Paul the south sea bubble; an economic history of its origins and consequences (2011)

The South Sea BubbleThe South Sea Bubble was a financial bubble that occurred on the London stock market in 1720.. 13 The Premodern Chinese 15 Management of the National Debt in the Uni

The South Sea Bubble

The South Sea Bubble was a financial bubble that occurred on the London stock market in 1720 In the traditional story, the Bubble was caused by a mysterious gambling mania The directors of the South Sea Company were also apparently fraudsters Modern economic history research has found these explanations to be inadequate This book aims to explain how a bubble can occur without assuming that everyone had lost their wits

The book shows that the South Sea Company’s prospects were bright enough

to encourage investment The company shipped African slaves to Spain’s can colonies It was hoped that the company might eventually gain its own colony there There were other rational reasons to invest in the company’s shares, due to features of the financial and legal system of the period Behav-ioural finance theories can also help to explain how and why Georgians invested

Ameri-as they did Some obviously lost money when the Bubble burst and society demned their apparent folly However, the economic consequences of the Bubble have been exaggerated for effect Contemporaries used the episode to discuss their fears about foreigners, Catholics, Jews, women and the nouveau riche The book is an economic history of the Bubble It combines economic theory and quantitative analysis with historical evidence in order to provide a rounded account It brings together scholarship from a variety of different fields to update the existing historical work on the Bubble Up until now, economic history research has not been integrated into mainstream histories of 1720 Technical work on share prices and ledgers has been inaccessible to a wider audience As well as providing new evidence against the gambling mania argument, the book also interprets the existing economic history scholarship for non- specialists

con-Helen J Paul is a Fellow in Economics at the University of Southampton, UK.

Routledge explorations in economic history

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John Hillman 49 The South Sea Bubble An economic history of its origins

and consequences

Helen J Paul

The South Sea Bubble

An economic history of its origins and consequences

Helen J Paul

First published 2011

by Routledge

2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN

Simultaneously published in the USA and Canada

by Routledge

270 Madison Avenue, New York, NY 10016

Routledge is an imprint of the Taylor & Francis Group, an informa business

© 2011 Helen Julia Paul

All rights reserved No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers.

British Library Cataloguing in Publication Data

A catalogue record for this book is available from the British Library

Library of Congress Cataloging in Publication Data

Paul, Helen J., 1975–

The South Sea Bubble: an economic history of its origins and

consequences/by Helen J Paul

p cm.

1 South Sea Bubble, Great Britain, 1720 2 South Sea Company–History

3 Financial crises–Great Britain–History–18th century 4 Finance–Great Britain–History–18th century I Title.

ISBN13: 978-0-415-46973-9 (hbk)

ISBN13: 978-0-203-84206-5 (ebk)

ISBN 0-203-84206-5 Master e-book ISBN

This edition published in the Taylor & Francis e-Library, 2010.

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To my late father, Alexander Duncan Paul

6.1 The number of ships arriving in Spanish America carrying

6.2 The number of slaves brought to Spanish America by the

6.3 The number of slaves landed from transatlantic South Sea

This book has been many years in the making and stems primarily from doctoral research and a postdoctoral fellowship I would like to acknowledge the financial support of the Economic and Social Research Council for funding both In addi-tion, I received an overseas conference grant from the British Academy The two economics departments at the Universities of St Andrews and Southampton have also funded my conference trips

I first discovered the South Sea Bubble during my Masters degree at St Andrews The course lecturer, Dr Gary Shea, became my doctoral supervisor

He has been a fount of knowledge about the company and has given me much support and advice His work on the Bubble is mentioned in this book Many other colleagues at St Andrews also gave their encouragement I should mention the support of my internal examiner, Professor Gavin Reid, and my late boss and friend, Professor Christopher Jensen- Butler I was advised to apply for my first academic post at St Andrews by Dr Laurence Lasselle The career paths of eco-nomic historians in UK economics departments had become quite precarious under the old system of research funding My employers at St Andrews, and later at Southampton, allowed me to continue in my chosen line of research My current boss, Professor Grant Hillier, has been very generous in reducing my teaching load Dr Jan Podivinsky has had the task of making this possible

I was very fortunate in gaining an external examiner of the calibre of sor Pat Hudson At the time, she was also head of the Economic History Society She, and other women in the EHS, have been an inspiration to many early career female academics The EHS annual conference is where I gave my first paper The EHS aims to bring together economic historians who would otherwise be spread across a variety of different departments Through the society, I met many people who work on some aspect of the Bubble and who have been gener-ous with their time They include Anne Laurence, Anne Murphy, Larry Neal, Ann Carlos and Stephan Altorfer The EHS also funded a postgraduate training course held, for some reason, in Windsor Castle This is where I first met Profes-sor Patrick O’Brien, who again has been a great source of encouragement

I would also like to thank audience members at other conferences who have commented upon my research Two research groups have been highly important and also generously funded conference expenses One is the Money, Power and

xiv Acknowledgements

Print Colloquium The other is the Fiscal–Military State group which formed at the World Economic History Congress in Helsinki Through these groups, I have met others working in my research field They are too numerous to name here but I am extremely grateful to them Joyce Goggin has given me numerous useful references and has also been a fantastic host

Clearly all historians must build upon the foundations laid by others W.R Scott, P.G.M Dickson and John Carswell all wrote books that are the basis for research into the Bubble The fact that I disagree with them on some points does not alter the debt that I owe them The archival work undertaken is largely from the Public Record Office (or National Archives) at Kew and the House of Lords Record Office The efficiency of these institutions and the helpfulness of their staff has been important Likewise, I have found it incredibly helpful that some unknown souls have made primary source materials available online (I would like to thank Stephanie Decker for pointing out the Harvard collection to me.) The Routledge staff have also been models of patience They include Terry Clague, Thomas Sutton, Simon Holt and Emily Senior

My friends and family have been good sounding boards throughout the writing of this book and the doctoral thesis that inspired it Lucinda Bromfield even proof- read parts of it John Bluedorn helped me to come up with the final title Sadly, my father died before the final version of the book was finished My parents always stressed the importance of a good education They also instilled

in me a truly Scottish appreciation of the value of saving Perhaps their ence, and the fact that I grew up in Newcastle- upon-Tyne, explains my interest

influ-in economic history My childhood home was only around two miles away from George Stephenson’s cottage where he built his first locomotive My teachers encouraged me to try to get a place at Oxford to study economics, instead of doing a mathematics degree as I had planned For that alone, I am grateful

I apologise if I have inadvertently missed anyone Any remaining errors in the text are, of course, my own

Helen Julia PaulSouthampton 2010

Notes on the text

A further complication was that the Julian calendar was several days behind the Gregorian calendar Until 1700, it was ten days behind Thereafter, it was eleven days behind

Dates quoted from primary sources will use the dating system used by the source For English documents, that is the Julian dates However, indications such as (OS), ‘new style’ or 1710/11 will be added to clarify the dating system

in some places in the text

Secondary sources use the author’s own convention P.G.M Dickson and John Carswell both rewrote Julian dates as if the year started on 1 January

