The South Sea and Mississippi Bubbles of 1720

Johannessen, Jon-Arild

doi:10.1007/978-3-319-41793-6_4

Jon-Arild Johannessen²

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1 Citations

Abstract

This chapter examines the assumption that there is a relationship between innovations and economic crises , with a special focus on the economic crisis in Britain in 1720. The Mississippi Bubble and the economic crisis in France is described and analysed as well, because the British and French economic crises were interwoven. The following question is considered: Is there a relationship between innovations and economic crises? The purpose of the investigation is to discover which innovations triggered the social mechanisms that led to the economic crisis of 1720.

The findings presented reveal that the following innovations, working through social mechanisms brought about the crisis : the establishment of the London Stock Exchange in 1698 (institutional and political innovations ); new public–private loan schemes (institutional and political innovations ); the English Revolution in 1688 and the Peace of Utrecht in 1713 (institutional and political innovations ); the Mercantilist doctrine dominated European economic thinking (institutional, cultural innovation); and the emergence of options, lotteries, “futures ” and new paper money (economic and financial product innovations).

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Notes

1.
Paul (2011: 1).
2.
Mackay adeptly relates bubbles to mania , irrational behaviour , illusion and trickery (Mackay 1995).
3.
Dale (2004).
4.
“Behavioural finance” uses psychological models to explain financial behaviour (Paul 2011: 5).
5.
Rational bubbles have been thoroughly explained by Tirole (1982, 1985); Garber (2000).
6.
Scott (1912); Dickson (1967); Mackay (1995); Carswell (1993).
7.
The classical works concerning explanations of effective markets are, amongst others, Fama (1970, 1991). The classical works in the field of economics which argue that people can act rashly and thereby create a bubble include, amongst others, De Bondt & Thaler (1993).
8.
Neoclassical economics emphasizes the idea that markets strive for equilibrium , where supply and demand are balanced through a “correct” price. My point in this context is that an innovation will always bring a market out of equilibrium, and introduce an “innovation price”. The market may strive towards equilibrium after an innovation has disrupted this equilibrium by means of entrepreneurs who fill the gap in the market which innovations have created. However, the more innovations that are introduced into the market, the more gaps that will appear in the market, bringing it out of balance. It is the rational actions that people—entrepreneurs—undertake in order to act in relation to an innovation that bring the market into equilibrium again.
9.
Cliometric research has been called the new economic history (Neal 1990).
10.
Carlos & Neal (2006); Temin & Voth (2004); Shea (2007a, b).
11.
This assumption is supported in part by Neal (1990). In Paul’s book she analyses the South Sea Bubble , and touches on the importance of innovation for the development of bubbles: “…These difficulties are part of the problems of financial innovation and development.” (Paul 2011: 101). There are of course innovations other than the financial ones that influence the growth of an economic bubble , including amongst others, institutional innovations (Johannessen, 2014, forthcoming).
12.
Goldgar (2007: 305), Balen (2003: 1–12).
13.
Paul (2011: 44).
14.
Dale (2004: 6).
15.
Dickson (1967). War and revolutions characterise the age. The English Revolution of 1688 resulted in, amongst other things, an institutional innovation in England . The Peace of Utrecht was signed in 1713; this put an end to several European wars, amongst them the War of the Spanish Succession, which also had consequences for several European countries.
16.
Goldgar (2007: 305).
17.
