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The First Crash

The First Crash: Lessons from the South Sea Bubble

Richard Dale
Copyright Date: 2004
Pages: 192
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  • Book Info
    The First Crash
    Book Description:

    For nearly three centuries the spectacular rise and fall of the South Sea Company has gripped the public imagination as the most graphic warning to investors of the dangers of unbridled speculation. Yet history repeats itself and the same elemental forces that drove up the price of South Sea shares to dizzying heights in 1720 have in recent years produced the global crash of 1987, the Japanese stock market bubble of the 1980s/90s, and the international boom of the 1990s.

    The First Crashthrows light on the current debate about investor rationality by re-examining the story of the South Sea Bubble from the standpoint of investors and commentators during and preceding the fateful Bubble year. In absorbing prose, Richard Dale describes the trading techniques of London's Exchange Alley (which included 'modern' transactions such as derivatives) and uses new data, as well as the hitherto neglected writings of a brilliant contemporary financial analyst, to show how investors lost their bearings during the Bubble period in much the same way as during the boom.

    The events of 1720, as presented here, offer insights into the nature of financial markets that, being independent of place and time, deserve to be considered by today's investors everywhere. This book is therefore aimed at all those with an interest in the behavior of stock markets.

    eISBN: 978-1-4008-5164-5
    Subjects: Economics, History, Finance

Table of Contents

  1. Front Matter
    (pp. i-vi)
  2. Table of Contents
    (pp. vii-viii)
  3. Acknowledgements
    (pp. ix-xii)
  4. Introduction
    (pp. 1-6)

    The year 1720 is a seminal date in financial history for it was in that year that stock markets in London, Paris and Amsterdam, as well as in lesser centres such as Hamburg and Lisbon, experienced a contagious collapse which brought ruin to investors and threatened the stability of governments. This was the first international financial crash and it has become the trigger for an intense debate about the rationality of investors and the very nature of financial markets. Are such markets inherently unstable? Are investors subject to periodic bouts of euphoria and despair—a kind of collective manic depression...

  5. CHAPTER ONE Coffee Houses, the Press and Misinformation
    (pp. 7-21)

    The South Sea Bubble coincided with the rapid development of financial markets in the late seventeenth and early eighteenth centuries. This period saw the introduction of an active secondary market in both debt and equity securities, the appearance of a new type of financial intermediary known as the “stock-jobber”, and the emergency of a breed of “monied men” whose recently amassed City fortunes were viewed both with disdain and envy by the landed classes. But before considering the trading practices and techniques of the new class of financiers, it is necessary to understand the communications network on which their operations...

  6. CHAPTER TWO Exchange Alley and the Evolution of London’s Securities Markets
    (pp. 22-39)

    The South Sea Bubble erupted during the early development of the London stock market and could not have occurred in the absence of an active market in corporate securities issues. Furthermore, the financing activities of the South Sea Company were intimately linked with the management of government debt and the evolving market for government obligations (“the Funds”). This chapter describes the key features of both markets in order to provide a fuller understanding of the origins of the South Sea Company and the events of 1720.

    The development of the government debt market preceded the emergence of a market in...

  7. CHAPTER THREE Origins of the South Sea Company
    (pp. 40-55)

    The South Sea Company was established on 8 September 1711 by a charter, authorised by act of Parliament, which incorporated “the Governor and Company of the merchants of Great Britain, trading to the South Seas and other parts of America, and for the encouragement of fishing”.

    The initial assets of the company were twofold. First, it was to have a trading monopoly covering “the kingdoms, lands etc of America, on the east side from the river Aranoca, to the most southern part of the Terra del Fuego, on the west side thereof, from the said most southern part through the...

