Many consider Alexander Pope to be one of the greatest poets of all time. But he also happened to grow up in the early 1700s during the earliest period of financial speculation. The Dutch had floated the first stock market, and brokers — known in those days as “stockjobbers” — handled transactions of many popular historical figures such as Richard Cantillon and Isaac Newton.
It was exactly a century after the Tulip Bubble that Pope got to experience and document the South Sea Bubble, the first speculative mania in the history of stock markets. How it inflated was eerily similar to the modern-day manias we have become accustomed to. A new technology, a new innovation, or a pie-in-the-sky vision, never fails to inflate a new bubble.
In 1719, the desire to profit from the South Sea Company’s government-sponsored trade monopoly with Spanish and South American colonies produced a mania. In exchange for these trading powers, the company agreed to privatize the British government’s national debt, converting it into company shares, along with a 6% annual interest payment.
The South Sea Company’s real motive, however, was to boost the price of its shares. Founder John Blunt and various co-conspirators devised a scheme resembling the modern-day “pump and dump”. Through various accounting tricks and excellent perception management, the company’s share price rose from £125 in early 1719 peaking at £1050 in late-June 1720, earning huge profits for Blunt and his friends.
Within Pope’s various writings, he remarked on the South Sea Bubble during its various stages. But instead of sending a tweet or updating his Facebook status, in an unconnected, nontechnical world, he sent a simple letter to his stockbroker: “I daily hear such reports of advantages to be gained by one project or other in the Stocks,” he said. Similar to today’s Robinhood trader, he could not resist partaking in the rampant speculation Blunt had created. In another letter, he declared to his friend William that he and others planned to acquire real estate with potential profits — while urging English aristocrat Lady Montagu to buy more shares as the mania peaked.
Right now, we’re nearing the peak of another mania. The central banks have established a monopoly on perception, fueling a speculative bubble. The modern-day financial technologists have developed a system to kick the can down the road — in the eyes of contemporary speculators — on a permanent basis. Whether it’s investing in profitless corporations, junk bonds, or real estate, investors have embraced the absurdity of buying risk assets while entering the biggest recession in the modern era.
This system, though, has created many unfavorable defects akin to the South Sea Bubble. Back then, the original financial alchemists had invented stock promotion schemes nicknamed “Bubbles”: companies that peddled bizarre and outlandish claims ranging from “improving the art of making soap” to “trading in hair” — to this day it’s unknown what the latter company’s function implied.
The modern parallel is the SPAC market which has grown exponentially in past few years. Since SPACs are companies that have bypassed the IPO process by performing reverse mergers, charlatans have exploited this loophole to take stock promotion schemes public. Investigators recently outed Nikola Motor, the poster child of SPAC tomfoolery, as a stone-cold swindle.
Deception is not the only sin we have yet to abolish. Still, when a mania hits its peak, people who have never thought about the stock market suddenly get involved. In the 1700s, it was the ladies of the aristocracy lusting after noblemen who owned South Sea stock. Now it’s your friends, family, and coworkers pitching you Amazon shares via instant messenger.
These sins and defects always originate from financial alchemy. Like how the architects of the South Sea Bubble kept it alive for as long as possible, we have too, but, this time, on steroids. Central banks consume everything, even assets outside their remit. They are one mini-crash away from buying stocks for the first time ever. Most public companies, even high-profile ones such as Apple, artificially inflate their stock price through share buybacks to make up for absent economic growth.
It’s this financial horseplay that keeps the economy afloat for longer than critics and skeptics expect. We have overcome all previous bubble-bursting catalysts. We have survived the European debt crisis that pushed the Greek and Spanish financial systems toward near collapse. We have survived the 2015 oil crash. We have survived the Federal Reserve rate hikes in 2018, and this year, a global pandemic and worldwide lockdown.
The incredible longevity of today’s bubble is a testament to its power. It’s the psychology of mainstream perception. The madness of crowds forces investors to front-run monetary and fiscal stimuli while ignoring everything else. When central banks print money and governments spend, investors must continue to buy assets, overlooking dire economic data and multiple economic drags. Of course, this speculative frenzy must come to an end.
In August 1720, the South Sea Company collapsed when its shareholders decided the business could not support a 50% dividend payment — which it had announced only to entice new buyers. “The fate of the South-sea Scheme has verified much sooner than I expected what you told me,” Pope said failing to escape the bubble alongside Lady Montagu. Shares of the South Sea Company had fallen back to pre-bubble levels, and the mania had ended.
The South Sea Scheme collapsed because its architects ran out of air to pump inside the bubble, and soon, we’re about to witness a repeat. The asset bubble phase is over. We have forgotten how to value money. We’re floating inside a full-blown, central bank confidence balloon, and all it takes to burst this is a flick of the psychological switch.
It’s unwise, though, to predict when this will happen, and what will cause market participants to sell and keep selling without fear of missing out on future gains. Who knows when the authorities will run out of juice? The complexity of the modern financial system has made it impossible to grasp.
The other puzzle is whether we’ll get deflation or hyperinflation? After seeing Venezuela’s stock market soar during a hyperinflation disaster, it’s foolish to assume that asset prices will plunge towards zero in the next crisis. Let’s pray we don’t get a scenario wherein Jim Cramer is shouting “DOW 1,000,000!” while Americans trail dollar-filled wheelbarrows to their nearest Costco just to buy a cup of coffee.
Either way, history is about to repeat itself as it has done since the crash of the South Sea Bubble over 300 years ago. Today’s authorities may have created the longest expansion on record, but they have committed financial suicide to achieve it. Grant Williams says it best: “They changed the color of the buttons, they changed the handles on the levers, but the principle’s the same. It’s the same scheme run over and over again.” In the end, all we’ve done is rewrite the history books but with a modern twist. No authority has ever defeated economic gravity, and it has no plan to surrender anytime soon.
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This article is for educational purposes only, not financial advice.