The South Sea Bubble
The New Economy in the 18thCentury
For Jonathan Swift the best of men was he who made two blades of grass grow where one had grown before. Swift's friend John Blunt had a different ideal: the man who could take one pound sterling out of his pocket and turn it into two or ten or a hundred, without any physical exertion.
The way to do it, as he proved in spectacular practice, was a new-fangled device called the joint-stock company, which nowadays we call a corporation.
As a matter of fact, there had been joint-stock companies in England since the middle of the sixteenth century. Queen Elizabeth herself had thriftily invested in a stock company that financed the piratical attacks on Spanish commerce by Sir Francis Drake, netting the Crown a profit of 150 percent.
Such companies, however, involved only a fairly small number of rich and powerful people. But at the turn of the 17th century a newer and now more familiar form came into being, one in which large numbers of small investors subscribed, as they do today, in the hope of providing a steady income from cash dividends and capital gains.
Investors began to see money-making in a new light. A piece of paper - a share or a bond, they discovered, could be as profitable as holdings in land, and far less cumbersome to administer. Furthermore, while land was taxed, profits from paper securities were not.
The moment was propitious. England, which had been winning wars against its commercial rivals all through the century, was bursting with capital looking for a place to be invested. London's merchants, who by then numbered several thousand, were shrewd hard-headed men, but they also displayed some of the innocent enthusiasm of clever children discovering a new toy.
The men who wound up the toy were called stockjobbers, or, as we now call them, brokers. In those days there were no Merrill Lynches or Paine Webbers with their legions of analysts and consultants in skyscrapers full of offices, just individuals with fast minds, and even faster tongues, who did their business in the narrow passageways forming what was called Exchange, or 'Change, Alley at the corner of Lombard Street and Cornhill. They met customers and toted up their accounts at tables in coffeehouses like Jonathan's or Garroway's. Like innovators everywhere, they sometimes aroused distrust and dislike. Daniel Defoe spoke of them as people who "can wheedle men to ruin themselves and fiddle them out of their money, by the strange unheard-of Engines of Interest, Discounts, Transfers, Tallies, Debentures, Shares, Projects."
The old aristocracy, the landed gentry that had ruled England for centuries, affected to look down their noble noses at this new breed of upstarts, but wealth and strength were passing into the hands of the new men. It was such men who in 1710 found the South Sea Company, greatest of all joint-stock enterprises; men like John Blunt, the son of a shoemaker; Edward Gibbon, a linen-draper whose grandson would become a famous historian; Robert Chester, a goldsmith; James Craggs, a barber and footman who would work his way up to be Joint Postmaster General, a position that allowed him to open people's mail and get valuable advance information about their business plans. When these men offered John Aislabie, Chancellor of the Exchequer, a chance to make 35,557 pounds 10 shillings profit on a fictitious sale of South Sea stock, he did not hesitate to dip his hands into the plebeian till.
He was not alone. The royal family, the "royal ladies" (the King's two mistresses, the thin Duchess of Kendall and the fat Countess von Platen), members of the House of Lords and members of the House of Commons all accepted substantial, and quite illegal, favors from the directors of the South Sea Company. People from all over England, country squires, bishops, literary people, theatrical people, ordinary people, all joined in the rush for profits. It was the first of the great speculative booms which have been such conspicuous features of economic life ever since.
The original idea for what became known as the South Sea Bubble has been ascribed to Defoe, but it appears in fact to have come from the fertile brain of John Paterson, a talented Scot who had migrated to London like so many of his penniless countrymen. Paterson was by no means an impractical fool; one of his brainchildren was the Bank of England. But his whole capital, says the historian Macaulay, "consisted in an inventive brain and a persuasive tongue," and he used them both steadily without much regard for the possible consequences. In 1695 he talked Scotland's Parliament in Edinburgh into approving, and 1400 innocent Scotsmen into investing in, a scheme to found a colony in Darien, the Isthmus of Panama, in order to exploit what were thought to be the fantastically lucrative possibilities of trade in that region. No one in Scotland seemed to care that Darien already belonged to the King of Spain, who had not intention of giving away all those possibilities without a fight. In 1698 and 1699 two expeditions actually sailed from Scotland with several thousand eager would-be settlers, almost all of whom either died quickly of fever or ended their days slaving as indenture servants in the sugarcane fields of the West Indies.
