by elmads

Introduction

“Bubbles, bright as ever Hope
Drew from fancy – or from soap;
Bright as e’er the South Sea sent
From its frothy element!

…

See!—But hark my time is out —
Now, like some great water-spout,
Scaterr’d by the cannon’s thunder,
Burst, ye bubbles, burst asunder!”

— Thomas Moore

In the modern English translation.

Bubbles, shining with hope and made from imagination or soap, were as bright as the ones that are formed in the frothy waves of the South Sea.

…

Look! But wait, I’m running out of time. Now, these bubbles should burst and break apart like a huge waterspout that has been scattered by the sound of cannon fire.

The South Sea Bubble, like its predecessor, the Tulip Mania of 1637, and the Mississippi Bubble—which happened in the exact same year as the South Sea Bubble—are cautionary tales of greed and financial ruin. No bubble, literally and metaphorically, will last for long. As the portion of Thomas Moore’s poem says, “Bubbles should burst and break apart”.

War, Debt & The Chancellor of the Exchequer

To understand how this bubble formed, we need to rewind the clock to the late 17^th century in England. This was a time when consecutive wars raged all throughout the European continent—superpowers during those times ate war for breakfast. They can’t just stop themselves from looking for one. 😂🤪 – The same can be said with England.

Note: Great Britain wasn’t formed yet, not until 1707. Meaning, England, and Scotland were not unified as one country before 1707.

England had multiple wars: civil wars like the Irish Confederate Wars (1641) and the English Civil War (1642) and international wars such as the Franco-Dutch War (1672), the Nine Year’s War (1688), and the War of Spanish Succession (1701), to name a few.

As most of us know, wars are very costly endeavours. It requires a substantial amount of manpower, money, and resources to fund one. And as such, like any other country that raged and joined wars during those times, England also took on massive amounts of debt.

“Who goes a borrowing, goes a sorrowing.”

—Thomas Tusser

Regardless of whether wars are won or lost, it is always the nation, its economy, and its people who pay the price. And England did, it ballooned its debt balance sheet, and paying those accumulated debts was one of the chief tasks of the chancellor of the exchequer.

NOTE: The chancellor of the exchequer, in simple terms, is like the chief financial officer of the UK government. They work closely with other government officials to make decisions about how to allocate money and manage the country’s finances.

This financial predicament seems very familiar, isn’t it? Well, it is, and that’s because the national debt problem of England was the same problem of France within that same period.

If you’ve read my blog titled “The Mississippi Bubble: How an Economist Financially Destroyed France”, you’ll see exactly the resemblance between how the Mississippi Bubble and the South Sea Bubble started.

In May 1707, the English and Scottish parliaments passed The Act of Union, which led to the unification of the two countries and the creation of the United Kingdom of Great Britain.

Robert Harley, The Chancellor of the Exchequer

In 1710, a new chancellor of the exchequer was appointed by Queen Anne (the reigning monarch at that time), and that person was Robert Harley. He was a prominent figure and a very influential person in the political sphere, and he had the ability to form alliances across different political parties at that time. He held various high-ranking positions in the government, one of which was chancellor of the exchequer.

Robert Harley reached government positions that only a few people would be able to reach in their lifetime. He thought that everything would be fine and great now that he was the Chancellor, but it did not last long. Everything turned south so quickly when he checked the balance sheet of Great Britain.

On the left column, he found out that the government treasury had roughly £5,000 in assets (£674,451.30 in today’s amount), not too bad. But then, when he looked at the liabilities side of the nation’s balance sheet, it showed an eye-watering and breathtaking £9,000,000 in approximation (that’s £1,214,012,331.20 or £1.2 billion in today’s amount!!! That is MASSIVE! most especially relative to the country’s assets back then).

NOTE: The inflation-adjusted amount from then to today was taken from the Bank of England’s inflation calculator website: https://www.bankofengland.co.uk/monetary-policy/inflation/inflation-calculator

To give you context for how massive that debt is, George Osborn, the chancellor of the Exchequer in 2015, announced that the payment towards the consolidation of this debt will be made in 2015. Yes, that £9,000,00 debt in early 18^th-century Great Britain is still being paid today by the Britons, even after 300 years. To make things worse, as the South Sea bubble popped, additional debts were incurred, which are still being paid today as well. See the 2014 image and article below.

https://www.nytimes.com/2014/12/28/world/that-debt-from-1720-britains-payment-is-coming.html#:~:text=After%20that%20financial%20crash%20in,small%20part%20of%20that%20obligation.

Robert Harley had a monumental and impossible financial task to solve, and it is indeed impossible, as Britons are still paying for that same debt that Robert Harley needed to resolve 300 years ago.

So how did Robert Harley then go about reducing this debt?

Robert Harley’s Financial Predicament

Robert Harley looked for ways to reduce the nation’s debt by raising capital, but to his dismay, he only found more problems and setbacks.

• 1.) Poor accounting records

The £9,000,000 in debt was just an approximation. Robert Harley needed to find out the exact amount that the nation owed and to do that he needed to investigate the financial records of the government.