Figures

English money was marked as pounds, shillings and pence The notation used

was l for pounds, s for shillings and d for pence There were twelve pence in a

shilling and twenty shillings in a pound Contemporary sources would quote figures down to the last pence, even for large sums This level of precision is usually unnecessary for the purposes of this book, so often sums will be rounded

up or down For the purposes of calculation, sums have been decimalised

1660 Restoration of the Stuart monarchy

1662 Royal Adventurers granted charter to trade in slaves

1665 James II succeeds his brother, Charles II

Second Anglo- Dutch War begins

1667 War of Devolution: Louis XIV of France invades Spanish Netherlands

Second Anglo- Dutch War ends

1668 Triple Alliance of United Provinces, England and Sweden formed

against Louis XIV

1670 Treaty of Madrid forbids English trade to Spanish possessions in the

West Indies and vice versa

Secret Treaty of Dover signed between Charles II and Louis XIV

1671 Stop of the Exchequer (1672 in Julian calendar)

1672 Royal Adventurers become the Royal African Company with monopoly

rights

Franco- Dutch War begins

Third Anglo- Dutch War begins

1674 Third Anglo- Dutch War ends

1678 Franco- Dutch War ends

1685 Start of Dutch Asiento

Revocation of the Edict of Nantes

1686 League of Augsburg forms against Louis XIV

1688 Glorious Revolution

Nine Years War begins (also known as War of the League of Augsburg

or War of the English Succession)

1689 William and Mary crowned at Westminster Abbey

End of Dutch Asiento

The fighting spreads to the North American colonies (King William’s War)

1694 Queen Mary dies

1695 Darien scheme begins

1697 Nine Years War ends

1698 New East India Company founded

1699 Darien scheme fails

Timeline xvii

1700 Death of Princess Anne’s last surviving child

Great Northern War begins

1701 Act of Settlement prohibits Roman Catholics from succeeding to the

throne

Grand Alliance forms to support Austrian Hapsburg claims to Spanish throne

1702 Anne becomes Queen

War of Spanish Succession begins (Queen Anne’s War)

Destruction of the Spanish treasure fleet at Vigo

1707 Act of Union which abolishes Scotland’s own parliament

1709 Great Frost

Battle of Poltava

Old and New East India Companies merge

1710 Lottery Loan

Sun Fire Office founded

1711 South Sea Company founded

Austrian candidate for Spanish Crown, Archduke Charles, inherits Imperial Crown

1712 Mississippi Company granted charter to trade to French possessions in

North America

1713 War of Spanish Succession ends with Treaty of Utrecht

South Sea Company establishes factories in Spanish America and refreshment stations in the West Indies

1714 Queen Anne dies George I succeeds her

1715 Jacobite invasion attempt

Louis XIV dies

1716 Septennial Act granting seven- year parliaments

1717 Whig party split

Prince of Wales leaves his father’s Court and establishes his ownBritish make bargain with French to expel James Stuart He leaves Avingnon for Rome

France, England and United Provinces form alliance against SpainWalpole establishes ‘Sinking Fund’ to reduce interest on redeemable annuities

1718 British declares war with Spain

Austria joins anti- Spain alliance, forming Quadruple Alliance

Byng destroys Spanish navy at Cape Passaro

Charles XII of Sweden dies

1719 James Stuart leaves Rome for Spain

Jacobite rebellion

Sweden signs a peace treaty with Hanover

South Sea Company proposes conversion of remaining government debt

Bill passed granting conversion of Lottery annuities

1720 Jan Felipe V of Spain announces adherence to Quadruple Alliance

xviii Timeline

Sweden signs peace treaties with Britain, Prussia and DenmarkLaw links Mississippi Company with his bank

Feb Law forced to reopen French stock market and issue more

paper money after he had previously tried to cool down the economy

Parliamentary committee set up to investigate company charters

Mar Law exchanges Banque Royale notes for Mississippi shares,

increasing the money supply and inflationary pressuresApr First and second money subscriptions

South Sea Company makes loans on stock

May First subscription of long annuities

First subscription of short annuities Loans made on stock

Law begins deflationary policiesJun Third money subscription

Loans made on stock Bubble Act passed

Aug Second subscription of long annuities

Second subscription of short annuities Fourth money subscription

Subscription of redeemable debt Bubble Act enforced

Sep Bank Contract – Bank of England promises to circulate

South Sea bonds and hand over some redeemable debt in exchange for South Sea shares

Market drops South Sea directors discuss altering terms made to annuitants

Sword Blade Bank fails Bank of England reneges on Bank Contract

Mississippi share price also begins declineDec South Sea Company shares at low point

1721 Great Northern War ends with Peace of Nystad

Peace with Spain confirmed

Secret Committee set up to investigate South Sea Company activities

South Sea Company reformed

Financial rescue package developed by Walpole

Henry Elking approaches South Sea Company with plan for whaling trade

1723 Black Act

1725 First South Sea Company whaling expedition

1726 Conflict with Spain

Admiral Hosier blockades Portobello

Timeline xix

1727 South Sea Company ship, Luxborough Galley, catches fire

1729 Peace treaty with Spain signed – Treaty of Seville

1731 British make secret agreements with Spain and Austria to stop Ostend

Company’s American trading activities

1739 War of Jenkins’ Ear begins

1740 War of Austrian Succession begins

Admiral Vernon captures Portobello

1745 Last Jacobite uprising

1748 War of Austrian Succession ends

1750 South Sea Company Asiento ends

1853 Act 16 Vict c.23 passed to redeem or commute annuities held by

South Sea Company

1854 South Sea Company begins to wind up its affairs

EHS Economic History Society (UK)

EIC (English) East India Company

IPO Initial Public Offering

MIT Massachusetts Institute of Technology

NS With reference to dates: New Style or Gregorian calendar

OS With reference to dates: Old Style or Julian calendar

PRO Public Record Office (National Archives), Kew, London

VOC (Dutch) East India Company: Vereenigde Oost- Indische

Com-pagnie

1 Introduction

At the end of the War of the Spanish Succession, the Spanish Crown granted the

Asiento contract to Queen Anne The Asiento gave monopoly rights to import

slaves into Spanish- held America Anne passed the contract over to a joint- stock company called the South Sea Company In exchange, the company was to help restructure part of the National Debt From the start, the company undertook public and private roles It was a quasi- public entity – a hybrid It was involved

in a range of activities which to modern eyes might seem to have little in common However, it was part of a national project to make England (and after

1707, Britain) strong enough to fight future wars Trade, government finance and military strength were thought to be interlinked It is not for these things that the South Sea Company is chiefly remembered Instead, its name is famous because

of a few months when its share price, along with the rest of the stock market, boomed and then crashed The architect of the sales of South Sea stock was Sir John Blunt, who is always cast as the villain of the piece He and the other dir-ectors were accused of fraud They were brought in front of the House of Commons and questioned They had their estates confiscated and were vilified

by the public Even before the crash, the nascent stock market in Exchange Alley was held in great suspicion Critics of the Alley bandied about the term ‘stock- jobbing’ The epithet ‘jobber’ is usually pejorative but there is no one definition

of what ‘jobbing’ might be Machlup (1940) defined a jobber merely as a broker,

or someone who trades on behalf of others Others use the term to mean a lator Many contemporary accounts seem to equate ‘jobbing’ with fraud Con-temporaries had a better understanding of the old rules of warfare and politics, than they did with the new ways of the stock market

