The South Sea Bubble

The greatest stimulus to the creation of Britain’s financial system came not from trade but from wars. During the 17^th century the Dutch were the most sophisticated financiers in Europe. The small nation were able to successfully fight against much greater powers such as the French and Spanish because they had developed a banking system that could fund their military. The expense of Britain’s military was the personal responsibility of each monarch and the Stuart dynasty continually struggled under a heavy burden of debt, which made it difficult to successfully fight the various wars in which they were involved. It was under Charles II that his royal debt evolved into the national debt, to be controlled by Parliament instead of the King. New financial ideas arrived from the Netherlands with William of Orange when he took the throne as King William III.

The mechanism to raise funds from investors was complex but it was simplified by using joint-stock companies. They could raise funds by offering shares that could not only be traded but also, all being well, would pay out dividends to shareholders. Thus, the Bank of England, a joint-stock company, was established in 1694 to raise money when William needed to raise £1.5 million to build a naval fleet to rival that of his long-time enemy France. The East India Company also lent to the government. British politics was dominated by members of the Whig political party and both the Bank of England and East India Company were largely under their control.

The Hollow Sword Blade Company had been founded at the time of conflict with France at the end of the 17^th century to manufacture swords but in the following years it expanded its operations. By the early 18^th century it was operating as the Sword Blade Bank, and was rivalling the Bank of England in lending money to the government. It sold shares to raise capital to provide loans. Directors of the Sword Blade Bank included John Blunt, George Caswall and Jacob Sawbridge. The Bank of England objected to the incursion on its near-monopoly, however, and ultimately Sword Blade failed.

England was involved in a series of costly wars, almost continuously from 1688 until 1714, and much of the national debt was money owed to naval contractors. In both 1699 and 1710 there were crises when debts to these suppliers became so large that they threatened to stop supplying the navy. In the latter of those two years, Queen Anne replaced her Whig government with a Tory ministry. By then debts amounted to £9 million and there was a reluctance for anyone to lend more. The government were desperately short of funds and could not rely on a Parliament divided between Whigs and Tories to raise money through taxation.

Historically there had been numerous lenders to the government, with many older loans incurring high interest rates. Robet Harley, the new Chancellor of the Exchequer, looked to restructure part of the national debt, consolidating various high-interest loans into one larger fund, without reliance on the Whigs. The issue was made particularly urgent because France, then Britain’s great rival, was putting itself on a stronger financial footing to fund future wars. The Scottish economist John Law was advising the French to consolidate its entire national debt into one organisation, what became the Mississippi Company.

Harley therefore agreed in 1711 that John Blunt should establish the South Sea Company as the vehicle through which the debt consolidation could take place. The directors of the venture included Blunt, Caswall and Sawbridge, who had all been involved in the Sword Blade Bank. The company’s first Governor was Harley, elevated to the Earl of Oxford, and it was based at South Sea House at the corner of Threadneedle Street and Bishopsgate in the City. From 1718 Queen Anne’s successor, King George I, was appointed Governor, increasing the stature to the company.

The mechanism by which money could be raised and then lent to the government was by selling shares, the same method as had previously been used by the Sword Blade Bank. But to drum up interest amongst the public to hand over their cash the company put forward the promise of trade with Spanish South America. For many it was a place of unlimited riches, the mythical El Dorado, of far greater potential than the farmlands of North America. It was a time of intense rivalry between European nations to gain colonies in the Americas, so there was a chance the company could at some point own a colony from which to profit.

Nine and a half million pounds was lent to the government. Part of that sum was in the form of company shares given to naval contractors in lieu of money owed to them by the government. The hope was that others who had previously lent to the government would convert those loans into shares. In return, the government granted the company a monopoly on trading with the east of South America, with the exception of Portuguese and Dutch colonies. There was expectation that it would profit from trade in cloth, agricultural goods and fishing, but certainly the main commodity required by that region was enslaved African labourers.

During the 16th century Spain had colonised large parts of Central and South America and it was from there that gold and silver were mined to be sent back. The mining required large-scale workforces undertaking heavy labour. The indigenous population had been decimated by the Spanish, as well as from their imported diseases, so African enforced labour was continually required. Spain never directly entered the trans-Atlantic slave trade. It initially relied on the Portuguese, and later contacted the business to other nations under asiento agreements.

The long War of Spanish Succession ended with a series of agreements signed between 1713 and 1715 known as the Treaty of Utrecht. The treaty, negotiated for the British by the diplomatic envoy Lord Lexington, provided Britain with several prizes including the new colonial possessions of Gibraltar and Minorca. Another was the exclusive right given by King Philip V of Spain to Britain’s Queen Anne to supply enslaved African labourers to Spanish colonies, which from 1701 until then had been held by France.