To his disappointment, he found out that there was no unified budget for the British government yet; the only thing that they had back then was a budget record for each government department—not all departments even had proper budgeting records. Thus, Harley did everything from scratch and took all the budget records of every department and made a unified list of their debts. Despite his hard work, he was still not able to make an accurate estimate of how much Britain owed, only an estimation.

• 2.) A partisan government

The political party systems of Britain strengthened during the 18^th century. There were two main political parties at that time, which were the Whigs and the Tories. It was a deeply partisan government, where both parties heavily opposed each other and had deep tensions. The opposing party blocked each piece of legislation presented by the government in the House of Commons.

The problem here was that both political parties were very busy attacking each other, trying to get the upper hand over the other. This made it hard to get a majority vote for legislation to raise taxes.

Taxation is one of the revenue streams of the government. Raising taxes would be helpful for Robert Harley, as he would be able to use those additional revenue streams to pay for the nation’s outstanding debt, but sadly, it did not happen.

• 3.) The Central Bank of England was a Whig-controlled institution.

The Bank of England was started in 1694. Its purpose is to be the lender of last resort for the government, to help raise capital for government projects and make sure the government is solvent. Sadly, Robert Harley was a Tory Party member.

A Tory party member asking for funding from the Whig-controlled central bank was the problem.

• 4.) Foreign Capital?

Britain was at war with a lot of countries back then. Who do you think would lend money to their enemy?

Also, Britain was already heavily indebted, and borrowing more would be counterintuitive.

It seemed like all hope was lost for Robert Harley. It would be a shame if the chancellor of the exchequer would not able to find a way around it, considering that this was the primary job of his position.

Harley would not give up. He would find a solution, even if it meant taking the unorthodox route.

John Blunt of the Hollow Sword Blade Company

Robert Harley raised capital by taking money from unorthodox sources. This is through a businessman named John Blunt, whom Harley had made an acquaintance with.

John Blunt was the secretary of the Hollow Sword Blade Company in 1703. The company manufactured hollow-ground rapiers, which were popular weapons in England, but in 1700 the company was purchased by businessmen, who eventually used it to operate as a bank.

Blunt was a financially savvy person for his time. Anything that has something to do with money, either legally or illegally, would catch his eye. He saw the debt crisis in Britain not as a national problem but as an opportunity to make a lot of money. This behaviour and frame of mind, including his knowledge and skills with money, paint an already grim picture of where this story will go.

John Blunt (the South Sea Company bubble) and John Law (the Mississippi Company bubble) both had good monetary skills. But the former was in a different league than the latter, not in terms of intelligence but with behaviour and purpose.

John Law, though a gambler and womaniser, had a good intention with monetary policies in making a better economy for France, but he miscalculated his monetary actions, which led to the demise of the French economy in 1720.

On the contrary, John Blunt’s intentions were all about money and power.

John Blunt’s Debt-Equity Swap

Blunt needed to raise capital; he needed more money, and he found a way. This is through a debt-equity swap. It’s the same way that John Law (The Mississippi Bubble) did it with the Mississippi Company and the government debt/bonds. But there’s a tiny bit of difference in the story.

Before we can go ahead with how Blunt did this, we need to first understand a bit of the UK’s history, specifically in Northern Ireland.

In 1689, a new king of Great Britain was crowned, King William III of Orange, a Dutchman by birth and, most importantly, a protestant. A few years before William’s coronation, the previous king was James II, who was a Catholic king. King James II favoured Roman Catholics and allowed them to be army officers, which an act of Parliament had forbidden. He did not seek to reach agreements with Parliament and arrested some of the bishops of the Church of England.

People in England worried that James II wanted to make England a Catholic country once more. The people’s only hope was that the heir to the throne would be a Protestant; unfortunately, King James II’s son was also a Roman Catholic.

In 1688, important protestants in England asked William of Orange to invade England and proclaim himself king, which he did. That same year, William took the throne successfully without any fighting or bloodshed. This event was later called the ‘Glorious Revolution’. King James II fled to France.

After two years had passed since the glorious revolution, James II wanted to regain the throne. He invaded Ireland with the help of the French army. King William III defeated James II at the Battle of the Boyne in Ireland. William re-conquered Ireland, and James II fled back to France. Since then, the King/Queen of Great Britain has always been a protestant. Supporters of James II were called ‘Jacobites’.

The recent reconquest of Ireland by King William III resulted in the confiscation of land from the Jacobites. This land had been given to members of the Williamite army (forces that were loyal to William III). John Blunt had something different on his mind: he wanted to buy the land; hence, he strongly campaigned that the property should instead have been sold to defer government expenses. An act of parliament was passed that cancelled the land grants that had been given to the Jacobites and instead allowed the land to be sold.

John Blunt wanted to buy those lands, but the Hollow Blade Sword Company did not have enough capital to do so. So, he looked for other ways, and he did it by swapping the shares of his company for the army debentures.

Let me clear things up with the terms I used here.

• Hollow Blade Sword Company SHARES: Companies usually raise capital by giving out shares of their company in exchange for money. This is called equity financing. “How Shares are Made and How the Stock Market Works”.

If a company goes into debt to raise capital, that’s called Debt financing. It is called a corporate bond when a company borrows money, while it is called a government bond when the government borrows money. “What are Bonds?”.