The London Stock Exchange was not officially opened until 1801. However, dealings of a stock exchange like nature were carried on beginning in 1698 in “Exchange Alley ” and in the so-called coffee houses. In reality, shares were traded in a way similar to a regular stock exchange.
18.
Carswell (1993).
19.
Scott (1912), Vol. 3.
20.
Goldgar (2007: 306).
21.
Paul (2011: 54).
22.
Neal (1990).
23.
Ibid.
24.
P/E stands for the ratio of price to earnings, i.e., the share price or market value in relation to a company’s income as represented through its net income.
25.
Mackay (1995).
26.
Clark (1999: 49–50).
27.
Dale (2004: 4), note 6 page 6.
28.
Sperling (1962: 1–14).
29.
Paul (2011: 54).
30.
Mackay (1995: 1–46).
31.
Dale (2004: 4–5).
32.
Sperling (1962: 1–14).
33.
Neale (1990: 91).
34.
Dale (2004: 4).
35.
Paul (2011: 55).
36.
John Houghton’s book, Collection for Improvement of Husbandry and Trade, was published in 1664; the target audience was people without special expertise in trading (Murphy 2009: 8).
37.
Balen (2003: 31).
38.
Brian (1988: 20–78).
39.
Balen (2003: 34–35).
40.
Paul (2011).
41.
Roseveare (1991).
42.
Balen (2003: 37).
43.
Balen (2003: 41).
44.
Brewer (1989).
45.
John Law is considered as having been responsible for the Mississippi Bubble in 1720.
46.
Magnusson (1994).
47.
“Controller General of Finances of France ” under King Louis XV.
48.
Balen (2003: 60–63).
49.
Balen (2003: 66–67).
50.
Mackay (1995: 1–45).
51.
Balen (2003: 69).
52.
Paul (2011: 56).
53.
Balen (2003: 68).
54.
Neal (1990: 62–141).
55.
Balen (2003: 70).
56.
Mackay (1995: 1–45).
57.
Balen (2003: 71).
58.
It is not possible over time to borrow one’s way out of a credit bubble , but only to save, produce or organise one’s way out.
59.
Morgan (1928: 143–166); Stein & Stein (2000: 109).
60.
The Spanish Empire was diminished by this war fought between 1701–1714; in its aftermath, the French and the British emerged as the new major powers in Europe .
61.
Dale (2004: 40).
62.
Defoe (2010) (first published in 1719). Defoe was well acquainted with the spirit of the age.
63.
Michie (1999: 16).
64.
Scott (1912), referred to in Neal (1990: 77).
65.
Dale (2004: 22).
66.
The lenders remembered when the king, Charles II, stopped debt payments to creditors in 1672, and had a 50 per cent reduction in the public debt negotiated (Roseveare 1991: 52).
67.
Dickson (1967: 347).
68.
Zaltman et al. (1973).
69.
Dale (2004: 24–25).
70.
Roseveare (1991: 52).
71.
Dickson (1967: 39–40).
72.
Exchange Alley is a narrow alleyway that is bounded by Lombard Street, Cornhill and Birchin Lane.
73.
Defoe 2010 (first published in 1719).
74.
Francis 2011 (first published in 1849).
75.
Defoe (2010).
76.
Dale (2004: 37).
77.
Neal (1990: 65).
78.
The Tulip Bubble in 1637 was not an international phenomenon in the same sense as the South Sea Bubble and the Mississippi Bubble in 1720.
79.
The normal price ranged from £3.88 to £3.92 per ounce, while from July to November 1920 it rose to £4.08 (Neal 1990: 65–66).
80.
Gold prices are very volatile. This can be explained by the fact that one sells gold when the prices of shares continue to rise, but take safeguarding measures shortly afterwards by buying gold. When share prices continue to rise, one will participate in the rally and sell gold. One dare not remain too long in the stock market , because it is assumed there may be a bubble , and so one safeguards oneself again by buying gold. The volatility in gold may be called the “Ashton Effect” due to the fact that T.S. Ashton first discovered volatility in exchange rates during economic crises (Ashton 1969: 113).
81.
Carswell (1993: 101).
82.
Neal (1990: 68).
83.
Scott (1912, Vol. 1: 404).
84.
Neal (1990: 69).
85.
Carswell (1993: 136; 165–166).
86.
Neal (1990, 77; 80–88).
87.
Dickson (1967: 123–143).
88.
Paul (2011: 48).
89.
Supple (1970: 26–28).
90.
Harris (1994: 610–627).
91.
Goldgar (2007: 306).
92.
Dickson (1967: 140–141; 152).
93.
Paul (2011: 43).
94.
Balen (2003: 95–129).
95.
Carswell (2001: 136) and Dickson (1967: 152) suggest this possibility concerning what triggered the bubble to burst.
96.
Dickson (1967: 145).
97.
Carswell (2001: 166).
98.
Ashton (1969).
