During the early 1700s Britain was involved in a series of wars with Spain better known as the War of Spanish Succession (1701–1713). Wars are expensive, and the British government fell into an enormous debt because of the wars. Robert Haley and John Blunt came up with an idea to relieve all the debt that was being incurred by the wars, that idea was the South Sea Company.
South Sea refers to South America and the surrounding lands in the nearby water. The South Sea company was a company whose primary purpose was funding the British government debt. The company agreed to assume 10 million pounds in government debt in exchange for exclusive trading rights with Spanish colonies, AKA South America. Now lets just overlook the fact that Britain was currently at war with Spain, but hey excellent business move by the British government right? In return for assuming the debt, beyond the trade route, the government gave South Sea company shareholders a continual annuity of 576,534 pounds a year or a perpetual loan of 10 million pounds at a 6% yield. The deal resulted in a steady stream of earnings for new shareholders. The British government intended to fund the interest payments by placing tariffs on goods that were imported from South America.
When the war with Spain was finally over in 1713, the details of the South Sea Company trading rights were finally finalized. South Sea was given the right to supply the Spanish colonies with slaves and to send one trading ship per year. The trading rights were a disappointment to Robert Haley, who expected way more ships and materials to trade than they gave him. He was cool with the slave trading though, given it was the 1700s.
By 1717, the South Sea company had assumed an additional 2 million pounds of the British government debt. In 1719 the South Sea company made a proposal to purchase over half of the British government debt with new shares, alongside a promise to the government that the interest rate on the debt would be reduced to 5% until 1727 and 4% for every year after that. This refinancing scheme allowed illiquid high interest debt to be converted into highly liquid low interest debt.
Though the South Sea company actual trading rights were modest, they were very good at marketing to investors. The executives sold exotic tales of gold and silver just flowing in the rivers in South America and just waited to be imported to Europe. The stories sparked a speculative frenzy for the company’s shares in 1720. The stock prices rose from 128 in January, to 175 in February, 330 in March and 550 in May. The company could support its high valuation thanks to a 70 million pound fund of credit that was granted by the King and Parliament for commercial expansion.
They offered shares to various politicians at market price. Those slick politicians didn’t purchase the shares conventionally, they held on to their shares with the option to sell them back to the South Sea Company at a later date. Any profit made would be kept by the politician. This purchasing arrangement enticed many government employees to invest. High profile share holders helped to pump up the value of South Sea Company shares and also added legitimacy to the scheme.
As South Sea Company share prices kept rising, other copy cat companies entered the market to take advantage of the booming demand for speculative investments. Many of these companies sold or peddled the most outrageous and fake claims.
List of what these companies promised to sell or supply:
1. A company for trading hair
2. A company for improving the art of making soap
3. A company for insuring and changing children’s fortune
4. A company for a wheel of perpetual motion
5. A company for importing Walnut trees from Virginia
6. A company for making Rape-oil
7. A company that transmuted quicksilver into a fine metal
8. A company for carrying on an undertaking of significant advantage; but nobody to know what it is (I did not make this up).
Essentially modern day Silicon Valley! Everybody was selling, or upgrading, a task that people didn’t realize needed upgrading. In the case of the last company there were selling fake dreams, sort of like an old school Theranos. These speculative companies were nick named “bubbles.” Parliament was so worried about these bubbles that they passed an act known as the Bubble act in 1720. Ironically, the passing of the Bubble act caused South Sea shares to soar to 820 in June 1720. A full-blown speculative stock frenzy had developed in all bubble company shares. All classes of British society took to investing in the bubble companies. People were going from rags to riches overnight as shares soared to astronomical heights.
Though the South Sea Company shares were skyrocketing, the company’s profitability was mediocre. If you listened to the company’s directors, future growth was just down the road! The company wanted people to invest and get in before the theoretical ship took off. Those flowing rivers of gold and silver were never found unbeknown to investors. Shares rose to 1000 per share in August 1720. With the market being so hot, John Blunt concocted a scheme to boost share prices even more. Under the plan, South Sea would lend investors’ money to buy its shares. This meant that many shareholders had to sell their shares to cover the plans first installment payment.
The bubble burst in September 1720. Speculators who purchased shares on credit went bankrupt immediately. The popping of the South Sea bubble set off a motion that popped similar bubbles in Amsterdam( Tulip Mania) and in France. South Sea shares hit 150 in September 1720. Banks and goldsmiths went bankrupt because they could not collect loans they had made to recently bankrupt common folk and aristocrats alike. Sir Isaac Newton even lost 20,000 in pounds (equivalent to 268 million in present day value) in South Sea Company shares. Isaac remarked, “ I can calculate the movement of the stars, but not the madness of men.”
Investor outrage sparked a Parliamentarian investigation into the matter in December 1720. The report revealed extensive fraud with the cabinet and current Parliament members. Several politicians were disgraced and people found to have profited immorally from the company had personal assets confiscated proportionate to their gains. The company was restructured and continued to operate for more than a century after the bubble.
Although this bubble happened 300 years ago, generations of British populations are still paying down this debt. Even today, a portion of the tax collected is used to pay off this debt.
Bubbles are not a novel concept. They happened in the 1700s and are still happening as recently as 2008 with the housing/mortgage bubble. Bubbles will happen in the future too because the one constant theme throughout these historical bubbles is greed. As long as there is greed in the world bubbles will occur. Humans don’t know how to be satisfied, and the constant want for more increases greed. Even with all the bad fallout and damages from bubbles, they will continue occurring.
Originally published at https://mwmblog.com on May 11, 2020.