Chapter 7--The South Sea Bubble

The South Sea Bubble 7

Late seventeenth-century England was a time of increased trade, industrial expansion, and, of course, war. All of these elements created the need, at least in the minds of the British, for a public bank. England’s close relations with Holland during this period gave the British a first-hand view of the vast Dutch economy and the important linchpin for that economy, the Bank of Amsterdam. In fact, after the founding of the Bank of Amsterdam in 1609, other public banks began to be formed: local banks at Rotterdam, Delft, and Middelburg, the Bank of Hamburg in 1619, and the Bank of Sweden in 1656. English merchants began to be exposed to public banks throughout Europe, and thus various proposals began to surface for a public bank in England.

But it was the British government that had the greatest need for a public bank. William of Orange, when he came to the throne in 1689, hoped to gain popularity by abolishing the hearth tax.¹ But, needing money to fight the war against France, in addition to the civil war in Ireland and Scotland, William imposed a series of other taxes: the poll tax, stamp tax, window tax, land tax, and taxes on peddlers, hackney coaches, births, bachelors, marriages, and burials. As is inevitable, government revenue was not increased in the same proportion as the increase in the tax levies. Even had all the taxes been collected, the war expenses were far in excess of the highest revenue potential of the taxes.²

Parliament made provisions allowing tallies to be issued on future sources of government tax revenue. At first these orders were issued against the proceeds of specific taxes. But the government then began to issue against revenue in general. These tallies were made assignable and eventually the majority of this government debt was held by England’s goldsmith-bankers.

In December of 1671, Charles II was in need of funding to finance his Navy. He called upon the bankers for help, but they refused. After a debate in Council, the King decided to prohibit certain payments out of the Exchequer. His proclamation of January 5, 1672 has come to be known as the “Stop of the Exchequer.” The Stop allowed the King to pay whom he wanted, with others being out of luck. Keith Horsefield quotes two items in the proclamation that allowed for the King’s payment discretion: “all other public services and support of the government” as well as “all other payments appointed by Warrant under the Privy Seal or Royal Sign-Manual.”³ The second item enabled the King to direct payments even on stopped funds. Not surprisingly, payments continued to flow to areas of the government. The most serious losses were absorbed by the goldsmith-bankers. With the government not making payments on their tallies, bankers were in turn forced to stop payment. Although Charles told the bankers to make payment to their customers, the banks did not have the money to do so.

The Stop was originally to only last for one year, but was continued until January 1674. But by that time the damage had been done, as Horsefield indicates: “By then the funds on which the orders had been drawn were all expended, so in practice the Stop became permanent.”⁴ The immediate effect of the Stop was that credit quickly evaporated. The goldsmith’s notes became worthless, and subsequently many goldsmith-banks folded. The long-reaching effect of the Stop was the postponement of joint-stock banking for ten to fifteen years.⁵

After the Stop, the King had difficulty borrowing money. Thus, the British government needed a bank, and of the many schemes proposed, the one advanced by William Paterson had the most promise. Paterson is described by John Giuseppi as, “one of those men whose ideas range some years ahead of their time and who have a streak of the true visionary about them, but never quite reaches genius.”⁶ Paterson and the spokesman for his financial backers, Michael Godfrey, took their plan for a “Bank of England” to Charles Montague, a Lord of the Treasury who subsequently, in 1694, became Chancellor of the Exchequer. Paterson’s financial backers were all men of great substance, influential politically and all Protestants.

In spite of such backing, the plan was vigorously debated upon reaching parliament for approval. The Tories feared that the Bank’s operation would greatly strengthen the Whig government, while the goldsmiths and money lenders feared being demolished. Also, some merchants worried that the Bank would pose a threat to their trade business, and there were even some Whig supporters who feared that the Bank of England would make the monarchy financially independent of the Parliament. Prior to the proposal reaching Parliament, there were concerns within the government about the scheme, most prominently, the note issue. Paterson and his promoters recognized the tremendous profit potential from note issue, by expanding on what goldsmiths were enjoying on a local basis. The government took a dim view of the bank encroaching on its domain—the manufacture and control of England’s currency.

Paterson’s first proposal was denied by Parliament because, as Clapham says: “It looks as though they thought the proposal was for the issue of legal tender bank notes; and apparently that is what it was.”⁷ Paterson quickly formulated a second proposal, which made no mention of bills, except in clause 28 of the Act, which was added to the original draft in a separate schedule. Sir John Clapham makes the comment that “the clause looks like an afterthought.”⁸ This proposal was brought before the Cabinet by Montague, who submitted that £1,200,000 be raised, which in turn would be lent to the government at 8 percent, under the condition that the subscribers be incorporated and that £4,000 a year go toward their management expenses.