Despite this disaster, in 1710, Paterson was still inventing, still persuading. This time he came up with a scheme for a company that would monopolize trade with the South Seas, that is to say, the coasts of the Spanish possessions in South America. That England was currently at war with the King of Spain was no matter. The long War of the Spanish Succession which had been drenching Europe in blood for more than two decades was finally winding down, and Robert Harley, Earl of Oxford, who was secretly beginning peace negotiations, thought this was a wonderful opportunity to wring some trade concession from the Spaniards.
Enter John Blunt, by profession a scrivener, a man who copied out in beautiful script the contracts and the legal documents that had to accompany all business transactions. He also acquired full knowledge of the little details, the fine print in the documents, and he learned how to put this knowledge to good use, as subscribers to South Sea stock would later learn at their own expense.
There was no law prohibiting the use of such privileged knowledge for personal gain in what is known today as insider trading. Eighteenth Century English did not even have a word for it, and there would have been no opprobrium attached to it if it existed. It was only natural for man who had a privilege to use it for his own advantage, that was what a privilege was for. Robert Walpole, the master politician who shaped the parliamentary system as we know it, once said that there was "nothing more reasonable and just" than using his official position to do favors for relatives and friends. And he expected the relatives and friends to do favors for him when the opportunity arose.
Until 1757 there was no law. either, against obtaining money under false pretenses. In 1703, when a case came to court about a man who had acquired some money by masquerading as a creditor's agent, Lord Chief Justice Holt put the question to the jury with all the hard hammering common sense of Old England: "Shall we indict a man for making a fool of another?"
John Blunt would have known how to answer that question. He had begun his career by leaping into the shifting world of the new joint-stock companies, where the supply of fools seemed to be unlimited. People had money which was burning holes in their pockets, and there were so many projects for them to put their cash in that it didn't seem to make any difference what was offered. It might be a project like James Puckle's machine-gun which would fire either round or square bullets depending of whether their target was a Christian or a Turk. There was a project for a mechanical piano. There was a project for a typewriter. There was Sir Richard Steele's project for a portable aquarium which would bring fresh fish to London markets. "I can measure the motions of bodies," said Sir Isaac Newton, "but I cannot measure human folly." He himself would lose twenty thousand pounds dabbling in South Sea stock.
The South Sea scheme offered Blunt and his colleagues a chance to borrow and lend money, more or less like a bank, with full government backing. The necessary papers were quickly drawn up. But before actually opening its doors, the South Sea Company had to receive the authorization of Parliament, and there was strong opposition from the established powers, notably the Bank of England.
Blunt figured out that an irresistible bait for the solid country squires who formed the backbone of the House of Commons. Next to the Church of Rome, what they most hated was the national debt, which had mounted to millions of pounds to pay for King William's and Queen Anne's wars against the archenemy Spain. The growing debt meant ever-growing taxes. Now here came Blunt and his South Sea Company offering to take over huge chunks of the national debt. People who had government obligations - debentures, bonds, annuities - would be able to exchange them at par for shares of stock in the South Sea Company. They might be giving up the security of a fixed income, but they would be getting he prospect of unlimited dividends coming from the unlimited profits of trade with land running over with gold and silver and uncounted inhabitants who all had a voracious appetite for such typical products of English commerce as woolens, sealing wax, clocks, Cheshire cheese, and African slaves.
It was too good an opportunity to pass up. In May 1711, Parliament authorized the sale of South Sea Company stock, and the public scrambled to invest 9,411,325 pounds in it, buying up the entire offering.
The only defect in this scheme was that there was not a penny of profits in the company's till, and no prospect of getting any in the foreseeable future.
