The South Sea Bubble 300 Years On

by William Quinn (Queen’s University, Belfast)

A special issue on the Tricentenary of the South Sea Bubble was published on The Economic History Review as open access, and it is available at this link

The South Sea Bubble, a Scene in 'Change Alley in 1720 1847, exhibited 1847 by Edward Matthew Ward 1816-1879
Edward Matthew Ward (1847) The South Sea Bubble, a Scene in ‘Change Alley in 1720. Available at Tate Gallery

In 1720, the British Parliament approved a proposal from the South Sea Company to manage the government’s outstanding debt. The Company agreed to issue shares, some of which would be bought using government annuities rather than cash. The Company would then pay the government a reduced rate of interest on these annuities. The government’s debt burden would be reduced, and in exchange, the Company believed it had gained the opportunity to establish itself as a competitor to the Bank of England (Kleer, 2012).

Superficially, the scheme didn’t make much sense. How would the public be convinced to exchange lucrative government annuities for equity in a company whose main asset was a reduced rate of interest on those annuities? The trick was to lure annuity holders with the promise of capital gains on South Sea shares. Consequently,  the Company’s directors, with the implicit support of the government, engineered a bubble, primarily by creating a liquid secondary market for their shares, then extending huge amounts of credit to investors to flood the market with cash (Dickson, 1967). This strategy was too successful:  the scale of the bubble subsequently  provoked a backlash that ruined the South Sea directors (Kleer, 2015).

Picture 1ss
Figure 1. South Sea Company Share Price (£) and Subscriptions, 1719-20. Source: European State Finance Database

Almost as interesting as the scheme itself is how the memory of this event evolved.  A century later, the scheme was recounted as a sorry episode in the nation’s history, an economic disaster never to be repeated (Anderson, 1801). In the mid-nineteenth century it was remembered as an outbreak of collective madness, a cautionary tale for ordinary people on the dangers of being caught up in a speculative frenzy (Mackay, 1852). More recently, the Bubble  has been used as a case study to assess the efficiency of financial markets (Dale et al., 2005, 2007; Shea, 2007).

But, how should it be remembered? None of the available data suggests that 1720 was in any way an economic disaster, which is unsurprising, since participation in the scheme was much too low to have had systemic economic effects (Hoppit, 2002). Others have suggested that the Bubble Act, which accompanied the bubble, hamstrung British finance for the next century. But Harris (1994, 1997) has shown that much of what the Bubble Act outlawed had already been illegal, and as a result, it was almost never invoked.

Remembering 1720 as a sudden outbreak of madness would let the government off the hook: the bubble did not emerge spontaneously, but was deliberately created (Dickson, 1967). The level of political involvement in the market also makes it an unsuitable test case for the efficient markets hypothesis, and in any case, the structure of stock markets in 1720 was so radically different from today that they are unlikely to tell us much about the efficiency of modern markets.

Perhaps, then, the most significant feature of the South Sea scheme was its success. Prior to 1720, Britain’s debt burden was an existential threat, as it kept interest rates high, making it very expensive to fund warfare. The South Sea conversion scheme significantly reduced this burden. In France, the unwinding of the Mississippi scheme led to the reinstatement of  debt at its pre-1720 level (Velde, 2006). But in the aftermath of the South Sea scheme, the British government managed to sustain the improvement in its debt position, largely by redirecting the anger of ruined investors towards the scapegoated South Sea directors (Quinn and Turner, 2020). This allowed it to borrow at much lower interest rates, giving the country a major advantage in subsequent wars. After 300 years, is it time to start remembering the South Sea Bubble as a net positive for Britain?

 

To contact the author: W.Quinn@qub.ac.uk

 

References

Anderson, A. ‘An extract from The Origin of Commerce (1801)’ in R.B. Emmett (ed.), Great Bubbles Volume 3, London: Pickering and Chatto, 2000.

Dale, R.S., Johnson, J.E.V., and Tang, L. ‘Financial markets can go mad: Evidence of irrational behaviour during the South Sea Bubble’, Economic History Review58, 233-71, 2005.

Dale, R.S., Johnson, J.E.V., and Tang, L. ‘Pitfalls in the quest for South Sea rationality’, Economic History Review, 60, 766-772, 2007.

Dickson, P.G.M. The Financial Revolution in England: A Study in the Development of Public Credit, 1688-1756. London: Macmillan, 1967.

Harris, R. ‘The Bubble Act: Its passage and its effects on business organization’, Journal of Economic History54, 610-27, 1994.

Harris, R. ‘Political economy, interest groups, legal institution, and the repeal of the Bubble Act in 1825’, Economic History Review, 50, 675-96, 1997.

Hoppit, J. ‘The myths of the South Sea Bubble’, Transactions of the Royal Historical Society, 12, 141-65, 2002.

Kleer, R. ‘“The folly of particulars”: The political economy of the South Sea Bubble’, Financial History Review19, 175-97, 2012.

Kleer, R. A. ‘Riding a wave: The Company’s role in the South Sea Bubble’, Economic History Review68, 264-85, 2015.

Mackay, C. Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, London: Robson, Levey and Franklin, 2nd edition, 1852.

Quinn, W. and Turner, J.D. Boom and Bust: A Global History of Financial Bubbles, Cambridge: Cambridge University Press, 2020.

Shea, G. S. ‘Financial market analysis can go mad (in the search for irrational behaviour during the South Sea Bubble)’, Economic History Review60, 742-65, 2007.

Velde, F. ‘John Law’s System and Public Finance in 18th c. France.’ Federal Reserve Bank of Chicago, 2006.

 

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