South Sea Bubble

Hogarthian image of the "South Sea Bubble", by Edward Matthew Ward, Tate Gallery

The South Sea Company was a British joint stock company that traded in South America during the 18th century. Founded in 1711, the company was granted a monopoly to trade in Spain's South American colonies as part of a treaty during the War of Spanish Succession. In return, the company assumed the national debt England had incurred during the war. Speculation in the company's stock led to a great economic bubble known as the South Sea Bubble in 1720, which caused financial ruin for many. In spite of this it was restructured and continued to operate for more than a century after the Bubble.

Initial stages

The company, established in 1711 by the Lord Treasurer, Robert Harley, was granted exclusive trading rights in Spanish South America. At that time, when continental America was being explored and settled, Europeans applied the term "South Seas" only to South America and surrounding waters, not to any other ocean. The trading rights were presupposed on the successful conclusion of the War of the Spanish Succession, which did not end until 1713, and the actual treaty-granted rights were not as comprehensive as Harley had originally hoped.

Harley needed to provide a mechanism for funding government debt incurred in the course of that war. However, he could not establish a bank, because the charter of the Bank of England made it the only joint stock bank. He therefore established what, on its face, was a trading company, though its main activity was in fact the funding of government debt.

In return for its exclusive trading rights the government saw an opportunity for a profitable trade-off. The government and the company convinced the holders of around £10 million of short-term government debt to exchange it with a new issue of stock in the company. In exchange, the government granted the company a perpetual annuity from the government paying £576,534 annually on the company's books, or a perpetual loan of £10 million paying 6 percent. This guaranteed the new equity owners a steady stream of earnings to this new venture. The government thought it was in a win-win situation because it would fund the interest payment by placing a tariff on the goods brought from South America.

The Treaty of Utrecht of 1713 granted the company the right to send one trading ship per year, the Navío de Permiso (though this was in practice accompanied by two "tenders"), as well as the Asiento, the contract to supply the Spanish colonies with slaves.

The company did not undertake a trading voyage to South America until 1717 and made little actual profit. Furthermore, when ties between Spain and Britain deteriorated in 1718 the short-term prospects of the company were very poor. Nonetheless, the company continued to argue that its longer-term future would be extremely profitable.

Debt for equity

In 1717 the company took on a further £2 million of public debt. The rationale in all these transactions was to the

• Government: lower interest rate on its debt
• South Sea Company (owners): a steady stream of earnings
• Government Debt Holder: upside potential in a promising enterprise

Slave trading

Most commentary on the South Sea Company focuses on the money lost by English investors. The primary trading business of the company was the forced transportation of people purchased in West Africa and sold into slavery in the Americas. The most commercially significant aspect of the company's monopoly trading rights to the Spanish empire was the 1713 Treaty of Utrecht's slave-trading 'Asiento', which granted the exclusive right to sell slaves in all of the American colonies.

The Asiento set a quota of selling 4800 people into slavery per year. Despite problems with speculation, the South Sea Company was relatively successful at slave trading and meeting its quota (it was unusual for other, similarly chartered companies to fulfill their quotas). According to records compiled by David Eltis and others, during the course of 96 voyages in twenty-five years, the South Sea Company purchased 34,000 slaves of whom 30,000 survived the voyages across the Atlantic.^[1] In other words, approximately 11% of humans transported as slaves died in transport. Employees, directors and investors persisted with the slave trade despite the ongoing death toll, continuing through two wars with Spain and the calamitous 1720 commercial bubble. The company's trade in human slavery peaked during the 1725 trading year, five years after the bubble burst.

Trading more debt for equity

In 1719 the company proposed a scheme by which it would buy more than half the national debt of Britain (£30,981,712), again with new shares, and a promise to the government that the debt would be converted to a lower interest rate, 5% until 1727 and 4% per year thereafter.

The purpose of this conversion was similar to the old one: it would allow a conversion of high-interest but difficult-to-trade debt into low-interest, readily marketable debt and shares of the South Sea Company. All parties could gain.

In summary, the total government debt in 1719 was £50 million:

• £18.3m was held by three large corporations:
  • £3.4m by the Bank of England
  • £3.2m by the British East India Company
  • £11.7m by the South Sea Company
• Privately held redeemable debt amounted to £16.5m
• £15m consisted of irredeemable annuities, long fixed-term annuities of 72–87 years and short annuities of 22 years remaining maturity

The Bank of England proposed a similar competing offer, which did not prevail when the South Sea raised its bid to £7.5m (plus approximately £1.3m in bribes). The proposal was accepted in a slightly altered form in April 1720. The Chancellor of the Exchequer, John Aislabie, was a strong supporter of the scheme.