None of the directors of the South Sea Company had ever been to the South Sea. And none of them could have had any idea of how much, if any, money was ti be made there. Trade with his New World colonies was almost the only valuable resource left to the King of Spain after the disasters of the war, and being a vigorous young man, and a Frenchman to boot (he was a grandson of Louis XIV), it was hard to imagine him being bribed or bullied into giving it away to a gang of rapacious Englishmen.
The truth was the company directors never really took the trade with South America seriously. After the Treaty of Utrecht brought peace to Europe in 1713, the company did spasmodically attempt to take advantage of some of the Treaty's provisions. It tried to bargain for the right to ship 4800 African slaves and 500 tons of cargo a year to the Spanish colonies. They toyed with the idea of importing jackasses from Spain, and they actually fitted out some ships for whaling in Greenland waters. None of this turned out to be profitable. The Company blamed the sullen opposition of Spanish bureaucrats, though it might equally have blamed the dishonesty of its agents, and its own inefficiency. In any case, the directors had little time to waste on trade in material objects. What they wanted was a company which could issue vast amounts of stock to be manipulated as they saw fit. For ten years, in that field, they proved to be masters.
Financial skulduggery as we know it today was then in relative infancy, so Blunt had to improvise as he went along. Realizing that to keep things going a steady flow of money was necessary, he worked out an efficient pumping system. Because he had government approval, he would periodically float a new loan at favorable interest rates, then promptly put out a new issue of stock under attractive terms that would lure the cash right back in. He invented margin trading by allowing purchases on the installment plan, with only 10 percent down. He made sure that most of these transactions were on paper. When cash did turn up, it generally went quickly into the pockets of the directors or their well-placed friends.
Such friends were needed because it was good publicity to have dukes, duchesses, bishops and famous actresses ostentatiously showing confidence in the Company by buying its shares and because their support was vital for getting favorable legislation passed in Parliament. Robert Knight, the Company cashier, kept a green book in which he marked the transactions by which a good portion of the ruling class of England was made part of the South Seas speculation. Depending on their importance, they would be issued more- or less-sizeable block of shares, for which they would not have to pay a penny When the stock went up, as it always seemed to do, it could be quickly sold to the clamoring public
In a fast-moving market the profits could be enormous James Stanhope, Secretary of the Treasury, one day collected 249,530 pounds, representing the difference between market value and the 50,000 pounds registered as his purchase price a few months before. Parliamentary investigators later tracked down some 574,500 pounds in out-and-out bribes, which Robert Knight slipped into the company books disguised as sales and loans "to sundry." As much as one third of that 'sundry" may well have gone to King George I and his son the Prince of Wales. They detested each other, but under the wings of South Sea Company they could come peacefully together. The Company directors always prided themselves on being strictly neutral in politics.
As long as most of its operations were on paper, and as long as Blunt's pumping machine could keep the paper in motion, the South Sea Company had nothing to worry about. Some money, though, inevitably slipped away when investors chose to cash in their profits. "Mrs. Barbier, a famous singer at the New Play House," said a 1720 press item, "having gained about eight thousand pounds in South Sea stock, has sung her last Farewell to the Stage." Such press items of course attracted more investors, who might put their winnings into gilded coaches or country estates, although they were all too often tempted to mortgage their new property and put money back into 'Change Alley.
A more serious threat came from across the Channel. John Law, the most brilliant financier of his age, could not come back to England because he was under sentence of death for murder, having killed a man in a duel back in 1695. In exile in Paris, he devised a plan for stirring up the sluggish French economy and dragging the richest nation of Europe into the modern world. By 1719 he seemed in sight of his goal. He had talked his way into taking over the whole national financial system.
The heart of Law's scheme was his Mississippi Company, formed to exploit the resources of France's North American colony. Unlike the South Sea Company's plan, Law's had a basis in reality, for the colony consisted of the entire Mississippi Valley, with a potential for fabulous riches in fur, tobacco and numberless other commodities. Stock in the Mississippi Company was selling and gaining in value very well, a bit too well after a while, for everyone in France wanted to get in on the profits. Soon the narrow Rue Quincompoix, site of Law's office, became a madhouse where ladies of quality and footmen trampled one another in their rush to bid up the price. . .