“The Catholic King doth furthermore hereby give and grant to her Britannic Majesty, and to the company of her subjects appointed for that purpose, as well the subjects of Spain, as all others, being excluded, the contract for introducing negroes into several parts of the dominions of his Catholic Majesty in America, commonly called El Pacto de el Asiento de Negros, for the space of thirty years successively, beginning from the first day of the month of May, in the year 1713, with the same conditions on which the French enjoyed it…”

Harley arranged for the South Sea Company to fulfil the asiento agreement, aware that the public’s enthusiasm for the slave trade, and the possibility to trade with Spanish colonies, would bolster its share price. The British government sold the contract to the South Sea Company for £7,500,000. It had an obligation to supply 4,800 enslaved labourers each year, and to pay the Spanish King 33½ pesos for each delivered safely, with an advance of 200,000 pesos.

The agreement additionally provided England with the right to send just one ship of goods each year, known as the ‘permission ship’, to a Spanish colonial port. That was far less than the impression given when shares were initially sold but still seen as an important foot in the door, with the hope of extending the right in the future.

Slave-trading was a complex business with a high barrier to entry. It required, amongst other things, a good knowledge of the African business, which the newly-established company lacked. On the other hand, the Royal African Company, together with its predecessors, had been involved in that business for fifty years. Its monopoly on the business had not been renewed after William came to the throne, and most of the business had been taken over by independent traders. Nevertheless, the RAC still retained much knowledge, as well as forts on the African coast. It therefore made sense for the South Sea Company and RAC to form a partnership to carry out slave-trading. Members of the RAC Court of Assistants were early subscribers of South Sea Company shares. The first South Sea Company slaving voyages took place in 1714.

By 1719 the government owed the South Sea Company £11.7 million. The Bank of England and South Sea Company competed to take on government debt. To aid its success the South Sea offered various share options to MPs and members of the royal court. In April Parliament authorised a further loan of £7 million from the company. As the loan increased the company was permitted to increase its nominal value, that is the maximum number of shares that could be issued, in proportion to the converted government debt. Thus, further shares became available to be sold to investors.

There was a growing business class of people with capital to invest and numerous unregulated schemes and lotteries were created that promised to increase the wealth of the unwary. Various joint-stock companies were established in the latter decades of the 17^th century yet investors’ options were still far more limited than in modern times. Dividends from shares were as yet untaxed and, unlike land, shares could be bought and sold by women. A new profession had emerged to trade in company shares: the stock-jobber.

The South Sea Company, with its loans to the government and involvement in the slave trade, must have looked like a safe and low-risk investment. It had strong links with both the Royal Navy and the long-established Royal African Company. To make its stock more attractive the company offered subscription shares, which allowed small investors with limited funds, or those cautious to enter the market, to pay over a period of time. Options, meaning the right to buy or sell shares in the company at a future date, were also widely used. Furthermore, in 1720 the company began to provide loans to investors so they could purchase additional shares, an idea copied from the Mississippi Company in France.

With investors having loans to buy shares, the market for joint-stock shares was buoyant. Two major wars had ended and there was more confidence within the country. Indeed, other rival schemes, some quite spurious, took advantage to launch themselves. With funds being diverted to other share offerings the South Sea directors persuaded the government to incorporate into an Act of June 1720 (later referred to as the Bubble Act) a section making it illegal to form a joint-stock company without a royal charter. The price of South Sea shares began to trade at increasing prices, which escalated into a frenzied buying of shares over the summer.

In June the share price of the Mississippi Company in France, which had copied aspects of the South Sea Company in England, crashed. Some people diverted their investments from France to England. With news of the latest loan to the government, the price of each South Sea share rapidly increased in 1720 from £126 to £400, then £890 in May, and reaching £1050 in August, fuelled by highly over-optimistic trading. It was said that ladies sold their jewels to buy stock. Daniel Defoe, writing about it some years later, called it a “General Infatuation” for South Sea stock. The company decided to sell off some of its redeemable debt to the Bank of England in the form of bonds at a share value of £400. At that point the share value was well above that level so the Bank of England would have been assured of a profit.

In September the share price fell, suddenly dropping as investors sold off their holdings. There may have been multiple reasons for the initial reverse in value. One was that royal courtiers required funds to follow the King’s annual trip back to Hanover. Another was the need for cash at harvest time when wages had to be paid. There had been rumours of South Sea directors selling shares. Some investors had probably borrowed to buy company shares and, as their value fell, urgently sold them to repay the loans.

Meanwhile, some people were committed to pay for shares at £800. There was an acrimonious and inconclusive meeting between them and the company, which caused the price to fall further. As the share price fell below £400 the Bank of England decided not to complete the contract to buy bonds. The value of both the South Sea and Bank of England shares fell. When the price of South Sea shares reached just £190 it was forced to compensate some who had converted their government debts into South Sea stocks at £1000 by giving them additional shares. But the bubble had burst and by December shared traded at just £124.