99.
Carswell (2001: 140). Dickson (1967: 142) says that the assumption is difficult to prove.
100.
Murphy (1997).
101.
Paul (2011: 50).
102.
Dickson (1967: 166).
103.
Neal (1990: 90–96).
104.
Neal (1990: 4).
105.
Dickson (1967: 17).
106.
Dickson (1967: 311–312).
107.
It must, however, be pointed out that the cliometric school even although it may use the world’s finest and complex mathematics and computers to compare the data, the patterns cannot be used to explain why these patterns occur. It is the explanation of the emergence of these patterns that the relationship between different types of innovations and economic crises can provide.
108.
Carruthers (1996: 170).
109.
Jones (1978: 285).
110.
Neal (1990: 90).
111.
Paul (2011: 32). “Tallies” were originally wooden sticks which were in two parts, where the creditor had the one part and the debtor other. Later, these two parts settled in paper notes that together showed who owed what to whom (Paul 2011: 130, note 20).
112.
Neal (1990: 14).
113.
De la Vega 1957 (English translation) (first edition in 1688 in Spanish)
114.
Paul (2011: 31).
115.
Roseveare (1991)
116.
Carruthers (1996: 116–121).
117.
Brewer (1989: 24).
118.
Goldgar (2007). Public–private projects were, however, already in existence in the second century in the Roman Empire, especially in connection with the mining industry, for instance in Spain .
119.
Carruthers (1996: 75–76).
120.
Dickson (1967: 486).
121.
Dale (2004: 127).
122.
Murphy (1997: 250).
123.
Dale (2004: 128).
124.
Murphy (1997: 283).
125.
Dale (2004: 131).
126.
Both countries had taken up large loans during the War of the Spanish Succession. Paper money was the innovation that would bring down the national debt by converting the debt to the bank notes guaranteed by the government and banks . The instruments used in the two countries were respectively the Mississippi Company and the South Sea Company .
127.
The Mississippi Bubble burst in summer, 1720.
128.
Dale (2004: 131).
129.
Magnusson (1994).
130.
Gramp (1952: 466).
131.
Hutchinson (1978: 23).
132.
It has been questioned whether Mercantilist doctrine was an overall coherent system of thought (Magnusson 1994: 21–60).
133.
However, not all Mercantilists argued for protectionist measures (Magnusson 1994: 8).
134.
Hutcheson 2010 (first published in 1721)
135.
Paul (2011: 75).
136.
Neal (1990); Paul (2011).
137.
Neal (1990).
138.
Hutcheson (2010); (2010a); Dickson (1967); Carswell (1993, 2001); Scott (1912).
139.
Paul (2011); Neal (1990); Kindelberger (1996); Garber (2000). One of Garber’s points is that bribery was an integral part of decision-making at the time, and says nothing about the trickery concerning share prices being planned (Garber 2000: 111). It was not irrational to invest in a stock that rose; on the contrary, it was rational (Garber 2000: 125). One of Garber’s points is precisely that if something went wrong, it does not mean it was wrong in principle.
140.
Rational bubbles are stressed by Garber (2000).
141.
Kindleberger (1996: 23).
142.
The point of chaos theory is that the system is so interconnected that small changes in one place can have a big impact somewhere else in the system due to various multiplier effects. The butterfly effect is meant to illustrate this by saying that if a butterfly flaps its wings in China , this can later cause a storm in Greenland. Obviously, this is only intended as a figurative image for network effects in an interconnected system.

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Kristiania University College and Nord University, Oslo/Bodø, Norway
Jon-Arild Johannessen

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Johannessen, JA. (2017). The South Sea and Mississippi Bubbles of 1720. In: Innovations Lead to Economic Crises. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-41793-6_4

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DOI: https://doi.org/10.1007/978-3-319-41793-6_4
Published: 15 November 2016
Publisher Name: Palgrave Macmillan, Cham
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