Collapse of the South Sea Bubble
The South Sea Bubble was a significant financial crisis that occurred in the early 18th century, primarily driven by the South Sea Company, which was established in 1711 to monopolize British trade with South America. The company was granted this monopoly in exchange for taking on a portion of the national debt, which had been exacerbated by the costly War of the Spanish Succession. The company's promise of immense profits from trade, particularly involving enslaved Africans, attracted a surge of speculative investment, driving stock prices to unprecedented highs.
By 1720, the stock price skyrocketed from £128.5 to £1,000, fueled by manipulation from company directors and a widespread frenzy of speculation reminiscent of similar ventures in France. However, the bubble burst later that year, leading to a catastrophic financial collapse that resulted in widespread bankruptcies, bank failures, and significant unemployment. The aftermath prompted an investigation into the company’s operations, revealing extensive fraud, and led to the confiscation of ill-gotten gains from company directors.
While some investors made profits by selling their shares at the peak, the overall impact of the collapse fostered long-term aversion to speculation and hindered economic growth, particularly delaying the Industrial Revolution in Britain. The South Sea Bubble serves as a historical example of the dangers of speculative investing and the complexities of financial markets.
Collapse of the South Sea Bubble
Date September, 1720
Fraudulent activities within the South Sea Company, political corruption, and mass mania for speculation resulted in a major stock market crash and widespread financial ruin.
Locale England
Key Figures
John Blunt (1665-1733), English scrivener turned stockbrokerRobert Harley (1661-1724), first earl of Oxford, English statesman, and bibliophileRobert Walpole (1676-1745), first earl of Oxford and English statesmanJohn Law (1671-1729), Scottish gambler, speculator, and financier
Summary of Event
The South Sea Bubble originated in 1711, when Robert Harley, the first earl of Oxford, founded the South Sea Company. Incorporated by an act of Parliament, the company was granted a monopoly of all British trade with South America and the islands of the South Sea. In exchange for this monopoly, the company assumed part of the national debt.
The War of the Spanish Succession, begun in 1701, was draining the British government’s resources and increasing its national debt. Harley carried on secret peace negotiations to end the war and secure a favorable treaty with extensive trading concessions from Spain. England hoped to prosper from the immense wealth of the Spanish colonies in South America, such as the gold and silver mines of Mexico and Peru.
Harley, who sided with the Tories, also envisioned the South Sea Company as a financial institution competing with the Bank of England, a Whig institution. Expectations of great wealth from the trade monopoly appealed to investors. Some owners of government bonds totaling £9 million traded their bonds for company stock, which the government secured at 6 percent interest. To pay this interest, the government levied permanent taxes on tobacco, goods from India, vinegar, wines, and other items. South Sea was a joint stock company, a partnership that had common capital called stock. Shares of the stock were owned by the partners, called shareholders.
In 1713, the War of the Spanish Succession ended with the Treaty of Utrecht, in which Spain granted an asiento de negros (“Negroes’ contract”) to Britain. The asiento was the exclusive right to supply 4,800 enslaved Africans annually to Spanish America for thirty years. The British government then sold this lucrative monopoly to the South Sea Company for £7.5 million. Imported African slave labor was essential to Spain’s empire, especially for the labor-intensive mining industry. The company also acquired the right to send a ship annually to trade with Peru, Chile, or Mexico. However, the first voyage of the annual vessel was delayed until 1717, and trade discontinued when England and Spain went to war again in 1718. Yet in spite of the company’s lack of trade or actual commercial value, speculators continued to invest with expectations of future profit, and the South Sea Company thrived as a financial institution.
Meanwhile, in France, John Law, the innovative Scottish financier, was in exile from Scotland to avoid a death sentence for killing a man in a duel. His Mississippi Company became France’s most powerful business, with authority over the French national bank (Banque Royale) and the mint. The Mississippi Company also held a monopoly on trade with France’s North American colony, and it controlled the French East India and China companies. In August of 1719 this company assumed the entire national, or public, debt by substituting paper currency for gold. Increasing amounts of money were printed for loans to buy shares, as shares rose in price. Law kept driving stock prices up, and France was experiencing a speculative fever.
Inspired by Law’s example and afraid of English money flowing to France, the lawyer John Blunt and the South Sea Company’s directors came up with a stock-jobbing (stock-brokering) scheme similar to that of Law. In 1719 the South Sea directors proposed to assume the entire English national debt, most of which consisted of bonds and annuities, which were loans to the government in exchange for a fixed income for life. These government obligations could be exchanged at par for shares of South Sea Company stock.
