less valuable unless the Parliament raised or lowered the interest of money.” (E, 77) This contains the implicit proposition that whenever the interest rate is constant the value of money is constant. This is reinforced in the following paragraphs where he asserts that if the interest of money had remained constant over the past 200 years a bank established on the second mortgage model would have kept its money constant in value (meaning purchasing power over goods generally). Speaking of the second mode of the land bank Law says:22

If 200 years ago a company had been established to lend notes upon land after this manner, land then at 14 years purchase, barley at 6 pence per boll, and money at 10 percent, if the interest of money had continued as then, and the Company had lent what sums were demanded and taken back what sums were offered to be returned, six pence of that land money would have been equal at this time to a boll of barley as then for the barley is near to the same value it was of then. (E, 77-78)

22Here Law asserts that the relative price of barley vs. other representative commodities has not changed, “barley is near to the same value it was of then”. In contrast to historical experience, Law considers a counterfactual in which the interest rate on silver money would have remained constant. I take Law to be asserting that the purchasing power of money will remain constant so long as the interest rate is constant. This is hinted at again a few pages later:

Being deigned to confine myself to a few sheets I shall not insist on this subject thought I believe it would be of use to examine the nature of the interest of money. I shall only desire these who doubt of the position I have laid down to consider whether when interest was at [f.67] 10 per cent 100 ounces of silver in bullion or money was not of more value than the same weight of silver of the same fineness in bullion of money is of now and whether it would buy the same quantity of goods now as then. (E, 84-85)

  • 23 Murphy (1997, 199, 215-216) suggests that Law wished to “force the interest rate down to the magic (...)

23Law’s thinking here is both innovative and dangerous. He is on the very threshold of recognizing that control over the supply of money allows interest rate targeting. In the Essay he restricts his attention to targeting the same interest rate that is paid on silver money so as to maintain a constant exchange rate between the two. But his idea that constancy of the interest rate implies constancy in the purchasing power of money constant could easily lead to targeting an excessively low interest rate, one associated with building inflationary pressure. Perhaps this notion that prices would be stable if the interest rate was stable contributed indirectly to Law’s attempt to hold the interest rate at 2% near the end of his system in 1720.23

4. The Essay in Contrast to Money and Trade

24Many of Law’s critical insights into the nature and functions of money are carried over wholesale from the Essay into Money and Trade, which is hardly surprising given that they appear to have been composed in subsequent years (1704 and 1705). Money and Trade is a much larger work, yet it does not reproduce everything that the Essay has to say about the nature of money. For instance, as Murphy (1994, 38) observes, Money and Trade does not contain the Essay’s discussion of partial monies. The Essay identifies Bank of England Shares and Irish debentures as means of exchange but notes that they did not have sufficient stability to function as a standard of payment over long time periods. The Essay also contains a far more detailed, and quite separate, examination of each of the two possible variations of the land bank.

  • 24 See Locke’s 1691 Considerations on the consequences of lowering interest (Locke, 1824). Locke’s not (...)

25As previously noted, Murphy very insightfully draws a parallel between the evolution of Law and Keynes’ thinking. The transition from the Essay to Money and Trade bears a resemblance to the movement from the Treatise of Money to the General Theory in that variations in output and employment rise to the fore. The Tract on Monetary Reform, which contains Keynes’ treatment of covered interest rate parity, can also in my view be said to share with the Treatise—indeed to express more adamantly—the importance of monetary stability. This is an important theme of Law’s Essay which emphasizes the “wrongs” done to various classes by inflation. Keynes’ overriding concern in the Tract lies with political stability: high inflation has eroded the social status and political confidence of business men who are perceived, and feel themselves to be, war profiteers (Keynes, [1924] 2000, 24-25). Law’s Essay was written to persuade one or perhaps a few readers, not a whole country and so it never approaches Keynes’ impassioned rhetorical heights. Nonetheless the stability of monetary values is clearly important because landed men have felt wronged by inflation and Law takes this as a politically very sensitive matter. It is important that any financial innovation “be effected without wronging the monyed man or any other part of the population.” (E, 85) Both Law and Keynes echo, in their very different ways, Locke’s concern that changes in interest rates threaten to disturb the political equilibrium between lenders and borrowers, or the Moneyed and Landed men.24

  • 25 See Berdell (2010) for the suggestion that Law’s system foreshadows aspects of twentieth century ec (...)

