Sunday, October 12, 2008

The South Sea Bubble

The South Sea Bubble (share prices in the South Sea Company, 1719-1721).

The stock market just finished its worst week in history, starting the week at 10,325 and ending at 8,451. In the course of the week, General Motors shares dropped 21%, falling to their lowest level since 1950. In the midst of mounting panic on Wall Street, here on "Main Street" I was on the lookout for some historical perspective. As this New York Times graphic shows, the current downturn is comparable to the bear market in 1974, and is beginning to look distressingly like the sustained downturn of 1929-1932. But the depressing history of market crashes really begins in 1720, with the infamous "South Sea Bubble."

In 1711, England's debts were mounting as a result of the War of the Spanish Succession (known in America as "Queen Anne's War," the second of the "French and Indian Wars"). The war was being fought to prevent a French claimant from assuming the vacant throne of Spain, thereby consolidating a Franco-Spanish empire in the New World that would tip the balance of power in Europe and seriously derail England's own imperial ambitions. In London, Lord Treasurer Robert Harley, anticipating a windfall in South American trade with the successful conclusion of the war, set up the South Sea Company with exclusive trading rights in South America.

At its inception, the South Sea Company bought up £10 million in short term government debt in exchange for stock in the company at 6% interest—then waited for profits from South American trade to start rolling in. The most reliable profits were generated by the slave trade, but hostility between Britain and Spain remained a significant barrier to trade in general.

In 1719, the Company purchased another £31 million in government debt (nearly half the total), touching off a frenzy of speculation that steadily pushed up share prices. Over four hundred members of the House of Commons and half the members of the House of Lords were shareholders, along with notables like Alexander Pope and Sir Isaac Newton. Government officials realized huge profits on insider deals as the price of a share rose from £128 in January 1720 to £1,000 in early August 1720.

Then, as investors scrambled for liquidity to purchase still more shares, a frenzied sell-off began that saw the price per share drop to £150 by the end of September. Massive fortunes were made and lost in a single year. One market loser, Alexander Pope, vented his frustration and anger in a poem:
How goes the Stock, becomes the gen'ral Cry.
Rather than fail we'll at Nine Hundred Buy.
Instead of Scandal, how goes Stock's the Tone,
Ev'n Wit and Beauty are quite useless grown:
No Ships unload, no Looms at Work we see,
But all are swallow'd by the damn'd South Sea.
Sir Isaac Newton, who lost £20,000 when the market collapsed, commented ruefully: "I can calculate the motions of the heavenly bodies, but not the madness of people."

1 comment:

Christopher Tassava said...

Great post. I've been seeing lots of allusions in the press to the South Sea Bubble, and dimly recalled some of the facts (the connection to the war), but this is useful. I'll have to read more about it. Santayana is shaking his head.

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