Last week, in the first of an occasional series on financial disasters, bubbles and busts, we had a look at the rather obscure credit crunch of 1966.
This week, I thought we’d go a bit bigger, and take a look at the great-granddaddy of them all.
The South Sea Bubble of 1720.
The South Sea Bubble – securitising the national debt
The South Sea bubble is one of the most fascinating bubbles in history. It’s distant enough to be romantic rather than hellish (like the Great Depression, say), and there’s an impressive list of supporting characters, from Isaac Newton to rogue Scots financier John Law.
It’s also not a topic that can be easily covered in detail in the 1,000 or so words available here. I’m more interested in taking a look at what sort of parallels the 1720 bubble might have for us today.
So here’s the quick version of what happened. The South Sea Bubble didn’t happen in isolation. The backdrop to the bubble is the War of the Spanish Succession (1701 – 1714) which left France and England (and many other European nations) carrying hefty national debts.
The bubble arose out of the way that nations refinanced their debts. In effect, listed companies were promised monopolies on trade with the New World, in exchange for taking on the national debt.
This cut the interest payments on the national debt. A punter on the shares in these companies would accept a lower dividend payment if it came with a side order of dreams about all of those juicy New World profits. The shares were also far more liquid than the government bonds they effectively replaced.
The South Sea Company was formed in 1711. It was promised a monopoly on trade with the Spanish colonies in South America, and took over part of the national debt. The South Sea Company was never very successful at its commercial business (it didn’t even embark on a trade voyage to the South Seas until 1717).
But it was a lot better at promoting its own shares and currying favour with government. Inspired partly by the spectacular profits being made across the Channel by speculators in Law’s Mississippi Company, in 1720, the South Sea Company offered to take over the rest of the national debt.
The terms of the conversion are again, complicated (and plenty of punters at the time didn’t really understand them either – which was deliberate on the part of the company management). But various features created a self-reinforcing spiral.
In effect, the higher the share price went, the more the stock was worth (because a higher share price made it cheaper to buy out the bondholders). The stock could also be bought on margin – the company would lend against its own shares, so again, the higher the share price, the more money was available to buy more shares.
What happened? In January 1720, South Sea Company stock was worth £128 a share. By the end of June, the shares hit a peak of more than £1,000 a piece. According to Hans-Joachim Voth, “from the minimum attained during the 12 months prior to the peak, the share price increased by 843%. This compares with a rise of 188% for Amazon… during the Nasdaq bubble”.
As with most bubbles, the precise cause of the turning point is not clear. But there were plenty of potential triggers. In France, the Mississippi Company was already on the turn, having peaked in spring.
Meanwhile, in England, new legislation – the Bubble Act – had been passed. This effectively prevented new joint-stock companies from being formed unless they received parliamentary approval. This was driven through by the South Sea Company itself, which didn’t like the competition for funds being generated by all the other joint-stock companies which were being launched in its wake.
However, the resulting crackdown on speculation in general seems to have rattled investors who were already feeling a little vertiginous. The share price crashed, plenty of prominent people lost a lot of money, and an atmosphere of breast-beating and moralising took hold.
That said, as Edward Chancellor points out in his classic history of financial bubbles, Devil Take The Hindmost (1998), “the depression which followed the collapse of the South Sea Bubble was neither long nor deep”.
The rise of a new financial technology
There’s a lot to the bubble of 1720 (it also extended to the Netherlands, and as Robert Shiller puts it, was arguably the world’s first global stock market crash).
But one point I find of particular interest right now is the role of the South Sea bubble in the evolution of capital markets.
Most bubbles involve some new technology or infrastructure. The railroad bubble, the internet bubble – you could even consider the roaring ‘20s as being partly an automobile bubble. But they also involve new financial technologies: investment trusts (in the ‘20s); portfolio insurance (the crash of ’87); and the elaborate usage of debt slicing and dicing in the lead up to the 2008 crisis.
You could argue that the South Sea Bubble was about “the New World” or trade, but in fact, it was really about the evolution of publicly-traded stocks. As Chancellor points out, the South Sea scheme was far from the only bubble company around at the time.
New joint-stock companies were listed every month, promoting visions as ambitious and as diverse as designs for a machine gun to a patented method for storing live fish on board boats (so that they could venture further out to sea and still be sold fresh at the London markets). The total capitalisation of the London market rose 100-fold in the 25 years between 1695 and the bubble imploding in 1720.
What does this remind you of today? Bitcoin and blockchain, I’d say. We have all these weird schemes and scams issuing “tokens” using the “blockchain”. People are winning and losing fortunes overnight, and there’s a sense of hysteria about it all – and there are also plenty of sceptics and satirists, just as there were during the 1720 bubble.
It’ll probably end badly. Only four of the 190 companies founded in 1720 survived, notes Chancellor.
But in time, we may look back on it and think, “that was the dawn of a new asset class”. As Matt Levine put it on Bloomberg this week: “Cryptocurrency might be to the 21st century what stock was to the 17th century: an administrative change in the bookkeeping for ownership of certain assets that over time completely transformed the economy and the world.”