  8. CHAPTER FOUR John Law and the Mississippi Bubble
    (pp. 56-72)

    By the end of the War of the Spanish Succession, France’s financial plight was even more acute than England’s. In 1715, the Crown’s annual peace-time expenditure was nearly 150 million livres,¹ tax revenues were running at less than half this rate, and the overall national debt stood at over 2 billion livres, representing a ratio of debt to national income variously estimated at 83 percent to 167 percent. The annual interest on this debt was around 90 million livres per annum. Additional taxation, whether through “impositions” (direct taxes on individuals) or “perceptions” (indirect taxes, e.g., on salt) was hardly feasible...

  9. CHAPTER FIVE The South Sea Scheme
    (pp. 73-95)

    The spectacular progress of Law’s financial experiments in France during 1719 had powerful repercussions in England. The English government became apprehensive that Law’s achievements would strengthen France’s national finances to an extent that could threaten England’s own economic position.¹ Therefore, renewed efforts to stabilise the English national debt were called for. At the same time, investors’ overwhelmingly favourable response to Law’s conversion of France’s debt into Mississippi stock suggested to the South Sea projectors that a similar initiative might be successfully implemented in England. Finally, the extraordinary profits reported to have been made by Mississippi investors unleashed a wave of...

  10. CHAPTER SIX The Bubble
    (pp. 96-124)

    The leading role played by John Blunt both in the establishment of the South Sea Company and the formulation of the debt conversion scheme has already been described. When the time came to implement the conversion scheme, Blunt took control of the Company’s affairs, the Court of Directors becoming little more than a rubber stamp. Given this central direction by a single domineering managing director, it is necessary to say something more about the individual concerned and his method of operation.

    Early in 1720, Blunt set out to establish personal control over the South Sea Company. He sought to by-pass...

  11. CHAPTER SEVEN The Crash
    (pp. 125-139)

    In the first few days of 1720, both John Law and the Mississippi Company appeared to be unassailable, with Law’s appointment as Controller-General of Finances coinciding with the high point of the Mississippi boom. Yet by the end of the year, Law had fled France in disgrace, the stock market had been shut down and the Mississippi Company effectively dismantled. Between the apogee of the Mississippi Bubble and the final denouement, France witnessed a bewildering sequence of contradictory financial measures whose cumulative impact was to destroy the French public’s confidence in paper money for more than three generations.

    The development...

  12. CHAPTER EIGHT Crisis Resolution
    (pp. 140-154)

    By mid-September 1720, it was becoming increasingly apparent that the South Sea Scheme was unravelling. Attempts to stabilise the share price having failed, the South Sea directors now sought to address two critical problems: a growing shareholder rebellion and a developing liquidity crisis.

    As Hutcheson had long foreseen, the eventual collapse of the South Sea share price exposed the massive wealth distribution that had occurred between original shareholders and latecomers who had subscribed at prices up to 1000. There were now clear winners and losers and the latter were in an ugly mood; far from being prepared to fulfil their...

  13. CHAPTER NINE Lessons from the South Sea Bubble
    (pp. 155-177)

    How, then, should we interpret the dramatic events of 1720? Was the South Sea Bubble an isolated episode of interest now only to financial historians and students of the evolution of stock markets? Or is there a message here for modern finance theorists, stock market investors and policy makers? And if there is a lesson to be learned from the rise and fall of the South Sea Company, is it that investors, then as now, are prone to bouts of irrational speculative mania, or that at a time of rapid financial innovation even rational investors have difficulty in determining the...

  14. CHAPTER TEN Conclusion
    (pp. 178-184)

    Despite its status as the most spectacular episode in English financial history the South Sea Bubble had little lasting impact on the British economy. Indeed, economic activity was largely unaffected:¹ industrial output, so far as it can be measured, showed no discernible downturn; overseas trade dipped only very slightly in 1720–1721; and there is no reason to believe that agriculture, the largest sector of the economy, would have been impacted. The resolution of the crisis also ensured that there were no mass bankruptcies,² although it is perhaps significant that, according to the bills of mortality, the number of suicides...

  15. Glossary
    (pp. 185-186)
  16. Bibliography
    (pp. 187-194)
  17. Index
    (pp. 195-198)