September 1720 marked the culmination of one of modern finance’s first asset bubbles—the South Sea Bubble. The British South Sea Company (for which the bubble was named) was created in 1711 on the assumption the War of Spanish Succession would end and permit greater trade with the Spanish colonies of South America. The South Sea Company was granted the exclusive right to trade British goods with South America for this purpose.
Extreme speculation in company shares began in 1718 when King George I was named governor of the South Sea Company. In 1720, the company struck a deal to take on Great Britain’s debt. Investors would exchange their illiquid UK debt holdings for South Sea Company stock. The premise was South American trade would generate revenues to pay off British debt and handsome guaranteed interest payments on company stock to investors. Many investors bought into the hype, expecting the South Sea Company to be the next East India Company—the successful venture which managed British trade with India.
Other new joint-stock ventures flooded the market after the South Sea Company’s success. Most weren’t reputable companies, but get-rich schemes for their founders. South Sea Company share prices further benefited from the speculation, rising eight-fold from £130 in January 1720 to £1,050 by June.[i] Fueling this speculation were fabricated stories of huge South American riches, insider trading, and other improprieties. All of this set expectations sky high relative to reality, setting the stage for the stock to fall. (This is common in bubble anatomy: Rampant new stock supply, euphoric investor expectations, all propped up against a reality of weak underlying fundamentals. For example, think back to the 2000’s Tech Bubble.)
By year-end 1720, the ruse was up and South Sea Company shares fell to nearly £100 a share, devastating the savings of individual investors and institutions alike.[ii] In 1721, a formal Parliamentary investigation exposed rampant insider trading, corruption, bribery, fraud, and deceit that led to the prosecution and downfall of many company and government officials.
Though some believe investment bubbles are only recent phenomena, examples like the South Sea Bubble show investor euphoria has come and gone for hundreds of years and the recipe for a bubble generally remains the same.