Some lucky investors who purchased shares at a low price and sold at a high level before September made a fortune. Perhaps the most famous of those is the publisher Thomas Guy. He used the fortune made during his lifetime to fund schools and hospitals, notably Guy’s Hospital. Others who purchased at a high price during the summer and kept them through the autumn months lost out, particularly those who had borrowed to buy shares. Some, known as ‘South Sea Sufferers’, lost a fortune, one of whom was the Duke of Portland. There was a general uproar in the country and it was considered a major disaster. Petitions were sent to Parliament, including from the entire town of York. Some petitions were couched in hysterical terms that blamed the South Sea directors for ruining the national economy. A mob entered Parliament to protest and the Riot Act had to be read to disperse them. The government set up a Committee of Secrecy to undertake an enquiry into the crash.

Despite the enormity of the event, there was little understanding of why the price of shares had sky-rocketed and then crashed. Investing in company shares was relatively new and there was a general lack of understanding about how the stock market operated. There was no stock exchange or body to regulate buying and selling. Instead, transactions took place by stock-jobbers in the coffee houses of Exchange Alley (often referred to as simply “the ‘Change”), a warren of narrow passageways near the Royal Exchange.

There was a widespread view at the time that trading in stocks was akin to gambling. The xenophobic regarded it as something that was undertaken by Jews and foreigners. Class prejudice and misogyny viewed something that allowed servants and women to become wealthy as immoral. Popular entertainments and literature portrayed those who had purchased shares as greedy and naive, people who gained as having made money by deceitful means, and those who lost as “knaves and fools”. Stock-jobbers who handled the buying and selling at the Change were vilified as fraudsters.

There were certainly some irregularities in how the company conducted itself. The government enquiry found that loans had been given out to purchase shares but the entries of purchases were fictitious and no stock had actually changed hands. As the share price rose, holders could then make a profit by selling the fictitious stock back to the company. In reality it was bribery to influential people in order to have favourable legislation passed. Similarly, the company had paid large amounts to both the King’s sister and mistress, with a promise of additional payments based on a rise in the share price, for access to George. Some directors were also found to be undertaking insider trading, taking future options on stock they then arranged to pay out with a higher dividend. The directors who were believed to be responsible for fraud were punished by forfeiture of assets as these issues came to light, and their estates used to compensate those who lost out. Yet, their activities were not unusual for the time and to some extent were probably also undertaken by other companies. Sir John Blunt, and company cashier Robert Knight who fled to France, became useful scapegoats to deflect blame away from the monarchy and royal court.

Pamphlets and plays pointed fingers at the “vile Arts of Stock-Jobbing”, a term without any specific meaning but bandied about as some form of gambling or fraud. Much of the criticism was unfounded and came from a general misunderstanding of the issue and selling of shares. For example, a publicly-traded company is not required to sell all its shares. It may hold on to some and sell them at a time when it decides to raise new funds. After the bubble had burst there was much mistakenly said about the company having artificially driven up its value so it could sell off shares, its so-called ‘surplus stock’, at a higher price.

There were suspicions about members of the government. One of the most prominent, Robert Walpole, for example, had profited hugely from selling his shares at the ideal time, making a thousand percent profit. The investigation implicated several high-ranking politicians of corruption, notably Chancellor of the Exchequer John Aislabie, Postmaster General James Craggs the Elder, his son Southern Secretary James Craggs the Younger, and Lords Stanhope and Sunderland. Both Craggs, father and son, died in disgrace, the father committing suicide, while Aislabie, Stanhope and Sunderland were impeached, with Aislabie imprisoned in the Tower of London. The influence of Walpole saved Stanhope and Sunderland from punishment, gaining him the nickname of ‘Screen-Master General’ and he was lampooned in satirical ballads and prints.

Despite these setbacks, the South Sea Company survived and continued with its activities. Following the crash, experienced investors were able to pick up dumped shares at bargain prices and it stabilised. Some investors who had purchased shares prior to the bubble of 1720 held them and continued to enjoy an income from dividends. The consolidation of part of the government debt into the South Sea Company was ultimately beneficial to the national economy as was planned.

In his speech to Parliament in August 1721 King George praised the House for their efforts in restoring calmness to the economy but warned those in Opposition against further agitation on the issue. That prevented any deeper investigation into any fraudulent activities involving members of the royal court. The King continued to own a fortune in shares and subsequent monarchs, from George II to Queen Victoria, held the office of Governor of the South Sea Company.

Public attention soon turned away from the South Sea Bubble and it was instead preoccupied by matters of religion. Some of the assets confiscated from directors were given back. From 1725 the company added whaling to its activities, with its large whaling fleet based at the Greenland Dock at Rotherhithe. Ultimately it was unsuccessful and in 1732 the company abandoned the trade.

The total number of enslaved Africans sold to Spanish colonies by the South Sea Company was at least in the region of 30,000 and could be much higher. In 1750 the asiento agreement came to an end and the company compensated with a payment of £100,000 by the Spanish Crown. The South Sea Company was wound up in 1854 but continued to manage part of the national debt until that time.