• Army Debentures: recall that Great Britain joined a lot of wars during this time, and like with any other war, they needed capital. By borrowing money, they were able to acquire money, that’s again called debt financing. Army debentures are a form of government debt that was used to finance the military. It is like a bond contract, a certificate of loan.

What John Blunt did here is a complex financial process, but I’ll still try my best to explain it.

Army debentures have a price in the secondary market (this is where people trade the said debt asset), but it is not valued highly during that time. What John Blunt did is he had the company buy a lot of army debentures in the secondary market at lower prices, and then in the succeeding days, he publicised that he was willing to swap shares of the Hollow Blade Sword Company for army debentures.

“Okay. So, what does this mean?”

You see, people were enticed to swap their army debentures for the company’s shares because the former is not that valuable compared to the latter. The potential for the Hollow Blade Sword Company’s shares to be worth more in the future, including dividends, is way better than the returns that a person could have with his/her held army debenture. Therefore, people agreed to the swap of their army debentures for shares of the Hollow Blade Sword Company. This in turn inflated the demand for the army debentures, which increased their secondary market price, because they could now be swapped for the said shares of John Blunt’s company.

As the price of army debentures rose, so did the previously bought and hoarded army debentures of the Hollow Blade Sword Company. The value of the army debentures eventually held by the company equalled £200,000, which is worth £38,687,352 today adjusted for inflation. This is the same amount they needed to purchase the land in Ulster/Northern Ireland.

John Blunt negotiated with the government to accept army debentures as payment for the land, which the government agreed to. Thus, the Hollow Blade Sword company was able to get the land without requiring any money at all—just a good, all-twisted financial strategy by John Blunt. That method he used is illegal today because it is a type of financial market manipulation.

With the newly acquired land, the Hollow Blade Sword company acquired roughly £20,000 yearly in lease revenue, which is worth £3,868,735 today adjusted for inflation. Blunt lent out the rental income they received to the government, which Robert Harley badly needed at the time.

In summary, the government agreed to accept their own debt as payment for the land it sold. 😅

This method of blunt was the core operation of the soon-to-be South Sea Company.

The Bank of England Lottery

As Robert Harley became Chancellor of the Exchequer, his first concern was for the government to survive the year. In short, the Kingdom of Great Britain is in the such dire financial shape that they don’t have enough funds to survive the year. Though Harley was able to get some funds from the Bank of England via the lottery they held yearly, the problem is that in 1711 the revenue of the said lottery performed poorly.

Harley wasn’t too happy about it because it meant a higher chance for the government to go bankrupt. His answer to this problem is to give John Blunt the authority to sell lottery tickets.

John Blunt did it outstandingly, selling all the tickets within four days. This made it the first successful English lottery in history.

The success of the lottery was followed by another large lottery that Blunt and the Hollow Blade Sword Company operated, which was named “The Two Million Adventure”.

As with the lottery it preceded, this one too became a success. This is because everyone who participated in the lottery won something.

Yes, you read it right, literally, everyone who joined won something. 😂 This made all the lottery tickets sell out.

At a minimum, the person who owns a lottery ticket is guaranteed to win 10% of the ticket price.

• A ticket for “The Two Million Adventure” adventure lottery costs £100 (£ 19,342 today adjusted for inflation).
• The top prize was worth £20,000 (£3,868,735 today, adjusted for inflation).
• Every ticket is guaranteed to win £10 (£1,934 today adjusted for inflation).

No one in their right mind would not take that deal. To be honest, it’s too good not to take it, and it is also too good to be true at the same time. 😂

Here’s the catch, though. That £10 guaranteed for every £100 bought ticket will not be paid one-off but in instalments yearly for years to come.

Thus, this provided government funding in the short term, but this still did not tackle a large amount of debt on the nation’s balance sheet, the £9,000,000, or £1.2 billion today adjusted for inflation.

Also, the lottery is a variation of debt. Why? Because the lottery promised £10 in winnings for each ticket, which they’ll be paying annually for a few years. That’s exactly the same with all government debts; they just masked it as a lottery. 🙄🤪

Anyway, Robert Harley was happy because it solved the more pressing matter of helping the government financially survive the year.

The Lottery, a satire by William Hogarth

The Lottery, by William Hogarth (1697–1764), is an engraved satire denouncing the greed, folly and disillusion of those who took part in state-sponsored lotteries in the hope of making a quick and easy fortune.

The print was first published in 1724, around three years after its sister engraving The South Sea Scheme appeared. Both prints use familiar London landmarks and classical allegories to satirise the evils of financial speculation. The Lottery is set in the Great Hall at the Guildhall, where state lotteries were traditionally drawn with much pomp and ceremony.

The human desire for quick gains and easy money has existed for centuries, and unfortunately, it often leads to greed and speculation. However, what exacerbates this issue is the lack of effort and self-awareness in managing personal finances.

Take accountability for your finances and be responsible by knowing why and how you use your money.

The South Sea Company

Ahhh! The great South Sea Company, where riches were all made and yet the pain was all gained when all things were set and done.

Despite the success of John Blunt’s lottery and the use of the capital to pay off the government’s debts, Robert Harley still found himself uneasy. Though he found short-term funding that helped the nation with its finances, the main problem was not yet solved, which was the £9,000,000 + interest to be exact.