26The overriding theme of Money and Trade is entirely absent from the Essay. There is no suggestion in the Essay that money can drive trade, or indeed that money can both ‘drive’ trade and indirectly generate greater population growth.25 The Essay is consistently focused on the long term stability of the land bank and the stability of its notes vis. a vis. either land or silver money. In contrast Money and Trade emphasizes the sudden revival of output and exports that a new bank will bring:

more money, by employing more People, will make an overplus to export: If then the goods imported balance the Goods exported, a greater addition to the money will employ yet more people, or the same people before employed to more advantage; which by making a greater, or more valuable export, will make a balance due. (Law, [1705] 1750, 23-24)

27As previously noted, Law’s Scottish land bank proposal was in competition with a proposal from Chamberlen (1700, 9-10) whose Scottish proposal asked: “are Manufactures multiplied... sufficient for home consumption and foraign exportation? Is there half a Million or a Million ready for the service of the African company, to recover their late disappointments.” The failure of the African company meant that money, and wealth, were depressed in Scotland, and this, together with Chamberlen’s competition, could easily account for the sudden emphasis on output dynamics in Money and Trade. Not only will the new money created by the land bank increase output, but the profits of this new bank are to be channeled towards drawbacks (export subsidies) and so the increase in money will not be inflationary because it increases output, and it will improve the balance of trade.

  • 26 In the Essay the rate of interest in London provides a clear benchmark which allows us (in my view) (...)

28A second difference between the Essay and Money and Trade lies in the absence of a link to the London interest rate. As previously remarked Money and Trade does not separately and sequentially examine its distinct proposals for, or variants of, a land bank the way the Essay does. Perhaps that partly explains why there is no discussion of a link between the interest rate contained within the land bank’s mortgages and the interest rate on sliver money available in London.26 It may also have been politically awkward to suggest that the value of newly minted Scottish land money was to be rendered derivative of the value of money in the London money market. There is the additional, but not persuasive, possibility is that the scarcity of money in the Scottish countryside made the notion that a mortgage corresponded to a stream of payments in silver money problematic.

  • 27 There are three ways humbly offered to the parliament, for giving out these notes: they in their wi (...)

29The third and key difference that separates the Essay from Money and Trade lies with the fact that the Essay clearly distinguishes the two different models for establishing the land bank, and discusses each separately. In contrast Money and Trade (Law, [1705] 1750, 159-160) lists three options that Parliament may choose.27 Law fails to clarify which of these “ways”, or as I would call them “models”, he has in mind when he goes on to assert that the value of land money will be stable. He does not clarify which model would deliver stability of notes against land and which would deliver stability of notes against silver. Rather in Money and Trade the two versions of stability are asserted right next to each other (Law, [1705] 1750, 166-167):

The paper-money proposed will be equal in value to silver, for it will have a value of land pledged equal to the same sum of silver-money that it is given out for. If any losses should happen, one 4th of the revenue of the commission, will in all appearance be more than sufficient to make them good.

This paper-money will not fall in value as silver-money has fallen, or may fall: goods or money fall in value, if the[y] increase in quantity, or if the demand lessens. But the commission giving out what sums are demanded, and taking back what sums are offered to be returned; this paper-money will be keep [sic.] its value, and there will always be as much money as there is occasion, or employment for, and no more.

30The first statement has the new paper staying at par with silver money while the second has it appreciating against silver and staying at par with land. This has to strike the innocent reader as a confused contradiction, but it makes perfect sense in the Essay where the properties of the different models are clearly and separately discussed. Law admitted that Money and Trade was rushed. He lacked “time to put my thoughts in that order they ought to have been.” (Law quoted in Murphy 1997, 76) Here the Essay serves as a key that allows us to better understand what Law intends to argue in Money and Trade. It is when the bank purchases land that the land notes are to maintain their parity with land, and it is when the bank purchases mortgages that its notes are supposed to maintain parity with silver.

5. Stability, Efficiency and Incentives

  • 28 Banks in Law’s day generally lent on commercial bills and at very short terms (with the exception o (...)
  • 29 Conversely the System lacked any and all of the Essay’s limiting mechanisms. Oversight was impossib (...)

