Nearly 300 years ago, a group of financial speculators dreamed up a plan to make money from England’s national debt. In an age when someone making £100 a year was considered wealthy, the national debt was huge: about £9 million. The idea behind the South Sea Company was that British merchants would trade English goods in South America, then controlled by Spain and Portugal. The problem was that Spain and Portugal wouldn’t allow any such thing to happen: they had a strictly controlled monopoly. What actually happened was that John Blunt, the director of the South Sea Company, ended up convincing the British government to sell its debt to the public through the Company in the form of shares. From the profits of the share sales, the Company would then repay the debt. Moreover, “in the persuasive but intrinsically nonsensical analysis” put forward by the South Sea Company, “as surely as night follows day, the bigger the debt, the greater the profit.”
This is insane, of course. There’s no such thing as a free lunch, and nothing from nothing still leaves nothing. But it looks good on paper, and greed is the great engine of capitalism. Like the Internet stock bubble of a few years ago, people are eager to throw their money into a black hole: few people are capable of the self-control required to see beyond the event horizon created by collective greed. Indeed, it’s from the early 18th century, when modern financial markets were first forming, that the term “bubble” was first used in a financial context.
There were “whimsical projects,” as one contemporary newspaper writer put it, involving, for instance, “melting down Carpenters Chips and Saw-Dust... and running them into Planks and Boards of all Lengths and Sizes.” Stock would be sold in this blatant scheme at “very advantageous Terms.” No doubt. “Shakespeare,” Malcolm Balen points out, “describes a ‘bubble reputation,’ and in Thomas Shadwell’s The Volunteers, written in 1692, men cheated or ‘bubbled’ each other for profit.” By 1720, the year of the great South Sea Bubble, the term was “understood literally: like their counterparts in soap and air..., financial bubbles were perfectly forms, and floated free of gravitational market forces.” The stock dealers “aim, in the saying of the day,” was “‘to sell the bear’s skin before they have caught the bear.’” But bubbles all eventually have to come to terms with gravity, as do we all: the bubbles always burst, leaving gullible investors broke while a very few, as in the recent Internet bubble, got rich.
Balen, a British journalist, writes that “Not even if Bill Gates were to lose his entire fortune overnight could America match the scale of the stock-market melt-down of three hundred years ago.” Nature abhors a vacuum, and the vacuum created by the debt-shares scheme of the South Sea Company suck up a lot of bucks (pounds, actually, of course). Balen heads each chapter with quotes from various newspaper accounts of modern bubbles, chiefly the Internet vaporware scams of the late 1990s. (Did people really think that selling dog food through a Web site was a good idea? If yes, then we really must be, as Plato said, featherless bipeds, because we’re all a bunch of greedy bird brains.)
While the Internet bubble parallel is certainly apropos, what the 1720 bubble really sounds like is the Enron debacle, as the South Sea Company, particularly in the person of its director, John Blunt, engaged in outrageous accounting practices. The South Sea Company literally had no assets, yet at one point, in the hot swell of the bubble, it claimed to be worth £12 million, which was “financially absurd. In the previous two years, forty-five ships had carried a total of thirteen thousand slaves for the Company..., but it had still not made a profit.” Which is also absurd, considering the profitability of slaving. Such indeed was the case: “the Company itself carried out no business whatsoever, other than sucking up cash.” Over the summer of 1720, share prices in the Company soared; to drive the share price even higher, the Company floated loans to potential investors so they could buy even more.
A few people kept their senses about them. A humble bookseller, for instance, bought a few of the first shares, held on to them for a few months, and then sold for a huge profit. God bless the bookish. But eventually the bubble collapsed and lives were ruined. Blunt, and his co-conspirators, were eventually punished, and some compensation made to a few investors. But the punishment was politicized and ended up in the bubbling of the status of a new generation of power brokers. As one victim protested, “First you pick our pockets and then send us to jail for complaining.”
Balen tells the story well, with sketches of the key players and, for the non-economically inclined, understandable explanations of the early market system. The rise and fall of the South Sea Company is a fascinating story, and one we would do well to remember every time an IPO offers us the chance to invest in on-line dog food. But we don’t. “Perhaps,” Balen concludes, “there is a reason for this strange amnesia, this curious refusal to remember. Capitalism, and the cause of progress, can ill afford too stark a reminder of the depth of human folly in the pursuit of riches, lest our willingness to gamble on the future also disappear into thin air.” The philosopher Hegel said that history always repeats itself. That’s right, said his young follower, a fellow named Karl Marx: the first time as tragedy, the second time as farce.