Then you have the low cash flow stream relative to Britain’s outstanding debts. On top of that, the central bank wasn’t even helpful in financing Robert Harley’s economic aims due to the deeply partisan government.

Remember that the central bank was controlled by the Whig party at the time, whereas Robert Harley was a Torie party member.

To solve this problem, Robert Harley had an idea. Why not create a company that would consolidate and take on the country’s debt? John Blunt was euphoric about this idea. Both devised a scheme to consolidate debt of Britain the same way that the Bank of England did with the country’s previous debt. Thus, the creation of the South Sea Company

Here is how it worked, from Robert Harley’s point of view:

• Persons who had a government debt (as an asset) would be able to exchange it for the shares of the South Sea Company at its nominal value. For example, let’s say one government debt (worth £10) equals one share of the South Sea Company (worth £10).
• The government would then pay some of its interest obligations to the South Sea Company. To lower the interest payments on the national debt, John Blunt and the South Sea Company agreed for the government to pay a lower interest payment than what it would have paid when it was owned by private individuals.

This is the reason why they were insisting that all owners of government debt assets swap their government debt assets for the shares of the South Sea Company. In doing so, the South Sea Company will be able to get a larger chunk of the said debt asset, and the larger the debt asset they possess, the lower the interest payments the government would need to pay.

The government paid only 6% interest on all the government debts that the South Sea Company had. That’s approximately £500,000 per year on their roughly £9,000,000 debt. That’s way better than paying more than 6%, which was the interest rate they were paying before Robert Harley and John Blunt started this scheme.

What John Blunt and the South Sea Company did with the interest payments they received from the government was to distribute a portion of them to their shareholders via dividends. Then the remaining would be used for the company’s investments and business operations, or so they said. 😏

Here is how it worked, from the point of view of the government debt asset owners:

• No one would want to initially swap their government debt asset for a share of the South Sea Company. Why would they? When the interest income you would receive from a government debt asset is higher than what you would receive from a company’s dividend payout. Despite this, the British, who owned those debt assets, still agreed to the debt-equity swap.

Why? Well, because the South Sea Company has great potential to massively increase its earnings soon.

Here is how and why they said that.

The South Sea Company was granted the rights and monopoly to trade with South America. And people were very optimistic about this venture, as the Americas were well known as the land of opportunity and riches. A lot of individuals joined the hype train, and both Harley and Blunt strongly marketed the unimaginable profits that the company would certainly generate for its shareholders.

Nevertheless, there was one problem with this monopoly route. Britain doesn’t have any territories in South America; this means that they would need to make a deal with a country in South America that is owned and colonised by another European superpower.

NOTE: It’s funny and saddening to read the strong resemblance between both the narratives of the Mississippi Bubble and the South Sea Bubble. It’s as if the culprits behind these two manias were communicating with each other on how to control the nation’s finances, government, and economy, considering that they’re miles apart. One is happening in Paris, France, and the other is happening in London, Great Britain.

Peace is The Answer

In 1713, the South Sea Company was given a trade monopoly with the Spanish and Portuguese Empires in South America. Maybe you’re wondering what they traded during that time; it was slaves. Yes, this was a time of the booming Transatlantic Slave Trade, which is one of the darkest inhuman acts committed by a person against another individual in our world’s history.

The demand for slaves from the colonies in the Americas was so high that slaves were badly needed. It was a time when slaves were inhumanely treated as tools of labour to increase productivity and the economy of the new colonies in the Americas.

“Between 1630 and 1807, Britain’s slave merchants made a profit of about £12 million (or £884 million today, adjusted for inflation) on the purchase and sale of African people. Enslaved people produced about 75 percent of exports of raw goods from the new colonies.” -BBC article

https://www.bbc.co.uk/bitesize/guides/zjyqtfr/revision/7#:~:text=Between%201630%20and%201807%2C%20Britain’s,goods%20from%20the%20new%20colonies.

The South Sea Company banked on the chance to have the sole monopoly to trade in the South Americas. The only problem, though, is that Britain was at war with almost everyone in Europe, including Spain, which held the majority of the ports in South America during that time.

To solve this problem, they needed to end the war as fast as they could! It’s as simple as that, as thought by John Blunt and Robert Harley. They went to realize their plans.

They strongly advertised and marketed to the public the need for peace to stop the decades of multi-national wars with their neighbouring countries. They tried their best to change the public’s opinion about the war from terminator mode to love and peace for the sake of money. 

And it worked very well, but the public only saw a few pieces of the bigger puzzle. They still needed to get a majority vote from the parliament (House of Lords) to stop the war. And they did a lot of things just to get what they wanted; it also substantially helped that Robert Harley was on good terms with the reigning monarch of that time, Queen Anne. After several political moves, Harley and Blunt eventually got the peace that they wanted, and on the international stage, the war also ended.

As the War of Spanish Succession came to an end in 1713 with the Treaty of Utrecht, Spain agreed to have a trading deal with Britain, but it wasn’t the deal that everyone hoped for.