Paterson’s scheme was debated at length by the Cabinet. Finally, it was agreed that a bill containing the proposal should be put before Parliament, where it was passed after being adroitly attached to an ordinary finance bill. The act was not known as the Bank of England Act, but as:

An Act for granting to their Majesties several Rates and Duties upon Tunnage of Ships and Vessels, and upon Beer, Ale and other Liquors: for securing certain Recompenses and Advantages, in the said Act mentioned, to such persons as shall voluntarily advance the Sum of £1,500,000 towards carrying on the War against France.⁹

Thus, the Bank in its early years was called the “Tunnage Bank.” On April 25, 1694, the Act received the Royal Assent, and subscriptions for £1,200,000 of the £l,500,000¹⁰ began to be taken. Opponents of the Bank attempted to postpone the commission, but Queen Mary squelched the antagonists immediately. King William, plain and simple, needed the money to fight France. The subscription books were opened at “Mercer’s Chappell” on June 21st, with £300,000 being subscribed the first day. The entire £1,200,000 was completed by July 2nd. The first subscribers were the King and Queen for £10,000,¹¹ followed by 1,267 individual holders. Subscribers were required to pay 25 percent of their subscribed amount in cash.¹²

As remarkable as the speed of filling the subscription is how quickly the subscription’s full sum made its way into the Exchequer. The Bank had promised to complete the operation by January 1, 1695, but full funding was in fact completed by mid-December. Clapham indicates that “this had been done while its capital, nominally of the same amount, was still only 60 percent paid up; and even some of this £720,000 existed in the form of subscribers bonds which, rather sanguinely, were ‘reckoned as cash’.”¹³

The Bank aggressively sought deposits from its very beginning, devising three “methods in keeping running cash.” These methods are described by Clapham:

...by “Notes payable to Bearer, to be endorsed”, by “Books or Sheets of Paper, wherein their Account to be entered”, or by “Notes to persons to be accomptable”. The third method is a kind of deposit receipt, as is shown by an August decision that only “accomptable notes” be given for foreign or inland bills of exchange until “the mony be actually received”. The second method anticipated the modern passbook: it blended with the third under a rule by which people who drew notes (cheques) should have receipts for their deposits “and ye particulars of the Bills drawn are to be entered on ye side”. It is the first method which produced those bearer notes “without which the Bank could hardly have carried on business”; and the third from which the cheque developed, for the holder of an “accomptable note” could create “drawn notes” against it, for himself or others.¹⁴

The Bank of England’s note issue monopoly was only limited by the formal order that prohibited it from issuing notes in amounts exceeding its capital. However, as early as 1696, critics of the Bank complained of the free use of notes. Clapham quotes from a broadsheet issued in connection with the recoinage of 1695–96 entitled The Mint and Exchequer United:

the Bank was limited by Act of Parliment not to give out Bills under the Common Seal for above £1,200,000; and if they did every Proprietor was to be obliged... to make it good, so that they give out Bank Bills with interest for but £1,200,000. But they give the Cashier’s notes [observe the term he uses] for all sums (ad infinitum) which neither charge the Fund nor the Proprietors, which seems to be a Credit beyond the intention of the Act... and never practiced before by any Corporation, and almost a Fraud on the Subject.¹⁵

In spite of frequent attacks, the Bank prospered. Its promoters were all influential Whigs, which ensured the support of both the government and the commercial world, both of which would run to the Bank’s aid whenever it was threatened. This success was reflected in the price of the Bank’s stock which hit the unprecedented price of £108 in January, 1696. But two dangers loomed on the horizon: the recoinage and the Land Bank project.

England’s coinage was depreciating daily as a result of continual clipping and other debasement, e.g., iron and copper coins being silvered over. The situation was so severe that trade was at a standstill, attracting the attention of Parliament, which passed the Re-Coinage Act of 1696. This act forbade the exchange, sale, or receipt of any coins, clipped or unclipped, gold or silver, for more than their nominal value. Additionally, the law called for a £500 fine for anyone caught in possession of coin clippings, plus the offender would be branded on the right cheek with a capital R. And, if this was not enough, only professional goldsmiths were allowed to buy or sell bullion. Any house suspected of containing bullion could be inspected at any time. If bullion was found on the premises, the owner was required to prove that the bullion was not the product of clippings or melted coin. County sheriffs were required to pay £40 to anyone who procured the conviction of a clipper. The law went even further to provide incentives to snitch on a person’s bullion holding neighbor. Any “clipper” who was able to secure the guilt of two other “clippers” would receive a pardon, and the ambitious apprentice who informed on his master was made a freeman of the City. This “war on clipping” which ultimately led to the harshest of penalties, execution, inspired the clergy to protest. Tw o difficulties that the Exchequer was forced to grapple with concerning the Re-Coinage Act were the expense of the recoinage and more importantly, the decision as to whether the coins should keep their old standard or be issued at a lower one.

The expense of the operation totaled £2,703,164 and was covered with difficulty. This ultimate cost was far in excess of that estimated in the beginning. The Bank also was naïve about the consequences of the recoinage, as Andréadès writes:

Possibly too, if the Bank had realized the difficulties it would have to face—the depreciation of its stock and notes, the suspension of payments and of dividends—its directors, in spite of their courage and intelligence, would have refused to enter upon such a formidable adventure, more especially since they were already threatened by the Land Bank.¹⁶

The question of whether the new coins should keep their old standard or be issued at a lower one was to be debated vigorously. William Lowndes, the Secretary of the Treasury, developed the idea that lowering the standard of fineness of the coins while continuing to call the coins by their former names, would defray the expense of the recoinage. Lowndes’s report was met with a crushing rebuttal from John Locke, who is quoted by Andréadès:

But this, however ordered, alters not one jot the value of the ounce of silver, in respect to other things, any more than it does its weight, this raising being but giving of names at pleasure to aliquot parts of any piece. No human power can raise the value of our money their double in respect of other commodities, and make that same piece or quantity of silver, under a double denomination, purchase double the quantity of pepper, wine, or lead, an instant after such proclamation, to what it would do an instant before.¹⁷

