The South Sea Bubble
England's Financial Panic of 1720
There are financial panics that are forgotten in a generation and there are depressions that are remembered for centuries. It is too early to tell which kind the current mortgage and credit crisis will be. Maybe it will be a small hiccup but if things continue to get worse it could be remembered for as long as England's South Sea Bubble of the early 1700s.
The South Sea Company and British War Debt
The story of the South Sea Bubble is told in Charles MacKay's 1841 masterpiece Extraordinary Popular Delusions and the Madness of Crowds. The South Sea Company, who was most responsible for the bubble, was founded in 1711 for the purpose of assuming Britain's debt, which had built up during the War of the Spanish Succession (1701-1714). In return, the company received six percent interest on the debt as well as a monopoly on trade with the wealthy Spanish Colonies in South America. Wild visions of trading English wool for Inca gold danced in the heads of South Sea Company investors.
As the Harvard Business School's history of the bubble shows, the use of that monopoly was dependent on Spain's willingness to trade with England after the war. The Treaty of Utrecht, which ended the war, left Spain with full authority to regulate trade with its colonies. Spain only allowed the South Sea Company to send one ship per year to trade in South America, and that ship would have to give a quarter of its profits to the King of Spain.
1720 - Year of the Bubble
Despite this, people couldn't wait to invest in the company. The idea of a trade monopoly proved irresistible to a growing middle class with money to invest. In 1720, Parliament approved a plan to let the South Sea Company take on more of the national debt. Confidence in the company was high and stocks, which had been trading at £130 began a fast climb. As Jonathan Swift wrote of South Sea Company investors, "Here they fish for gold, and drown."
Encouraged by promises of huge profits from company officers, investors drove the stock price to £400 by April and it continued to climb. In late May the price of stock rose from £550 to £890. In August, the price touched £1000, but confidence in the company was beginning to crumble. A rumor circulated that company directors were selling their stock and pocketing the profits. The term "bubble" came into use for the first time. By the end of September, the stock was worth no more than it had been at the beginning of the frenzy and many investors were ruined.
Punishment of the South Sea Officers
MacKay reports that the thoughts of the British populace quickly turned to punishment for those responsible. As always, no investors wanted to blame their own greed and blindness. The directors of the South Sea Company took the brunt of the public fury. One member of Parliament, Lord Molesworth, was concerned that the company had not broken any existing laws, so he proposed passing a law with a retroactive punishment. Those found guilty of bringing the nation to financial ruin would be sewn into sacks with snakes and thrown in to the Thames to drown.
The public didn't get the bloodbath it wanted, although Londoners celebrated with bonfires and dancing when financial penalties were assessed against high-ranking company officials who secretly sold shares at a huge profit. Although some of the South Sea Companies profits were returned to shareholders as dividend, most investors suffered great financial hardship. It was many years before the British economy was fully sound again. Hopefully today's American economy can make a faster recovery.
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