We talk much of the Industrial Revolution, in which natural instead of human energy was harnessed to tools that operated on an industrial rather than artisanal scale. Often, however, we forget what might be called the Entrepreneurial Revolution. In this the invention of the joint stock company or corporation, an enterprise owned by many participants and with freely transferable shares, played a large part. Toward the end of the seventeenth century the English began to view owning wealth in joint stock company shares as more convenient in many ways than the traditional holding of land—much as we view the situation today.
Agricultural land requires constant, skilled attention. If you buy stock in a large corporation with a history of profitable operations and run by dedicated management, you are not expected to intervene personally. Then, common stock dividends were not taxed (and indeed logically should not be, if the company has already paid tax at the corporate level). And a portfolio of securities is much easier than a farm to divide up among a group of heirs. Particularly, ownership through common stock makes possible the financing of an enterprise on whatever scale its nature may require, which may well exceed the means of a family or partnership. In mounting large industrial undertakings or overseas developments a division of the burdens and the rewards among many broad shoulders presents great advantages.
England had created over one hundred of these companies by the end of the seventeenth century, for banking and insurance, for expeditions, for industrial projects, and to exploit patents, which started to be taken out more freely at that time.
Most wealth still derived ultimately from land, and the high fertility of agriculture in southern climates made such areas as the Caribbean islands and parts of Central America of particular value. Not only are the yields per acre far higher than in England, with its weak sunshine and limited growing season, but spices and fruits proliferate that in England cannot be grown at all. So subtropical agriculture assumed some of the same investment importance that we assign to oil fields. Public interest in Western Hemisphere plantations was whetted by such successes as Sir William Phipps’ expedition to the West Indies, which returned its backers a profit of 4,700 percent.
After the defeat of Louis XIV by Marlborough, Spain became England’s great commercial rival. The Peace of Utrecht in 1713, which ended the War of the Spanish Succession, opened the Caribbean, Central America, and the northern part of South America to British mercantile undertakings.
The British were groaning under the huge national debt incurred to pay for the French war. The landed gentry and nobility, who had great political influence, loathed this debt, which they saw as a mortgage on landed property—their property. This debt existed in two forms: annuities, typically for a period of ninety-nine years, and bonds, usually bearing interest at 5 percent. The bonds were being paid off progressively. It was the annuities that most vexed the landed proprietors, since having been issued in troubled times they provided an abnormally high return, and could not be redeemed without the holders’ consent.
Somehow, the annuitant had to be coaxed out of his shell. So when in 1711 a proposal was put forth to convert some 6 percent government debt into stock in a monopoly company to trade with the Caribbean, Spanish America, and the Pacific Islands, collectively called the South Seas, there was widespread enthusiasm. The necessary legislation was rapidly enacted. The South Sea Company, having taken over £10 million of government debt, in return received this monopoly, plus an annual subsidy from the government.
The first Court of Directors was convened in September, composed of thirty-three members. None had any knowledge of Spanish America or its commerce. Still, thanks to carefully planted rumors, newspaper publicity, and bribes in high places, the company succeeded in conveying an impression of present prosperity and wondrous prospects.
In 1719 the company proposed, in essence, to offer its stock to the public in exchange for the remaining government debt if the government in turn would grant it various further subsidies and concessions. The government was delighted. It had been looking with keen interest across the channel at John Law’s machinations in France. Lord Stair, the British ambassador, wrote, “By the success of Mr. Law’s project the public debts of France are paid off at a stroke, and the French king remains master of an immense revenue and credit without bounds.”
The hidden thought of the company’s managers, however, was that if by whipping up speculative interest in the company’s stock they could drive up the market price, they could offer less and less of their stock in exchange for any given amount of debt, since debt holders would be able to convert and sell out for an immediate profit. Meanwhile, the managers could keep the excess stock that they had been allowed to create.
That was exactly what happened. The House of Commons accepted the deal on February 2, 1720, and South Sea Company stock forthwith jumped from 129 to 160. When the Lords also agreed, it climbed to 390. “South Sea is all the talk and fashion,” wrote a Mrs. Wyndham. “The ladies sell their jewels to buy.” Even Isaac Newton succumbed. Originally he bought £7,000 worth of stock, which he sold for twice his cost. He could calculate the motion of the heavenly bodies, he declared, but not the madness of the people. Too true! Seized himself by the same madness that gripped the crowd, he bought back in on a larger scale, and eventually succeeded in losing £20,000.
