The Ascent of Money: Episode Three

The rise of the stock market last night.

The price of a company's shares inform people how much it is worth.

Stock markets, however, and rise or fall due to the irrational behaviour of humans. Every so often, there is a stock market bubble.

John Law:

John Law once owned a quarter of the United States, but lost it all in the first stockmarket crash.

Born in Edinburgh in 1671, he killed a man in a London duel and was sentenced to death.

Law escaped from prison and fled to Amsterdam. The Dutch had introduced a national lottery to finance a war with Spain, the national bank and the company.

East India enterprises were set up to manage the Asian spice trade, as merchants had to pool resources due to the risk involved in the voyages. The government ordered the enterprises to form the Dutch East India Company.

Anyone who put money into the company received an "action", one of the first shares. Shares had to be sold to another investor, creating the first stock market.

Professor Niall Ferguson explained how the company had a private army to keep English and Spanish warships at bay.

Key to its success was its ability to reduce transaction cost and obtain information quickly. It was a networked company and established a virtual monopoly.

The company paid a 16.5% dividend.

Law felt the Dutch financial system needed to increase the number of shares and issue banknotes to the public.

He arrived in Paris in 1716, where the country was facing its third bankruptcy in a hundred years.

His aim was to establish a bank with paper money and to establish a "Company of the West", a monopoly trading company.

He explained his plans to the Duc D'Orleans. The French laid claim to Louisiana and the French were encouraged to buy shares in the company.

The Mississippi company's share price soared, creating many millionaires including John Law.

In charge of all indirect taxes, overseas trade, all France's mints and the French national debt, the Louisiana colony, Law was extremely powerful.

However, Law did not know when to stop. His scheme needed more money from shares in order to pay people, an example of a "Ponzi scheme".

The Mississippi Bubble was generated, with the city of New Orleans created and named after the then French regent.

The share price began to slide. The bubble burst, many people tried to sell their shares, and Law fled France.

He spent the rest of his life in Venice and died in 1729.

The first stockmarket bubble was not the largest.

The Wall Street Crash of 1929 saw the American stockmarket decline 86%.

Crashes happen due to herd psychology.

A bull market can see "irrational exuberance" as Alan Greenspan terms it. And when bull markets turn into bear markets, people are again carried by the herd.

Next week: hedge funds