The South Sea Bubble of 1720 is one of the most famous financial market crashes in history Indeed, it has become a byword for folly and fraud Its name

is evoked every time a devastating crash occurs Journalists mentioned the South Sea Bubble when reporting the Dotcom Bubble of the late twentieth century and, more recently, during the Credit Crunch of the early twenty- first No doubt, jour-nalists will mention it again when the next crash occurs At each economic setback, a crop of books appears on the financial history of crashes Some cover

a number of episodes and often look for similarities between them Some centrate on just one event in detail

con-2 Introduction

Work on the South Sea Bubble traditionally blames the rise in share prices on the outbreak of a mysterious ‘gambling mania’ There are plenty of contempor-ary accounts of jobbing and of uproar in Exchange Alley that are used to promote this view However, professional economic historians do not tend to believe that such a mania existed For a variety of reasons, insights from eco-nomic history have not permeated mainstream academic history writing They seem to have had no effect at all upon the popular histories of bubbles and crashes This book differs from others in the field because it dispenses with the

‘gambling mania’ approach It gathers much of the existing economic history research and makes it accessible to a wider readership However, it differs from much of the cliometric (or mathematically based) economic history work in that

it looks at more than share prices and stock ledgers.1 It considers the wider context of the South Sea scheme It analyses the company’s trading activities in detail and also the company’s social context There were many good reasons for investors to be hopeful about the trading side of the company The book also includes some insights from modern financial theory, especially the field of behavioural finance Ultimately, it is not necessary to explain a financial bubble

by claiming that everyone has lost their common sense Behavioural finance allows bubbles to be explained even when some, if not all, investors are behav-ing rationally

The three classic books on the Bubble provide the basis for most research on the episode (They all promote the gambling mania argument.) W.R Scott wrote his history of the joint- stock companies in 1910s P.G.M Dickson’s work on the Financial Revolution was published in 1967 John Carswell’s book focused on the Bubble itself and is a more historical approach It was initially published in

1960 although Carswell did publish a revised edition in 1991 All three authors have provided valuable, detailed information about the South Sea Company However, all three predate the cliometric work on the Bubble and sometimes use arguments that do not make sense in economic terms Their mistakes or omis-sions are important, as they have provided the key secondary texts for other his-torians Many readers are unable to unravel economic theory for themselves and must take what Scott, Dickson and Carswell have told them on trust For example, all three authors felt that the company’s trading prospects were negli-gible None of them used slave trade records to test this assertion

Cliometric work on share prices has been difficult for non- economists to access and understand However, this type of research sheds more light on how the early financial system functioned than the standard catch- all theory that the Georgians were gambling mad If early Georgians were complete fools, then it seems incredible that their economy recovered and the new Hanoverian monar-chy survived The glee with which some commentators damn our ancestors mixes schadenfreude with a prejudiced attitude to those who have gone before

us This book will try to rescue something of the Georgians’ reputations, whilst acknowledging that some of them did make poor bargains The book aims to be

an economic history with a balance between economics and history

Economic history should be a marriage of two major disciplines In practice,

Introduction 3

the field has faced a number of problems These difficulties might help to explain why cliometric work has not found its way into mainstream history books on the Bubble For organisational purposes, historians and economists are located in separate university departments and are usually in different faculties The methods they use and their worldviews usually have little overlap Economic historians should be able to bridge this gap In previous years, many mainstream historians were alienated by the use of a highly mathematical approach to eco-nomic history called cliometrics The Cliometric Revolution promoted the use of mathematical techniques to analyse historical data The movement coincided with the development of powerful computers that could process large quantities

of data Many sources, such as account books for slave plantations, had not been fully exploited before In addition, many historians lacked the relevant math-ematical skills to use quantitative data properly A few economic histories had been written using large data sources, but only with the mainframe computer did the new field of cliometrics appear Today, the term ‘cliometrics’ has different meanings Economists think of any mathematical approach to history as cliomet-rics Many economic historians and historians use it only for research which is extremely mathematical and uses advanced econometric techniques

One of the key works in the early years of cliometrics was A Time on the Cross by Robert Fogel and Stanley Engerman It is a good example of how

quantitative data (such as accounting data) and written texts may tell two ing stories Fogel and Engerman had been taught that slavery in the southern United States of America should have withered away of its own accord The consensus was that it was unprofitable and was only kept going by the intransi-gence of southern slave- owners Numerous books had been written on the subject and, as is the way with research, authors had cited other authors in order

oppos-to make their case They had not used plantation account records oppos-to calculate profits directly This is what Fogel and Engerman did and they found, to their surprise, that slavery was profitable after all The implications of this result were immensely important Mainstream historians had thought that if slavery was unprofitable, it should have eventually ceased and the American Civil War need not have been fought According to cliometric evidence, if the American Civil War had not been fought, slavery would have continued on

Although it had its critics, A Time on the Cross encouraged other economic

historians to attempt large- scale cliometric exercises.2 Mainstream historians worried that too much attention was being paid to numbers and not enough to traditional sources, such as written texts Cliometricians countered that written texts had given the misleading impression that slavery was unprofitable Histor-ians had used abolitionist propaganda as fact, without attempting to consider economic issues for themselves (Abolitionists had claimed slavery was unprofit-able in order to induce slave- owners to free slaves and use paid labour instead.) When cliometric studies were in their infancy, computing was something of a black art and computers were highly expensive A whole generation of historians was genuinely bamboozled by the techniques of the cliometricians Cliometrics was a dirty word in some quarters.3 However, our forebears communicated their

4 Introduction

ideas in a variety of different forms, including texts, objects and numbers They did not live in modern economies, but they did have an economy and made eco-nomic decisions

Economic history is not the most widely known of the branches of history, or

of economics Political histories of great men and battles are more popular with the public Even within academic history, there is a gap between economic history and practically all other fields (Coleman 1995) Likewise, there is a gap between economics research and the type of economic history which borders on social history Often, individuals who are mathematically minded and interested

in economics have different capabilities from those working in the humanities Whilst economists like to create elegant models and theories, historians pay a great deal of attention to contextualisation Based in different faculties, the two tribes have little contact Yet they can stray into each other’s territory History written by economists or economics explained by historians can produce Frankenstein effects

The economic historian Sir Alexander Cairncross (1989) recalled that when

he first started his studies there was no great divide between economics and nomic history This is no longer the case, and economists can fall into the trap of writing a Whig history.4 Whig history is a disparaging term for any model which shows an inevitable stage- by-stage progression from a low level to a high one.5Whig histories have been used to explain society’s political development, indus-trialisation, legal changes and much more They all assume that the later stages are better than the earlier ones and that there are no reversals of fortune Despite its critics, the Whig history model is surprisingly pervasive It easily lends itself

eco-to the works of economists Economic theory is often the hiseco-tory of success, when success is measured in economic growth and material wealth One issue which counters the idea of inevitable, irreversible progress is the existence of crises such as bubbles The complacency inherent in Whig history is undermined

by the recurrence of economic setbacks

The South Sea Bubble presents problems both to mainstream economic theory and mainstream history It is difficult for neoclassical economic theories

to explain the existence and timing of financial bubbles, other than by claiming that investors become irrational.6 Historians have often relied upon the explana-tion that the Bubble was caused by a gambling mania At first glance, the idea that bubbles are due to an outbreak of gambling or irrational investing is a per-suasive one It would explain why prices rose to such heights However, it would also mean that people took leave of their senses for no apparent reason Such a catch- all theory is worse than no theory at all A wave of gambling would have had to appear and then just as quickly recede Dickson (1967) thought that Geor-gian society was more risky than later periods and that this state of affairs encouraged risk- taking However, the Georgian stock market was very similar to modern markets and Dickson’s explanation cannot be used for modern bubbles