You see, Blunt and Harley strongly marketed and relayed to everyone in Britain that as the war ended, the slave trade would further bring enormous amounts of wealth to the South Sea Company. That it would also continue or even surpass the two centuries of successes of the slave trade industry.

But it didn’t. Britain had the short straw with the deal it had with Spain. Though Spain agreed for them to sell slaves in their South American ports, they only allowed limited amounts of trade, with 1 ship per year for each of their ports.

That seems not so bad if you think about it, but it was. This is because the great Dutch East India Company was sending fleets of ships every month! That’s what Harley and Blunt thought would have happened as well with their company, but they failed to make that kind of deal with Spain.

Despite this failure, Harley and Blunt continued to advertise the supposed riches of the business venture of the South Sea Company, and surely they didn’t disclose the fact that their company had made a poor trade deal with Spain.

The unfortunate fact, though, was that the profits the South Sea Company would generate were nowhere near enough to sustain its business operations. Also, Spain taxed the importation of slaves. The story would have been different if they had been able to send multiple ships to the Spanish South American colonies monthly.

The Changes in Power

The South Sea Company was heavily dependent on the government. In the year after the peace treaty and the trade agreement between Spain and Britain were signed, the British government also changed. The previous Tory government was replaced by the Whigs. Furthermore, Queen Anne died in 1714 and was replaced by King George I.

As any honourable man would do when changes in political power occur, John Blunt kicked out his partner Robert Harley from the company and replaced the Tory board members of the South Sea Company with Whigs. Political games as usual. 😂

In 1715, George II, then the Prince of Wales and son of King George I, was elected and became the governor of the company. A lot of influential people and government officials had a significant investment in the South Sea Company. And with John Blunt’s sales prowess, he was also able to get King George I to invest the royal household’s money in his company.

The previous government was not able to pay two years’ worth of interest payments on their debts, which were held by the South Sea Company during that time. The current government insisted that the company forgive the debts that the previous government owed it; in return, they agreed to let John Blunt and his company make more shares and sell them to the public. This is to offset the loss that the South Sea Company had from the unpaid interest payments by the previous government.

With these additional shares, the South Sea Company had approximately £10,000,000 worth of stock issued, or £1.5 billion today adjusted for inflation.

Evan, what does making additional shares for the company and selling them to the public mean? It literally means making more shares of the company. For instance, if a company currently has 10,000 shares traded in the market and plans to add 1,000 more, then the total number of shares outstanding would eventually be 11,000 shares that would be traded in the market.

This is one of the ways a public company will be able to raise capital—this is called equity financing. Other ways are to take on debt and save money from its generated profits. The downside is that the previous shareholders would lose their percentage ownership stake in the company, this is called share dilution.

To know more about this, see my blogs titled “How Shares are Made and How the Stock Market Works,” “Stocks & Shares,” and “Beware of Share Dilution.”

The more people bought the stock sold by the South Sea Company, the more money would come into the company, and the stock price would rise.

In 1719, the government thought of a scheme to cover the debts it incurred not just from its previous wars but also from the state lottery it held a few years earlier. Recall that the Bank of England held state lotteries to fund the endeavours of the government, then was eventually given the rights to operate by John Blunt, who found a way to magnificently increase its profits. That’s the same lottery that the government also needed to pay, which is also a form of debt just masked as a lottery! (See ‘The Bank of England Lottery’ section of this blog.)

The new scheme passed by the government was to convert the nation’s debts, including the 1710 lottery debts, into South Sea Company stock. In short, it’s a debt-to-equity swap where the person who owns the government debt asset and the 1710 lottery ticket would swap them with the South Sea Company. Again, why not? when the South Sea Company’s stock price was increasing and it was receiving dividends from the company.

On top of that, in 1717, King George I and his son Prince George II had an argument, which resulted in Prince George II stepping down as governor of the South Sea Company. Guess who replaced him as governor of the company—it was King George I. Boom!

Having the King of the country be a part of your company would surely garner a billion times more prestige and trust from the people. And it did; this fuelled further stock price speculation on the company.

The Grand Scheme Explained

John Blunt and the South Sea Company started a new scheme and oh boy they took it to greater heights. The new scheme involves them taking most of the unconsolidated debts of Britain, at the tune of £30,981,712 or $5.6 billion today adjusted for inflation.

Evan, I thought Britain only had £9 million worth of debt. How did it balloon to £30 million? Good observation. It was £9 million in 1710, and since then it has further increased due to the country’s national lottery of the past, which is also the same as debt financing. (See “The Bank of England Lottery” portion of this blog.)

But before they were able to get the unconsolidated debts, they needed to have the majority votes from the parliament. And they did, but this took a lot of lobbying, or shall I say bribe?😆 And other political plays.

After being granted the right to take on the majority of the nation’s massive debt, a scheme to reduce it ensued. Here is how it worked:

• To reduce the debt, the government needed the South Sea Company to get the debt assets from private holders (individuals and groups of individuals or companies that own the debt). The way to do it was through the debt-to-equity swap. Encouraging people to swap their debt assets for the shares of the company. By doing so, the government and the company had an agreement where the company would accept a lower interest payment (5% during that time), then after 4 years it would decrease to a 4% interest payment yearly—this gave the government a substantial breathing room on its interest payments.
  
