b-school, Business, Economy, History, MBA, Thoughts

The South Sea Company (or how Sir Isaac Newton spurned the dismal science)

Some days ago I started writing about bubbles with the post Tulipmania, XVIIth century. Today I want to resume this journey throughout the major bubbles of the economy. Hopefully we’ll reach some conclusion together (I already have thought of some, and some are unexpectedly positive), or even see some bubble burst (probably).

We jump is from 1593 to 1711, from the Netherlands to England: the South Sea Company.

But the story begins somewhere else, earlier, with this king that was said was under a spell:

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It’s 1700 and we are in Spain. King Charles II (Carlos II el Hechizado) has just died. He has been ill for almost all his life. He was 38, but looked much older.

But he has been the king of the biggest empire in the XVII century. An empire spread around the world that has splashed Europe around with his colors. An empire that imported tons of precious metals and discovered that the excess of currency also meant higher prices (hyperinflation). An unsustainable empire, thought to be very rich, but nonetheless an aging empire.

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But Europe’s bound to change a lot after Charles II. Different powers were pushing at each other. And the rivalry of two families: the Habsburgs (Charles II was one of them) and the Bourbons.

And the prey is the Spanish Empire in Europe, not only Spain but also the Low Countries and parts of Italy. And, as vultures, the different European nations take sides in the Spanish Succession War.

The Bourbons win this war in Spain, but not in Europe. The initial plan had been to unite Spain with the emergent France, but Phillip V of Spain is forced to resign his post in the French line of succession.

He retains Spain’s overseas possessions but renounces to the Spanish Netherlands and the Spanish Italy both to Austria and Savoy, and Gibraltar and Minorca to Great Britain. France also cedes many colonial possessions overseas, but their borders are not changed.

All this is written and signed in the Treaty of Utrecht, 1713.

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The South Sea House in Threadneedle Street

Why is this important for a company like the South Sea?

The company is established in 1911 by the financiers John Blunt and George Caswall, backed by Robert Harley, Lord Treasurer. It’s a time of war. The company is granted exclusive trading rights with South America if they take over the national debt caused by the war and consolidate it. Somehow it’s established as a sort of parallel organisation to the Bank of England.

After the war Britain is in debt for more than £10 million. (yes, 1713’s Pounds, not 2007’s). All that debt is funneled through the company transforming short-term debt into stock. In exchange the government is committed to paying £576,534 perpetually, that is roughly a 6% return.

But a trade company needs more than an annuity to exist. That is also provided by the Treaty of Utrecht. In it is also established that the Kingdom of Great Britain and Ireland will be able commerce with Spanish South America (something that they already discounted when founding the company). The South Seas company is able to send one trading ship each year.

Astonishingly, the company fails to do any trade for the first four years. Nonetheless it has the backing of the British Government, which soon converts a further £2 million in stock. No actual business, but a promise of a bright future (sound familiar?).

The company is also granted the exclusivity over the Spanish Asiento. That means being able to sell 4.800 slaves per year to the Spanish colonies. In 25 years they make around 70 voyages and sell 30.000 slaves. Only 4.000 perished in the journeys: that means being quite efficient for a slave trader.

Stocks going up…

But the company is not good enough at trade. What they are increasingly good is into transforming public debt into shares. And they manage to give away enough shares to important people (and rebuy them when they have increased enough) so that most politicians are interested in supporting and backing the South Seas Company. That is, to drive value up.

1719 is a good year for the South Seas company. They offer to buy half of the British national debt: £15 million. That means £15 million more in shares. But demand’s pace keep up. There’s a huge interest in their shares. After all they continuously rise and lucky owners feel they are richer every day.

1720 is going to be known as the bubble year. Not only will witness the skyrocketing of the South Seas but also the appearance of many similar ventures. The price per share will go from £100 to £1,000. People of all kinds will buy, selling whatever they have, going into debt, it’s the South Seas frenzy!

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The fall follows the rise

The last idea that the company has is to lend people money to buy the shares. But the money has to be returned. And there is no other way to return it than selling shares again. Until it all collapses and the shares fall back to £150 in september. A great loss for most investors. And from that to obliteration.

Sir Isaac Newton

What about Sir Isaac Newton? Well, he won a lot of money with the South Sea when he sold it, but the shares kept rising and rising. Until he couldn’t resist the temptation to buy again. At the highest price. In the next week they plunged. He lost £20,000.

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I can calculate the movement of the stars, but NOT the madness of men

Jonathan Swift also lost a fortune. He wrote Gulliver’s Travels, a satire about the British society. The cons fled somewhere else with their fortunes but, for Britain, the consequences of the crash lasted for a century.

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One thought on “The South Sea Company (or how Sir Isaac Newton spurned the dismal science)

  1. Pingback: Financial weapons of mass destruction unleashed in the U.S. « Gabriel’s scarcity rent - it’s management stupid!

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