Episode 27: The South Sea Bubble

London's history has been punctuated by financial crises. But perhaps one of the most famous crisis in London was The South Sea Bubble in 1720.

Let's get to the bottom of this early 18th century crises with City of London Tour Guide, Ian McDiarmid and London Tour Guide, Hazel Baker




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Recommended readings

The First Crash by Richard Dale

The South Sea Bubble by John Carswell

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Private Financial City of London Tour

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Full Transcript

Hazel Baker: Hello and welcome to our London History Podcast where we share our love of London, its people, places, and history in 20-minute espresso shot served with a dash of personality. I am Hazel Baker, London Tour Guide and CEO of London Guided Walks.

And don't forget we've launched The Daily London, providing you with daily inspiration of things to do in London for Londoners. You can listen on iTunes, Spotify, or even add it to your Alexa Flash Briefings.

London's history has been punctuated by financial crises. Most recently, we have had the dot com bubble and the 2008 crash. But perhaps one of the most famous crises in London was that of The South Sea Bubble in 1720. Today, I intend to get to the bottom of this early 18th century crises with the help of City of London Tour Guide, Ian McDiarmid.


Ian McDiarmid: Hello.

Hazel Baker: Hello. Thank you for joining us today. Alright, first of all, I want to know exactly what is The South Sea Bubble?

Ian McDiarmid: The Bubble refers to the price movements in the stock of The South Sea Company in the course of 1720. So there's enormous speculation, which draws in thousands of people. And in the spring, the stock is trading about 150 there's some debate as to what price has actually reached that height, but it reaches about a thousand and then starts collapsing in October. And by December ends up slightly below the level it started at. And there are massive losses. People get very badly burnt in this process.

Hazel Baker: And why is it a bubble?

Ian McDiarmid: It's a bubble because it bursts. Prices are driven up very high and then they fall spectacular. But it's also a bubble because it's irrational. So the people who are chasing the prices up, we're buying the stock as irrational prices and they would only make money if somebody else came along and bought at a higher price again. So it's a bit like a pyramid scheme. So there's a very big element of irrationality in it, which contemporaries were very quick to seize upon.

Hazel Baker: And what did the South Sea Company do? Why were people interested in it?

Ian McDiarmid: It had two selling points. The first was that it was in theory, a trading company and by its act, the charter that set it up in 1711, it was granted a monopoly by the British government to trade with Latin America. There's a big problem in that, Latin America doesn't belong to the British. Apart from Brazil, it belongs to the Spanish and the Spanish at this period at war with the English.

However in 1713, there's the Peace of Utrecht, which brings the war to an end. England is victorious in this war. There are a lot of contemporary see the Peace being far too soft on her enemies, the French and the Spanish. But what are the elements of the treaty of Utrecht? It's that the Spanish grant, the RCN the right to trade with Latin America to the British because of this belongs to the South Sea Company.

Hazel Baker: And what are they trading?

Ian McDiarmid: Well the have the right to trade everything into Latin America, so manufactured goods. But the main thing that the Spanish are interested in is importing slaves. They have a great demand for these. Historically the Spanish empire has no presence in Africa, but by this time the British do. The British are quite well equipped to supply slaves because they have a series of forts down there. And they have the Royal African Company, which is already up and running, whose principle business is dealing in slaves. So the South Sea Company will work arm in arm with the Royal African Company to supply slaves to the Spanish Empire.

There's one big problem with this. And that is that the Spanish are throughout this period, although they are for the most part at peace with the British, relations are frequently poor. And when diplomatic relations take a turn for the worst, Spanish can easily just apply pressure on the South Sea Company and make things very difficult for them.

And it looks as though through the life of the company that they basically didn't make any money out of this trade looks for much of their history, that it was loss making. And when they did make money, they didn't make very much money from it.

Hazel Baker: And what was the second thing that the South Sea Company did?

Ian McDiarmid: I can think that they were involved in with the, what we would call The Restructuring of British government Debt. So the background of this is an enormous expansion in the national debt from the 1690s onwards. And this is the result of war. William III comes to the throne, Britain is involved in the 9 years war. Later on, it's involved in the Spanish war of succession, which is the one we've already mentioned that comes to an end in 1713. And the National Debt just balloons and the way the government finances itself at this time is rather cruise.

So there's a lot of opportunities is for people to come up with schemes to make that borrowing cheaper. And this is one of the things that the South Sea Company does. It does what would also be called in modern terms a Debt for Equity Swap

Holders of British government debt are encouraged through the various South Sea schemes that are launched to give up their debt for South Sea shares.