• The government gave the green light for the South Sea Company to make more shares. More shares mean more people could swap their government debt assets for the shares of the South Sea Company, which in turn would help the government further reduce its interest payments.
  
• The price at which the company would sell its newly issued shares was equal to the value of government debt. The amount was dependent on whatever share price the South Sea Company stock was trading at the time the shares were made.
  
  For instance, if the government debt had been worth £100,000 and the current market price of the company is worth £100, then the company would issue an additional 1,000 shares.
  
  £100 current company stock price x 1,000 additional company shares = £100,000.
  
• The debt holders had the option to swap their government debt assets for stock in the South Sea Company, depending on the value of the debt and the current stock price of the company. Again, why would government debt asset holders not do it when there is a strong potential for the South Sea Company to grow as a business and rake in large profits for its shareholders—as marketed by John Blunt.

It is a grand scheme that would substantially help the government. But wait, there’s more. You see, the exchange of government debt for stock in the South Sea Company was based on whatever the stock price of the company was during the exchange. But what happens then if the stock price goes up?

For example:

• The government agreed to allow the company to sell 1,000 more of its shares. The company’s stock is currently trading at £100/share. This means that the total value of the newly issued shares of the company is worth £100,000 as per its current stock price. The purpose of these 1,000 additional shares was to swap them for government debt assets from private owners.
  
• After the approval and issuance of the additional 1,000 shares of the company, a sudden surge in its stock price occurred. From £100 per share to £120 per share.
  
• This means that the company would now only need to swap 833 of its newly issued shares with some of the government debt held by private individuals. 833 newly issued shares x the current stock market price of £120 = nearly £100,000.
  
• What happens now with the remaining 167 newly issued shares? Well, it can be sold at the current market price of £120 per share, which would give a profit of £20,040. Profits could then be put back into the person’s pocket, and that’s what John Blunt did. 😂

As long as the government kept agreeing for the company to make more shares, swap those shares for the value of the national debt, and its stock price just went up, then John Blunt and other individuals within the South Sea Company board would take home massive amounts of money for themselves.

Take Off!!!

Everything went well for Blunt and the South Sea Company, provided that its stock price go up.

We’re so focused on the stock price that we forget about the underlying business of the equity asset. You see, South Sea Company was an unstable company in terms of earnings, mostly unprofitable year over year. The trade they were doing with Spain wasn’t as good as they had expected, and their other business endeavours weren’t doing well either.

No matter how high the stock price of a company is, if the underlying business, profitability, and management are poorly performing over a long period of time, then its downfall is imminent.

A stock price in the short term is an auction, but in the long term, it reflects the fundamentals of a company.

Nevertheless, euphoria and expectations can last a long time. Stock price often deviates from a company’s fundamentals, and the reasons behind this are many, but sentiments are always present in such phenomena. This was also the case with the South Sea Bubble.

John Blunt did a lot of things to prop up and increase the stock price of the South Sea Company.

• By buying shares of the company with a down payment, people could buy a share of a company like they would a home. 20% down payment, then the remainder will be paid every 2 months.
  
  For example:
  Current stock price = £100 per share.
  Down payment = £20, then you get the South Sea Company share.
  Then you’ll be paying the remainder every 2 months until you get to pay the total of £100.

The problem here was that people bought a lot of shares—more than they could afford.😅 This doesn’t matter for John Blunt as long as people continue to buy more shares of the company to further increase its stock price.

The amazing part about this is that people just can’t get enough. As people made more money on this, they reinvested the proceeds from their previous profits. And as usual, the stock price further went up.

• They loaned money to people who wanted to buy more shares of their company. Yep, Blunt and the board of the South Sea did this. They loaned an amount as high as £3,000, or £536,802 in today’s money. So, they’re making more shares of the company and loaning money to people who want to buy more shares of their company. 😅🤪
  
  And again, with this move, the stock price went further up.
  
• The extermination of startup companies. Other companies took notice of South Sea company’s rising stock price. By issuing more shares, the company does not simply exchange them for government debt; some of them are also sold directly to investors. With this comes funding from the public. Other companies also want a piece of the pie.
  
  Therefore, a lot of companies started to go public. The problem was that there was only a limited amount of money in circulation in the nation. Having more companies go public meant that the money would not be invested in the South Sea Company.
  
  For the South Sea Company, having an increasing stock price was the only profitable revenue stream they had.
  
  As the government was backed by the South Sea Company. The government closed new start-up companies in Britain during that time. This secured South Sea Company’s monopoly through increased funding and, in turn, a higher stock price.

In June 1720, John Blunt was made a baronet in recognition of his extraordinary services in raising public credit to a height not known before.

In August of 1720, the South Sea Company reached £1,000 per share. An exorbitant 10-fold increase from £100 per share in 1718.

To give you context, a £10,000 investment would be worth £100,000 just within 2 years.

The Party is Over

The stock price of the South Sea company went down after August of 1720, and some people intuitively started selling their shares of the company. But John Blunt still wouldn’t let this happen.

He tried his best to prop up the stock price. He made more shares of the company and sold them to the public at the current market price, which was about £900 per share. Remember that a few months ago, he sold the stock by accepting a 20% down payment and paying the remaining amount after two months? He changed that to a 10% down-payment and to pay the remaining amount after a year.