A major school of financial theory, called behavioural finance, has emerged to tackle issues such as bubbles It considers how people actually approach finan-cial decisions It does not assume that humankind is all- knowing and perfectly

share price information is John Castaing’s The Course of the Exchange which

was published and distributed at the time It charts the prices of shares and bonds Share prices are also available for other stock exchanges, such as Amster-dam and Paris Some private brokers ledgers still survive, as do the Bank of England subscription lists Many historians are unaware of cliometric work on the Bubble, or else find it hard to use It is far less accessible than the classic works First, this is because it often uses advanced econometric techniques Second, it is often published in specialist academic journals rather than in book form.8 For the same reasons, the findings of cliometric research have made little impact on popular histories of the Bubble

This book will use behavioural finance theories to complement the cliometric evidence Behavioural finance takes techniques from psychological research to investigate financial decision- making It does not assume that investors are wholly rational automatons Instead, experimental techniques are used to study just how rational people are These studies have tended to show biases in behavi-our and cases where people are overwhelmed by the complexity of the task they face A vast amount of information, and also rumour, exists in the stock market The human brain can only process so much The term ‘bounded rationality’ was coined by Simon (1955) to describe this phenomenon Fallible human beings may try to be rational, but there are limits to their ability to take in and process information Instead of maximising their results, they are ‘satisficing’, or trying

to get by

A useful economic model to help to explain the Bubble episode is the idea that there are rational bubbles.9 In this model, share prices might move up due to apparent good news, fraud and the like There might be naive (noise) traders who invest too much However, there is also a role for rational traders (The dis-tinction between rational and naive (or noise) traders is a standard one in finance literature.) Noise traders are said to be influenced by fads and false news, rather than information Although the distinction is hard to make in practice, it is assumed that there are some fools in the market They do not need to make up a large proportion of traders for a rational bubble to appear Once noise traders have registered their interest in something – say, dotcom companies – then others should rationally predict that the share price will rise in the short term Jumping onto the bandwagon and then jumping off again at the right time should bring in profits The noise traders should end up with the overpriced shares and

be pushed out of the market Then all should return to normal In reality, noise traders’ losses might have wider economic, social and political impacts The Great Crash of 1929 exacerbated economic difficulties These effects contributed

6 Introduction

to the problems of the Depression years Many ordinary investors were affected and there were knock- on effects in the wider economy The rise of the Nazi Party was made possible partly because of the economic collapse of the Weimar Republic (Although many have claimed that the South Sea crash was an unmiti-gated disaster, it did not precipitate regime change and war.)

Peter Garber (2000) has argued that many historical crashes were rational

bubbles Indeed, certain investments might have seemed reasonable ex ante

Tulipmania (1637) was a bubble in the prices of tulip bulbs Garber was ested in investments in a certain type of bulb, the ones which produced a varie-gated flower These blooms were highly prized as they were difficult to propagate They commanded high prices, much like rare orchids do today Anne Goldgar’s (2007) book on Tulipmania explored the historical episode thor-oughly Tulipmania, like the South Sea Bubble, has become prey to a large number of myths Garber argued that the South Sea scheme might also be a rational bubble This idea does not require that all investors were rational, of course Rather it means that there were some sound reasons for optimism In the case of the South Sea, Garber felt that the sound reason was the trading potential

inter-of the company This has always been a minority view Traditional histories have acknowledged that the British were envious of Spain’s access to precious metals from America However, historians have usually concluded that there was

little chance of making profits from the Asiento or of encroaching on Spain’s

imperial power For example, Carswell (1960) thought that the prospects of the trade were only of ‘fairy gold’

If Carswell was correct, then the public’s interest in the shares would indeed

be puzzling Investment decisions are forward- looking, not made with hindsight They are not without risk This book argues that there were valid signs that the company would make something of the trade and might even have gained a colony The book uses different subfields of history to consider the company’s prospects The triangular trade between Europe, Africa and the Americas cannot

be looked at just from the world of Exchange Alley A key question about the

Asiento trade is what the relative strengths of other players might be The British

were highly effective slavers The South Sea Company conducted its slaving business with the help of an older company, the Royal African Company Both had close links to the Royal Navy Their trading prospects depended partly on the situation on the African coast, and partly on the situation in the Americas The transatlantic slave trade was complex and it required experience and capital

to make it work The attitudes of local elites were also important Therefore, the linkage between a new company with money to spend, the Navy and an experi-enced slaver would have been an important signal to investors Quantitative evidence of numbers of slaves shipped by the companies shows that the company did seem to be operating efficiently

The Asiento is usually presented only as a contract between the Spanish and

the British The colonial authorities and the African kingdoms were just as vant Whilst Spain had a large empire, the central hub was apparently weak It was this potential weakness which gave hope to the British that they could seize

rele-Introduction 7

more power in the Americas Perhaps they might even gain more territory, as they eventually did in North America Private and public concerns were not truly separate for companies such as the South Sea They were part of what John Brewer (1994) has called the ‘fiscal–military state’ Finance and trade helped the

country wage war, and wars brought commercial prizes such as the Asiento

Patrick O’Brien (2005) has said that Britain might be properly called a ‘fiscal–naval state’ as it relied so much on sea power The power of the Royal Navy was

at the South Sea Company’s disposal and this was no negligible asset Investors would have been very well aware of the importance of having convoy protec-tion, access to naval dockyards and exemption from the impressment of crewmen (Paul 2006)

It is unlikely that this book will be entirely successful in removing one of the main myths of the South Sea Bubble – the idea that it was caused by a mysteri-ous gambling mania The notion has been too popular for too long to be easily dislodged However, the book will use the works of both economists and histor-ians Economic history has some features of both parent disciplines, but is not merely a copy of either The holistic approach taken here aims to explain the episode to both historians and economists For the historian, the economic theory has been simplified and explained For the economist, the historical background has been provided It includes a warning against the assumption that the Geor-

gians were a species of homo economicus.10 The landed elite’s distrust of eigners and Jews influenced many who warned against ‘stock- jobbing’ These writings, taken out of context, will mislead people as surely as abolitionist tracts misled historians of U.S slavery Three contemporary writers who are often quoted in the Bubble histories are Adam Anderson, Daniel Defoe and Archibald Hutcheson Anderson was a clerk in the company who wrote an account of it in many decades after the crash Defoe was a paid propagandist as well as an author However, he had also been a debtor and run a lottery so his views on

for-‘jobbers’ must be taken with a pinch of salt Hutcheson was a Member of ment and was part of the enquiry into the crash It is from these three writers that many quotations about jobbing and fraud are taken However, all were writing at