Hazel Baker: And the bank of England was very new at this point as well. Wasn't it?

Ian McDiarmid: Yeah. Yeah. So the Bank of England plays an important part in the background as does the general expansion of financial markets, which begins in this 1690s to take the bank of England. First that's founded in 1694. And it raises 1.2 million in its first share issue, which then lends to the government.

And then later on it does some of this debt repackaging itself. It buys up old bits of British government debts and exchanges them for British, for Bank of England stock. The Bank of England is a very successful institution. It makes a lot of money. It makes a bit of money from these bits of debt repackaging.

It makes money from the original loan that it makes the government, it has banking privileges, and it is a very successful institution. In addition to being a successful institution, it's also rather a political institution. Because Like the other big company at the time, the East India Company, the Bank of England is dominated by the wigs.

And we're talking about the time of political faction. Politics is divided between the wigs and the tourists they're often referred to as parties. Parties, I think uses the label of convenience, but obviously it's a big historical debate as to when political parties actually emerged. But nevertheless, anyway, we can say that politics is divided between the wigs and the tourists.

And in 1711, the tourists are riding high and Harley is prime minister, and he wants an alternative to the Bank of England. And this is part of the motivation for setting up the South Sea Company. And in their original charter, it stipulates that directors cannot be directors. The Bank of England cannot be directors for the East India Company.

And the initial appointment of the directors is vested in the crown, which is to say that Harley, prime minister gets to say, who is going to be on the board of the South Sea Company. So its origins are very political.

Hazel Baker: And events in France played a role didn't they ?

Ian McDiarmid: Yes, they did. And here the culprit is a Scotts gambler by the name of John Law. And Law is an interesting character. He's forced to flee England where he was living because he fights a Juul with a man in Bloomsbury square. He kills him. He's sentenced for murder and he escapes. And then he leaves for about a decade on the continent as a professional gambler, which is significant. He's very clever. And he manages to get control of French finances. And he runs a scheme, which has many similarities to the South Sea Company, but his scheme is even more ambitious. So he runs the Mississippi Company in France. So similar thing, trading with America in this case, Louisiana, enormous French possessions in America.

And he also has control of the issuance of paper money in France, which is one of the differentiators. And he has a similar scheme whereby people are encouraged to give up old debt for shares is in his Mississippi Company. And his scheme is initially very successful. The share price on Mississippi Company, like the South Sea Company initially goes up and up and up and people are looking over to the channel in envy saying, Oh, the French being very successful, but also worried because maybe the French have permanently put their economy on a new level. And this is one of the things that encourages the British government to endorse the plans of the South Sea Company, and also encourages people to buy into the South Sea story because initially law schemes in France are very successful too. Successful in the sense of the price initially rising. Looking back, they rise ahead of a spectacular collapse and the collapse in France will actually be far more devastating than the South Sea Bubble in England.

Hazel Baker: So the lesson there is to not try and keep up with the Joneses.

Ian McDiarmid: Yeah. When you're not trying to emulate the French too closely yeah. And I was saying earlier, how much I like walking around exchange alley in the heart of London today, you can do a similar thing in Paris where Le Salle is now bang in the Centre of Paris, running from the North of there to the North is who can come poor, which is where the trading in the Mississippi Company took place. And similarly to exchange alley, initially the trading is done indoors, but it becomes so frenetic that it spills out onto the street. And indeed the authorities move the trading from a little bit later on because of complaints from other people living there. And Law himself buys a posh residence in the class from dome, which is this great square, very plush. Today it's filled with designer shops, art market hotels with this big column with Napoleon sitting on the top. And Paris is very, very good at providing information. I love their plaques, But I don't recall in plus fandom seeing a plaque recording John Law.

I think that they've got one in route can't come forward, but I've got a feeling that it might upset the up-market visitors who perhaps don't want to have their own sources of wealth questioned in the way that people in the 18th century questioned the origins of John Law.

The other bits about the background I was talking about was the expansion of financial markets from the 1690s onwards.

So from the 1690s, you get the beginnings of the modern share market in this area of London we've talked about. You get what are known as a projectors, who we would call entrepreneurs, launching all kinds of schemes. And there are all these, what we would call initial public offerings, which are sales of new shares.

