What Gulliver’s Travels teaches you about financial bubbles

Gulliver's Travels is a novel by Jonathan Swift, written in 1726-7. It is an adventure story about a shipwrecked sailor's various encounters with strangers, including a race of miniature people; he also makes the acquaintance of some intelligent horses. At the end of his travels he returns home completely disillusioned about humanity, and chooses to live the rest of his life as a recluse. The book is seen as a satire of the various political and financial scandals dogging Britain at the time.

The key moment

Gulliver's problems begin when he decides to "accept an advantageous offer" from a captain "making a voyage to the South Sea", which ends up in disaster. Later on in the book the hero ends up in Balnibarbi, a country that "lies miserably [in] waste, the houses in ruins, and the people without food or clothes". The ruler explains that these problems are due to the population's enthusiasm for wasting money on schemes organised by the "Academy of Projectors" located on "a continuation of several houses on both sides of a street" (in Swift's time London's financial centre was located in the streets next to the Royal Exchange).

Lessons for investors

These episodes are references to the 1720 South Sea Bubble. During the first half of the year, there were rumours that the Spanish would allow the South Sea Company to massively expand their trade with South America.

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This chatter, combined with a complicated scheme to encourage people to convert British government debt into South Sea stock, caused the price of South Sea shares to surge from £150 to around £1,000 before collapsing. Swift, like many investors, lost large sums because he bought at the top of the market.

Other financial wisdom

The South Sea episode reminds us that financial bubbles aren't just a modern problem, but seem to be an inevitable byproduct of financial markets. The best way to avoid being sucked into them is to look dispassionately at a company whose shares you are thinking of buying, considering various scenarios rather than just the most optimistic ones. However, this is easier said than done, especially when less cautious people all around you are making fortunes. That's why bubbles occur so frequently.