Parlia-a time before economics becParlia-ame Parlia-a sepParlia-arParlia-ate discipline.11 Therefore the body of economic theory at their disposal was limited There were texts about how to invest, but there was nothing that amounted to a theory of finance Hutcheson, in particular, has been lauded as an great economist (Dale 2004) Closer inspection

of his work shows that he was nothing of the sort (Paul 2009c)

The next chapter outlines how the early stock market functioned The most basic investment strategies have not altered Investors reduce the risks they face

by spreading their investments They should consider how the investments might interact with one another during different economic conditions What has changed is the social attitude to investing Early modern ideas on economic issues were still influenced by older debates about usury and luxury The stock market was strange and new It had the potential to create a new class of wealthy people Some were drawn from the ranks of foreigners, dissenters (non- Anglican Protestants), Catholics, Jews, women and servants The loudest critics, and those

8 Introduction

whose works tend to survive, were from the landed elite They were usually Anglican men and their analyses concentrate not on financial theory, but on social commentary Archibald Hutcheson’s pamphlets show him to be xenopho-bic, anti- Semitic, patriarchal and to have a strong belief in the class system None of these traits are mentioned when his works are filleted for apt quotations Yet his assessment of the Bubble was based largely on his prejudices about the brokers’ and traders’ backgrounds Chapter 2 introduces basic financial concepts

to provide some structure Otherwise, terms such as ‘gambling’, ‘risk’ and

‘rationality’ would remain ambiguous A longer discussion of behavioural finance also appears here

Chapter 3 describes the changes which together have been termed the cial Revolution’ The profligacy of the later Stuarts, the influence of Dutch finance, and war debt were contributory factors A range of changes to the finan-cial structure occurred over a long period of time, from the later Stuart reigns onwards Perhaps the key events were the creation of a National Debt in place of the Royal Debt, the foundation of the Bank of England, and the emergence of a stock market The full ramifications of each were not to emerge until later The Financial Revolution does not fit the model of a Whig history (of inevitable and linear progress) Rather, it was a piecemeal response to various pressures and opportunities At the same time, the country was dealing with changes of polit-ical regime William of Orange, and later the Hanoverians, blocked out the male Stuart line from the accession The Jacobite cause was supported by the French, who were also conducting their own financial experiments Under the aegis of Scotsman John Law, French trading monopoly companies were amalgamated into a leviathan popularly known as the Mississippi Company The Mississippi Bubble, the share price bubble on the Paris exchange, immediately preceded the South Sea Bubble The South Sea and Mississippi companies copied each other and competed for investors However, there are key differences between the two bubble episodes The French financial system was more centralised and Law went further with his experiments than the British did Law tried to launch a paper currency The South Sea scheme was never allowed to swallow up its rivals in the same way, even though it had pretensions to do so The twin events show that even if there are similarities between bubbles, each one has its own particular history

Chapter 4 covers the founding of the South Sea Company and the details of

the Asiento The transatlantic slave trade was made easier by the prevailing

winds and currents Europeans had the shipping technology and expertise in ocean sailing The Africans had an existing slave trade which they adapted for the export market The Americas had a need for labour in the mines and on the plantations The practical issues of the trade overcame religious, national and ethnic differences So important was slave labour to the Spanish Empire that

they were prepared to grant the Asiento to foreigners, and Protestants at that

There was always a tension between the desire to trade and the desire to control

The Asiento was valued not only because it permitted the sale of slaves, but also

because it allowed other types of trade, both licit and illicit In addition, some

Introduction 9

may have hoped that the company’s foothold in Spanish America was the first stage of a new colonisation Spain appeared to be the weak core of a sprawling empire Under the Hapsburgs, the Spanish economy had apparently become atro-phied The new Bourbon monarchy instituted some reforms However, the War

of the Spanish Succession had only recently ended at the time of the Bubble It was not then clear whether or not the Bourbon regime would manage to keep the empire together

The South Sea Company was also guaranteed a fee from the government for managing the debt A shareholder had claims on a low risk stream of income, and the opportunity to gain from any bonanza from Spanish America Chapter 5 covers the Bubble period itself and the key events of 1720 Chapter 6 considers the reasons that investors might have had to invest in the company The company was not uninterested in slave trading, as has sometimes been stated It quickly started discussions with the Royal African Company and the Royal Navy to make preparations It was able to draw on their expertise and resources The Royal African Company assisted in the business of buying slaves at the coast and put its infrastructure of forts and protected harbours at the South Sea’s dis-posal The Royal Navy provided convoy protection There were lulls in the trade during conflict with Spain One of these stoppages occurred just before the Bubble, which has puzzled many The spike in share prices occurred when the trade was halted This has been seen as proof that the investors were fools However, the company’s track record and its closeness to the state should have reassured investors A temporary stop in trade might not worry investors who were considering a long- term investment The Bubble period aside, the company was a slave trader on some scale

There were other reasons to invest in the South Sea It was a quasi- public company that had a guaranteed income from the state It also was one of the few key joint- stock companies Investors had more limited choices in order to build their investment portfolios Chapter 6 discusses some of the real- world examples

of investors There has been a bias towards the claims of those who lost in the Bubble The gainers kept a lower profile, especially as there were calls for their assets to be seized One notable gainer was the bookseller Thomas Guy His posthumous reputation as a miser was due to a vitriolic book about him However, the founder of Guy’s Hospital was involved in charity work during his lifetime and made money in the South Sea Bubble quite by chance He was not a speculator who entered the market at the last minute and he had the sense to realise his gains rather than being greedy Another famous player was Isaac Newton It has often been thought that he got his fingers burned in the crash There is no real evidence for this It seems to be another myth of the Bubble Chapter 7 confronts some of those myths Curious economic arguments were made by contemporaries The chapter attempts to unravel some of them It also revises some of arguments put forward by the great triumvirate of Dickson, Car-swell and Scott Precisely because their work is the cornerstone of the Bubble historiography, errors have had a substantial effect on the secondary literature All three were historians first and foremost, rather than economists As has been

10 Introduction

mentioned, the combination of economics and history is not an easy one Some readers may find this chapter to be hard- going In summary, it simply shows that the directors have been accused of many things and some of the accusations do not make any financial sense Sir John Blunt may have been a scoundrel and guilty of sharp practice This does not mean that he engaged in the activities which some have accused him of, largely because the economic reasoning is not sound Blunt’s true plans may never be known in any detail All the evidence left

is so prejudiced against him that it is difficult to know the truth, unless he really was as bad as they say Like his rival, John Law, Blunt may simply have unleashed forces that he was unable to control

