Nearly four years ago, I posted a message about the Darien Scheme, an unsuccessful attempt by Scotland to colonize Panama (see my message from August 29, 2011). Then yesterday I read an article listing the worst investments of all time, and it reminded me that until now I have not written about one which was distantly tied in with Latin American history – the 1720 South Sea Bubble. The action took place in London, England, but it involved trade with Latin America, and the person who thought up the Darien Scheme may have thought this one up, too, so I am adding this to the section on Darien, in Chapter 3 of my Latin American History. Here is how the new addition (not the band called the New Edition!) will read:
Meanwhile, the European wars of the seventeenth and eighteenth centuries taught the British that it was safer to take colonies overseas, especially small islands, than it was to occupy a territory on the Continent. Limiting their landholdings on the European mainland meant they could sit out the frequent conflicts there, if they chose to do so. Overseas colonies could also be more profitable, if defended and managed right. Accordingly, in the Treaty of Utrecht, one of the things the British asked for, and got, was the French half of the island of St. Kitts. They also won the right to sell up to 4,800 slaves and 500 tons of cargo per year in the Spanish colonies, something they probably considered more important than the land they gained.
The British wanted trading rights because wars are expensive, and they had run up some big debts during the War of the Spanish Succession. By 1711 the national debt was estimated at £9 million; the government staged lotteries and sold tickets to citizens looking for a chance to win prizes, but this only raised a fraction of the money needed to pay down the debt. Then the idea came up of floating a company that would assume at least part of the debt. In return this company, called the South Sea Company, would be given the right to trade in Latin America and the Caribbean, once the Spanish colonies opened up to non-Spanish merchants. The government would also give the company an annual annuity, worth 6 percent of the debt it took on, and this annuity was distributed to the shareholders as a dividend. We don’t know who thought of the South Sea Company first; some historians think it was Daniel Defoe, the author of Robinson Crusoe; others think it was William Paterson, the same fellow who gave us the Darien Scheme. If it was Paterson, this shows us that Great Britain did not learn anything from Scotland’s experience in Panama.
The trade rights granted by the Treaty of Utrecht were much less than what the South Sea Company had expected, meaning its ability to make a profit legally would be limited. Nevertheless, many saw great potential in Latin America, and persuaded themselves that the company was another Dutch West India Company; once Latin American colonists tried British-made products, the profits would pour in. When the company issued its first shares of stock, investors bought them eagerly. The first voyage by a company ship in 1717 only brought a moderate return, but then King George I became governor of the company in the following year, boosting investor confidence again. By 1720 the company was doing so well that it offered to take over the entire national debt, and Parliament accepted the proposal.
What Parliament did not realize was that the company was experiencing its first cash flow problem; it did not have enough money to pay the Christmas 1719 dividend, and it informed shareholders that payment would be delayed twelve months. Since it would take too long to get the money by expanding trade, Company executives tried bidding up the value of their stock. In January 1720, company shares were trading at £128, and had not changed much for a while. Back then one pound (£1) was worth about $400 in today’s dollars, so if you do the math, you will see why the stock wasn’t selling very fast.
When the company executives told wild stories about the wealth of the lands beyond the "South Sea," how Latin America was loaded with gold and silver that the company would eventually bring to Europe, this caused a buying frenzy, now called the South Sea Bubble, that drove up the value of the stock, to £175 in February, £330 in March, £550 at the end of May, and at the peak in August, around £1,000 a share. Politicians were offered a chance to buy shares at pre-bubble prices, allowing them to make a profit when they sold the shares later. The big bubble also led to the appearance of little bubbles, as swindlers went to investors who missed out on the company stock and offered them absurd get-rich-quick schemes that were limited only by imagination. The proposals put forth by these "companies" ranged from making better soap, to importing walnut trees from Virginia, to cannon that fired square cannonballs. Probably the cleverest and craziest proposal got investors to put down money "for carrying on an undertaking of great advantage; but nobody to know what it is."
Well, what goes up must come down. When those running the South Sea Company realized that their personal shares were worth many times as much as the company itself, they sold their stock, hoping that if they kept this move secret, the company would continue to do all right without them. Instead, word of them cutting and running got out, a panic selling replaced the frenzied buying, and share prices instantly collapsed; prices fell to £175 by the end of September, and £124 by December. Those who got in after the bubble started swelling were financially ruined when the bubble burst, especially those who had borrowed money to purchase shares. Among the losers was the great scientist Sir Isaac Newton, who lost £20,000 (worth probably $8 million today) and remarked, "I can calculate the movement of the stars, but not the madness of men."
The House of Commons conducted an investigation in 1721, which found plenty of deceit and corruption; at least three government ministers had taken bribes from the company. The prosecution of those officials and the company managers followed. The South Sea Company stayed in business until 1853, but its stock was given to two real moneymakers, the Bank of England and the British East India Company, and it sold most of its rights to the Spanish government in 1750. Finally, the British government outlawed the issuing of stock certificates, and that law stayed on the books until 1825.