What Is The South Sea Bubble? The South Sea Bubble And The Rise Of Financial Bubbles

The South Sea Bubble describes the financial collapse of the South Sea Company in 1720, which was formed to supply slaves to Spanish America and reduce Britain’s national debt. The story behind the South Sea Bubble is somewhat complicated. However, it begins with the formation of the South Sea Company in 1711 by Robert Harvey.

Understanding the South Sea Bubble

Harvey created the company with the intention to partner with the government and reduce the English national debt. He also wanted to make money for investors by underwriting the national debt in exchange for interest in return.

When the War of the Spanish Succession ended in 1713, the Treaty of Utrecht was signed. As part of the negotiations, Britain secured the rights to supply slaves to Spanish America. The deal was deemed a coup for the country because there were huge profits to be made by trading South American nations that were rich in silver and gold. 

Investor excitement

To reduce its national debt, the government sold a contract to the South Sea Company worth £9,500,000. In return for taking on a substantial percentage of Britain’s national debt, the company gained monopoly access to the lucrative west coast of the Americas in 1720.

Once the deal was signed, excitement grew dramatically. Investors saw the potential for the South Sea Company to collect interest on the loan in addition to profiting from its gold, silver, and slave interests. 

To some extent, positive market sentiment was also reinforced by the actions of the government. South Sea Company ships received convoy protection from the Royal Navy and even the King himself made a sizeable investment in the company. With backing from the seemingly robust British state, shareholder confidence was high. 

The bursting of the South Sea Bubble

By the summer of 1720, South Sea Company shares became dangerously overvalued.

Nevertheless, some investors continued to purchase shares hoping to sell out in time as waves of more naïve investors entered the market. In the short term, this pushed the share price from a mere £100 in 1719 to £1,050 by August 1720. 

Unfortunately, the lucrative trade profits spruiked by management never materialized. Instead, the South Sea Company operated more like a bank and less like a shipping business. It lent money to investors which maintained demand for company stock and artificially inflated its price. In what some suggest was an early Ponzi scheme, money from the issuance of new shares was used to award dividends to more substantial investors.

By December 1720, the share price had fallen back to £124.

Aftermath

Once the South Sea Bubble burst, many investors suffered financial ruin.

The disaster was particularly damaging for wealthy investors who had invested large sums of money. One of these was Sir Isaac Newton, who claimed to have said that he could “calculate the motions of the heavenly bodies, but not the madness of people.

Several directors of the South Sea Company were impeached and had their estates confiscated. Later, it was found the company had gifted political figures company stock in exchange for their support. Chancellor of the Exchequer John Aislabe was famously imprisoned in the Tower of London for his involvement.

While the South Sea Bubble did prompt calls for tighter controls of unregulated markets, Georgian society carried on as usual. The South Sea Company continued operating for another 133 years until it was disestablished in 1853.

Key takeaways:

  • The South Sea Bubble describes the financial collapse of the South Sea Company in 1720, which was formed to supply slaves to Spanish America and reduce Britain’s national debt.
  • Investors saw the potential for the South Sea Company to collect interest on the loan in addition to collecting profits from its gold, silver, and slave interests. Positive sentiment was also driven by the actions of the government. 
  • Lucrative trade profits never materialized, which caused the share price to become dangerously overvalued. Instead, the South Sea Company operated more like a bank and less like a shipping business. Capital invested from waves of new investors was redistributed to older investors in an early Ponzi scheme. The share price crashed in December 1720, with many South Sea Company directors impeached or imprisoned.

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