The company had a limited time to conduct its conversion, so every few weeks new issues of stock were floated, to be paid for with small amounts down and the balance over time. The king himself, who had become Governor of the company, subscribed. In April a 10 percent dividend was declared, payable in stock. The price advanced to 400.
In May the company announced the terms of the first debt-conversion offer directly to the public. For one week, those who submitted their annuities for exchange would receive the equivalent of 375 in South Sea Company stock. By the fifth day the stock had been manipulated up to 495, and the offer became hard to resist. More than half the annuities were exchanged.
By June, thanks to skilled financial moves, an unremitting barrage of propaganda, and the madness of the speculative fever, the stock reached 890.
The “bubble” mania now metastasized. Hundreds of new schemes, seeking over £200 million, were floated, some rational, many not. “For furnishing funerals to any part of Great Britain”; “For trading in hair”; “For a wheel for perpetual motion”; “For assuring seamen’s wages”; “For insuring and increasing children’s fortunes”; “For the transmutation of quicksilver into a malleable fine metal.” Puckles’ Machine Company was to revolutionize warfare by firing square shot.
The most notorious bubble company was launched by a promoter who took an office in Cornhill and announced the formation of “a company for carrying on an undertaking of great advantage, but nobody to know what it is.” Shares cost £100, and were entitled to a profit of 100 percent per annum. Subscribers made an initial down payment of £2 per share, with the remaining £98 to follow in a month, after the particulars of the business had been announced. This absurd proposition attracted subscriptions—and down payments—for 1,000 shares in a single day. All these flotations of course soaked up a lot of investment demand.
In June the South Sea Company made a £5 million stock offer for cash, at a price of <£1,000. Only a tenth of the subscription was due at once, with the next tenth more than a year later and the remaining eight installments over another four years. Half the House of Lords and the House of Commons subscribed.
The insiders and some of the better-advised speculators, who could understand what was happening, sold. The Canton of Berne caught almost the exact top, clearing £2 million on an original investment of £200,000.
As the succession of conversion offers and cash subscriptions continued, the market became tired. In August the Court of Directors proposed a dividend of 30 percent for the year, and not less than 50 percent for the next ten years. This was to support the stock price at close to its then level by assuring a satisfactory yield—the last concern of the speculators who had bought only a few months before, when vast capital gains had been the expectation. The stratagem failed. The stock faltered. It declined. It began to sink, faster and faster. Greed suddenly turned to fear, and fear to desperation.
By November South Sea stock had collapsed to 135. So many expectations, so many obligations, so much credit had been built upon the structure, that its collapse profoundly shook British finance and business.
King George I, who had remained Governor of the company, returned early from his vacation in his native Hanover. In December Parliament was called into session. Someone had to be responsible; someone should be punished. Lord Molesworth urged that the malefactors be tied in sacks and drowned in the Thames. Nobody dared observe that the speculators themselves, by their lust for profit and their abandonment of common sense, had infallibly brought about their own fate. No, there had to be scapegoats.
Parliament appointed a committee to investigate, which after some months reported that to push the legislation creating the company, free stock had been handed out to influential persons, including Charles Stanhope, a Treasury commissioner, the Earl of Sunderland, and James Craggs the elder and the younger, joint Postmaster-General and Secretary of State respectively.
The Chancellor of the Exchequer, John Aislabie, had received about £800,000, an immense sum in the eighteenth century. In the resulting trial, only Aislabie was convicted—of “notorious, dangerous and infamous” corruption—and imprisoned, but under the South Sea Sufferers’ Bill over £2 million was recovered from the directors, whose estates were confiscated.
In addition, those who had borrowed money from the company on the security of stock—including 138 members of the House of Commons—were relieved of this obligation if they paid off 5 percent of the loan. The annuitants who had lost their income recovered about half their loss.
The treasurer of the company, Robert Knight, who knew all its secrets, escaped in disguise by boat to the Continent, taking his papers. Arrested in Flanders, he demanded trial there instead of England. He escaped to France before the jurisdictional conflict could be resolved.