There's also the trading of the very big companies like the East India company and the Bank of England. And this revolution beginning in the 1690s gets people used to the idea of trading shares. And this activity all occurs around, as I've mentioned, around exchange alley, particularly Johnathan's and Garraway's, but it spreads out onto the streets. And people by the 1720s, when there's a new wave of these projected companies, there's fervent interest in the South Sea Company at this stage. And the 1720s, if you'd like as a kind of second stage of great enthusiasm for financial innovation and the South Sea Bubble will emerge out of that.

Hazel Baker: And this popularity is prompted by regular people. This growing class of actually having an extra bit of spare money in their pocket to spend on something. So why not invest it for the future? I mean, how very exciting the first time they can do this kind of thing?

Ian McDiarmid: Yes, that's right. So the crucial one, one bit or the crucial background to this expansion in 1690s and the 1720s is the growing wealth of England. So you've got the old aristocrats, they can go and invest if they want. But crucially in England, you've got these commercial classes. You've got the, in particular, you've got people engaged in overseas trade, but you've also got all the professions. We mentioned women. You've got quite a lot of widows coming in to invest their money. And also with shares, what's significant is that you can divide them up into small packages.

The share size may be small if you're lucky, which means if, if you know, you can buy a small amount. But also the very ingenious ways of encouraging people to part with their money. So one of the things that the South Sea Company does is that when it launches new offerings of shares, it does so by subscription. So you only pay 10% down and then you will have a series of calls for another 10%, then another 10%.

And another thing that the South Sea Company does, which will feed into the bubble is it's very happy to lend people money to buy it shares. And, it'll, it'll, in particular it will lend money against It's own share.

So if you, if you're already a South Sea share owner, you can take your shares along to the company and you can borrow money against those to buy more shares. And this will be something that's picked up on later when they examine what's gone wrong. And one of the significant things about this is that the South Sea Bubble draws in all kinds of people. So it's not just the wealthy to some extent it's also the poor getting involved, obviously not the absolute poor, but people with just a little bit of cash are very much drawn in by the excitement.

And this is one of the things that contemporaries are very shocked about. They're mostly shocked about, what they see as decent people. Like for example, widows losing their life savings.

Hazel Baker: We've got some big names though, haven't we? That got involved?

Ian McDiarmid: Yes. In particular, there were some very notable writers who claimed to have made large losses, Pope Swift and Defoe all said that they were victims of the bubble. And in addition to the literary people, we also do need to mention Hogarth, who does this fantastic print on the South Sea Bubble in which he shows a kind of scene of London mixed up with various, important buildings of London and predominant on the right of the pictures you look at it is an image of The Monument. So The Monument is a monument to The Great Fire, the actual building itself

But in Hogarth's print on the pediment is written something like "this is a monument to the destruction of the city brought about in 1720 in the South Sea". So you can see where he's coming from. Centrepiece of his prints are around about, on which of the various punters who are going to lose their money.

And one other detail that I remember it the print, we haven't got it in front of us is down the bottom left. There's a figure of the Pope with two priests playing at some kind of gambling game down the bottom. So The South Sea Bubble figures very prominently in the British collective memory. Not simply because of the damage it did, but also because it was memorialised by some of the greatest writers. And in the case of Hogarth, one of the greatest engravers of well, British history.

Hazel Baker: Yeah. For the listeners, I will add a link to the British library of where Hogarth's print is. And Ian it just sounds like a huge mess, doesn't it? Everyone's involved.

Ian McDiarmid: Yes. It was a great melay of all involved and great melay also in the physical sense of it spilling out from the coffee houses onto a change alley itself.

Hazel Baker: What made this one so exciting of all the others cause slave trade is wrong. I know it wasn't illegal then, but also there's debt conversion. I mean, what was so attractive for people to get involved?

Ian McDiarmid: Well, it's difficult to rationalise, well I think the Latin American side appeal to some people, but not to others. I think the company began to play it down, frankly, because they realised they were never going to make much money from it. But nevertheless, there was always the possibility that if you owned South Sea stock, that they would make a great success out of Latin America. And that would be reflected in high dividends. So there was this kind of vague story behind the shares and the element of converting into government debt this is the really irrational part of it because the higher South Sea shares went, the more advantageous the conversion of the old debt was for the people who were holding a debt.

So if you had an annuity and you convert it into South Sea share stock and that South Sea stock rose in price, then you were quids in. So everybody had a kind of vested interest in the price going higher and higher and higher, but there was no real rationality behind it. And some people were alive to this. So obviously there were a couple of contemporaries who were making the comment. Notable one was a man named Hutchison who was an MP. They did rather detailed analysis pointing out. That this was a bubble, but they were kind of like a siren voice and nobody was paying attention to them.

