Ludwig von Mises Institute

South Sea Bubble

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The English South Sea Company, created in 1711, was given a monopoly on trade with South America in exchange for extinguishing £9 million in government debt. The British had attempted to break the Spanish stronghold on the Americas since the reign of Queen Elizabeth I, either by force or license. This attempt, like the others, was to fail. However, the government debt was dramatically reduced.[1]

From the growth to the collapse[edit]

In 1720, the government wanted to decrease its debt even more. Against the staggering sum of £31 million, the South Sea Company was to issue an equal amount of stock that the debt holders would voluntarily exchange one for the other. A high stock price was necessary for the plan, since the company had practically no real income.

The demand for shares was enormous, supported by the beginning collapse of John Law's Mississippi Bubble in Paris. The Company’s first stock subscription was on April 14th, at a per share price of £300. The second issue came two weeks later, on April 29th, at a price of £400. The terms of payment quickly became more liberal. With the market frantically trading up the stock, the Company made its third and largest issue on June 17th, at £1,000 per share. The fourth, and final issue was made on the 24th of August, at, again, a £1,000 share price.

This tremendous speculation led to a flood of other proposals for new companies in Exchange Alley. Many of the proposed operations were swindles, with promoters marketing a particular stock with the tool of low down payments and deferred-payment plans, only to confiscate the down payments and leave the city. Some, however, were respectable ventures. The number of "bubble company" proposals hit its height in June, with 88 being promoted in that month. Only eleven more were sponsored the entire rest of the year. Speculation was not limited just to South Sea shares or these "bubble companies." Other securities rose as well, along with the price of land.

Ironically, at the height of speculation in June, the pin that would eventually pop the bubble was being fashioned by the British government. The Bubble Act made it an offense to "presume to act" as a corporate body or to divert an existing charter to unauthorized ends. In August, four companies were found to be in violation of the Act. Although the Act had been enacted to keep capital from being channeled away from the South Sea Company, the writs against the four companies signaled the beginning of the steep fall in the price of South Sea shares. In spite of desperate attempts to increase the demand for shares by declaring a 30 percent Christmas dividend (à la John Law), a torrent of sell orders descended upon Exchange Alley. By mid-September the share price had dropped to £520, and by October the price was £200, on the its way to £120 in December. The bubble had exploded.

After the "house of cards" had finally been leveled, the financial prospects of the South Sea Company were put in a clearer light. The Company’s only asset, besides trading privileges that were for the most part unexploitable, was a stream of income from the Exchequer in the amount of £2 million per year. The bad news was that expenses for the coming year were £14.5 million. The South Sea Company was hopelessly insolvent.

In spite of the Company technically being bankrupt, it was able to stay in business for many years through a massive reorganization engineered by Sir Robert Walpole. Walpole’s ability to sift through the wreckage and decide who the winners and who the losers would be from this financial train wreck made him a revered and beloved man of such high reputation that he went on to rule England as Prime Minister for twenty years.

The South Sea bubble episode was relatively short compared with that of the Mississippi Bubble. The difference between the two bubbles was that Law used the Royal Bank to print more money, and thus sustained the system for a longer period of time. Conversely, the Bank of England stood apart from the South Sea government debt conversion. As the bubble burst, the Bank of England, concerned about its own survival, discontinued discounting, called in loans made against its own stock and loans made to the East India Company, and sold customers interest-bearing notes in an attempt to raise cash.[1]

References[edit]

  1. 1.0 1.1 Doug French. Early Speculative Bubbles and Increases in the Supply of Money (pdf), p.75-103, Second Edition, 2009. Referenced 2011-01-09.

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