31In places Law’s early Essay is all too remindful of recent events. The second variant of his bank homogenizes and liquefies mortgages, which is of course exactly what the shadow banking system did in conjunction with money market mutual funds. Law does not interpose the complex cascade of asset backed securities in the process, but his plan should be seen as capitalizing the value of a stream of mortgage payments. In this respect Law’s proposals for a land bank had much in common with the Bank of England’s foundation as its principal asset at its inception was a government loan; hence its stock capitalized a stream of government interest payments. This was true of all the companies floated in the English financial revolution. Their stock securitized a heterogeneous collection of government debts. In doing so they made room for new borrowing and assisted in the birth of an autonomous and highly liquid government bond market (see Quinn, 2006). Thomas Sargent (Sargent, 2011) has forcefully argued that a trade-off between stability and efficiency is inherent in the functions of banks and their relations with regulators. By transforming maturity, providing liquidity and sharing risk financial intermediaries promote efficiency but expose themselves to destabilizing runs. Lenders of last resort both stabilize the system and encourage risky lending practices among the, explicitly or implicitly, guaranteed institutions. The time consistency of lenders of last resort is in turn greatly dependent upon the incentives of the elected officials who ultimately oversee the system. Seen from this perspective Law does go to some length to inoculate his proposed banks against runs. The notes are 100% backed, and not by reserves of an equally liquid asset but by one far less liquid. It is difficult to imagine a bank less prone to runs. This stability came at a price, however, in that Law’s proposals were not sufficiently attractive to politicians, investors and potential note holders. The very properties of the banks that sought to make the value of their notes stable reduced their potential profitability to investors, and would have exposed note holders to maturity risk.28 Most importantly, however, neither of Law’s variations provides the significant war funding that English ministers expected of any corporate proposal of the time. Scottish affairs were more complicated. The fact that Law’s bank did not provide financial assistance to the state was not an insuperable stumbling block, and for a brief moment there was considerable support for Law’s proposal from a coalition of powerful Scottish parliamentary factions. Yet the sudden negotiation of the Equivalent inflated the value of the parliamentarian’s equity wealth faster than Law’s bank could ever hope to. Parliament’s decisive turn away from his proposal did not dampen Law’s enthusiasm for banking proposals. But it is interesting to note that Law’s French System of 1719-20 provided, at least briefly, both spectacular financial returns to his influential investors as well as unprecedented financial resources to the state.29

I thank Antoin Murphy, Mauricio Chalfin Coutinho, Yutaka Furuya, anonymous reviewers, as well as participants at the 2016 History of Economics Society conference at Duke University for their insights and corrections, but claim any remaining errors and misconceptions as personal property.

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Notes

1 Citations of the form (E, 67-75) are to pages 67-75 of Law, John and Antoin E. Murphy. 1994. John Law's “Essay on a Land Bank”. Donnybrook, Dublin: Aeon Pub. Spelling and punctuation has been modernized when quoting from Law’s Money and Trade Considered (Law, [1705] 1750).

2 See also Murphy (2006, 173).

3 The 1696 failure of the National Land Bank may indicate that an elaborate proposal containing a clear governance structure might be a political liability. In contrast to the Land Bank, the Bank of England’s structure was only vaguely limned in the Tunnage Act, and loopholes large enough to “drive a coach and six” were left in the rules limiting its activities and advances (Rubini, 1970).

4 Watt (2007, 83) demonstrates that the Scots devoted considerably more of their resources to the Company of Scotland than the English did to The Bank of England or the English East India Company: “The ratio of shareholders to population, tax yield and money supply was significantly higher than for contemporary English joint-stock companies. Scotland had approximately 1/5 of the population of England, 1/36 of the tax yield and 1/40 of the money supply. Using an estimate of 3,000 for the total number of investors, the ratio of share-holders to population was about 13 times that of the EIC [East India Company], shareholders to tax yield about 91 times and shareholders to money supply one hundred times.” He (2007, 87) quotes Sir John Dalrymple on the influence which the capital raising of the Company of Scotland had on Law: “The famous Mr Law, then a youth, afterwards confessed, that the facility with which he saw the passions of speculation communicate itself from all to all, satisfied him of the possibility of producing the same effect from the same cause, but upon a larger scale, when the Duke of Orleans, in the year of the Mississippi, engaged him, against his will, to turn his bank into a bubble.” He (2007, 24) also notes that the Company issued bank notes, some of which were lent out to buy its own shares, a strategic use of leverage that would reappear on a larger scale during the Mississippi bubble.

5 Law ([1705] 1750, 70) thought that a larger supply of Bank of Scotland notes might have prevented the bank’s stop of payments.

6 See Murphy (1997, 50); Robertson (2005, 173).

7 See also Neal (2012, 33) on the Scottish Parliament’s discussion of Chamberlen and Law’s proposals.

8 Here Antoin Murphy (1997, 73) quotes William Greg’s correspondence.

9 The idea that parties or the three great “interests” of the day (generally given as land, money and trade) had clearly different preferences over financial proposals has ebbed and flowed. Jonathan Pocock (1975, 75-76) influentially asserted that Whigs and Tories “share not only the same reading of the economic facts, but the same underlying value system, in which the only material foundation for civic virtue and moral personality is taken to be independence and real property.” Pinchus and Wolfram (2011) have however sought to rehabilitate contemporary accounts of the English Land Bank debate as highly partisan, and eventually blocked by the Junto Whig ministers. Desan (2015, 34) avers that “the National land Banks authors, its most active promoters in Parliament, and its public advocates were men with a deepening attachment to the Tory cause.”

