A professor of economics at MIT, Peter Temin, and a professor of economics at Barcelona, Hans Joachim Voth, had access to a remarkable archive. The Hoare Bank has been at its Fleet Street home since the late 17th century and they have their accounts dating back to their early days. The two professors analysed those records and wrote academic papers on what they found, and eventually published their findings in Prometheus Shackled in 2013.
They say that there was an “explosion of debt” after the Glorious Revolution, and most of that debt was used to fight wars. By 1719 that debt was over £41 million, which was close to seven times the annual revenue from tax and customs duty. Half of that revenue was spent just on the interest payments of the debt.
Much of those interest payments went to the Bank of England, which was founded soon after the 1688 Glorious Revolution, which saw William of Orange come over from Holland to replace his Uncle, James II. In 1694 William granted a charter to a newly-formed private company which called itself The Bank of England Company. The charter gave The Bank of England Company the monopoly right to create money for the British Government. So they created money (trust inscribed) and then loaned it to the Government. It doesn’t take a great brain to figure out that if the country’s money is all loaned to it and must be paid back, then ever-increasing debt in perpetuity is the logical and only possible outcome.
The business started with a loan of £1.2 million (25 years later, in 1719, it was £41 million – nearly 40 times bigger) to the British Government, who agreed, on behalf of the nation, to repay the loan at 8 per cent interest plus a £4,000 annual service charge. The professors say that it “introduced some order into the process of gathering resources for the Government.” I would add that it also introduced a highly profitable business (or, if you want to get pedantic, a highly profitable confidence trick). You remember this from Video 7 when Professor Ferguson was talking about those breathtakingly clever Renaissance Italians, who conjured up this very same bond system that worked so well.
Now the Government didn’t just owe money to the Bank of England. People had taken out annuities. They had loaned the Government money, and the Government agreed to pay 9 per cent on the loan annually until 1807. And the agreement was that the Government couldn’t buy back the annuity if the owner didn’t wish to sell. And with a secure investment that gives you 9 per cent for the next 90 years, who would want to sell it?
According to Professors Temin and Voth “the South Sea scheme was an attempt to convert annuities into equity in a way that enticed debt holders to participate voluntarily.” And the ploy worked. Two out of three people did convert their annuities into South Sea shares. Remarkable because the professors say that the South Sea Company “did not run a flourishing commercial operation.” In fact, it was “a classic Ponzi scheme.” It was a con. And there is plenty of evidence that people were aware that it was a con. The fact that the South Sea Company’s business plan rested solely on exploiting the wealth of South America was obviously nonsense, as Daniel Defoe pointed out at the time: “Unless the Spaniards are to be divested of common sense, throwing away the only valuable stake they have left in the world, and in short, bent on their own ruin, we cannot suggest that they will ever, on any consideration, part with so valuable, indeed so inestimable a jewel, as the exclusive trade to their own plantations.” And of course, Britain was at war with Spain. As Professor Temin and Professor Voth say it was a classic Ponzi scheme.
There were, of course, some important differences between Charles Ponzi’s scheme and that of the South Sea Company. Charles Ponzi was operating alone. When he was caught he did not have powerful allies in government and the law to save him. No big name economists were explaining that “whatever their culpability we should view their actions as a consequence of the excitement about investing opportunities and complacency about risks.” The South Sea Company had “the prominent involvement of leading ministers, the royal household (The Prince of Wales was Governor of the Company from 1715 and in 1718 he was replaced by his father George I; both these men had significant holdings in the company) and Members of Parliament.” And of course, the sophisticated investor, Richard Hoare, invested in the South Sea Company from its inception.
So the professors ask “Why did the price of the South Sea Company move up so rapidly? Understanding the causes of major bubbles has been a challenge to financial economists and historians alike.”
Well it maybe a challenge but it’s also rather important so we will take on the challenge in the next video.
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