Author: Zikongli
Reviewer: Guanfu · Juntian

  The previous installment, “Financial Crises (IV): Britain’s South Sea Bubble,” explained how the South Sea Company acquired a monopoly on trade with the South Seas—that is, South America—by taking on government debt. Numerous publications of the day advertised South America’s abundant produce and deposits of precious metals. Spain had already developed many silver and gold mines there, so the public had little reason to doubt these claims. Buoyed by rosy expectations for the company’s future, its shares held a remarkably steady market value.

  In reality, however, the precious-metal deposits described in those pamphlets lay chiefly within Spanish colonies, and Spain was hardly going to hand that wealth to the British for free. For many years after the South Sea Company was founded, trade with the region generated little revenue and remained unprofitable. To keep paying dividends and stay in business, the company had only two options: assume still more government debt and collect the annual interest, or issue more shares. This situation directly gave rise to the “South Sea Scheme” of 1720.

  Until then, the South Sea Company had still been a fairly conventional enterprise that exchanged the assumption of government debt for trading privileges. By the end of 1719, however, the government had another £31 million in debt awaiting repayment. The company saw an extraordinary opportunity: taking on this enormous sum would bring in more government interest each year while also providing a pretext to issue more shares and drive up their price.

  To secure this vast debt-conversion project, the South Sea Company embarked on a wide-ranging campaign of bribery. Negotiations were led by company director John Blunt on one side and Chancellor of the Exchequer John Aislabie on the other. To ensure that the company won the contract, Blunt openly promised immense fortunes to Aislabie and other political figures. Aislabie and his allies in government then became forceful political sponsors of the scheme. On January 21, 1720, the South Sea Company agreed to pay the government as much as £3.1 million for the right to convert the national debt. Parliament insisted that other companies be allowed to compete, so the Bank of England submitted its own proposal. To outbid the bank, Blunt raised the company’s total offer to £7,567,500 on January 28. The government accepted it that same day, and South Sea shares immediately rose from £129 to £160. (The British South Sea Financial Crisis and Its Political-Economic Causes)

  Why did the South Sea Company value this mountain of debt so highly, and why did its share price rise? By this point the company could no longer profit from South Sea trade; its only income was the annual interest paid by the government. The more government debt it held, the more interest it would receive each year. Because it converted that debt into company shares, its share capital would also expand enormously once the government repaid the debt within the agreed period. To the market, the company appeared to combine a stable expected income—government interest—with privileged access to South Sea trade. A higher future share price seemed almost inevitable, and the public’s optimism itself helped push the price upward.

  After acquiring this enormous debt, the South Sea Company began preparing a new share issue, for which it chose not to impose an upper limit on the share price. Parliament resisted. Opponents led by Robert Walpole considered an uncapped price extremely dangerous and firmly opposed the South Sea Scheme. Blunt and his associates also knew how much risk the plan concealed and that the bill might not pass, so the company began bribing senior figures on a broad scale. The effort plainly worked: on April 2, the bill passed by 172 votes to 55. With the support of both government and Parliament, South Sea shares immediately climbed to £400. Yet although the new issue drove up the price, the company had no underlying value capable of sustaining it.

  Between April and August 1720, the South Sea Company conducted four cash subscriptions and two debt-for-equity subscriptions. The first cash subscription opened on April 14. The company planned to issue £2 million in shares with a nominal value of £100 each, but the actual issue price was £300 per share. The offer was extraordinarily successful: subscriptions opened at 9:00 a.m., and £1 million worth of shares were taken up within an hour. King George I was among the investors. To stimulate demand, the directors announced a 10% dividend for both old and new shares and offered purchasers £500,000 in loans. The announcement immediately lifted the share price to £340. Seizing the moment, the company launched its second cash subscription on April 29, initially for £1 million and later increased to £1.5 million, at a price of £400 per share.