In spite of Lowndes’s suggestion being the prevailing view, Montague’s support, combined with Locke’s keen analysis, led to passage of the resolution to preserve the old standard.¹⁸

The Land Bank proposal was put forth by Dr. Hugh Chamberlain and John Briscoe. Their idea was to raise a public loan twice that of the Bank of England. This loan would be backed by the security of landed property and have an interest rate of 3¹/₂ percent. Chamberlain and Briscoe fell into the same trap as John Law, viewing paper money backed by land as equivalent, if not superior, to gold or silver. Their plan called for the printing of money equal to the total value of all property. As Andréadès points out, these promoters knew that government coercion was needed to carry out their scheme:

The promoters did not deny that the public preferred the precious metals, and that in consequence if the Land Bank were forced to pay in gold, it would soon have to suspend its payments. But they proposed to overcome this difficulty by making the notes inconvertible and legal tender.¹⁹

The British government in the spring of 1696 was again, as is the case with all governments, in need of money, and the Land Bank received Royal Assent on April 27th by way of a Ways and Means Bill. The bill was to raise £2,564,000, with the interest on the loan to be covered by a salt tax. But alas, the Land Bank act died as quickly as it was engendered. Only £7,100 was subscribed, with £5,000 of that being the King’s investment. With the government on the brink of bankruptcy, the Exchequer stepped in with an issue of Exchequer bills to fill the breach. Also, the King was able to secure a loan from the Dutch in the amount of £500,000. This scrambling for funds was due to the fact that the government had borrowed all that the Bank of England could lend, based on it not being able to lend an amount more than its capital. The Bank’s bills had fallen to a 10 percent discount. Additionally, its stock had dropped from £107 to £83 with the passage of the Land Bank proposal and the subsequent floating of the Exchequer bills. The Bank had many competitors, with all of them issuing their own paper. As Carswell writes:

Neither recoinage nor expanding trade could have been financed without paper money, which was issued during the war in increasing quantity from the Exchequer, the Bank of England, and the innumerable goldsmiths and running cashes of Lombard Street.²⁰

It was the damage that the Bank received from the Land Bank scheme, the recoinage, and its pesky competitors, that led its promoters to seek aid from the government in the form of monopoly status. The case was made that, for the Bank to be useful to the State, its notes must not be faced with competition which “causes distrust and contracts credit instead of enlarging it.”²¹

The main provisions of the act in 1697, which gave the Bank of England monopoly status, were:

1. The Bank would add £1,001,171 to its capital,
2. Subscriptions could be paid 80 percent in Exchequer bills, 20 percent in Bank notes,
3. Subscribers were to be incorporated in the company,
4. The Bank was granted monopoly status for the duration of its charter until August 1, 1711, since no other banking corporation was to be established by an Act of Parliament,
5. 8 percent interest was guaranteed by the salt tax on tallies accepted in payment by the Bank,
6. Before opening the subscription for the additional capital, the original capital was to be paid up to 100 percent for each proprietor,
7. The Bank was authorized to issue notes to the amount of its original capital (£1,200,000), plus the sums to be subscribed, on the condition that they were payable on demand,
8. All property of the Bank was exempt from taxation,
9. It was to be a felony to forge or tamper with Bank notes.²²

By consequence of this act, £200,000 in banknotes and £800,000 in tallies were drawn out of circulation, thus the discount on the remaining Bank notes disappeared, and these banknotes began to circulate without bearing interest.²³

England’s war with France also ended in September, 1697, relieving the government treasury of the burdensome expense of the war, perhaps just in time. Early in 1697, over £5 million of shortterm government borrowings were due and had to be extended, and to add to the distress, the Malt Lottery loan subscription in April was a complete flop.²⁴ The government’s credit was repaired with the help of the Bank of England, three years of peace, and the successful floating of New East India Company stock in 1698, which in turn loaned £2 million to the Exchequer. This new entity, like the Bank of England, was allowed to use the government’s debts that it owned as a “fund of credit.”²⁵

The tranquility of peace was not to last long, as the War of the Spanish Succession began when Louis XIV of France marched into the Spanish Netherlands in February 1701. William, who hated Louis XIV, was eager to join the European coalition. However, the public was not in the mood for more of William’s war and commercial unrest. In spite of three years of peace, taxes and interest rates had remained high, hangovers from the previous war debts. But with a hostile enemy just across the English Channel, the English joined the fray in earnest, especially after the death of King William in 1702.

The long and bloody confrontation was to again tax England’s treasury. The Bank of England supplied short-term funding, with long-term funding supplied mainly by the sale of 96 to 99 year annuities. Sidney Godolphin was named as Lord Treasurer in 1702 by Queen Anne, and was, in the view of Dickson to manage “the national finances with great care and skill.”²⁶ Godolphin seemed to be able to raise funds to fight the French with relative ease, being aided by the British army’s battlefield conquests, which bolstered investor confidence. The war’s expense was running at between £8 million to £9 million per year. This unprecedented expense was far greater than what could be extracted from the populace by way of new taxation. Thus, tax revenues through the end of the century were mortgaged with long-term debt. From 1704 through 1710, the British government’s long-term borrowings totaled £10.4 million. In addition to these loans from the public, Godolphin borrowed £1.7 million in Exchequer bills from the Bank of England, and obtained loans from the East India Company.

