Until recently, the online game "Second Life" allowed anyone to start his own virtual bank and issue his own money via "pretend ATMs." To attract depositors, who exchange real-life money for virtual money, these banks offered exorbitant interest ratesup to 30 percent a year. Some of the banks ran into trouble after speculating on virtual land and other risky bets, their customers panicked and withdrew their money. Banks failed, and the game's managers announced new regulations to protect the "integrity of our economy."
It's amazingthough perhaps inevitablethat an old-fashioned financial panic could occur in a made-up world. "Second Life" is like a brand-new entrepreneurial economy without the legal and regulatory checks and balances, honed over two centuries, which protect the integrity of our real entrepreneurial economy.
For a vivid historical example of an unfettered economy in its infancy, pick up "The Exchange Artist," Brandeis history professor Jane Kamensky's absorbing tale of one man who, like the Second Life bankers, transformed outlandish promises into a fleeting illusion of success and then, finally, ignominious failure.
Speculator Andrew Dexter had an audacious idea in the first decade of the 19th century: to build the biggest building in Boston. The Exchange Coffee House would give Boston what European cities already had: an opulent indoor arena to conduct financial transactions so that traders wouldn't have to huddle outside. The domed seven-story building would also serve as a fancy hotel and convention center of sorts.
Dexter told himself the fanciful numbers behind the fanciful building would workand back then, that was enough. For the most part, Dexter's investors had no idea they were putting their hard-earned cash into such a speculative venture.
Dexter could gull the public because in post-colonial America, no bank regulator watched over our money. Indeed, there was no proper American money; state-chartered banks printed their own currency. Sometimes, they backed it by adequate coin; often, they didn't, by accident or design.
Dexter quickly learned to game this system, convincing several banks to print and sign hundreds of thousands of dollars of paper money that he could cart to Boston to pay for his building. The further away the bank from Boston, the better, from Dexter's perspective, as he knew it wouldn't be worth their while for the ultimate recipients of the paper money to bring it all the way back to, say, Detroit and exchange it for coin. "I'll sign [money] as fast as I can," one clerk promised his increasingly desperate boss. "I believe I can finish 50,000 a week."
Masons, painters and quarry owners were paid in dollars Dexter printed. They used that money to pay other people, spreading the eventually worthless money around Boston and the nation.
Dexter's run ended as all such runs do. Critics publicly raised questions about the value of "Dexter dollars," meaning Dexter had to issue more such dollars to buy the same amount of goods and services: the machine, after cycling faster, screeched to a halt. When one of Dexter's banks became the first in the nation to fail, investigators determined it had issued nearly $1 million backed by less than $100 in real currency.
Dexter's plan did hold out long enough for his building to get built, but as he fled the country, some of his creditors became the new owners of the Exchange Coffee House. They discovered quickly that traders and brokers preferred to work on the street and that the building was so eclectically designed that it was impossible for visitors to know which entrance was the main one.
Eventually, Bostonians made their peace with the Exchange building: by 1818, a decade after it was built, the tower's hotel and meeting rooms were, if not full, at least not empty, helped along by economic recovery after the War of 1812. Fate cut short any long-term assessment of the building, though: an uncontrollable fire cut off the Exchange's support structures and in November 1818 the building collapsed into rubble. Today, vastly improved knowledge, regulation and technology make both spectacular building failures as well as spectacular financial failures less likely. But Kamensky's book is doubly compelling because less likely doesn't mean never.
The Exchange Artist: A Tale of High-Flying Speculation and America's First Banking Collapse
by Jane Kamensky
Original Source: http://www.nypost.com/seven/01272008/postopinion/postopbooks/putting_the_con_in_colonial_619569.htm