Despite this, the stock just kept going down. Some individuals started to look now on the South Sea Company itself, not on the stock price anymore. And it was a shock when they found out that the company was unprofitable and was not able to do what it had promised it would do.

John Blunt did another round of manipulation just to stop the fall in the company’s stock price. He stated that he will pay 30% dividends to the company’s shareholders for the next decade, then 50%. Unfortunately, instead of enticing people to buy more shares of the company, it did the opposite. People woke up to the reality that John Blunt was trying so hard to sell the shares of the company, realizing that he was promising unrealistic returns to its investors. Dividends that amounted to what a signle industry in Britain would generate during that time.

This cemented the fall of the company’s share price. In December of 1720, the South Sea Company’s stock price fell to £120 per share from £1,000 in August of the same year. A loss of more than 80% from its peak

People who participated in the market were ruined, suicide rates went up, people were discontent, businesses went bankrupt, the economy and the financial system were hit hard, the government was in disarray, and the monarchy’s credibility and approval from the public were at their lowest points.

Britain seems to be in chaos, on the brink of both civil and economic unrest. Luckily, one man was able to find a way around this problem and took advantage of it to be able to get the highest government position in Britain. This man was Sir Robert Walpole, the person who is said to be the first person called the Prime Minister of Britain.

He wasn’t a hero of any sort, but he presented himself as one to the public. He made questionable political plays, he played everything on his hand. Though his approach can be considered extreme, which I won’t be writing about here, what he did was proven to be effective in stabilizing Britain. You see, this South Sea Company fiasco and bubble were all due to government corruption and greed; even the monarchy was involved in it.

Thus, with the help of Sir Robert Walpole, the government and the monarchy did not crumble, unlike France (The Mississippi Bubble) that underwent an economic depression. Yet the economy and a substantial portion of the British people did experience the pain and suffering that this market bubble brought.

Only a few influential people who were bribed and who colluded with Blunt went to jail. As for John Blunt, he survived, he retained a small portion of his wealth, and he still retained his baronet status. In fact, his family even holds the Blunt Baronet status to this day.

Additional Content: The South Sea Bubble & Sir Isaac Newton

Even the genius Sir Isaac Newton, who discovered the laws of motion, was not able to outsmart his own emotions.

Sir Isaac Newton was actually able to bag 300% gains from his initial investment in the South Sea Company stock, but he noticed that his friends just kept on getting richer as the stock price of the said company went up.

“He watched anxiously as friends who still held their shares continued to get rich.”

-An excerpt from the book Investing: The Last Liberal Art by Robert Hagstrom.

Because of that, he committed one of the most critical mistakes of his entire life. He again acquired shares of the said company just because other people were making money, despite not understanding the investment itself.

Sir Isaac Newton re-entered the market once again in around January of 1720, where the stock price of the company was approximately at 700/share.

His great financial demise happened after a few months where the south sea company stock tumbled afterwards. It was estimated that he lost roughly £20,000 in 1720, approximately £3 million today, adjusted for inflation.

Warren Buffett and Charlie Munger even talked about this at one of their past Berkshire Hathaway annual meetings. Charlie Munger even said that “just I.Q. points alone won’t do it”.

“I can calculate the motion of heavenly bodies, but not the madness of people.”

-Sir Isaac Newton

Warren Buffett shared his thoughts regarding market bubbles. He said that it is unavoidable due to human nature, jealousy, and greed.

“People start being interested in something because it’s going up, not because they understand it or anything else. But the guy next door, who they know is dumber than they are, is getting rich and they aren’t,” he said. “And their spouse is saying, can’t you figure it out too? It is so contagious. So that’s a permanent part of the system.”

In investing, it is prudent to know what you own and why you own it.