By this time, the public had become anxious about the length of the war and its cost, both in blood and financially. The harsh winter of 1708–09, which led to a bad harvest the following summer, pushed up prices. This inflation and the failure of peace talks at The Hague in August was followed by a bloody battle at Malplaquet in September and created an adverse political climate that led to a new Tory Ministry the following year. The new Ministry sacked Godolphin on August 8, 1720, with Robert Harley being named Chancellor of the Exchequer two days later. In May of the following year Harley was named Lord Treasurer.²⁷

In the meantime, Sir John Blunt and his partners had transformed the Sword Blade Company into a finance company in order, as Carswell says, to “annex for themselves as large a part as they could of the politico-financial empire that had been carved out by the Bank of England.”²⁸ The Sword Blade Company’s business was to acquire estates with the proceeds from stock issues that were paid for in government obligations. The obligations chosen were Army Debentures, issued by the Paymaster of the Forces. The market price of these debentures was £85, for which the holders were then offered Sword Blade stock valued at £100. The government was thus traded their own debt instrument, at a discount, for their land.

In the spring of 1704, the Bank of England took offense of the activities of the Sword Blade Company, serving notice to the Treasury that the monopoly clause of the Act of 1697 was being violated by Mr. Blunt and his company. Blunt contended that the Act of 1697 only prohibited rival corporations set up by an Act of Parliament, which the Sword Blade Company was not. By May of 1707, the Bank managed to get the Treasury’s promise that it would take action against Sword Blade Company and to fortify the Bank’s privileges.

The Sword Blade Company provided good, healthy competition for the Bank of England, but the Treasury needed money, and the Bank was willing to lend £1¹/₂ million at 4¹/₂ percent.²⁹ With the Treasury getting what it wanted, it in turn extended the Bank’s charter to 1732, along with allowing the bank to double its existing capital of £2,201,171. The additional capital was raised before noon the same day subscriptions became available. Andréadès provides a breakdown of the Bank’s capital position at this point:

Capital of the Bank.....................................................£2,201,171
This Capital doubled..................................................£4,402.343
And increased by the £400,000 now advanced............£4,802,343
To which must be added for the Exchequer bills.........£1,775,027
Total £6,577,370³⁰

The activities of the Bank, along with those of the Sword Blade Company and the East India Company, ensured that there was plenty of money available. As Carswell writes: “The war had encouraged, not checked, the advance of wealth and the multiplication of paper. It was no uncommon thing, now, for a man to have made a ‘plum,’ as current slang described £100,000.”³¹

As was the case in the Bank’s original charter, the Bank’s note issue was only restricted by the amount of its capital. Andréadès quotes H.D. Macleod’s stinging criticism of this scheme:

Now, to a certain extent, this plan might be attended with no evil consequences, but it is perfectly clear that its principle is utterly vicious. There is nothing so wild or absurd in John Law’s Theory of Money as this. His scheme of basing a paper currency upon land is sober sense compared to it. If for every debt the Government incurs an equal amount of money is to be created, why, here we have the philosopher’s stone at once. What is the long sought Eldorado compared to this? Even there the gold required to be picked up and fashioned into coin.³²

The new Chancellor of the Exchequer, Robert Harley, had inherited from his successor, Godolphin, a mountain of debt, and the immediate problem of having to satisfy the creditors of the Navy, all of whom were anxious to be paid. Harley received proposals from John Blunt and George Caswell of the Sword Blade Company, and from Sir Ambrose Crowley, a large contractor with the Navy Board. The Blunt-Caswell plan essentially called for the incorporation of the Navy and other creditors, along with cancelling the state’s debt to them in exchange for stock.

Harley was not flush with options. He did not have the cash to pay the floating debt, and had no alternative to the Blunt-Caswell proposal. On June 12, 1711, the plan was given Royal Assent. The government’s short term creditors, holding close to £9 million, were to be incorporated under the Great Seal as “the Governor and Company of Merchants of Great Britian Trading to the South Seas and other parts of America and for encouraging the Fishery.”

This new entity, in exchange for extinguishing £9 million in government debt, was given a monopoly on trade with South America, on the east coast from the River Orinoco to Tierra del Fuego, and for the entire west coast. This region had for some time held an allure of riches to the British. Thus, it was the perfect vehicle to placate the government’s creditors, given its potential for high profits. In fact the British, since the reign of Queen Elizabeth, had attempted to break the Spanish stronghold on the Americas, either by force or license. This attempt, like the others, was to fail. The opening of this market would come much later, in the nineteenth century, with the political independence of the Spanish colonies.

The establishment of the South Sea Company coincided with the British expedition in August, 1711 against Quebec, and the planning of an Anglo-Dutch attack on the Spanish West Indies. Dickson theorizes that: “It can therefore be regarded as part of a three-pronged drive for empire in the new world, though there is little doubt that in fact this grand design was three-quarters bluff, intended to assist Harley’s peace negotiations.”³³

At war’s end in 1713, the South Sea Company’s trading rights were defined. The company had permission to send, annually, one 500 ton ship to trade at the fairs of Cartagena or Veracruz and to send 150 ton supply ships to supply food to the factories. In addition, it was given a thirty year contract to supply African slaves to New Spain. This contract called for the delivery of 4,800 slaves per year of a specified condition, with the company paying taxes on 4,000 of these. The King of Spain was to receive 10 percent of the company’s slave trade profit in addition to the 28 percent of all other trading profits. This limited amount of trading privilege, along with the payment to the King of Spain of his share, left but a meager return for the company.