  South Sea shares rose through most of May and surged to £890 on June 2. The third cash subscription began on June 17, offering a total of £5 million in new shares at £1,000 for each £100 of nominal value. Investors were fervent. Anderson recalled: “The crowd surged into South Sea House, loudly demanding another subscription and even shouting out a price of one thousand pounds per share.” Before the fourth cash subscription, the company also opened two subscriptions that converted government debt into shares. The price kept climbing, and successful completion of the debt conversion seemed close at hand. (The British South Sea Financial Crisis and Its Political-Economic Causes)

  The repeated share issues created a funding model much like a Ponzi scheme. The company raised money from newly issued shares to pay dividends to existing shareholders, while new shareholders could do little but wait for the next issue or sell their holdings to someone else.

  Before the South Sea Scheme, the share price had remained fairly stable. In the single year of 1720, however, it multiplied several times over. The phenomenon was not unique: speculative fever had gripped all of Europe, and France’s Mississippi Bubble was then at its height. Inspired by the South Sea Company, numerous illicit speculative ventures also appeared in London.

  Those economic conditions supplied the broad backdrop to the South Sea mania and gave the soaring price considerable momentum, but they were far from the whole story. The company’s financial methods—or, more accurately, its financial fraud—played a more direct role in driving up the shares. That fraud was a major cause of the bubble; without it, the price could never have climbed so high.

  Subscription payments, for example, could be made in installments rather than all at once; investors received loans with which to buy shares; and even after four subscriptions, subscribers still had no receipts. These practices dramatically lowered the barrier to buying shares. At the same time, the company propelled the price upward by restricting the number of shares circulating on the secondary market and promising high dividends.

  The fourth cash subscription began on August 24, 1720. Shares with a nominal value of £100 were issued at £1,000, with a £200 down payment. At first there was no hint of danger. Anderson wrote: “The subscription was still crowded and was completed within three hours. By that evening, the selling price had risen by 40%.” The rise did not last. Shares that sold for £1,000 on August 26 fell to £820 within days. The directors tried to stabilize the price, again sending brokers to buy shares and later announcing a dividend. Nothing reversed the slide. On September 9 the quoted price was £550: the bubble had burst. (The British South Sea Financial Crisis and Its Political-Economic Causes)

  Two factors dominated the collapse: a shortage of liquidity and the enactment of the Bubble Act. Although the four share issues had raised a great deal of money, the company lent most of it back to the market to finance purchases that would lift its own share price. When the price later plunged, it had nowhere near enough cash to support a recovery. The Bubble Act was an even clearer case of the company engineering its own downfall. As noted earlier, the South Sea and Mississippi companies had inspired a proliferation of stock-market bubbles in London. Hoping to concentrate the market’s funds in its own shares, the South Sea Company pressed Parliament to pass the Bubble Act and curb the promotion of rival shares.

  The measure dealt a severe blow to speculative enthusiasm. At the same time, France’s Mississippi Bubble collapsed. Investors began to question the price of South Sea shares, and insiders rushed to sell their holdings. In a remarkably short time, the stock went from an object of frantic demand to virtually worthless.

  The collapse struck the British economy hard. Countless people who had failed to withdraw their money in time saw their wealth vanish with the share price. Many institutions connected to the South Sea Company were caught in the fallout, and the shares of companies such as the East India Company and the Bank of England also fell. The government’s credibility came under fierce attack as numerous officials linked to the company were exposed as bribe takers; some people even called for George I to abdicate.

  The bubble also cemented the Bank of England’s unique position. After the crash, the bank took responsibility for resolving the crisis, acting as lender of last resort to the South Sea Company and preventing the damage from spreading further. Even so, Britain, like France, took nearly a century to emerge from the shadow of the disaster.

  The South Sea Bubble ravaged every stratum of British society. Even the physicist and Master of the Mint Isaac Newton invested heavily. After making a modest profit and then suffering a much larger loss, he reportedly lamented: “I can calculate the motions of heavenly bodies, but not the madness of people.” (The Story of the South Sea Bubble)

References

  • Source: Xu Bin, “The British South Sea Financial Crisis and Its Political-Economic Causes,” Historical Review, January 2012.
  • Fei Xue, “The Story of the South Sea Bubble,” China Business Journal, March 23, 2015.