Newton and the South Sea Bubble

Throughout the early modern period, European powers competed for possession of new, increasingly profitable trade routes and resources. This race for global power and the cost of international war forever altered the shape of European society. The Americas became a battlefield, as both France and Britain sought to challenge Spanish control of the Atlantic trade, which had been weakened as a result of the War of Spanish Succession (1701-1714) and the War of the Quadruple Alliance (1718-1720).

In 1711, English speculators formed the South Sea Company in order to exploit a government-granted monopoly trade with Spain’s Latin American colonies. In the Treaty of Utrecht, Britain had been awarded the right to the Assiento (‘Contract’) by the Spanish Crown, giving them monopoly rights to import African slaves into Spanish-held America. This right was given to the South Sea Company in return for its agreement to buy up £11 million of Britain’s outstanding official debt. This debt-for-equity conversion was a new kind of financial technology, one that was believed would improve trade, government finance and military strength. South Sea shares were given to naval contractors in lieu of cash payments, helping to ease the burden of the British government’s arrears.

This was also a time of growing commercial optimism, and widespread popular and political investment in joint-stock overseas trading companies such as the East India Company, the Scottish Darien Company (1696-1707), which sought to establish a trading colony between Europe and the Far East on the Isthmus of Panama, and the French Mississippi Scheme. This was the brain-child of the Scottish economist, John Law, who in 1716 established the Banque Général to support government finance after the war by replacing scarce gold and silver with paper ‘notes’ and replacing national debt with economic ventures. In 1717, Law purchased a company holding royal patents to colonize the American territory of Louisiana and develop its agricultural and mineral potential, and an extremely successful advertising campaign ensured popular buy-in. Law acquired several other trading firms and, in 1720, merged the Mississippi Company with the Banque Général to create a monolithic private company controlling most of the French fisc. Prospects were inflated and share prices in the Company share rose by a factor of 10 in 1719 and early 1720, before the Mississippi Bubble burst in the spring of 1720.

The chart below shows the day by day stock prices (interpolated) for the Old East India Company shares traded at London from 21 August 1719 until 6 December 1720 (NS), taken from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1371007.

Chart below shows the day by day stock prices (interpolated) for the French Mississippi Company shares traded at London from 21 August 1719 until 6 December 1720 (NS), taken from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1371007.

The South Sea Company, though never succeeding in taking over the Bank of England, similarly overreached itself. The bountiful trade promised to its investors never fully materialised, and the Company began to act almost exclusively as a kind of bank, lending money to potential purchasers of its stock. In 1720, it recapitalised its existing debt by loaning a further £2.5 million to the government and then converting the older obligations into new company shares (paying a fee to do so). They were now the main creditor to the government, earning 5 percent on all the debt they absorbed.

A great deal of hype was engineered around the sale of these Company stocks, with many exciting rumours circulating around the Royal Exchange and Exchange Alley in the City of London, as well as all the coffeehouses in the surrounding locale, where newspapers were provided to patrons and all kinds of information were traded. William Stukeley recorded the ‘Suprizeing Scene in Change Alley’ when ‘Nobility, Ladys, Brokers, footmen’ all scrambled as equals in the sale of these shares. More than twice the amount of stock available was sold to an eager public, with the money coming in from new investments being used to pay fantastic amounts out to older investors. By the end of that month, stock was selling at almost £350, then nearly £600 by the end of May, and £950 by the end of June. The overinflated share prices peaked at £1050, then suddenly dropped to £190 (below their original value) in the late summer, and even further to £124 in December 1720.

The chart below shows the day by day stock prices (interpolated) for the South Sea Company shares traded at London from 21 August 1719 until 6 December 1720 (NS), taken from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1371007.

Grand fortunes were lost alongside humbler life savings and lucky bets by a wide variety of British society. That September, Stukeley wrote that ‘the World [was] in the utmost distractions, thousands of families ruined.’ He wrote how the Royal Society had even lost £600 through its subscription to the scheme: ‘Sir Isaac very readily offerd to add to his large donations before made, in the most gen[teel] manner, in order to repair the loss, but the Society would not permit it.’ Famously, Newton himself supposedly lost a fortune of around £20,000 and exclaimed with frustration that he could not calculate ‘the madness of people.’

It is likely that Newton lost some money, but the evidence is inconclusive. In September 1713, he instructed the South Sea Company to pay him the dividend due on the 2500 South Sea stock he owned, a request he had issued twice more by 1722.[1] Newton wrote to his trusted Deputy at the Mint, Dr John Fauquier, in April and July 1720, authorising him to sell Newton’s stocks and convert irredeemable debts into new stocks, respectively, but it is unclear whether these actions were conducted on behalf of his personal accounts or those of the Mint’s.[2] Regardless, as Master Newton was required to deal with the aftermath of the crash: part of the bail-out arrangements for the Company involved an order for them to send large quantities of silver to the Mint.

The South Sea Bubble has typically been viewed as the result of human folly, gambling fever, corruption and the inherent cruelty of capitalism. Those who profited from the scheme were called vultures in the press, and the public outrage forced a parliamentary enquiry which found some evidence of insider trading and bribery. Several company directors were punished, and the Chancellor of the Exchequer, John Aislabe (who had been £20,000 of company stock in exchange for his political support) was removed from power and imprisoned in the Tower of London.

Yet it must be remembered that this was a time when such markets and mechanisms were emerging for the first time, and contemporaries were struggling to find effective means by which to evaluate and predict potential profit and risk: international stock markets were a novelty, and there was not yet a solid body of financial theory to draw upon. Through deft political manoeuvring Robert Walpole, newly appointed First Lord of the Treasury, was able to soothe the public and limit the damage to Crown and City. The South Sea Company, meanwhile, continued to operate until 1853.