The speculative storm in Paris was bad news for the South Sea directors in London; they could see good English money sailing across the Channel to join in the fun. The only defense available was to push up the price of South Sea stock. They had the company buy up ;large quantities of its own shares. They floated new loans. They put out new stock issues. In exchange for new shares, they offered to assume more of the national debt.
And it worked. The price of a single share moved inexorable upward, to 250 pounds, 400, 600, 800. A major part of the national debt was in the form of annuities, and their holders swarmed by the hundreds through the South Sea offices to sign up for the exchange. In 'Change Alley every one was going wild. It was said that you could buy your stock at one door of Garroway's and sell it at a profit going out of another. King George made John Blunt a baronet in recognition of "his extraordinary services in raising public credit to a height not known before." In July 1720, the stock was quoted above 900 pounds.
The end had to come sometime, as it had already begun to do in Paris, where John Law's great structure was going up in smoke. The South Sea directors probably hastened the disaster by their own ambition and greed. To choke off competition from anyone who might have a desire for the public's cash, they used their familiar forms of persuasion to get a bill passed forbidding the sale of stock in any joint-stock company not authorized by Parliament - the so-called Bubble Act.
During the summer the atmosphere turned ominous. The plague had arrived in Marseilles and was moving pitilessly north, killing thousands and spreading a sense of gloom, a feeling that mankind was suffering divine punishment for its sins.
The price of the stock obstinately refused to more above 1,000 pounds. In desperation, the directors announced that they would pay a thirty-percent dividend for the current year and guarantee a fifty-percent dividend for ten years to come. The rate was based on par, the value of the stock as originally issued, which was about one hundred pounds. This was fine for anyone who had bought in early. But for those, and they were the overwhelming majority, who had gotten in late, it was a shock. They belatedly began to calculate that a fifty-percent dividend on stock they had bought for a thousand pounds was only a five-percent dividend for them. And besides, where would the money come from to pay for even that five percent? A low-level episodic war with the Spaniards was on again, and without the possibility of Spanish trade, just where did the Company expect to find any reliable sources of income?
These questions were not the sort of thing the South Sea directors wanted to hear. They preferred customers like the Duchess of Rutland, who wrote her agent, "I am almost sure I can mack an advantage by buying today in the South Sea with the hundred and four-score pounds still in your hands, so I would bye as much as that will bye today and sell it again next week." (As long as people like Her Grace are in the market for quick big capital gains, a stock market boom can flourish. When they begin to calculate the exact rate of return on their investment, it is sure to be doomed.
At the beginning of September 1720, South Sea stock sagged to 830 pounds, then to 750, to 576, to 370. Blunt's nephew Charles cut his throat with a razor. Blunt himself - Sir John, as he was now - narrowly escaped with his life when an angry speculator tried to shoot him down in the street. He had taken the precaution of selling out all his stock near the high in August.
The collapse of the South Sea stock led to a collapse of all credit. By October it was clear that a financial crisis had engulfed England. No one wanted paper any more. The real estate market collapsed. Unemployment, especially in the luxury trades, spread. So did bankruptcies. The government fell.
Everyone who had had any dealings with the South Sea Company, and that meant almost everyone of consequence in Great Britain, was in a rage and a financial fix. Robert Walpole, England's most powerful parliamentary leader, came up with a sensible scheme for bailing out the company that somewhat resembles the savings-and-loan bailout in the U. S. in the 1980's. With the help of the Bank of England, the losses were split evenly among all the aggrieved parties and the everyone got back to business.
Walpole's motto was "Let sleeping dogs lie." But the people and the Parliament were in no mood to let the scoundrels who had bilked them of so many millions of pounds get off scot-free. They insisted on a full inquiry which, before it was through, dragged many a distinguished name in the mud. Blunt himself turned state's evidence, providing juicy derails about the royal ministers and even the royal mistresses. James Craggs, the Postmaster, swallowed poison.