It was to take over two years to even come close to selling out the South Sea subscription. The books were finally closed on Christmas of 1713, with a total of £9,177,968 having been raised, an amount smaller than the £9,471,324 envisaged by the South Sea act. The company was to receive annually £550,678 in interest and £8,000 for management from the government. In the beginning the government paid promptly. But this situation changed, and by the summer of 1715 interest was six months in arrears. With no interest income coming in and little progress made in starting trade with Spanish America, the company was quickly in financial trouble. In 1712, 1713, and 1714 the proprietors were given the option of receiving dividends in cash or in bonds. In 1715, no choice was given, dividends were paid in bonds; and, in 1716, dividends were paid in the form of stock. Fortunately for the subscribers the stock was now at par.

From 1712 through 1715, the government used South Sea stock to pay creditors and to secure loans. “For the use of the public,” £2,371,402 of the company’s capital had been set aside; plus £500,000 in stock was created for the government’s use by the South Sea Act. This use of funds was not popular, and eventually, in 1717, the company was able to shed its encumbrances, with Parliament proclaiming that government deficiencies were to be paid, in the future, out of the General Fund. Also, by this date progress had been made on the trade front and the company appeared to have weathered its difficult beginnings.

By the use of the South Sea Company vehicle, the government was able to rid itself of its floating debt. However, this repayment did nothing to fund the burden of the war expense that had reached its height at that time (1711). To fund this shortfall, Harley created Exchequer bills on a massive scale to handle the short-term needs, and used the Bank of England as receiver for £9.2 million in lottery loans floated in 1711 and 1712 to cover the revenue deficit. Harley went on to float smaller lottery loans in 1713 and 1714, with the Bank acting as receiver. One loan was to discharge the debts of the Civil List, and the other was to go to the public service.³⁴

The War of the Spanish Succession was finally over in 1713. England and the other participants had each created a huge mountain of debt with which they were forced to contend. On September 29, 1714, Britian’s national debt stood at £40,357,011. Additionally, there were over £4¹/₂ million in Exchequer Bills outstanding, not to mention debts of back-pay to the army and foreign subsidies of unknown amounts. The government undertook a massive restructuring of its debts in hopes of lessening the interest burden.

This restructuring was accomplished through three conversion Acts. The first called for the conversion of the 1711–12 lottery loans outstanding and half of the 1705 Bankers’ Annuities debt to be exchanged into 5 percent stock to be managed by the Bank of England. The second act reduced the interest rate on various debts owed to the South Sea Company and the Bank of England. The third act established a sinking fund for reduction of the national debt and called for reducing the interest rate on Exchequer bills to l¹/₂ percent.

These measures, which were implemented between 1715–1719, were for the most part successful, reducing the government’s annual interest charge by 13 percent and providing welcome relief to the state. Although the yield on government obligations had been lessened, most holders of the government stock felt their principal was more secure. This feeling was reflected in the market price of government stock. At the end of 1717, the stock was trading four points above its par value.

However, there was one finance problem left to be solved, that of the high and virtually perpetual interest to be paid to annuitants. These annuity holders would have to be persuaded to exchange their annuities for redeemable stock. The Treasury turned to the South Sea Company in 1719 with a plan for this conversion. The interest payable on these annuities was £135,000 yearly, thus the Treasury calculated that this interest should be capitalized at a market price of eleven and a half years purchase, or £1,552,500. To be added to this was £168,750 in back interest owed the company and the £778,750 the company was to lend to the Exchequer. Thus, the total increase in the state’s debt was to be £2.5 million as a part of this conversion.

In the spring of 1719, it turned out that only two-thirds of the subscription was taken. As a result the South Sea Company’s capital increased by £1,746,844 to a total of £11,746,844. The subscription, which was payable in fifths, was fully funded in December 1719, with the company receiving £592,800. The Exchequer was to be paid £544,142. This was raised by selling £520,000 in new stock at £114 in July. The company’s claims against the state now stood at £193,582. Thus, when all was said and done, the company had made a tidy profit of £242,240 from the operation, and had £24,000 in stock still in hand. This success led to a much bigger operation of the same kind the following year.

Across the Channel, in 1719, John Law’s system was at its height and was viewed with more than a twinge of jealousy and concern from the Brits. Law’s debt conversion had already inspired John Blunt and his fellow Sword Blade partners. But what concerned the British government was the ever increasing flight of capital leaving London to seek the much-talked-about returns to be enjoyed in Paris. With further debt conversions being contemplated by the government, it did not want this loss of capital to hinder its plans. These fears were raised when rumors began to circulate that John Law was opening a large “bear” account to depress British Government stocks. At the same time, another rumor had him buying the East India and South Sea Companies so as to become the financial czar of Europe. But the government’s worries were pointed in the wrong direction. John Law’s system was about to fall apart, and besides, Law had a very ambitious imitator in Sir John Blunt, who was about to embark on his own grand scheme.