Crucial in this conversion was the proportion of holders of irredeemable annuities that could be tempted to convert their securities at a high price for the new shares. (Holders of redeemable debt had effectively no other choice but to subscribe.) The South Sea Company could set the conversion price but could obviously not diverge much from the market price of its shares.

The company ultimately acquired 85% of the redeemables and 80% of the irredeemables.

Buying the share price

The company then set to talking up its stock with "the most extravagant rumours" of the value of its potential trade in the New World which was followed by a wave of "speculating frenzy". The share price had risen from the time the scheme was proposed: from £128 in January 1720, to £175 in February, £330 in March and, following the scheme's acceptance, to £550 at the end of May.

What may have supported the company's high multiples (its P/E ratio) was a fund of credit (known to the market) of £70 million available for commercial expansion which had been made available through substantial support, apparently, by Parliament and the King.

Shares in the company were "sold" to politicians at the current market price; however, rather than paying for the shares, these lucky recipients simply held on to what shares they had been offered, "sold" them back to the company when and as they chose, and received as ‘profit’ the increase in market price. This method, while winning over the heads of government, the King's mistress, etc., also had the advantage of binding their interests to the interests of the Company: in order to secure their own profits, they had to help drive up the stock. Meanwhile, by publicizing the names of their elite stockholders, the Company managed to clothe itself in an aura of legitimacy, which attracted and kept other buyers.

Bubble Act

A number of other joint-stock companies then joined the market, making usually fraudulent claims about other foreign ventures or bizarre schemes, and were nicknamed "bubbles".

In June, 1720, the Royal Exchange and London Assurance Corporation Act 1719 (repealed in 1825) required all new joint-stock companies to be incorporated by Act of Parliament or Royal Charter. This became known as the "Bubble Act" later, after the speculative bubble had burst. The South Seas Company held a charter providing exclusive access to all of Middle and South America. However, the areas in question were Spanish colonies, and Great Britain was then at war with Spain. Even once a peace treaty had been signed, relations between the two countries were not good. The best terms that the South Sea Company was able to obtain allowed them to send only one ship per year to Spain’s American colonies (not one ship per colony; exactly one ship), carrying a cargo of not more than 500 tons. Additional wrangling won the company the right to transport slaves, although steep import duties made the slave trade entirely unprofitable.

The grant of a charter to the South Sea Company was an added boost, its shares leaping to £890 in early June. This peak encouraged people to start to sell; to counterbalance this the company's directors ordered their agents to buy, which succeeded in propping the price up at around £750.

Top reached

Tree caricature from Bubble Cards

The price of the stock went up over the course of a single year from about one hundred pounds a share to almost one thousand pounds per share. Its success caused a country-wide frenzy as all types of people—from peasants to lords—developed a feverish interest in investing; in South Seas primarily, but in stocks generally. Among the many companies to go public in 1720 is—famously—one that advertised itself as "a company for carrying out an undertaking of great advantage, but nobody to know what it is".^[2]

The price finally reached £1,000 in early August and the level of selling was such that the price started to fall, dropping back to one hundred pounds per share before the year was out, triggering bankruptcies amongst those who had bought on credit, and increasing selling, even short selling—selling borrowed shares in the hope of buying them back at a profit if the price falls.

Also, in August 1720 the first of the installment payments of the first and second money subscriptions on new issues of South Sea stock were due. Earlier in the year Blunt had come up with an idea to prop up the share price—the company would lend people money to buy its shares. As a result, a lot of shareholders could not pay for their shares other than by selling them.

Furthermore, the scramble for liquidity appeared internationally as "bubbles" were also ending in Amsterdam and Paris. The collapse coincided with the fall of the Mississippi Scheme of John Law in France. As a result, the price of South Sea shares began to decline.

By the end of September the stock had fallen to £150. The company failures now extended to banks and goldsmiths as they could not collect loans made on the stock, and thousands of individuals were ruined (including many members of the aristocracy as well the composer Handel). With investors outraged, Parliament was recalled in December and an investigation began. Reporting in 1721, it revealed widespread fraud amongst the company directors and corruption in the Cabinet. Among those implicated were John Aislabie (the Chancellor of the Exchequer), James Craggs the Elder (the Postmaster General), James Craggs the Younger (the Southern Secretary), and even Lord Stanhope and Lord Sunderland (the heads of the Ministry). Craggs the Elder and Craggs the Younger both died in disgrace; the remainder were impeached for their corruption. Aislabie was imprisoned.

The newly appointed First Lord of the Treasury Robert Walpole was forced to introduce a series of measures to restore public confidence. Under the guidance of Walpole, Parliament attempted to deal with the financial crisis. The estates of the directors of the company were confiscated and used to relieve the suffering of the victims, and the stock of the South Sea Company was divided between the Bank of England and East India Company. A resolution was proposed in parliament that bankers be tied up in sacks filled with snakes and tipped into the murky Thames.^[3] The crisis had significantly damaged the credibility of King George I and of the Whig Party.