In April, 1720, Parliament accepted the proposal and speculators eagerly purchased South Sea Company stocks. Blunt and the directors of the company manipulated company stocks for their own profit. Blunt drove prices higher and higher by permitting the purchase of stocks on an installment plan, issuing new loans at favorable interest rates, and then offering new subscriptions or issues of stocks to draw the money back in. As a result, the company’s stock rose in price from £128.5 per share at the beginning of the year to £1,000 in July.
The success of the South Sea Company led to the appearance of hundreds of new joint-stock companies, mostly bogus imitators hoping to take advantage of the speculation mania. Threatened by this competition, the directors of the South Sea Company convinced Parliament to pass the Bubble Act of June 9, 1720, an act requiring parliamentary permission for the establishment of a company. On July 12, the lords justice in the Privy Council published an order dismissing all petitions for patents and charters and dissolving all bubble companies. Some famous, far-fetched bubbles included companies for trading in hair, for extracting silver from lead, and for building a wheel in perpetual motion.
In spite of these actions against other bubble companies, the momentum of rising prices for South Sea stock could not be sustained. In August, John Blunt sold all his South Sea stock just before prices began falling. Other insiders sold too, and soon everyone was a seller and no one was buying stocks. In September the bubble burst and there was a complete financial collapse by the end of September. The price of South Sea stock fell to £135, and other stocks lost their value. Unemployment jumped, banks failed, thousands of investors became bankrupt, and the real estate market suffered.
Furious investors demanded revenge against the South Sea Company’s directors, so Parliament reconvened. An investigation of the company determined that there had been widespread fraud among company administrators and some government officials. Parliament confiscated profits made by the directors. In a settlement in August, 1721, these assets of approximately £2 million were redistributed to stockholders at £140 per share.
Significance
The South Sea Bubble marked a turning point in the career of Robert Walpole, the powerful parliamentary leader who had opposed the scheme from the beginning. He successfully helped in the aftermath and made proposals to restore public confidence. As a result, he rose to power and was appointed the first lord of the treasury and chancellor of the exchequer. Walpole helped reorganize the South Sea Company, but the company ceased commercial activities with the loss of many special privileges in 1750. By 1807 it had lost all exclusive rights. Remaining company annuities were either converted into government stock or redeemed in 1853.
Although enormous fortunes were lost, many investors had actually made huge profits. Numerous members of the court and the Parliament took bribes from the South Sea Company and profited from secret share options. Others investors were able to sell South Sea shares when prices peaked. One notable example was Thomas Guy, who later used his stock gains to help build Guy’s Hospital for the sick and poor of London.
Most significant, the collapse of the South Sea Bubble had long-term negative effects on the British economy. Sir John Barnard’s act of 1734, which forbade speculative techniques such as short sale and futures and options, remained in effect until the middle of the nineteenth century. The general aversion toward speculation and the existence of joint-stock companies discouraged the entrepreneurial spirit and investment in new projects, thus delaying the Industrial Revolution for generations.
Bibliography
Balen, Malcolm. The King, the Crook, and the Gambler: The True Story of the South Sea Bubble and the Greatest Financial Scandal in History. New York: Fourth Estate, 2004. This complete, entertaining history includes discussion of the financial and political ramifications of the bubble. Illustrations, bibliography, and index.
Carswell, John. The South Sea Bubble. Dover, N.H.: Alan Sutton, 1993. Originally published in 1960, this is the classic, thorough study of the South Sea scheme. Illustrations, index, appendices, and extensive bibliography.
Chancellor, Edward. Devil Take the Hindmost: A History of Financial Speculation. New York: Plume, 2000. This well-researched account covers the origins of financial speculation in ancient Rome through the 1990’s and has an entertaining chapter, “The Never-to-Be-Forgot or Forgiven South-Sea Scheme.” Index, notes, and bibliography.
Garber, Peter M. Famous First Bubbles. Boston: MIT Press, 2000. The book’s main premise is that major early bubbles were driven by economic and financial conditions rather than crowd irrationality. Appendices, bibliography, and index.
Kindleberger, Charles P. Manias, Panics, and Crashes: A History of Financial Crises. New York: Wiley Investment Classics, 2001. A well-researched examination of centuries of major financial crises, including the South Sea Bubble. Index and bibliography.
MacKay, Charles. Extraordinary Popular Delusions and the Madness of Crowds. New York: Three Rivers Press, 1995. This reprint of the popular, humorous classic first published in 1841 chronicles the South Sea Bubble plus other fascinating tales of mass mania, deception, and greed. Illustrations and index.