Echoes of Mania: The First Stock Market Bubble

Echoes of Mania: The First Stock Market Bubble

 

Introduction-

 The South Sea Bubble is a sore ballad of what happens when speculation mania and mass delusion come together. Considered the world’s first stock market crash, it was a full-blown frenzy that brought even the smartest minds like Isaac Newton, an avid investor in the company, crashing down. The South Sea Bubble of 1720 had the same essential ingredients that cook up an investing disaster- geopolitical turmoil, novel financial products, new communication technologies, misinformation, and an abundance of tricksters ready to prey on the gullible.

 

The South Sea Company and its operations-

 The South Sea Company was a British joint stock company founded in 1711 by an Act of Parliament. It was a public and private partnership whose main purpose was to consolidate, control, and reduce the national debt and to help Britain increase its trade and profits in America. Britain had been involved in numerous wars and had amassed a debt of around 50 million euros. The Company proposed to take over a large portion of the debt, around 9.5 million euros on the condition that it be granted a monopoly over trading in the South Sea (hence the name) particularly the region of Central and South America. 

 
At the time, slave trading was a well flourishing and profitable business thus the company got the rights to trade African slaves. However, when the Company was created, most of South America was controlled by the Spanish and the Portuguese, so there was little prospect of the British capturing much of that trade. Nevertheless, after the War of the Spanish Succession ended, as part of the provisions of the Treaty of Utrecht (1713), the Spanish granted a monopoly over the slave trade (the Asiento) to the South Sea Company. But here is the plot twist, Spain allowed the company to send only 1 ship per year with 4,800 slaves. This was hardly enough to sustain a company like South Sea which was banking on the popularity created by companies like the East India Company. 

 

 Ponzi or genius?

Such challenges didn’t stop masterminds like Blunt, the co-founder of the company, from coming up with Ponzi schemes to deceive the public and churn profits. The company bought government debt with new shares of their company, but the number of shares depended on the share price. Blunt knew that by temporarily inflating the share price, the company could not only buy more debt with fewer shares but also sell off the surplus shares in the market and pocket the profits. Thus, he began his propaganda campaign to get the investors enthused. There was a great deal of general public excitement. This was a new way of seeing and handling money, in which the Crown and its people might both ‘get rich quick’. The Company Executives began selling a dream of riches and patriotism- that the company’s success was Britain’s success. People from all walks of life, including nobles, politicians, author Jonathan Swift, and scientist Issac Newton became trapped in this financial crisis. 

 

 

 

Where the Wind Lies, Lies the Debt-

In 1720, the parliament allowed the South Sea Company to further consolidate national debt valued at 32 million pounds at the cost of 7.5 million with a low-interest rate of 4%. The company board had the idea of encashing the overvalued stock to repay their debt or better, swap the stocks for debt themselves. Stocks were sold well, generating higher interest which in turn pushed the price and demand of the stock. There was a hype created around this stock, that made even the common public dive into this “Get rich Quick” scheme. The company would itself, lend loans to the public to buy their stock. As long as the stock prices rise, the loan would pay for itself.  By August 1720, the stock prices rose to a staggering 1000 pounds from its initial 100 pounds. The company never actually had any operational profits but was just trading its stocks with the debt to inflate the prices. Little did England know that this was the formation of a bubble, which like a ticking time bomb would burst any moment. 

 

The Fallout-

One fine September, the whole of Britain scratched their heads as the stock market crashed and the company shares plummeted to 124 pounds, losing 80% of its value. The bubble burst, affecting all sections of the society, from the commoners to the elites, everyone incurred unrecoverable losses on this one investment. Several notable politicians, royal family members, and even geniuses like Isaac Newton lost their money in this crash. However, the bigger problem lay in the possible bankruptcy and a complete fallout of the public confidence in the government’s financial position, triggering a domino effect and collapsing the entire economy. 

The mess was sorted by Britain’s first prime minister Robert Walpole, when he passed the Bubble Act which forbade the creation of any joint stock companies without permission of the Royal Charter. Several such bubble companies were shut down because of this Act. The faith in the financial system was restored by passing over the debts to the Bank of England and revamping the company’s operation with illegal trading of slaves which generated profits to repay the debts.

 

 

How is the South Sea Bubble still relevant today?
The crisis took a toll on the British Government’s finances, as it took them 300 years to pay off the debt of over 2.6 billion pounds. The final payment was made in 2015. But apart from the financial loss, the South China Sea bubble draws parallels to today’s financial markets and the dark reality of corporate finance. 

The concepts of overhyped stocks and securities were introduced by such bubble bursts. Even in today’s financial markets, the values of certain stocks are judged by their existing brand values and speculation based on false hopes, rather than the company’s actual financial performance. This results in the overvaluation of the stocks which attracts institutional and retail investors. The classic examples are Non-Fungible Tokens(NFTs) and Cryptocurrencies, whose value skyrocketed due to the “popularity” they gained over the past few years. 

Moreover, the stock manipulation involved in the South Sea bubble still exists in different forms. The infamous Hindenburg 2023 report on Adani Groups, raised allegations on the existence of offshore shell companies that would recycle the company’s money to inflate stock prices. Several Stock Manipulation cases are reported by the Securities and Exchange Board of India every quarter in India. 

Conclusion

 History repeats itself they say. We mention the 2008 Financial Crisis or the 1929 Wall Street Crash when we talk about the worst financial disaster in mankind. But the contemporary relevance of this chapter in our history books cannot be ignored. Given the warnings by many financial experts, a potential market crash because of overvalued stocks might be hidden somewhere in the disguise of an economic boom.