Restructuring

This section requires expansion.

The company continued its trade (when not interrupted by war) until the end of the Seven Years' War (1756–1763). However, its main function was always managing government debt, rather than trading with the Spanish colonies. The South Sea Company continued its management of the part of the National Debt until it was abolished in the 1850s.

Arctic whaling

The Greenland Company had been established by Act of Parliament in 1693 with the aim of catching whales in the Arctic. The products of their "whale-fishery" were to be free of Customs and other duties. Partly due to maritime disruption caused by wars with France, the Greenland Company failed financially within a few years. In 1722 Henry Elking published a proposal, directed at the governors of the South Sea Company, that they should resume the "Greenland Trade" and send ships to catch whales in the Arctic. He made very detailed suggestions about how the ships should be crewed and equipped. ^[4]

The British Parliament confirmed that a British Arctic "whale-fishery" would continue to benefit by freedom from Customs duties and in 1724 the South Sea Company decided to commence whaling. They had 12 whale-ships built on the River Thames and these went to the Greenland seas in 1725. Further ships were built in later years, but the venture was not successful. At this time there were hardly any experienced whalemen remaining in Britain and the Company had to engage Dutch whalemen for the key posts aboard their ships. Other costs were badly controlled and the catches remained disappointingly few, even though the Company were sending up to 25 ships to Davis Strait and the Greenland seas in some years. By 1732 the Company had accumulated a net loss of 177,782 pounds sterling from their 8 years of Arctic whaling. ^[5]

The South Sea Company directors appealed to the British government for further support. Parliament had passed an Act in 1732 that extended the duty-free concessions for a further 9 years. In 1733 an Act was passed that also granted a government subsidy to British Arctic whalers, the first in a long series of such Acts that continued and modified the whaling subsidies throughout the eighteenth century. This, and the subsequent Acts, required the whalers to meet conditions regarding the crewing and equipping of the whale-ships that closely resembled the conditions suggested by Elking in 1722. ^[6] In spite of the extended duty-free concessions, and the prospect of real subsidies as well, the Court and Directors of the South Sea Company decided that they could not expect to make profits from Arctic whaling. They sent out no more whale-ships after the loss-making 1732 season.

Quotes on the bubble

Joseph Spence wrote that Lord Radnor reported to him "When Sir Isaac Newton was asked about the continuance of the rising of South Sea stock… He answered 'that he could not calculate the madness of people'."^[7] He is also quoted as stating, "I can calculate the movement of the stars, but not the madness of men".^[8] Newton's niece Catherine Conduitt reported that he "lost twenty thousand pounds. Of this, however, he never much liked to hear…"^[9] This was a fortune at the time (equivalent to about £3 million in present day terms^[10]), but it is not clear whether it was a monetary loss or an opportunity cost loss.

See also

• List of notable business failures
• List of stock market crashes
• Mississippi Company
• Extraordinary Popular Delusions and the Madness of Crowds
• Atlantic Slave Trade

References

This article includes a list of references, related reading or external links, but its sources remain unclear because it lacks inline citations. Please improve this article by introducing more precise citations where appropriate. (April 2009)

Further reading

• Carswell, John (1960), The South Sea Bubble, London: Cresset Press 
• Cowles, Virginia (1960), The Great Swindle: The Story of the South Sea Bubble, New York: Harper 
• Dale, Richard S.; et al. (2005), "Financial markets can go mad: evidence of irrational behaviour during the South Sea Bubble", The Economic History Review 58 (2): 233–271, doi:10.1111/j.1468-0289.2005.00304.x 
• Shea, Gary S. (2007), "Understanding financial derivatives during the South Sea Bubble: The case of the South Sea subscription shares", Oxford Economic Papers 59 (Supplement 1): i73-i104, doi:10.1093/oep/gpm031 
• Temin, Peter; Voth, Hans-Joachim (2004), "Riding the South Sea Bubble", American Economic Review 94 (5): 1654–1668, doi:10.1257/0002828043052268 

Fiction

• Liss, David (2000), A Conspiracy of Paper, New York: Random House, ISBN 0375502920 . Novel set around the South Sea Company bubble.
• Goddard, Robert (2000), Sea Change, London: Bantam Press, pp. 416, ISBN 0593046676 . Novel set against the background of the South Sea bubble.

External links

• South Sea Bubble collection at Harvard University
• Famous First Bubbles - South Sea Bubble
• From Market to Exchange, 1693–1801
• Charles McKay's Account of The South Sea Bubble in Modern English
• Helen Paul's Account of The South Sea Company's slave trading activities