The Speculative Bubble and the Birth of Modern Capitalism

Thomas Levenson, Money For Nothing: the Scientists, Fraudsters, and Corrupt Politicians Who Reinvented Money, Panicked a Nation, and Made the World Rich

The South Sea Bubble, an economic surge that helped solidify nascent capitalism in 1720, maybe isn’t as sexy as, say, Holland’s Tulip Mania of 1637. It hasn’t captured popular imagination the same way. Yet by helping invent mature bond markets and consolidating the power of the finance industry in modern politics, it ushered in the industrial “ownership society” we live with today. And it feels chillingly familiar.

Thomas Levenson, MIT Professor of Science Writing, seems an unlikely historian of Great Britain’s newly invented bond markets. His prior works for general audiences have focused on science icons like Galileo, Newton, and Einstein. Yet during the early Eighteenth Century, many British scientists, including Newton, reinvented themselves as financiers and civil servants. Their faith in mathematics and empiricism helped create a “scientific” approach to early modern economics.

This book covers roughly the period from 1693, when Parliament struck a deal with William of Orange to nationalize the public purse, to 1722, when the South Seas Bubble nearly bankrupted Britain. Before 1693, the public purse was basically the monarch’s personal resources, available to boost the crown’s personal glory. Taxes could supplement public funds, but decisions were tied to the monarch personally, making futures trades on public funds virtually impossible.

Once Britain’s national funds belonged to Parliament, it became possible to organize and sell derivatives. London had two markets then: the official Exchange, and the unofficial, unregulated coffee shops of Exchange Alley. Laws creating joint-stock corporations were more restrictive then, meaning fewer companies existed, and trades often occurred informally. Without standards, buyers often didn’t know what futures were really worth; stock-jobbing was a casino.

Into this unregulated market swaggered Parliament, and its new invention, the Bank of England. Britain needed cheap money to support ongoing wars with its traditional rivals, France and Spain. So Parliament began floating derivatives on the Exchange: annuities, pensions, and even lotteries. These derivatives had recently been invented by government mathematicians, including Newton and Edmond Halley (of comet fame), and the market was really an experiment. Failure was always a possibility.

Thomas Levenson

Alongside the government’s gambling, the South Sea Company emerged, willing to take another huge gamble, hoping to establish trade between London, and Spain’s Caribbean colonies. One problem: Britain and Spain were at war, again. While waiting for traditional enemies to resolve their differences, South Sea executives derived elaborate business plans based on Newton and Halley’s actuarial tables. Those plans looked so good, Exchange Alley began salivating.

Soon, the South Sea Company began seeing lucrative stock valuations, based not on anything they’d actually manufactured or sold, but upon the putative value of their future plans. Company principals used this valuation as leverage for their own borrowing. In so doing, they invented a rudimentary form of modern credit swap, creating actual monetary prices for promises. South Sea money wasn’t based on gold or land; it was based on futures.

Anyone familiar with the Great Recession will anticipate where this is headed. Because early government attempts to borrow on credit involved annuities with absurdly long payouts, Parliament was saddled with old debt when it needed to finance new. The Bank of England saw a convergence of Parliament’s needs with the South Sea Company, and devised an idea entirely new in Western finance: privatizing the public debt.

Through a Parliamentary action too complex to summarize, the South Sea Company began hoovering up public debt and translating it into common stock. Stockholders began receiving dividends based on government obligations, while the company continued conspicuously doing nothing. To untrained eyes (which included most of Exchange Alley), this looked like free money. Jealous investors began buying in, and stock prices soared. Many people became rich… on paper.

Levenson includes an epilog comparing the South Sea Bubble to the Great Recession, but not extensively. He trusts informed readers to recognize the parallels. What happened on Exchange Alley in 1720 looks rudimentary compared to today’s credit-default swaps and other derivatives, but in principle, they’re basically identical. And when the crash came, London had two choices: repair this newly discovered system, or return to the old ways.

To their credit, Britain’s investors chose wisely.

Alongside this new economy came a new government. As Levenson relates, the monarch becomes increasingly irrelevant, while an eager young politician, Robert Walpole, consolidates power, and becomes something new: a Prime Minister. The rise of early-modern economics helps create the early-modern government. Though Levenson says it’s risky to suggest our world was birthed around 1720, that implication clearly exists.

We’re living in the South Sea’s shadow.