In the absence of financial explanations of the crash, there was a bustle of activity to apportion blame The beginnings of an industry in myth- making appeared Chapter 8 discusses the contemporary commentary on the Bubble period All is not as it seems Although histories of the Bubble use Hogarth’s prints and apposite quotations from Hutcheson’s tracts, these pieces of primary evidence are usually taken out of context The South Sea scheme became a focus

of worries about religious and national identity, misogyny and class prejudice These contemporary concerns were more important, and more readily under-stood, than the newfangled stock market All the writings of the landed elite should be considered with the following proviso: the elite were a largely anti- Semitic, xenophobic, anti- Catholic group who wished that servants and women would stay in their places The new stock market threatened to put money into the hands of Jews, dissenters, women, etc In Exchange Alley, these people could interact without the landed squires having much idea of what they were about This situation raised the spectre of not just one group of troublemakers, but various permutations between groups With regard to women, they might meet and marry men of a different rank and religion Even at the time, social commentary was not merely about the effects of folly It was also a warning to maintain the status quo which had, after all, been ordained by a male God who favoured the Church of England Shorn of these concerns, many primary sources cannot now be fully understood

Whilst all this was going on, the economy was reviving The South Sea Company was continuing its trading activities and its financial role for the state Chapter 9 covers the aftermath of the crisis The King had called for an end to the debates and hunts for scapegoats The directors were given back some of the assets confiscated after the crash The company’s ships sailed on and the company itself took up whaling At this, it was not a great success A few decades later, the British did manage to make a go of the whaling trade The company at least did not stint on its preparations, but probably entered the trade

at the wrong time The famous Bubble Act legislation did not actually limit nomic growth and development as has been thought In comparison with Britain, the French system was more deeply scarred by the Mississippi Bubble In France, a halt was called to the type of financial experiments beloved of John Law Only decades later would the French tolerate such things again

In conclusion, the tale of the South Sea Company covers many different

Introduction 11

aspects of history The financial history can be complicated and has been terpreted Alternatively, a focus purely on stock market data excludes the many important issues to do with the company’s trading activities and social setting The South Sea was not a truly private company, but one which was connected to the state The state’s finances and success in war had an impact on the compa-ny’s fortunes Investors did have a variety of sensible reasons to buy South Sea shares However, over- optimism and naivety brought in people who invested too much and at the wrong time Many histories and commentaries have followed the losses of this group, rather than the more reasoned strategies of others Over the years, layers of myths have built up to satiate an appetite for cautionary tales Whilst the Georgians were condemning share- trading, they spared little thought for those unfortunate souls chained in the holds of slave ships Thousands of people were transported across the Atlantic by the South Sea Company, and about them we know virtually nothing

misin-2 The stock market in early modern England

The stock market was unfamiliar to most people and was a relatively new nomenon Early modern religious and social ideas were often hostile to banking and finance Contemporary commentary on the stock market tends to be negat-ive, even outside of the Bubble period Primary sources of this type form the basis of the gambling mania argument The revisionist school of financial history

phe-on the Bubble counters the idea of a gambling or speculative mania Revisiphe-onist works tend to be highly technical and aimed at a specialist audience Therefore, the financial history literature has not succeeded in removing the traditional belief that the Bubble was caused by a mysterious outbreak of gambling fever This chapter explains why the early modern stock market was not a gambling den It uses qualitative evidence to explain the historical context It also uses financial theory to explain how bubbles can form without being caused by a speculative mania

Morality and money

There was a widespread contemporary belief that the stock market was immoral This notion developed from earlier ideas which criticised usury and the accumu-lation of wealth The love of money was the root of all evil Making money without producing anything tangible was considered suspect This theme contin-ued into the early modern era Moral philosophers such as Shaftesbury argued that virtue was more important than commerce, and that frugality was better than luxury (Hundert 1997: xviii) Shaftesbury believed that society needed a wide-spread dispersion of virtue, and that one of the goals of society was to encourage gentlemanly conduct (Klein 1994: 3) Economic activity was seen as a potential threat to virtue as it was thought to encourage selfishness, which would then undermine society as a whole Gentlemen were not just superior to tradesmen in social rank, but also in moral stature

In the early years of the century, it was common to identify the country with the family.1 The analogy led to the conclusion that any vices that could destroy a family could, by extension, destroy the country The nation was simply the family writ large The fate of ‘luxurious nations’ was to be overtaken by their frugal rivals The example of Sparta triumphing over Athens was commonly

The stock market in early modern England 13

used (Hundert 1997: xvii) The prosperity of the United Provinces was partially ascribed to the thrift of the inhabitants In reality, excessive thrift could lead to disaster for the country if everyone became a hoarder and no one wished to buy.2Nicholas Barbon, writing in 1690, touched on this point when he argued that

‘prodigality is a vice that is prejudicial to the man, but not to trade’ (Horne 1978: 58) Mandeville noted that self- interested behaviour could have beneficial results (Horne 1978: ix–xii) However, only later in the eighteenth century were Enlightenment thinkers such as Rousseau, Kant and Adam Smith able to wrestle with the moral paradoxes created by increased material progress (Hundert 1997: xxxi)

In this moral climate, the stock market was easily criticised by observers It did not follow the guidance of an outside authority or any regular pattern like the agricultural seasons It was not identifiable as part of the family analogy of the economy Nor did it fit well within a social structure that stressed order, author-ity and virtue To make sense of the unfamiliar, contemporaries compared the new stock markets with something already well- known – gambling dens There are some similarities between the two Stock markets and gambling places do not directly produce tangible outputs Speed is of the essence in making trades or bets Both give the possibility of large gains or losses However, there are also key differences In the stock market, profit- seeking arbitrageurs process informa-tion and assist the directly productive sectors of the economy by improving resource allocation For example, they can divert funds to the most productive businesses Entrepreneurs find it easier to raise capital in such a specialised market place These positive externalities were hidden from eighteenth- century commentators, who focused upon the noise and confusion of Exchange Alley Gambling was a pastime already strongly identified with ruin and immorality Therefore, by extension, the stock markets were predicted to lead to the very same outcomes Stock market gains were presumed to be made at the expense of others (i.e honest citizens), and the old religious strictures against usury were also cited by writers such as Defoe (1719) The legal system had set the rate at which loans were considered to be usurious at 5 per cent in 1714 Notably, state borrowing was exempt from this restriction (Banner 2002: 22)

For many, the unwholesome nature of the markets was confirmed by the ence of certain groups of people Jews, foreigners, dissenters, women and serv-ants were able to trade there Xenophobia, misogyny and class prejudices were important factors in social commentary Large- scale investors had international links and often came from minority groups Individuals of foreign extraction or unaffiliated to the Church of England were suspect to the traditionalist landed interest Indeed, this cut both ways As major financiers relied upon credit and international links, it was not easy for the country squire to emulate them There-fore, the status of outsiders was reinforced, until they attempted to join the elites They did this by buying land This process brought financiers into the fold, but it naturally dismayed those who felt that they were on the verge of being pushed out Defoe complained that ‘Wealth however got in England makes Lords of mechanics, gentlemen of rakes’ (Porter 1984: 64)

pres-14 The stock market in early modern England

The elite’s ownership of land made their position much more secure than Defoe implied Land was the key to gaining a right to vote and a right to stand in Parliament It retained its importance even when the financial and commercial sectors became new sources of great wealth The high tax rates levelled on land partly reflect the inefficiencies of the tax system They also show people were willing to tolerate the high cost of land ownership for the social status it alone could confer Land and the countryside had a powerful place in contemporary culture In addition, despite landowners’ conspicuous wealth, they benefited from almost feudal loyalty from tenants Mingay wrote that, as agriculture was seen as the base of the economy, so contemporaries believed that the ‘political and social hegemony of landowners was justified’ (Mingay 1963: 5) Shaftes-bury argued that the ‘hegemony of gentlemen’ was the proper social order (Klein 1994: 20)