I think a crucial thing is that the South Sea Company gets the backing of the government. And a lot of people who are victims of it later on, they said, oh I couldn't read the small print. There was such a mellow people buying, wanting to either buy the shares outright or convert their existing holdings of debt into the South Sea stock that couldn't actually see the small print, which was on the other side of the paper. But also very few people would actually read the small print about the terms to conversion and then they probably wouldn't understand it either.

And also the terms of the conversion from the annuities in the South Sea stock was always fixed by the company itself. So you couldn't actually get advance notice of it anyway. But I think that one of the things that a lot of people say is that the government was involved in this. They were there in the founding of the charter. There were all these great names signed up to it. You know, why shouldn't we believe it? It seemed almost as though it was endorsed by the government.

And this plays into another crucial thing it's that the South Sea Company basically bribed people, bribed politicians. So what they would do is they would go up to people of influence and they'll say, we will give you say 20,000, 50,000 pounds worth of stuff, but don't worry, you don't have to pay for us. We'll just, it's just per transaction. But any profit that's made on that theoretical transfer of shares to you, we will give you in cash.

The list of people bribed like this was extensive and when it's all over, the guns are out as it were for various high ranking politician. Ace Libby is the main culprit. He's the chancellor of the Exchequer. And then there's a couple of them like Sunderland who's briefly prime minister. Stanhope, who's the paymaster general. They're projected by Walpole. So Walpole isn't in theory involved in the South Sea Bubble. But he's very good, he becomes prime minister afterwards. And there's a lot of suspicion that part of the reason he's so powerful is that he's helped some people get off the hook. And in particular, he probably helped the Kings mistresses. So the King had German mistresses. They were widely suspected. Being bribed by the South Sea Company to turn his ear and Walpole protected them. And the key figure here is the company's key cashier Knight who runs what he called it, Green Book in which he has all the details, these payments, and he absconds to the continent.

He flees to the continent. He flees to the Austrian Netherlands. From which there is no legal rights to extradite him and contemporaries are quick to point out that this is very, very convenient for the government really. So when it's all over, they go for, they go for people. They go for certain culprits, but Walpole, it appears is there to protect people.

So when we're trying to explain why people are caught up in it, there is some justification. There's feeling that it was kind of half endorsed by the government, but ultimately we're talking about a bubble. We're talking about speculation. And you mentioned in the introduction, the dot com boom, you mentioned 2008 financial crisis.

The 2008 financial crisis, actually, wasn't really for kind of small investors that was mainly about the subprime market in the US, I mean, when you can see, you can read Michael Lewis's book, The Big Short, there's also a film of that if you want to watch. And basically he is charged in that film and in that book is what complete mugs the ratings agencies were, and not just the ratings agencies, but so the people who believe them, and the banks who were all caught up in this.

And then if you go back to the dot com boom, people were buying shares and lots of small investors were. Just on the basis of clicks on the internet, you know, discarding, all financial morals. And then we're recording this in October 2020, London Guided Walks does not give out financial advice, people, but I mean...Tesla, are their shares in a bubble?

I would guess that...tentatively, I would guess that they are. And if we were to look back in a year's time, they may would've crashed. There are other things that may well be bubbles now, and it's difficult to discern them. Maybe the Americans, there are plenty of people who think the American stock market as a whole is.

I mean, I don't gold might be. Tech stocks in general might be. Apple is now currently worth more than all of the footsie when you put it together. So they're difficult. I'm sorry. I'm not. I don't want to put myself on the line here. These are just possible targets. The fact that we have difficulty in deciding whether they are actually or not makes the difficulties that people always have.

And what's key here from the psychology point of view is the fear of missing out.

Hazel Baker: Yes.

Ian McDiarmid: Yes. Last week, South Sea stock we're trading at 150. In spite of that, I bought them the following week at 250. They're now 450 and sure enough, they go up to about a thousand. People get dragged in.

Hazel Baker: Call me old fashioned, but I feel really disheartened to think that 300 years on and MPS is still taking bribes for big companies.

Ian McDiarmid: I didn't say that Hazel, you said that.

Hazel Baker: Cool blimey. That was a lot of content to get into 20 minutes. I hope you all enjoyed it. As you can see, it's a very complicated and very interesting subject. And Ian does a Financial City of London Tour, which you can book online.

If you've enjoyed this podcast, please do leave us a five star review. It will be very much appreciated. And thank you, Kelsey, for taking the time to write a lovely message about what you enjoy about our podcast. So that's enough for now, catch you next week.

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