The South Sea Bubble: Hail The Greath British Empire
Evan Louise Madri?an
Finance & Investment Writer and Author | Value Investor | Registered Nurse ?My book and website are my way of empowering Millennials and Gen Zs to take control of their financial lives.?
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 17th 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 wars 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 of how the Mississippi Bubble and 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 breath taking ￡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 18th-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.
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.
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.
The political party systems of Britain strengthened during the 18th 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.
The Bank of England was started in 1964. 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.
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 were 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.
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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.
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?”.
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 they 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 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 the 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. Everyone who participated in the lottery won something. "What?!?!?"
Yes, you read it right, literally, everyone who joined won something. ?? This made all the lottery tickets sell out.
At minimum, the person who owns a lottery ticket is guaranteed to win 10% of the ticket price.
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 the 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 South Sea Company
To be continued . . .
Knowledge is my Sword and Patience is my Shield,
elmads
DISCLAIMER:
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.