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).

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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.

 

An Efficient Market? Going Public in London, 1891-1911

by Sturla Fjesme (Oslo Metropolitan University), Neal Galpin (Monash University Melbourne), Lyndon Moore (University of Melbourne)

This article is published by The Economic History Review, and it is available on the EHS website

 

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Antique print of the London Stock Exchange. Available at <https://www.ashrare.com/stock_exchange_prints.html>

The British at a disadvantage?
It has been claimed that British capital markets were unwelcoming to new and technologically advanced companies in the late 1800s and early 1900s. Allegedly, markets in the U.S. and Germany were far more developed in providing capital for growing research and development (R&D) companies whereas British capital markets favored older companies in more mature industries, leaving new technology companies at a great disadvantage.
In the article An Efficient Market? Going Public in London, 1891-1911 we investigate this claim by obtaining detailed investment data on all the companies that listed publicly in the U.K. over the period 1891 to 1911. By combining company prospectuses, which provide issuer information such as industry, patenting activity, and company age with those company’s investors we investigate if certain company types were left at a disadvantage. For a total of 339 companies (out of 611 new listings) we obtain share prices, prospectuses, and detailed investor information on name and occupation.

A welcoming exchange
Contrary to prior expectations we find that the London Stock Exchange (LSE) was very welcoming to young, technologically advanced, and foreign companies from a great variety of industries. Table 1 shows that new companies were from a great variety of industries, were often categorized as new-technology, and almost half of the companies listed were foreign. We find that 81% and 84% of the new and old technology firms that applied for an official quotation of their shares were accepted by the LSE listing committee, respectively. Therefore, there is no evidence that the LSE treated new or foreign companies differently.

Table 1. IPOs by Industry

  IPOs Old-Tech New-Tech Domestic Foreign
Banks and Discount Companies 4 4 0 0 4
Breweries and Distilleries 13 13 0 12 1
Commercial, Industrial, &c. 155 137 18 125 30
Electric Lighting & Power 11 0 11 9 2
Financial Land and Investment 23 23 0 2 21
Financial Trusts 12 12 0 8 4
Insurance 7 7 0 7 0
Iron, Coal and Steel 20 20 0 20 0
Mines 8 8 0 0 8
Nitrate 3 3 0 0 3
Oil 11 11 0 0 11
Railways 10 9 1 5 5
Shipping 3 3 0 3 0
Tea, Coffee and Rubber 48 48 0 0 48
Telegraphs and Telephones 3 1 2 1 2
Tramways and Omnibus 6 0 6 5 1
Water Works 2 2 0 1 1
Total 339 301 38 198 141

Note: We group firms by industry, according to their classification by the Stock Exchange Daily Official List.

We also find that investors treated disparate companies similarly. We find British investors were willing to place their money in young and old, high and low technology, and domestic and foreign firms without charging large price discounts to do so. We do, however, find that investors who worked in the same industry or lived close to where the companies operated were able to use their superior information to obtain larger investments in well performing companies. Together our findings suggest that the market for newly listed companies in late Victorian Britain was efficient and welcoming to new companies. We find no evidence indicating that the LSE (or its investors) withheld support for foreign, young, or new-technology companies.

 

To contact Lyndon Moore:  Lyndon.moore@unimelb.edu.au

How accounting made financial markets in the Early Modern age

by Nadia Matringe, London School of Economics

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In the early modern age, accounting was the site of finance.

From the sixteenth century onwards, the unprecedented growth of international trade and banking gave rise to the great exchange fairs (Lyon, Bisenzone, Castile, Frankfurt, etc.), with international clearing and banking functions. To exploit these new opportunities while limiting risks, a growing number of banks at the fair locations specialised in the commission business, which required a high demand for goods and capital to yield substantial profits.

Both these transformations deeply affected the international payments system. In particular, they gave rise to new uses of accounting as a payment and credit instrument.

The research, to be presented at the Economic History Society’s 2017 annual conference, analyses this transformation and highlights the role of accounting in shaping early modern financial markets. It shows that at that time, accounting tables were not only used as local means of payment through book transfers initiated by oral order: they also became the sole material support for a growing number of international fund transfers and credit operations.

Indeed, as chains of commission increased in length and density, both the exchange and the deposit business changed in form and started to be increasingly operated through the accounting medium.

The classical exchange operations, which usually involved four parties (a drawer, a remitter, a payer and a payee) and the circulation of a bill of exchange between two markets, could now be conducted by two parties through their corresponding accounting systems, on behalf of several clients.

In these transactions, bank A would draw on and remit monies to bank B on behalf of clients who appeared as drawers and remitters by proxy. Payments on both markets took the form of book transfers, and no bill of exchange was issued: banker A simply informed banker B in his usual correspondence to credit and debit the pertinent accounts according to agreed exchange rates.

Such transactions performed multilateral clearance between distant regions of the world, where the bankers’ clients had business.

Two-party exchange transactions reduced to accounting entries also served banking activity at the local level. In this case, at least one side of the exchange transaction (the remittance or the draft) was meant to lend or to borrow money in one of the two markets. The exchange was followed by a rechange in the opposite direction, and at a different rate, and interest was charged according to the differences in exchange rates.

Finally, the taxation of overdrafts on current accounts at the fair location enabled clients to buy bills of exchange on foreign markets without provision, and to postpone payment of those drawn on them. Consequently, deposits in Lyon, Antwerp or Castile could create credit in Florence, Paris, London, etc.

Furthermore, this old fair custom of deferments gave rise in the sixteenth century to autonomous deposit markets whose rate circulated publicly, enabling ‘outsiders’ who otherwise had no business in the fairs, to invest their savings there.

The research thus shows that in the context of the rapid development of international banking centres and the correlated rise of commission trading, accounting made financial markets.

Its function was similar to that of modern algorithms used to match orders and perform financial transactions. Accounting tables were used to make payments, transfer funds, operate clearance and grant interest-bearing loans – all of which could be combined in a single game of book entries in the accounts of corresponding partners.

International trade and banking were supported by a network of interconnected accounting systems. This accounting network appears as a major infrastructure of early modern trade, without which the whole European payment system would have collapsed.