Two categories of debt were particularly troublesome to the government. One was the ninety-six and ninety-nine-year annuities which had been sold when interest rates were high, and could not be redeemed by a lump-sum payoff or a sinking fund (they could be redeemed only if annuitants were persuaded voluntarily). The other category was miscellaneous debts, which were being redeemed by Walpole’s sinking fund at approximately £750,000 per year. Total government debt service, not including management charges and amounts converted into stocks already, was over £1.5 million per year, and as Carswell relates:

this was the amount negotiators at the Treasury were concerned to disguise as a single huge redeemable annuity to the South Sea Company. For this purpose it was necessary to represent the whole as a capital sum. ...To keep one’s head in the maze of South Sea finance, it is important to lay firm hold on the fact that the capital figures were mere paper calculations.³⁵

The capitalization of the redeemable debt was straightforward and totaled approximately £16 million. As for the irredeemable annuities, the capitalization was much more difficult to formulate. The overriding objective was to reduce the cost of this debt as much as possible. This was accomplished by capitalizing these annuities at their original term of years, but without regard to the date they were issued. Ninety-nine and ninety-six year annuities were capped at 5 percent for twenty years, with the thirty-two year and the Lottery annuities being capped at 6 percent interest for fourteen years. The total capitalization for the annuities was £15 million, making the grand total £31 million.

Against this staggering sum of £31 million, an equal amount of South Sea stock was to materialize when debt holders would voluntarily exchange one for the other. The amount of stock that the company would issue for any given debt was to be decided by the market. Thus, as was the case with the 1719 conversion, the higher the price of the stock, the more profitable the conversion would be for the Company.

The Company’s deal with the government in regards to the conversion was very precise: for every pound of yearly expense spared the government, the Company received a pound a year from the government. The exception to this was on irredeemables where the Company would receive only 14 shillings for each pound the government was saved. This was worth £40,000 a year to the Exchequer. The ultimate savings to the government was to come after seven years, when the government would only pay 4 percent on all of the converted debt, a savings of roughly £400,000. In addition this obligation could be redeemed. Thus, the government was allowed to pay off the debt in total whenever it might be able. It was calculated that if the interest savings were applied according to sinking fund principles, Britian’s debt would be retired in twentyfive years. And if the prospect of being debt free was not enough incentive, the Company offered a carrot that was to be paid at the end of the one year conversion term: a gift to the Exchequer of £3 million, payable in four quarterly installments, to be used to pay off redeemable debts incurred before 1716, with any amounts that remained being available for use in whatever way the Exchequer desired.

This £3 million sweetener also served as an insurance policy for Blunt. If all of the redeemables were not converted, this £3 million would be available to pay these debts off. Thus, with the Bank of England owning most of these notes, the threat of repayment was enough for the Bank, which would not be able to reinvest the cash at attractive returns, to convert the debts it held for South Sea stock. Blunt knew that he would never earn, in the normal course of business, the £3 million in cash needed to make this promised gift, for every penny of income would have to go toward payment of the 5 percent dividend on the capital. What Blunt was counting on was a rise in the share price of South Sea stock to generate the needed funds.

Blunt calculated correctly that, if a boom in stock prices was engendered, holders of government annuities would quickly exchange this debt for the opportunity to make huge capital gains relatively quickly. The fuel needed for this boom was endogenous to the plan, as Carswell points out:

The plan amounted to the injection into the economy which was already booming, of another £5 million or so of new money—ten times the injection of the previous year— with a simultaneous lowering of interest rates.³⁶

The final days of 1719 brought news that spurred the fortunes of the South Sea Company. Peace between Spain and England had been declared on the terms of the latter, opening up trade passages to South America. The time had come for Blunt’s grand plan to be presented to the Parliament. Chancellor of the Exchequer, John Aislabie, laid the plan before the House of Commons on the basis that the plan was forthcoming from the Company. Secretary Craggs followed with the suggestion that the House receive the plan. But to Aislabie’s dismay, an influential Anglo-Irish Whig, Thomas Brodrick, suggested that the House consider other offers before it accepted this one, and the measure was not voted on. This allowed the Bank of England time to make a rival proposal.

The Bank was suddenly put in a position of having to fight for the top financial perch upon which it had sat for so many years. For ten years the South Sea Company had slowly increased the amount of annual payments it received from the government, to over £500,000, and now the Bank was faced with the possibility that the South Sea Company would be the recipient of £2 million in annual annuity payments at its expense. It was feared that the loss of this conversion would relegate the Bank to being just an ordinary commercial bank, with its old enemy, the Sword Blade Company, the credit-creating agency behind the South Sea Company, depriving them of their lofty position within the London money market.

The bidding for the conversion was spirited. The critical deal point, which the Bank and the Company continued to make more and more attractive, was the amount to be given as a gift to the Exchequer. The South Sea Company’s original £3 million was increased to £3¹/₂ million, only to be increased to £5¹/₂ million with the Bank’s bid. But the Company finally won out by raising the stakes of the gift to £4 million certain to the Exchequer, with the possibility of as much as another £3¹/₂ million. The additional amount was dependent upon the amount of debt that was actually converted. Also, the Company promised to make the annuity open for redemption in four years rather than the seven years originally proposed, and, at the same time, reduce the interest rate to 4 percent. Finally, the Company offered to circulate £1 million in Exchequer bills with no management fee or interest. This was an offer that the Bank of England could not match, and the South Sea proposal passed in the House with ease. With the news of the Company’s triumph, the traders in Exchange Alley bid the price of its stock up 31 points, from 129 to 160, and what a journalist of the time called “the English Mississippi” was underway.³⁷

As the debt conversion was being negotiated and subsequently bid for, English pounds continued to flow across the channel into the awaiting tempest that John Law’s system had now become. After hitting a high in January 1720, Mississippi Company shares had fallen. Law was now desperately trying to hold up the shares at the expense of his inflation ravaged currency, and the financial freedom of the French people. Law’s proposals put forth in the spring, in hopes of salvaging the currency, were met with suspicion from the savviest of London’s investors, who began to pull their money out of Paris and return it to the London market.