By contrast, the ‘monied interest’ was accused of reducing other sectors of society to dependence through its ability to grant credit (Jones 1978: 91) Even the government needed its assistance as state finances were difficult to adminis-ter There were frequent cash- flow problems, especially in wartime The solution was to use the personal credit of the government officials concerned in funding their departments (Carruthers 1996: 58) They required a financial return for the risks they bore This could eventually make them large fortunes, with which they could buy up estates The most famous example was James Brydges, later Duke

of Chandos, the Paymaster of the Forces between 1707 and 1712 (see Baker and Baker 1949) Such a meteoric rise did not escape the notice of the landed inter-est However, they too needed financiers Some landowners used credit to main-tain their standard of living or to improve their estates Financiers and landowners were linked by marriage and obligations Money men bought land, and younger sons of the landed class went into commerce There was a gap between rhetoric and the way in which society actually functioned

There is a bound to be a gap between the Georgians and later commentators,

as moral values have changed Georgian social prejudices may no longer be acceptable Likewise, the common contemporary practice of gift- giving would now be condemned as bribery, yet it was acceptable within the social context of the period Courtiers relied upon the monarch’s favour but could supplement their incomes by taking ‘gifts’ Life at court precluded earning a living through trade or ordinary business, and it was expensive James Brydges had made presents of money to George I’s mistress, Melusine von der Schulenburg, and his half sister, Sophia Charlotte, amongst others Brydges secured an earldom for his father which he would obviously inherit The gifts were granted discreetly, and Brydges delayed his acceptance of his new title by granting it to his father first Hatton argued that as this behaviour cannot be simply condemned as cor-ruption She noted that the sale of offices was common in Europe However, she also pointed out that the Hanoverians themselves wished for change In George I’s time, no important place at court was for sale (Hatton 1978: 148) Both he and his son unsuccessfully tried to reform the system of purchasing military commissions (Brewer 1994: 57) The South Sea Company’s bribes to political

The stock market in early modern England 15

figures have been taken as evidence of widespread corruption within the company However, this argument is not convincing, as such inducements were

an accepted part of public life The existence of bribery alone does not prove that directors were planning to defraud investors

Semantics

Care must also be taken with other concepts whose meanings may have changed Terms such as ‘risk’, ‘rationality’ and ‘gambling’ may appear to be straight-forward, but their precise definition or definitions are changeable The social meanings attached to them can also change Economics has its own terminology

A word like ‘risk’ has a precise meaning in economics, which it does not have in colloquial speech A risk might be defined as a hazard or danger in general English usage For example, a business venture might succeed or it might fail Economics uses the term ‘risk’ as distinct from the term ‘uncertainty’ For an event with two or more possible outcomes, there is some likelihood of each outcome occurring Risk is defined as having some set of probabilities attached

to the outcomes, whilst uncertainty does not This distinction was proposed by Knight and has been debated in the literature (LeRoy and Singell 1987) The classic example concerns the throw of an unbiased coin There is an equal chance that it will land ‘heads up’ or ‘tails up’ Each outcome has a probability assigned to it (of one half ) If the coin was biased so that the probability of

‘heads’ was not known, then this would be a case of uncertainty, not risk This is probably an abstraction to historians Outside of economics, risk might be defined by the likelihood of mishap or danger There is no mention now of cal-culating probabilities Economists use their definition in order to aid mathemat-ical approaches

The use of formulae and mathematical models in economics gives a sense that risk is quantifiable and explicable However, the future remains unknown even with the most sophisticated of models Assignment of probabilities is often

a function of the individual’s own frame of reference and also of the information available

A situation is said to involve risk if the randomness facing an economic

agent can be expressed in terms of specific numerical probabilities (these probabilities may either be objectively specified, as with lottery tickets, or else reflect the individual’s own subjective beliefs)

(Machina and Rothschild 1990: 227–239)The gambling mania story implies that investors deliberately took excessive risks, i.e invested more than they could afford to lose Dickson claimed that Georgian society was more risky than later periods and that Georgians became inured to risk They were therefore more likely to take large risks (Dickson 1967: 46) This argument is not convincing First, it is not clear whether Geor-gians faced more risks than other societies at other periods Second, an

16 The stock market in early modern England

increased level of risk can encourage people to hoard their wealth rather than gamble with it

‘Gambling’ is a word that appears frequently in the economics and historical literature It is loaded with meaning and often used pejoratively However, his-torians, economists and the Georgians themselves meant different things when talking of gambling To economists, a gamble is simply an event with two or more outcomes with a known probability and from which an expected value can

be calculated The expected value is the average outcome if the gamble is taken a large number of times To illustrate this, consider the unbiased coin again A gambler agrees to pay two shillings every time it turns up ‘heads’ and gets two shillings every time it turns up ‘tails’ On average, the gamble is worth nothing.3 This is the expected value of the gamble

The probabilities and values used in the calculation can be subjective (best guesses) For example, a marine insurance agent may use the best information available to estimate the likelihood that a ship will sink on a voyage The estima-tion process would probably involve evaluating data from a large number of pre-vious voyages It might also take into account factors such as whether the country is at war or not The voyage is a gamble in the economics sense of the term Here ‘gamble’ does not imply irrationality or immorality It is these other connotations of gambling that have been ascribed to the investors in Exchange Alley

To historians, gambling tends to be linked to entertainment or addiction, rather than to a set of outcomes Gambling could be defined as an entertainment

in a game of chance for stakes Throwing dice or playing roulette would be in this category The definition could be broadened to include games of skill Various card games would be then be included There is also the third option of betting on events like horse races Historians are interested in the context in which these activities took place and their meanings to contemporaries However, the concept of a gambling mania is a normative statement about the folly and immorality of Georgian investors

Porter’s vivid description of the South Sea episode is as follows: ‘England was gripped by gambling fever Men bet on political events, births and deaths – any future happenings For a few pounds challengers galloped against the clock, gulped down pints of gin or ate live cats’ (Porter 1984: 255)

Economic historians have analysed the workings of the early modern stock markets to prove that investors were not merely playing games of chance This

is to counteract the idea that a gambling mania was loose in Exchange Alley Without the word ‘mania’, the term ‘gambling’ might refer purely to a leisure activity Gambling was part of social life for many, but had a dual nature Where

it interfered with the proper functioning of society, it was deplored Gambling could distract the lower orders from their work or ruin a family’s wealth However, gambling was also one of the rituals that enabled society to function

It was integrated into a range of social activities The development of leisure facilities in Shrewsbury showed how important gambling was to polite society

‘Arguably the most important of the new [leisure] facilities were “assemblies” –

The stock market in early modern England 17

smart evening gatherings given over to dancing, tea- drinking and card games’ (McInnes 1988) Even Quaker conferences in the town were apparently an excuse to lay on horse racing and concerts Gambling was not occurring in isola-tion and was part of a wider culture Card games could be for pin money and more about socialising than winning

