Thursday, June 26, 2014

South Sea Bubble: 18th Century Meltdown

South Sea Bubble by Edward Matthew Ward
In 2008, a global recession hit the world hard. It is a fact in an economy that there are periods of highs and lows, booms and bust. Bursting bubbles were inevitable if an authority is not careful enough. Bubbles are characterize by rapid rise of prices of a commodity and its sudden deflation caused by different circumstances. After nearly a century after the Tulip Mania, another bubble was created just a sea across, to England. A new and more volatile bubble was created. From a flower, the crazed turned to hopes and lies of a monopoly and profit of a company, the South Sea Company.

Europe woke up to a new century with a war. 1701 roared quickly with gun fires for the throne of Spain. The Spanish Succession War dragged through the first decade of the new century. England entered the war to protect its nation for the possible threat of French and Spanish union. After a decade of fighting, Great Britain incurred a lot of war debt.
The debt was enormous. Chancellor of Exchequer, Robert Harley Earl of Oxford looked for a way to ease the debt somehow. Already, the big companies of Britain, the Bank of England and the East India Company, already shared some burden of the debt, but more had to be done. In 1711, he pushed for the granting of a charter for a company which would shoulder the debt. The charter of the South Sea Company was issued.

The Company was established to handle trade in South Atlantic as well as the £10 million debt of the national government. The South Sea Company was meant to handle trade in southern Atlantic. It was to export British textiles to South America. In turn, Spanish colonies in the region would sell them silver, especially from Mt. Potosi, gold, and diamonds.

The Company was also given privileges to trade stocks. The debts of the government bought by the company was then made into share of stocks. And from these stocks, dividends would be issue that could serve as payment of the interest or the debt itself.

On the business front, the company promised a lot, but little materialized. For example, they spread words that the company would be allowed by the Spanish government to trade with four ports in Chile and Peru, areas with gold and silver. From this pronouncements of the company, stock prices rose. But the reality was much smaller. The company was in fact granted with an Asiento or contract. The company was allowed to ship slaves from Africa to Spanish South American colonies. Profits in the sale would be shared by Spanish monarch (accounting 25% of the profits) and Queen Anne and company. It was a small activity. In 1717, the first ship of the company sailed to South Atlantic for the trade.

A small contract, however, did not deter speculators from hoping of huge profit. The management proved to be excellent public relation officers. They continued to promise big things, such as the company would gain more foothold in South America. From this projections they showed, more bought South Sea Company stocks and prices moved within £100.

Another stimulus for the rising of stocks of South Sea Company was from the other side of the English Channel. The Mississippi Company of John Law was operating the same way as the South Sea Bubble. Paris was crazed by wannabe investors wanting to have instant wealth. London heard the news and also went gaga over the South Sea Company stocks. Stock prices rose even further.

In the same year, the South Sea Company made an ambitious proposal. They proposed that the company to buy another £2 million worth of debt. Eventually, parliament agreed. The South Sea Act allowed the South Sea Company to give the government £2 million to fund the state lottery that it was due to pay. 

In 1718, Great Britain and Spain went into against each other. Spain’s ambition in Italy angered Great Britain, France, the Dutch Republics, and the Holy Roman Empire (together known as the Quadruple Alliance). Thus the privileges of the South Sea Company in supplying slaves ended. And so, the natural tendency was for its stocks to falter. However, it did not happened. With few embellishments and still with the promise of huge wealth and monopoly, the stock prices continued to be stable.

In 1720, the war ended. Once again, war debt brought a huge burden to the government. Following the Treaty of Hague that ended the war, the South Sea Company made a proposal that would brought high profits for its management.
The company offered a pay the whole national debt of Great Britain. Over £30 million debt was to be bought by the company. The interest rate would remain 5% through the whole seven years and were to be reduced in 1727 to 4%. The Bank of England did not wanted to be overshadowed by such an ambitious proposal. A mere company that only existed over a decade could pay a debt of the whole nation. While an institution such as the Bank of England that began in early 1690’s was horrified. The Banks allies in the parliament delayed the debate over the acceptance of South Sea Company’s proposal. South Sea Company director, John Blunt, revised his proposal. Instead of 1727, he offered to reduce the interest by 1724.