10 Hugh Chamberlen it should be noted was an avowed supporter of political union spanning not just England, Scotland and Ireland but the Americas as well. His 1702 tract is self-explanatory: The Great Advantages to the Kingdoms of Scotland and England by a Union (see Armitage, 2000, 164).

11 Anton Murphy traces the fortunes of Law’s proposals in the Scots Parliament. The proposal was introduced on 10 July 1705 when Baillie of Jerviswood moved that “Mr. Law’s project for establishing a land-bank and paper money might be taken into consideration”. The subsequent discussion of Law and Chamberlen’s land bank proposals was precipitously terminated in hopes of avoiding a duel between rival factions (Murphy, 1997, 74-75).

12 Archibald Campbell was one of the few investors who subscribed more than a thousand pounds to the Company (Watt, 2007, 271). In Watt’s view (2007, 164) Tweeddale and his political supporters, including Baillie, “represented the most powerful faction on the court of directors” of the Scottish African Company, so they would have had much to gain from the Equivalent and news of the political breakthrough might well have focused their attention in that direction rather than towards supporting the establishment of novel financial companies. Baillie was on the initial board of directors and Hay also served as a director (Watt, 2007, 162, 264).

13 When the £398,085 10s Equivalent arrived in Scotland it was born by a large wagon train under heavy military escort. Ironically the payment was largely in exchequer bills rather than cash, and that they were accepted conclusively proved the liquidity and homogeneity of English, now British, government debt. As David Hume would write some three decades later in Of Public Credit “Public securities are with us become a kind of money, and pass as readily at the current price as gold or silver.” But of course Law had already observed that government bonds were being used as money in the Essay.

14 Patterson received £18,241 which Watt (2007, 246) reckons was some £2.5m in present money.

15 Neither the Essay nor Money and Trade promise aid to the state. The failed National Land Bank did promise, but could not deliver state aid. Law and Chamberlen’s emphasis on providing credit to the private sector receives some support from Temin and Voth’s (2005, 2006, 2008) recent findings that government borrowing caused considerable crowding out. (On the French evidence see Hoffman, Postel-Vinay et al., 1995)

16 Instead the Trustees overseeing the operations of the bank are charged with judging whether “the lands for which these notes are given out be of equal value to the notes according as lands to be appointed by Parliament as a standard are at the making of the Act”. If the land bank purchases land for more than this standard would seem to warrant (E, 69), the profits or the capital of the bank should “be applied to make good the deficiency”. This suggests that the overvaluation of land should be charged to profits and capital. A better method—that did not require the Trustees to make such difficult judgements—would be one in which the Trustees simply ensure that the land bank maintain a significant portfolio of standard land. The role and nature of the “Commissioner’s Trustees” is unfortunately not discussed in detail, but they are clearly distinct from the Company’s “directors” who are elected by the shareholders and who appoint the “other managers” and frame the “rules and ordinances as they shall think needful for the good management of the Company always consistent with the laws of the kingdom.” (E, 68) Later in the Essay Law mentions in passing that the bank could also be established as a public institution. (E, 79)

17 Law’s discussion of the mechanism limiting monetary over expansion is not entirely free of contradictions. While discussing the insecurity of land titles and the introduction of a land register Law suggests that lands will become more valuable once purchased by the land bank, because the law establishing the land bank would include a provision that definitively established the title to any land purchased by the land bank. Yet the land bank is required to sell lands at the bank’s initial purchase price. This would certainly initially limit the volume of notes outstanding, but it would also impair the bank’s profitability. Nonetheless an inflationary cycle would be prevented if the Trustees rigorously monitored the land purchases of the bank and prevented it from repurchasing any parcel of land at a price higher than the bank had previously paid for it. One could also argue that there are problems within the pricing of standard land. Law says little about the standard land. Today it is natural to think of using averages and indexes. Was he thinking that Parliament could identify an area of land in which each acre sold for the same price? He acknowledges early in the Essay that investments or improvements on the land will increase its price but does not return to this point. If all land that is identified by Parliament as standard land is literally to be kept at the same price it would be a significant deterrent to investment as once a parcel of land was improved it would be purchased from the land bank at the low initial price. Matters would be easier to handle if Law had suggested that the Land Bank stabilize the average price of land of a particular type. This would have the bank targeting the price level of an important asset class. François Velde (2012) credits Law’s ever able assistant and clerk DuTot with having constructed an early (and apparently unweighted) price index. Just how DuTot’s work with Law during 1719-20 led him to produce a price index is unclear, but it is fascinating to note that Law’s most important employee in the Compagnie Des Indes was exactly the sort of person who might have produced a serviceable land price index. Chance (1966) points to Rice Vaughn’s considerably later work of 1765 as the first instance of index number thinking.

