The Great Swindle

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The Great Swindle, Virginia Cowell's excellent account of the events that surrounded the South Sea Bubble and the Mississippi Scheme was published in 1960, but her analysis is as sharp today as it was forty years ago. Although over the following 300 or so years the stage of investment manias repeatedly changed, the script, the accessories, and the nature of the actors participating in the bubble have largely remained the same.

The "bubble" model always involves a "displacement", which leads to extraordinary profit opportunities, overtrading, over-borrowings, speculative excesses, and swindles and catchpenny schemes, followed by a crisis during which fraud on a massive scale comes to light, then by the closing act during which the outraged public calls for the culprits to be taken to account. In each case, excessive monetary stimulus and the use of credit fuels the flames of irrational speculation and public participation, which involves a larger and larger group of people seeking to become rich without any understanding of the object of speculation.

The saga of the Mississippi Scheme and the South Sea Company is historically relevant because it contains all the major features of subsequent manias: shady characters, corruption, fraud, dubious practices, the creation of money and the extension of risky loans in order to keep the speculative orgy going, the catalyst, which leads to the initial collapse -- usually the revelation of fraud, the inability of a large speculator to come up with the money to meet a margin call, the revelation that insiders cashed out, or some adverse economic or political news -- and then the panic during which greed and euphoria are replaced by fear and the speculators' desire to get out at any price.

What is also important to understand is that both the promoters of the South Sea Company and John Law attempted to support the market at any cost, but at some point the market forces proved to be far more powerful than any price-supporting measures that could have been taken. In particular, John Law's policies remind us of current central banks' policies, the aim of which is to solve any problem the same way Law tried to solve the Mississippi Company's problem -- simply by increasing the money supply. That such monetary policies will lead to the same price increases, which, at the time of Law's Mississippi Scheme, destroyed people's faith in paper money, ought to be clear. Whether, at that point, current central bankers and government officials will conspire to expropriate investors' gold possessions, as Law did, remains to be seen, but we shouldn't forget that in 1933, in the midst of the Depression, the US government declared the possession of gold by individuals to be illegal.

I should also like to mention that during the booms in the shares of the Mississippi Company and the South Sea Company, there were critics, but no one wanted to pay attention to the party spoilers. The British ambassador to France, the Earl of Stair, resisted the temptation to invest in the shares of the Mississippi Company and in a heated argument with John Law contended that his crazy scheme would more likely ruin France than enhance its power. But the cold relationship between Stair and Law, which was well known in London, brought him down. All over Europe, Law enjoyed an enormous prestige as the most successful minister of finance, and he was also greatly admired in England.

Therefore, the rift between Stair and Law became an embarrassment to the British government, which decided to call him back. In the case of the South Sea Company, the prominent member of Parliament, Archebald Hutcheson, began to publish a series of pamphlets in which he maintained that people who bought shares in the company at an elevated price must be "deprived of all common sense and understanding", since in the absence of the company having any real business, they would be giving money to the original shareholders and the annuitants.

Similarly, the Irish-born French economist Richard Cantillon (known as the first true monetarist) thought that the shares of the South Sea Company could be held up for a number of years, but that there was "a melancholy prospect for those who shall stay last". But, as is usually the case during an investment mania, the speculators didn't pay any attention to these rare voices of scepticism. It's worth noting that Cantillon had a full understanding of how a rise in money supply could, on occasion, produce short-term increases in output and employment, but would in due course also drive up the prices for commodities.

Cantillon had made a huge fortune in the shares of Law's Mississippi Company, because he had sold out near the peak of the market in early 1720 and had the foresight to leave France that year for Holland. (Upon his return to Paris ten years later, several counter-parties who had incurred significant losses took him to court. The suits, however, had no merit and were all dismissed.) But in the case of the South Sea Company, even Cantillon -- one of the most brilliant financiers and economists of his time -- clearly underestimated the forces of gravity, since the share price collapsed soon after his comment that "those who would stay last" would incur losses. (Cantillon was murdered in London in 1734 and his house, with all his writings, was set on fire. The crime was presumably committed by his cook, whom he had dismissed a week earlier. The only surviving work by this brilliant economist is "The Essay on the Nature of Trade in General", which contains an analysis of banks, bank credit, coinage, and the automatic mechanism that distributes the monetary metals internationally. Schumpeter, in his History of Economic Analysis, regarded the "Essay" to be almost "faultless", saying that it stood "in most respects unsurpassed for about a century".)