“The act for carrying on a trade to the South Sea . . . will in all probability, if duly executed, be of mighty advantage to the kingdom and an everlasting honour to the present parliament.”
Jonathan Swift, The Examiner, no. 45, June 7, 1711
As of 1711, Great Britain was in considerable debt. They had been drawn into a coalition formed to counter the aggression of Louis XIV of France. The debt represented British expenses during the Nine Years War (1688-1697) and the War of Spanish Succession(1701-1714). These conflicts were not restricted to the European continent but also played out in North America and the Caribbean colonies. The British also needed to deal with uprisings in Scotland and Ireland. At the time, there was no unified budget process. Therefore the government had no true accounting of the actual debt amount, but it is estimated that it was nearly £ 9 million.
Lord Robert Harley, the Chancellor of the Exchequer (later the Lord Treasurer), was appointed by the House of Commons to look into the extent of the debt. His final report to Parliament underscored the disarray of the government finances and stressed the urgency of the situation.
Traditionally, the government relied on the Bank of England to finance the debt through loans. The more liberal Whigs headed the bank. Harley and much of the current British administration were conservative Tories. Because of this, Harley was unable to work with the bank, and another solution needed to be found to resolve the government's debt issues. Harley had made the acquaintance of John Blunt, a businessman who was a director of a company manufacturing swords. Blunt had been the administrator of the successful state lottery that brought in short-term capital. He also speculated on land in Ireland. He funded his speculation by exchanging company stock for army loan certificates called debentures.
Harley and Blunt used the debt-equity swap as a model for the South Sea Company, which they derived from the ideas of John Law, then the Finance Minister of France. ("South Sea" was a general term used to refer to South America and surrounding waters.) They set the company up as a private-public partnership whereby the government's debt was converted into shares of the corporation. The government then promised to pay 6% interest as dividends to the stockholders. Harley utilized his influence to get Parliament to grant the South Sea Company a monopoly on trade with the Spanish in South America. Parliament saw the company as a way to broaden Britain's influence in that part of the world.
In 1713, Great Britain signed the Treaty of Utrecht with Spain, thereby ending England's involvement in the War of Spanish Succession. As a result of the treaty, Spain granted England the asiento, the exclusive license to conduct the slave trade with Spain's colonies in the New World. The license was then, in turn, given to the South Sea Company. The slave trade was integral to the Atlantic economy, and this convinced the directors of the South Sea Company that the value of the stock would only go up. On this premise, they began to encourage investors to buy stock.
There was some initial opposition. Some felt that the new company could not conduct the slave trade, nor were they experienced enough to handle the English, French, and Dutch competitors that often violated the Spanish contracts. Also, the Spanish themselves were lukewarm to the thought of allowing a former enemy a foothold in the colonies. The risks seemed too large, and these factors had to temper any grandiose thoughts of large financial rewards. To counter this, the South Sea Company embarked on an intense publicity campaign aided in part by the growing print culture in London. More of the population was literate and more information was being disseminated to a broader audience, not unlike changes brought on by the advent of social media. Print publicity boosted the company's image and built confidence in the potential financial gains.
Many publications listed stocks, commodities, values, interest tables and offered advice and information on different corporations. Coffeehouses became central places to meet, read the multitude of pamphlets and newspapers, share information about the market, and transact business. Many of these coffeehouses appeared near Exchange Alley outside the Royal Exchange building where most stock trading took place.
It was here that the stockjobbers, or brokers, bought and sold stocks. They worked as intermediaries and took in clients from all classes of English society. With little regulation, the jobbers were able to manipulate prices. Daniel Defoe observed that the jobbers had the power to make the value of a stock "dance attendance on their designs, and rise and fall as they please, without any regard to the Intrinsick worth of the Stock."
In 1719, in France, John Law conceived of a similar plan of action. French debt was to be converted into shares of a corporation with exclusive trading rights within French North America. Law's initial successes prompted the South Sea Company to proceed with an additional debt swap. Early in 1720, they won a bid over the Bank of England to assume more government debt. Parliament was then bribed into passing the Debt Acquisition Act whereby £40 million of debt was to be transferred to the South Sea Company with a return of 5% interest. The directors knew they needed to increase the value of the stock and increase sales. They came up with several different schemes to make it easier for investors to purchase stock.
The goal was to sell £2 million worth of stock. Under different subscriptions, investors were able to pay in installments. One plan involved 20% down and paying the rest in two-week installments. Another plan allowed investors to borrow £3,000. Or investors could put down 10% and pay back over four years, or if they put down 30%, they would receive dividends by the end of the year. The company even made loans so investors could purchase more stock. When life expectancy was short, people were more willing to take risks, especially when large windfalls were promised. People from all walks of life began buying stock in the company. Prices rose steadily, and some early investors sold off shares and then used the profits to purchase more. The cycle continued at a frenzied pace. The value of South Sea Company stock rose from £125 in January to £320 in April and then to £950 in July of 1720.
The names of prominent shareholders were published. These included members of Parliament, King George I, and even the king's mistresses. This gave the venture an air of credibility. Word spread, and speculation ensued. Stock fever infected other companies, both large and small, in all manner of businesses. There were a fair number of hoaxes as well, and in response, Parliament passed the Bubble Act, which required that joint-stock companies be incorporated by royal charter. As the share values rose, less stock was required to buy the government debt. The company sold the surplus stock at higher prices, and the company began paying out more than they took in.
Some began to advise caution and warned that prices were overinflated. The bubble burst in the Fall of 1720. South Sea Company stock was down to £400 in September and then plummeted to £185 in December. Many who invested, especially those who invested later, lost their fortunes overnight. Many had purchased shares on credit and no longer could pay back loans. Bankruptcies rose, and suicides spiked. The crisis rippled out to the banks that were unable to collect on loans. The British economy collapsed. In France, John Law's Mississippi bubble burst as well as several Dutch stock failures. All this precipitated what is considered the first major international stock market crash.
Members of Parliament, many of who had been investors in the South Sea venture, called for accountability. Officials confiscated property and estates of company directors. Many high-ranking members of Parliament were expelled, including John Aislabie, the Chancellor of the Exchequer. The national debt would need to be restructured.
Sir Robert Walpole, a Whig and an early opponent of the South Sea Company, oversaw the efforts to rectify the fallout. He pushed through a series of emergency measures. The government debt was split into three parts. The South Sea money was transferred to the Bank of England, another part back to the Treasury, and then a "Sinking Fund" was established. This was to be a repository for saved income taken in by the government. In August 1721, the "Act For Making Several Provisions to Restore the Publick Credit" was passed. It outlined bold initiatives to reallocate and redistribute money from those who had gained during the bubble to those who lost. It included debt forgiveness, family aid, and efforts to stabilize the financial markets. Under Walpole's guidance, the British economy recovered. This solidified Walpole and the Whig's political stature giving the Whig's control of the government into the second half of the 18th century. Walpole would be named Lord Treasurer, Chancellor of the Exchequer, and the House of Commons leader. He is considered England's first true prime minister.
Further Reading
Money For Nothing: The Scientists, Fraudsters, and Corrupt Politicians who Reinvented Money, Panicked a Nation, and Made the World Rich: Thomas Levenson
Boom and Bust: A Global History of Financial Bubbles: William Quinn and Jonathan Turner
The First Crash: Lessons from the South Sea Bubble: Richard Dale