John Blunt and the rest of the South Sea stock promoters, like John Law in the case of the Mississippi shares, sparked the fire of speculation in the Company’s shares by allowing the governing class the opportunity to be in on the ground floor of the stock issue. This virtually assured them a profit. Nearly all of London’s bourgeoisie had purchased their shares prior to the publishing of the Bill calling for the debt conversion on March 17th. Subsequently, between March 19th and 21st, the share price soared from £218 to £320 on reports from Paris that John Law was taking criticism from the Regent and having nightmares. A second reading of the Bill on the 21st inspired a debate on the 23rd over whether the terms of the conversion should be fixed in advance and be written into the statute. The debate lasted six hours, with contrary news causing the price of the shares to trade in a broad range of 110 points, between £270 and £380. The company prevailed, which propelled the stock to £400 for a brief period before it retreated back to £330.

On March 25th, the Bank of England was further humiliated. It was announced that the entire debt held by the Bank (£3.75 million) that was not to be redeemed by the South Sea Company would be repaid by the end of the year. The payoff of this debt meant that the Bank would no longer be a national institution. Any support the Bank had enjoyed from those individuals in government that was now firmly behind the South Sea Company, with more than a few having been given shares in the company to enjoy in the speculation and reap the financial reward. The Bill finally received Royal Assent on April 7th. The Company had provided £574,500 worth of stock in bribes to government officials to get the bill passed, and now London was poised for the boom. Carswell added up the liabilities that the Company would incur over the next year (£11.4 million), which the profits of the conversion would have to cover.³⁸ A share price of £140 was needed to break even. On April 7th the stock stood at £335.

The South Sea Company’s subscription and debt conversion was begun in April, with the Company’s primary motive being very clear: to market its new stock while the share price was rising, while deferring the second conversion of government debt until August, when its share price was at its height (£1,000). This would maximize its exchange advantage over government debt holders. The Company’s first stock subscription was on April 14th, with 2,250,000 issued at a per share price of £300. The terms of payment were 20 percent down, with the balance to be paid for over sixteen months with calls every two months.

The second issue came two weeks later, on April 29th, with l¹/₂ million shares issued at a price of £400. The terms quickly became more liberal, 10 percent down, with the balance over twenty months payable in nine calls at three to four month intervals. With the market frantically trading up the stock, the Company made its third and largest issue on June 17th, issuing 5 million at £1,000 per share. Terms again called for 10 percent down, but payments were stretched over fifty-four months, with nine payments made semiannually. The fourth, and final issue was made on the 24th of August, with 1,250,000 issued at, again, a £1,000 share price. The terms of this issue called for 20 percent down, with the balance to be paid over the next thirty-six months. Had all payment calls been made, the Company would have received £75,250,000 over the subsequent four and one-half years! The market had two vehicles with which to trade the South Sea Company: the actual shares and the subscription receipts.

Demand for the shares was enormous, as exhibited both by the increase in price and how quickly the shares were snapped up during the four offerings. The first was said to have been filled in an hour, the second and third issues in a few hours, and the final issue in three hours. There was even talk of an additional issue, however it was scuttled in early September when the market was beginning to crumble.

The decision by John Blunt and the rest of the South Sea directors to begin with stock issues or “Money Subscriptions” as they were known, rather than the conversion of the government debt was driven by the following motives, outlined by Dickson:

first, to the knowledge that they could legally increase their capital without any limit, provided they applied part of the proceeds to paying off the government’s creditors; second, to their wish to take the exchanges in stages, rather than spoiling the market by taking them all at once. A third motive was, of course, their wish to cash as quickly as possible the cheque which the Government had handed them without waiting to see if there were the funds to meet it.³⁹

When the Company began to convert the annuities to South Sea stock, the holders of these annuities were eager to get hold of the new South Sea shares and sell them in the now booming market, but the Company was not keen on a flood of shares pouring into the market, putting a damper on the share price. Annuitants or their attorneys showed up at South Sea House, with their title documents in tow, to sign their names and the annual amounts they received into the books. These documents were headed by an introductory statement that most of them, unfortunately, neglected to read. This preamble gave three South Sea clerks the power to subscribe the capital stock in whatever way the company saw fit to the annuitants. Rather than delivering shares, a book entry was made, with the actual stock not being delivered until December 30, 1720. This method was repeated in July and again for the third and, as it turned out, final debt conversion in August. The government creditors had thus exchanged their debts for no more than the expectation of possessing South Sea stock.

The primary holders of the government debts were, not the unsophisticated masses, but no less than the powerful Bank of England, Million Bank, and a host of wealthy, powerful individuals. Dickson gives the result of their collective gullibility:

80% of the long and short annuities (the Irredeemables) and 85% of Government ordinary stock (the Redeemables) were converted into South Sea stock. The company’s nominal capital increased by over £26m., on which the Government was to pay interest partly at 5% and partly at 4% until midsummer 1727, then entirely at 4%. Despite bitter pressure on the part of the disappointed public creditors in the winter of 1720–1, the exchanges were not rescinded,...