In the end, Parliament took violent revenge on all the directors. It totted up their net assets and confiscated the bulk of them, some £2,000,000, to be distributed among the stockholders. They calculated Blunt's worth at £183,000 and left him £5,000. Francis Haws, who had made many enemies, had a net wroth of £40,031, 0 shillings. 2 pence. They left him £31, 0 shillings, 2.5 pence.
One big fish that got away was the cashier Robert Knight. He had slipped over the Channel to Calais, taking with him what he described as "little more than a sufficiency to maintain myself." plus the green book in which all the names and numbers of the illegal stock transactions were recorded. He hid out for a while, but one day British agents tracked him down in the Low Countries. He was clapped into a dungeon in Antwerp, and extradition papers were drawn up. But then the authorities opportunely recalled an ancient ordinance called the Joyeyse Entrée, under which the first Hapsburg ruler of the province of Brabant had promised that no one ever imprisoned there would ever be extradited for trial.
Whether this applied to a foreigner like Knight was debatable, and while the lawyers were debating it, ,he dug a hole through his prison wall and disappeared. Popular belief, with which it is hard to disagree, was that while one branch of the British government was pressing for his return to face the wolves, another was bribing the Brabant officials to make sure that he never came back to his native land with his green book in hand. At any rate, he ended up in Paris, where he built himself another fortune and lived quite comfortably, though he was said to visit Calais once a year and look across the water, groaning, as a certain Lady Irvine put it, "for the leeks and garlic of England."
As for Sir John Blunt, he lived out his life in modest obscurity in Bath, having adequately provided for all 17 of his children.
The investors were finally quieted down with a settlement in August 1721, which left them with something like £140 per share. For the few who had held on to the original offering at £100 this represented an actual profit. The others swallowed their losses and vowed that nothing the South Sea Bubble - "the deepest Villainy and Fraud that Hell ever contrived to ruin a nation," as Lieutenant-General Charles Ross, M. P. put it - would ever happen again.
Such vows are not meant to last. The past 280 years have seen so many speculative frenzies, booms and busts, that historians disagree as how to rate the South Sea Bubble against all its reincarnations. Was it a national calamity with ill effects that rumbled on for years, like the great crash of 1929? Or was it just a hiccup, like the great crash of 1987? Looking at the history of England in the 18th century, a period of steadily increasing wealth at home and steadily expanding empire abroad, it would seem at first sight that the great crash of 1720 was of no great consequence.
It did however have some long-range negative effects. For decades, joint-stock companies languished in dreadful disrepute. Writing 50 years after the crash in The Wealth of Nations, Adam Smith used the Bubble as an example of the inherent defects of a corporation as opposed to a partnership. Modern corporate directors, who like to cite his book as Holy Writ, might be surprised to learn what he thought of corporations: "The directions of such companies, being the managers of other people's money rather than their own, it cannot well be expected that they should .watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own...Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company." Stockholders of Enron would have been well advised to study this text in the year 2001.
For John Carswell, author of the most recent and most authoritative account of the South Sea Bubble, the eclipse of the joint-stock company meant a stifling of the vital forces of the British economy. The outburst of inventiveness that had marked the turn of the century temporarily petered ut for lack of adventurers to put their money into visionary projects like typewriters and mechanical pianos. There was a working steam engine in Cornwall 70 years before James Watt's, but no one had the resources or the daring to exploit it properly. A couple of generations vegetated before the great entrepreneurial boom known as the Industrial Revolution really began to transform England and the world.
It is always fun to speculate on what might have been. Suppose there had been no South Sea Bubble to be pricked, with all its attendant scandal, and that joint-stock entrepreneurs like James Puckle had been allowed to go on trying to turn their dreams into reality. If the British Army had been equipped with Puckle's machine-guns firing square bullets into the musket-bearing farmers at Lexington and Concord, how different the history of the world might have been.