It is often the degree to which an activity is undertaken, and by whom, that affects social commentary For most Georgians, drinking alcohol in moderation was vastly different to alcoholism or drunken rowdiness A drunken lady would

be judged differently to a drunken gentleman Whilst some contemporaries would deplore any drinking or gambling, this was an extreme view When gam-bling and alcohol were under social control, they were acceptable Gambling was part of the social culture, but this does not prove the existence of Porter’s culture of gambling Even if Porter was correct, the existence of a gambling culture outside of Exchange Alley does not prove that people were gambling within the Alley It certainly does not prove the existence of a gambling mania The question of mania versus rationality is an important one

Historians tend to find rationality a slippery concept, dependent on the context Economists like to define rationality in a way that suits their calcula-tions (see Sen 1990: 198–216) There are several possible definitions in eco-nomics and each has its own drawbacks The Present Aim theory of rationality argues that an individual is acting rationally if he or she follows actions that will lead to the accomplishment of his or her aims (Kagan 1986: 746) It is difficult

to determine whether the aims themselves are rational as this too will be dependent There are no objective set of standards, and future aims are not taken into account If an individual wishes to commit suicide, then any steps he or she takes towards this goal would be rational Present Aim theory is not much use at distinguishing between rational and irrational behaviour in the stock market Theories that maximise a variable such as utility (usefulness) or profit avoid the circularity of the Present Aim approach.4 A person gets utility from a resource or activity This is a subjective measure, partly dependent upon the per-son’s preferences.5 Utility is not easy to measure, unlike profit which can be cal-culated according to set formulae However, it is common for economists to discuss people’s utility functions (i.e how people judge how useful something is) Utility maximisation means trying to get the most use or benefit out of a given set of resources or situation This concept underpins the discussions of rationality in the financial literature of the Bubble

In economics, if a person dislikes taking risks, they are ‘risk- averse’ If they like taking risks, they are ‘risk- loving’ The preferences can be revealed by pre-senting them with a choice between a gamble and the equivalent sure thing.6 For instance, the choice could be between a gamble with an expected value of £50 or the certainty of gaining £50 as a sure thing Some people will choose the gamble

as there is the possibility that they will gain more than £50 A person with a love

of risk will be rational if they accept a gamble over a sure thing This definition

is purely based on the idea of acting in accordance with the individual’s ences There is no sense that those preferences are themselves irrational in most

prefer-18 The stock market in early modern England

models There is also no discussion of whether the preferences are morally acceptable So, for economists, a rational risk- averse person will always take the sure thing A rational risk- neutral person will be indifferent between the gamble and the sure thing A risk- loving person is rational if they take the gamble, but irrational if they do not

In simple models, some people are always risk- averse and some always risk- loving This seems unlikely in real life, so more sophisticated models assume that an individual’s attitude to risk can be dependent on the context Friedman and Savage argued that individuals may be risk- loving for small bets and risk- averse for larger bets (Friedman and Savage 1948) Therefore, to an economist,

it is rational for such individuals to take small bets but to avoid large risks This might explain why Georgians played cards after dinner, but took out fire insur-ance They also had a flourishing marine insurance industry (see Supple 1970) Their anxiety about the possibility of feckless heirs or sons- in-law prompted them to write contracts for the entailment of their estates and jointures for their daughters (Stone 1979: 71–72) Dickson and Porter may be correct in thinking that gambling was part of Georgian life For most, it was not a way of life Share- trading occurred in a different social context and space to the card- playing at the assemblies People could choose to go to Exchange Alley partly for social reasons (Glaisyer (2006) noted that the Royal Exchange was a tourist attraction which featured prominently in London guidebooks.) Some tourists might even have treated share- trading as a day’s entertainment, similar to going

to the races Novices could invest a small amount of money just for the thrill, just as infrequent race- goers place a bet on a horse with a nice name This is not irrational or a sign that the person is an inveterate gambler These small bets are often made with the understanding that the money is likely to be lost It is unlikely that such tourists would affect the stock market very much A gambling mania would have to be something more than an occasional small bet

Gambling or speculative mania itself is not well defined A definition has been coined here based on reading the Bubble literature Speculative mania appears to refer to a situation where the majority of investors use the stock markets purely to gain immediate and large returns, without regard to the risks undertaken Often (but not always) the implication is that they approach these transactions as a form of entertainment in the same way that gamblers play games of chance The use of the term ‘mania’ means that a large number of people (possibly the majority) were behaving completely irrationally This is an extreme position to take There is no convincing explanation why so many people would suddenly take leave of their senses

The revisionist financial history literature has attempted to discover how the early stock markets actually functioned There is a wealth of information regard-ing share prices and transactions (see Garber 2000; Hoppit 2002; Neal 1990)

Sources such as Castaing’s The Course of the Exchange and ledgers from large

institutions such as the Bank of England have been used profitably by several authors Concepts used by financial historians, such as ‘noise trading’ and

‘rational bubbles’, have already been mentioned ‘Noise trading’ is defined by

The stock market in early modern England 19

Black as making decisions to buy or sell shares by trading on ‘noise’ as opposed

to information He had several definitions of what noise might be which guished it from information (Black 1986) However, it may be more useful to demonstrate the intuition by using an example Chartism is the practice of plot-ting the patterns made by past movements of share prices and then applying them to an ideal pattern.7 Say that a certain group of chartists believe that share prices follow a zigzag pattern If the share price has gone up, then down, then up again in the recent past, the zigzag pattern would be continued if the price went down again The chartist would expect a fall in price If there was an economic boom, the prices should go up News about the state of the economy is informa-tion The zigzag pattern is just noise

Such a clear distinction between noise and information is useful for building economic models In practice, it might be difficult to distinguish between the two Complete and verifiable information is not usually available Also, evidence

is interpreted subjectively In order to explain the economic models that follow,

a simple definition of noise has been coined here Noise is a misleading signal that cannot be used to correctly predict the future prospects of a company

In a simple economic model, there are informed traders and noise traders in the same market Informed traders know the available information set and cor-rectly interpret it They are aware of what a particular company’s prospects are and make a correct valuation of its worth In other words, they conform to rational expectations theory Rational expectations theory ‘holds that investors use all pertinent information and always make consistent, rational choices’ (Jacobs 1999: 344) An efficient market will then price securities according to the value of the company.8 Sharpe defined it as one in which ‘every security’s price equals its investment value at all times’ (Sharpe 1985: 8) Noise traders would not tend to judge investment value correctly, but their influence on prices can be nullified by arbitrageurs

Arbitrageurs play a central role in standard finance They trade to ensure that if a security has a perfect substitute – a portfolio of other securities that yields the same returns – then the price of the security equals the price of that substitute portfolio If it does not, then arbitrageurs buy or sell until the prices are equalised

(Shleifer and Summers 1990: 20)The Efficient Markets Hypothesis assumes that arbitrageurs are able to spot opportunities when stocks are priced incorrectly due to noise trading Arbi-trageurs will be able to prey upon the noise traders, by buying up undervalued shares or selling overpriced ones The noise traders will get the worst of the bargain and eventually withdraw from the market due to lack of funds The arbi-trageurs will be sustained by their gains

Consider the example of chartism that appeared above (p 19) There are two types of traders in the market and only one company’s shares to trade The chartists follow their zigzag price pattern The informed traders follow the