When it put the accounts together, the company found that, thanks to the rise in the market price of its stock, it had been able to persuade holders of £26m. of the £31m. subscribable debts to exchange them for South Sea stock so over-valued that they only obtained £8.5m. of it.⁴⁰

By the late spring, early summer of 1720, foreign buying began to push the price of South Sea stock ever higher, as investors fled Paris in ever increasing numbers. Also, specie from Holland began to arrive in London to be used for the purchase of shares. At the same time, the Company gave Exchange Alley a liquidity injection by giving the directors the power to lend money on the security of South Sea stock. This action produced £11 million in loans. At the same time, the Bank of England was throwing gasoline on the fire in the form of loans on its own stock. The government also got into the act by lending the South Sea Company £1 million in Exchequer bills that were subsequently used to purchase the Company’s shares. Even the Royal African Company, which lent £102,000, joined the party.

The South Sea share price was now rocketing upward. At the start of June, the price was £600, and by the end of that month it stood near £1,000. This tremendous speculation led to a flood of other proposals for new companies in Exchange Alley. Many of the proposed operations were swindles, with promoters marketing a particular stock with the tool of low down payments and deferred-payment plans, only to confiscate the down payments and leave the city. Some, however, were respectable ventures. The number of “bubble company” proposals hit its height in June, with 88 being promoted in that month. Only eleven more were sponsored the entire rest of the year.

Speculation was not limited just to South Sea shares or these “bubble companies.” Other securities rose as well, along with the price of land, as the following quote of Lord Bristol, who was negotiating with William Astell over the price of a land parcel from Dickson, illustrates: “land has almost doubly increased in value since ye time I first fix’d for your final answer.”⁴¹

Ironically, at the height of speculation in June, the pin that would eventually pop the bubble was being fashioned by the British government. On June 11th, the King’s assent was given to the Bubble Act, which made it an offense to “presume to act” as a corporate body or to divert an existing charter to unauthorized ends. In August, four companies were found to be in violation of the Act: the English Copper Company, the Royal Lustering Company, the York Buildings Company, and the Welsh Copper Company. Although the Act had been enacted to keep capital from being channeled away from the South Sea Company, the writs against the four companies signaled the beginning of the steep fall in the price of South Sea shares. In spite of desperate attempts to increase the demand for shares by declaring a 30 percent Christmas dividend (à la John Law), a torrent of sell orders descended upon Exchange Alley. By mid-September the share price had dropped to £520, and by October the price was £200, on the its way to £120 in December. The bubble had exploded.⁴²

After the “house of cards” had finally been leveled, the financial prospects of the South Sea Company were put in a clearer light. The Company’s only asset, besides trading privileges that were for the most part unexploitable, was a stream of income from the Exchequer in the amount of £2 million per year. The bad news was that expenses for the coming year were £14.5 million. The South Sea Company was hopelessly insolvent.⁴³

In spite of the Company technically being bankrupt, it was able to stay in business for many years through a massive reorganization engineered by Sir Robert Walpole. Walpole’s ability to sift through the wreckage and decide who the winners and who the losers would be from this financial train wreck made him a revered and beloved man of such high reputation that he went on to rule England as Prime Minister for twenty years. This reverence for Walpole is evidenced by Clough’s comment:

He [Walpole] was able, moreover, to save for government bondholders about 60 percent of their investment, and he was successful in salvaging enough of the South Sea Company to keep the organization in business, eventually, however, with government securities as its only assets.⁴⁴

Clough fails to realize that government securities were the only asset the company ever had. Furthermore, we can only wonder if the government bondholders at the time thought that taking a 40 percent “haircut” on their investment was a good deal.

Far from being an isolated mania engendered only by the urges of a populace with the gambling spirit, the South Sea Bubble was the inevitable result of a government living beyond its means. Britain had the help of some enterprising entrepreneurs who, with the example of John Law, produced the various schemes and institutions through which to create the money needed to pay for its wars and largess. As is always the case when paper money is created illegitimately, some groups benefited at the expense of others, with speculation taking the place of honest work and production as the way to achieve wealth. This environment of frenzied speculation led to political corruption, great disparities of wealth, fraud, and violence. As aptly put by Andréadès:

But all these must not lead us to infer that the South Sea crisis was beneficial to England. It had produced enormous agitation and an unjust redistribution of wealth and had very nearly ruined the Hanoverian monarchy. ...Those who shared in it knew perfectly well that it was only a fraud, but hoped notwithstanding to make some profit out of it. ...These speculators—and this is one of the most painful features of the crisis—represented all classes of society, and things were so arranged that the poorest man might ruin himself as easily as the millionaire.⁴⁵

The big winner in this story of financial debauchery was, of course, the British government, which was able to transform an insurmountable mountain of debt, through their agent, the South Sea Company, and at the expense of the public creditors, into a much more manageable expense. In effect, a portion of the government’s debt service was repudiated, with the financial pain being thrust upon those people who were least able to shoulder it, an unsuspecting public.

The South Sea bubble episode was relatively short compared with that of the Mississippi Bubble. The difference between the two bubbles was that Law used the Royal Bank to print more money, and thus sustained the system for a longer period of time. Conversely, the Bank of England stood apart from the South Sea government debt conversion. As the bubble burst, the Bank of England, concerned about its own survival, discontinued discounting, called in loans made against its own stock and loans made to the East India Company, and sold customers interest-bearing notes in an attempt to raise cash.⁴⁶

If the Bank of England had been successful in outbidding the South Sea Company for the conversion of the government debt, a replay of the Mississippi bubble is a distinct possibility, the likely result being a British populace suffering even greater financial pain.