18 A point made by many observers recently, see for example Richter (2015).

19 Note holders can also exchange their low denomination notes for interest bearing large notes or equivalently for ‘the security’ of the bank—which I suppose we might call a bond, although a clear distinction was not then drawn between stocks and bond (E, 75-76).

20 On Keynes and covered interest rate parity see Keynes ([1924] 2000, 115-139) , Dimand (2006, 176) and Taylor (1989).

21 In Law’s discussion ownership of the land (or a mortgage) entitles the holder to a pre-determined silver payment. It is convenient to take this as F=1. It reflects the ability of land note holders to purchase mortgages at the same price as was paid for them by the land bank which is the key link between the two money markets.

22 Had a land bank been established on the first mode then its notes would have risen in value (against goods generally) just as the value of land had done.

23 Murphy (1997, 199, 215-216) suggests that Law wished to “force the interest rate down to the magic figure of two percent”. Law’s share price target for the Company of the Indies seems to be compatible with a two percent target. See also Velde (2007), Berdell (2010) and Bentemessek (2012).

24 See Locke’s 1691 Considerations on the consequences of lowering interest (Locke, 1824). Locke’s notion that deviations of the legal interest rate away from the natural interest rate could generate serious political strife between the landed and moneyed men is examined by Céline Bouillot (2016) in some detail.

25 See Berdell (2010) for the suggestion that Law’s system foreshadows aspects of twentieth century economic populism.

26 In the Essay the rate of interest in London provides a clear benchmark which allows us (in my view) to use covered interest rate parity to explain the stability of the new paper notes against the pound sterling. In Money and Trade this is replaced by a far less clear reference to the “ordinary” interest rate:

To authorize the Commission to lend Notes on Land Security, the Debt not exceeding one half, or two Thirds of the Value: And at the ordinary Interest.

Ordinary interest is a bit vague consequently the mechanism by which land notes are to maintain parity with silver money is not as clearly articulated as it is in the Essay. Nor does Law examine how noteholder or his bank would be affected by a change in the London interest rate.

27 There are three ways humbly offered to the parliament, for giving out these notes: they in their wisdom may determine which will be most safe (Law, [1705] 1750, 159-160):

- To authorize the commission to lend notes on land security, the debt not exceeding one half, or two thirds of the value: and at the ordinary interest.

- To give out the full price of land, as it is valued, 20 years purchase more or less, according to what it would have given in silver-money, the commission entering into possession of such lands, by wadset granted to the commission or assignees; and redeemable betwixt and the expiring of a term of years.

- To give the full price of land, upon sale made of such lands, and disponed to the commission or assignees irredeemably.

28 Banks in Law’s day generally lent on commercial bills and at very short terms (with the exception of loans to the state), so they avoided building up the large maturity mismatches that we have since come to associate with banking (Goodhart and Perotti, 2015). Law’s proposed land banks were transferred what could have been a maturity mismatch risk for the bank to the note holders. Sudden changes in interest rates would of course affect the value of the bank’s very long term assets, but this is passed on to the note holders. In a panic the land bank did not have to seek liquidity from other entities, such as a central bank, as it was only required to exchange land notes for the assets on its books, and at a predetermined price. But these factors could considerably dampen the public’s desire to hold the notes, a problem Law never clearly brings to his reader’s attention.

29 Conversely the System lacked any and all of the Essay’s limiting mechanisms. Oversight was impossible as Law’s System fused his company with the state and he served as both central banker and minister of finance.

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John Berdell, « The Structure and Stability of John Law’s Early Land Bank Proposals », Œconomia, 7-4 | 2017, 459-479.

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John Berdell, « The Structure and Stability of John Law’s Early Land Bank Proposals », Œconomia [En ligne], 7-4 | 2017, mis en ligne le 01 décembre 2017, consulté le 20 septembre 2018. URL : http://journals.openedition.org/oeconomia/2622 ; DOI : 10.4000/oeconomia.2622

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John Berdell

Department of Economics, DePaul University Chicago. jberdell@depaul.edu

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