We’ve all heard the term “bubble” in reference to an investing fever fueled by speculation in what participants erroneously perceive to be an infinitely rising curve of valuation. The dot-com “bubble” and the recent real estate “bubble” being modern examples of what Alan Greenspan referred to as “irrational exuberance”. We would be wise to be on the lookout for the next such bubble. But where did this term come from?
I thought it might be drawn from the well-known childhood activity of blowing bubble gum past the point of structural integrity, to find the mess plastered across one’s youthful face. An apt metaphor for the results experienced by late-entrants to the bubble-blowing investment activities of exuberant speculators. But the reference predates the invention of bubble gum. As we collectively pick off the gooey remnants of the last bubble, let’s journey to the source of this investing term, back to 1711, to talk with its creator, Harley, Earl of Oxford.
“Your eminence”, I began, guessing at the correct salutation. “What prompted the adventure which has become known as the South Sea Bubble?”
Harley fingered his robes, seemingly pleased with my knowledge of proper British social protocol, and replied, “As you may appreciate, the public credit was in poor repair, amounting to nearly ten million pounds sterling, having risen from military expenditures beyond treasury reserves and the unfortunate dismissal of the Whig ministry, so skilled in financial mechanics as which the government should surely benefit from. The solution, in my estimation, lay with private industry. And so, with fair design, a company of merchants was assembled to assume the debt, for which they were compensated at the rate of 6%.”
The Earl paused in his discourse, allowing the information to settle in my mind. I immediately saw the correlation to our own national debt, stemming from deficit spending in both social and military categories. The privatization of that debt is accomplished through public sale of treasury notes today, to individuals and to companies, not dissimilar to Harley’s day. The Earl of Oxford continued.
“To satisfy the interest owed to the merchants, temporary taxes on certain goods were made permanent”, he said. Well, we certainly have many permanent taxes established in the last 100 years as well. The Earl went on. “As an additional inducement, an exclusive contract for trading along the eastern cost of the southern Americas was granted to these merchants, which parties now became known as the South Sea Company. It was envisioned that the trading revenues would repay the national debts, while concurrently assuring the prosperity of English citizens through the increase of trade from these rich lands.” His grace, or whatever, took a breath.
“It was well-known that gold, silver and other myriad valuable substances existed for ready access in many of the regions of South America,” his honor continued. “The public confidence in the South Sea Company therefore swelled like the chest of a champion who sees a weaker foe across the field. The Company thus issued stock for sale to the public, further raising its value and concurrently diminishing its exposure as the responsible party for the debt of ten million pounds sterling, and more besides, it assumed from the government.”
Let’s see now. The government pays interest on the debt to a private company. That company has a monopoly on a rich trading region. The company issues stock and uses that capital to offset the debt it has assumed, so the interest is being received without exposure. The British citizenry is paying the interest through use taxes while the company management has control over the application of its capital, and has promised grand returns based on its exclusive trading rights to South America.
The Earl was just getting started, however. “The value of purchased equity in the South Sea Company was perceived to be so great, owing to the rumors of outlandish discovery of riches in the southern hemisphere, that the trading of South Sea Company stock further pushed its value higher, which resulted in additional offerings by the Company. This propelled the wealth of both high and low classes who entered the grand plan through stock transactions.”
The Earl went on to describe how the entire country was consumed with speculative grandeur. Many of its citizens one day were scrambling for roots and the next wearing embroidered finery, riding in tended coaches. For a period of several years, the rise continued. It made little difference in the attractiveness of company stock that the King of Spain had not allowed but a single ship of the South Sea Company entry to Spanish territories in South America, to provide limited trading in commodities and slaves. And Spain’s King would receive a good portion of the profits. The first ship was not scheduled to depart for southern waters until 1717, six years after the formation of the South Sea Company. The years went by. Trading revenues were nearly nonexistent, but the Company’s monetary transactions continued, while Parliament passed various laws cementing the Company’s rights and position. Why would government so completely support such a plan that was clearly based on expectations without real value as its underpinning? The good Earl explained.
“Why, because those officials were the beneficiaries of the rising tide of the Company’s fortunes,” he replied. Apparently, many a good public servant, at the highest reaches of power, were found to be entered into the books of the Company’s shareholders, often without having had to trouble with actually providing a monetary investment. The story continues until 1720, when, after multiple occasions of public debt transference to the South Sea Company, and through a period of such pervasive stock “jobbing” that an entire street known as Exchange Alley had been completely taken over for the purpose of trading, the fragile structure of public delusion began to unravel. The demise was heralded by the proliferation of countless other schemes which mimicked the South Sea Company, and which were based on everything from trading companies to insurance firms to commodity provision and on and on. During this time of proliferating schemes, the term applied to such fanciful speculations was “bubbles”, according to Charles Mackay, who wrote of it in his “Extraordinary Popular Delusions and the Madness of Crowds”, published first in 1841.
At the end of 1720, the entire structure collapsed, careers were ruined, public officials jailed, wealth evaporated, and the country’s economy broken for years to come. Sound familiar?
The one enduring value of the period was the creation of “Bubble Cards”, which pictured allegorical demonstrations of the folly of greed which is coupled with ignorance of history. I wish that I could obtain such a deck, to remind myself of how “bubbles” are blowing in every era.