With South Sea Company’s proposal, the stock prices of the company soared in record pace. In February 2, 1720, the stock price of South Sea Company was £130. After two days, the prices went up to £400. It only then stabilized after wards in £330. Speculators were amazed for such a company to be bold to pay the debts of the country; and the only capable doing so were those with high potential of high profits.

After months of battle, a decision was made in Parliament over South Sea Company’s proposal. The Chancellor of Exchequer, John Aislabie, fought hard for the passage of the proposal. He succeeded. In April 7, 1720, the proposal was passed overwhelmingly in Parliament: 172 in favor, 55 against.

With the passage of the proposal, Exchange Alley roared with thunderous voices of speculators. From all walks of life, people tried their best to buy stocks of the company. A month after the passing of the proposal, in May, the prices were about £500. A month later, it skyrocketed further to £890. Buying of stocks was further boosted by a credit system that began to appear. A buyer could buy a stock by paying first a 20% down payment followed by monthly payment.

Inspired by the rapid rising prices of stocks, dubious people began to made money by making companies and entering it in the stock exchange. Companies, known as Bubbles, began to appear and sell stock promising huge return for their outrageous projects. Examples included making iron from pit coal or extracting silver from lead. Among also were businesses like providing insurance from highwaymen and improving of horse breeds. Many outrageous crazy companies such as these appeared, duping speculators in the stock market for their money. When prices of their stock rose, the owners sell their shares of stock and made a lot of money. Those who bought then had worthless pieces of paper.

The South Sea Company then played a key role to clear the competition in stock market. They pushed for the passing of the Bubble Act. Passed on June 9, 1720, it aimed in ending ridiculous bubble companies. It banned a list of 86 companies from operating. It also revoked 18 charter requests to the parliament. With the act, the South Sea Company remained as the biggest instant money maker in the stock market.

Because of the South Sea Company, the Exchange Alley became a buzzing center of London until June 22. Some traders were content of their profits and sold their stocks. Meanwhile within the company, many of the officials saw that their company only remained afloat because of stocks and not with realistic profits from its business. Thus, many of them sold their stocks. With the officials of the company selling their stocks, confidence of began to wane. Suddenly, price meltdown began. Prices plummeted to £640. Stocks bought with borrowed money then became overvalued and loses were made. By the second half of 1720, further collapse of prices followed. Prices became £400. Panic ensued Exchange Alley. People wanted to get out of the bursting bubble. A meeting was made in September 8, but nothing came out as delegates who attended were those who got out during the highs. At last, by October 1720, prices tumble to £170 per share of stocks. The South Sea Bubble burst.

Many of the people became broke. Individuals who had meager incomes who sacrificed many for South Sea Stocks became highly in debt.  From rich to poor, many became a victim of the fraud of South Sea. The famous scientist, Isaac Newton fell victim to the South Sea Bubble and lost £20,000. Banks then had problems in collecting payment for loans as the borrowers had nothing. Many of the borrowers who were unable to pay were imprisoned to the so-called debtors’ prison, like the one in Fleet.

The government acted immediately to save their debt plans and the company itself. The debts bought by the company was then divided between the Bank of England and the East India Company. The company faced restructuring. People who were responsible for the creation of the South Sea Bubble faced imprisonment most of which were cabinet members. Among them was the man responsible for the passage of the 1720 South Sea Company proposal, John Aislabie. They faced scrutiny and humiliation up to their deaths.

The South Sea Bubble was a huge disaster for Britain. Lack of prudence created a mania for instant cash in a company that did not even had a stable revenue. The biggest loser in busts like this were always the poor, who invested their whole savings for a bright future, only to be taken as profits by few. The South Sea Bubble was an economic disaster, one of the first in a world of rising capitalism and speculation.

See also:
Tulip Mania

MacKay, C. Extraordinary Popular Delusions and the Madness of Crowds. United States: Start Publishing LLC., 2012. 

Micklethwait, J. & A. Wooldridge. The Company: A Short History of a Revolutionary Idea. Toronto: Random House of Canada Limited, 2003.

Potter, G. The New Cambridge Modern History. New York: Cambridge University Press, 1970.

Shipman, M. The Next Investment Boom: Learn the Secrets of Investing from a Master and How to Profit from Commodities. London: Kogan Page Limited, 2007.

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