If you open Wikipedia on John Law page you can read the following:
"...Law proposed to stimulate industry by replacing gold with paper credit and then increasing the supply of credit, and to reduce the national debt by replacing it with shares in economic ventures. Though they failed, his theories ironically live on 300 years later and "captured many key conceptual points which are very much a part of modern monetary theorizing"...
Today almost all central banks of the developed countries operate on the principles formulated by John Law. But as we remember, Law's experiment caused one of the biggest financial catastrophes in history. So will the result today be different?
I don't think so. History is repeating itself, and again, the first to follow John Law's fate will be Europe.
This week the European Central Bank (ECB) decided to lower the interest rates, although the inflation situation requires exactly the opposite. Actual inflation in EU is already in the double-digit numbers, but even officially reported inflation is above the 2% ceiling that requires action from ECB.
Instead of raising the interest rates and selling government bonds to withdraw money from the market, Mario Draghi decided to lower the rates. Some European politicians encouraged expectations that more bonds will be bought by the bank. As a matter of fact, the ECB is now not a guardian of the Euro, but a guardian of bankrupted EU governments that are so deeply indebted that they cannot repay their loans.
But isn't this exactly the path John Law chose? He created a fiat currency not backed by gold, and when the bonds market neared collapse, he printed more money to avert the crash. The result was a complete crash of everything - bonds, money and Mr Law himself.
The big mistake made by Law was the idea that money supply can be a tool for repairing other problems. I.e. when we have a debt crisis, we can resolve it by printing more money. However the result of this is not recovery of the bonds market but infecting money itself. Using money supply to heal the bonds leads to an infection of money.
That is exactly what the ECB is doing now (the same goes for FED, BoJ, BoE and other major central banks, but EU is leading the run towards the crash). Using money supply is the easy decision that lowers the interest rates and frees the governments of their obligation to spend only the money they collect as tax-income. This way they can continue to spend more, earning more time for the convenient system of debt-financing.
The main weakness of John Law's Central Bank system is the risk that the bank is subordinated to non-money stability priorities and thus sacrifice money itself.
All indebted governments in EU now say one and the same: "Spending cuts are very painful and impossible to pass. People are crying. We cannot punish our own citizens... Something different must be done..."
And after these words all eyes are directed towards the ECB that can resolve all problems with a finger snap or at least provide some more time. But such decision does not exist. It is an illusion - just like the illusion that was John Law's system.
Money is not magic. Money is just a tool of market exchange. When we transform money into magic and start making charms, the only possible outcome is destruction of money.
Inflation is not a solution. It is a problem. When we devalue the currency and repay the debt with money that is losing more and more of its value, we are erasing not only the debt. We are erasing also the wealth. Yes, if the Euro is devalued 2 or 3 times, the debt of Spain and Italy will become 2-3 times lower. But along with this the wealth of Spain and Italy will go down. If we compare one and the other, we will see the simple fact that the loss will be much bigger than the benefit. Therefore, the right decision is to use part of the wealth to repay the loans, instead of devaluing everything altogether.
But where is the problem with John Law's system? It is in the fact that the government is a debtor and money-issuer at the same time. And when devaluing the money the government looks only at its benefit of erasing debts, and not at the losses for society where wealth is eradicated.
Such manipulation would not be possible if money issuing was out of government control.
After every paper-money crash people are returning to gold and silver as real money that is independent from politics. This is just exactly what happened after firing John Law from French finances in 1720...
July 14th 2012