October 14, 2024
Newton’s law of speculative bubbles
Dear Reader,
If I told you there was a company whose objective was to wipe out national debt, and that I’d secured a trade monopoly with a vast, rich nation to make it happen…
Would you be interested in investing?
This very proposition drew some of the 18th century’s highest profile players — including pioneering physicist, mathematician and philosopher Sir Isaac Newton — to invest their money into one of the most insane bubble-and-bust stories you’ve ever heard.
This is a tale of greed, speculation, and financial ruin that makes today’s market swings and scandals seem mere ripples on a pond.
The business of saving national economies
The South Sea Company was founded in 1711 by an Act of Parliament.
In 1713, the company was granted a trading monopoly in the South Seas region. This referred to South America and surrounding waters at that time.
This monopoly was granted as part of the Treaty of Utrecht, which ended the War of the Spanish Succession.
Specifically, Britain had been awarded the right to the Asiento (‘Contract’) by the Spanish Crown, giving them monopoly rights to import African slaves into Spanish-held America.
The British government then granted this right to the South Sea Company.
In exchange for this monopoly, the South Sea Company agreed to buy up £9.5 million (some sources say £11 million) of Britain’s outstanding official debt.
In other words, the business was going to free Britain from debt with the enormous profits of its zero-competition business activities.
This one company, with this enormous competitive advantage (secured by the government), quickly became the hottest investment narrative in Britain.
The company’s stock price ran higher on speculation and misleading claims.
At its peak in 1720, South Sea Company stock had risen by over 800%.
Investors, from the working class to the nobility, rushed to get a piece of the action.
Isaac Newton, pioneering physicist and father of classical mechanics, was among them.
Newton reportedly lost as much as £40 million (adjusted for inflation) in the scheme.
Other luminaries joined Newton as shareholders.
Jonathan Swift (author of Gulliver’s Travels).
King George. Parliament. The Church.
This bubble ran to the very top.
Optimism morphs into delusion
The South Seas Company looked like it couldn’t lose.
The company could make money on trade and interest on the loan it had made to the government (to buy it’s national debt).
Speculation surged.
By summer 1720, the share price was rising fast.
King George I had became governor of the company in 1718, giving it the ultimate seal of approval.
The company launched an aggressive propaganda campaign, promising astronomical returns and framing investment as a patriotic duty.
They offered loans to investors to buy its shares, creating a self-perpetuating cycle of demand and price increases.
As share prices rose, FOMO kicked in, hard.
More people rushed to invest, fearing they’d miss out on easy riches.
Share prices charged from £128 in January 1720 to more than £1,000 by August — an increase of nearly 700% in just seven months.
What goes up…
In September 1720, the bubble burst spectacularly.
Stock prices plummeted from £950 a share in July to £185 by December.
Down 80% in just five months.
The fallout was catastrophic.
Investors were ruined, suicides spiked, and the national economy took a massive hit.
Here’s an account containing the Amount of the Sales of the Real and Personal Estates of the late South Sea Directors:
Back before we had modern portfolio trackers like Navexa
Jonathan Swift, who lost a considerable sum himself, captured the chaos in a satirical ballad:
Thus, the deluded Bankrupt raves;
Puts all upon a desp’rate Bet
Then plunges in the Southern Waves
Dipt over Head and Ears – in Debt.
Aftermath: South Seas Company’s sunken dream
The public outrage was, of course, strong.
Parliament — despite having created, promoted and invested in the whole thing — launched an inquiry.
It uncovered a web of insider trading and bribery that would make even the shadiest of modern-day corporate raiders blush.
Several company directors were punished, including prominent Cabinet members.
The Chancellor of the Exchequer was removed from power and imprisoned in the Tower of London.
It was financial and political carnage on a scale we can’t really imagine, today.
Sir Isaac Newton: Abandoned reason to ride the South Seas wave
Too good to be true, too bad to be false
The South Seas Company saga played out about 300 years ago.
But its lessons still burn bright.
If it sounds too good to be true, it probably is.
Speculation can create a dangerous disconnect between stock prices and underlying value.
Even the smartest people (Isaac Newton — seriously) can get caught up in market mania.
Government involvement doesn’t guarantee safety — it might even amplify risks.
As we navigate today’s markets, from crypto booms and busts to AI stock mania (the jury is still out on this), the South Sea Bubble serves as a stark reminder of the dangers of unchecked speculation.
And a reminder, not only of the importance of due diligence — but of weighing the facts independently of public opinion about those facts.
Quote of the week
‘I can calculate the motion of heavenly bodies, but not the madness of people.’
— Sir Isaac Newton
That’s it for The Benchmark this week.
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Invest in knowledge,
Thom
Editor, The Benchmark
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