To Sum It Up

• War, Debt & The Chancellor of the Exchequer
  • England, like other countries at that time, had to fund wars that required a significant amount of money, manpower, and resources. The country’s debt problem was similar to that of France during the same period. The Act of Union, passed by the English and Scottish parliaments in May 1707, led to the unification of the two countries and the creation of the United Kingdom of Great Britain.
• Robert Harley, The Chancellor of the Exchequer
  • In 1710, Robert Harley became the Chancellor of the Exchequer in Great Britain and discovered that the country had a massive debt of approximately £9,000,000 (equivalent to £1.2 billion in today’s amount) while only having £5,000 in assets. The debt was a result of the country’s involvement in multiple wars. Harley tried to reduce the debt by selling annuities and government bonds, but it wasn’t enough.
• Robert Harley’s Financial Predicament
  • Robert Harley attempted to reduce Great Britain’s massive debt by raising capital but faced several setbacks, including poor accounting records, a partisan government that made it difficult to raise taxes, a Whig-controlled Bank of England, and the unavailability of foreign capital due to ongoing wars. Despite these challenges, Harley persisted and attempted to find a solution to the problem.
• John Blunt of the Hollow Sword Blade Company
  • Robert Harley turned to John Blunt, a financially savvy businessman, to raise capital for Britain’s debt crisis. Blunt was the secretary of the Hollow Sword Blade Company, which was eventually used to operate as a bank. Blunt saw the debt crisis as an opportunity to make a lot of money and had a different purpose than John Law, who had good intentions for France’s economy but miscalculated his monetary policies. Blunt’s intentions were all about money and power.
• John Blunt’s Debt-Equity Swap
  • John Blunt was able to acquire the land in Ulster/Northern Ireland by swapping the shares of his company, the Hollow Blade Sword Company, for army debentures. The Army debentures were a form of government debt that was used to finance the military. Blunt had the company buy a lot of army debentures in the secondary market at lower prices and then publicized that he was willing to swap shares of the Hollow Blade Sword Company for army debentures. People were enticed to swap their army debentures for the company’s shares because the former is not that valuable compared to the latter. This inflated the demand for the army debentures, which increased their secondary market price, and as the price of army debentures rose, so did the previously bought and hoarded army debentures of the Hollow Blade Sword Company. The value of the army debentures eventually held by the company equaled £200,000, which is worth £38,687,352 today adjusted for inflation. With the newly acquired land, the Hollow Blade Sword company acquired roughly £20,000 yearly in lease revenue, which is worth £3,868,735 today adjusted for inflation.
• The Bank of England Lottery
  • Robert Harley became Chancellor of the Exchequer in 1711 and found the Kingdom of Great Britain in dire financial straits. To address this, he gave John Blunt the authority to sell lottery tickets. The first lottery was a success, and another large lottery called “The Two Million Adventure” was launched, guaranteeing a win of £10 for every £100 ticket purchased. This provided short-term government funding but did not address the nation’s large debt. The lottery promised to pay out the winnings annually for a few years, making it a variation of debt. However, the success of the lotteries helped the government financially survive the year.
• The South Sea Company
  • The South Sea Company was created to consolidate and take on Britain’s debt. People could exchange their government debt for shares in the South Sea Company, which would then pay a lower interest rate to the government. The South Sea Company was granted a monopoly to trade with South America, which made people optimistic about potential profits. However, Britain didn’t have any territories in South America, and they needed to make a deal with another European superpower.
• Peace is The Answer
  • In 1713, the South Sea Company was granted a monopoly to trade slaves with the Spanish and Portuguese Empires in South America. However, Spain only allowed limited amounts of trade, with one ship per year for each of their ports, while the Dutch East India Company was sending fleets of ships every month. The South Sea Company failed to make a better deal with Spain, and its profits were not enough to sustain its business operations. To end the war with Spain and increase their profits, John Blunt and Robert Harley strongly advertised the need for peace to the public and made political moves to get a majority vote from the parliament. However, the public only saw a few pieces of the bigger puzzle, and the deal with Spain did not bring the enormous amounts of wealth as advertised.
• The Changes in Power
  • The South Sea Company had major changes in its management. The government owed the company money, but couldn’t pay it back, so they agreed to let the company sell more shares to the public to make up for it. This caused the company to have a lot of money and its stock price to go up. Later, the government came up with a plan to swap their debts for shares in the company. The company’s stock price continued to rise, especially when the King of England became involved with the company.
• The Grand Scheme Explained
  • In the early 18th century, Britain had a lot of debt, which they wanted to reduce. The South Sea Company was created to help with this. The government gave the company permission to take on a lot of the nation’s debt, and the company encouraged people to swap their government debt for shares in the company. The more shares the company sold, the more the government’s interest payments decreased. The government also agreed to let the company make more shares, which could be sold for the value of the government’s debt. However, if the stock price went up, the company would make a profit, which the people running the company, like John Blunt, could keep for themselves. This led to a big financial scandal known as the South Sea Bubble.
• Take Off!!!
  • The South Sea Company was a company that did not make much profit, but its stock price increased because people were buying a lot of shares. John Blunt, the company’s leader, did many things to keep the stock price rising, like loaning money to people to buy more shares and stopping other companies from starting up. Eventually, the stock price became very high, but the company’s business was still unstable. It is important to remember that a company’s stock price reflects its fundamentals in the long term, not just short-term sentiment.
• The Party is Over
  • The South Sea Company was a British trading company that promised investors huge profits. But the company was actually unprofitable and eventually, the stock prices went down. The company’s director, John Blunt, tried to manipulate the market to keep the prices up, but his tactics failed, causing a financial crisis that affected many people, including businesses, the economy, and even the monarchy. However, Sir Robert Walpole, who became the first Prime Minister of Britain, was able to stabilize the country. Though many people suffered, only a few of those who were involved in corruption and bribery went to jail. John Blunt survived and even retained his wealth and title.

“Don’t let government favouritism, and nationalism obscure faulty ventures”

-BizBrain.org

In the 4th Instalment of my Market Bubbles in Financial History blog series, I’ll take you back again in Britain. In a time of the great British Industrial Revolution.

“History gives us the opportunity to learn from others’ past mistakes. It helps us understand the many reasons why people may behave the way they do. As a result, it helps us become more impartial as decision-makers.”

-UoPeople

Knowledge is my Sword and Patience is my Shield,

elmads

This blog is for informational purposes only and not a Financial Recommendation. Not all information will be accurate. Consult an independent financial professional before making any major financial decisions.