HISTORY

At the time of Charles III rule, the Government of England was in the debt of 9 million euro and had no income to pay it back. It also needed to fund its military as Britain was at war with Spain and France who were well funded by Dutch banking system.

Similar to Dutch East India Company (VOC), a scheme was devised by the government in 1711 to form a company known as South Sea Company to pay back the debt. Instead of money the debt collectors will be given a lottery (it could not be called share as it was illiquid*) as same value as their debt.

The shares were available in the open market. Isaac Newton brought the shares at the early stage along with many other wealthy investors.

The South Sea Company operated as a monopoly, a joint-stock company and to make sure other smaller companies would from taking a market share, the government also formed The Bubble Act 1720. It traded slaves from South America and would pay dividend to the debt collectors but the only problem was that during that time South America was controlled by Spain and Britain was at war with Spain.

It does not look like a good idea, right? To be dependent on the country you are war at?

And as expected, Treaty of Utrecht was signed which would allow Britian to trade slaves but their expectation fell flat when Spain allowed only limited amount of trade and took a large percentage of profit in exchange. Therefore, no real profit was generated and the company ability was questioned by the public.

In 1714, Arthur Moore, sponsored by a director of the company tries to use the company ship for its own benefit which exposed the company’s corruption and questioned the company’s capability. Following the negative sentiments of the people, the government decided to buy South Sea Company and revive it.

The only difference was the government would directly manage the company rather than indirectly, which in a way does not change anything.

THE RISE OF THE SHARE

Unexpectedly, the move worked and the stock went to 1,000 euro. But how?

In 1719 the government came up with the plan that the company would issue 1,150-euro new stock against the surrendering of stock of 100-euro which would give 5% interest every year. (The conversion was made voluntary). The government considered their scheme as a hit as it would reduce their debt and the people attracted by the scheme would buy and raise the stock value which they would use to pay of their debt.

The conversion of the lottery to stock would make the investment liquid and the shareholder would able to sell the stock and make money anytime.

After some changes the plan was implemented and the price of the stock shot up to 1,000-euro, mainly because of herd behaviour. Newton also brought shares many times in this time period and once the stock began selling, it did not stop and dropped down to 100-euro in the matter of months, from which Newton also lost a bit of money.

It triggered bankruptcies and ruined many individuals, including the early investors who owned many company shares creating outrage across the public. The government incompetence was revealed and the investigation was conducted. The next year the report came out which reported the fraud and corruptions which were conducted in the company.

The whole idea was no less than a Ponzi scheme. The South Sea Company was hollow from inside from the beginning because of its lack of profit was clear from the beginning but the rising of stock coupled with the mentality of gaining benefit in the public ruined the economy in one year.   

Citation

The South Sea Bubble. www.thehistoryoflondon.co.uk

Marples, A. (September 2020). The South Sea Bubble of 1720. nationalarchives.gov.uk

Stewart, T. The South Sea Bubble. www.historic-uk.com

Odlyzko, A.(2020).Isaac Newton and the perils of the financial South Sea. Physics Today