For nearly three centuries the spectacular rise and fall of the South Sea Company has gripped the public imagination as the most graphic warning to investors of the dangers of unbridled speculation. Yet history repeats itself and the same elemental forces that drove up the price of South Sea shares to dizzying heights in 1720 have in recent years produced the global crash of 1987, the Japanese stock market bubble of the 1980s/90s, and the international dot.com boom of the 1990s.
The First Crash throws light on the current debate about investor rationality by re-examining the story of the South Sea Bubble from the standpoint of investors and commentators during and preceding the fateful Bubble year. In absorbing prose, Richard Dale describes the trading techniques of London's Exchange Alley (which included 'modern' transactions such as derivatives) and uses new data, as well as the hitherto neglected writings of a brilliant contemporary financial analyst, to show how investors lost their bearings during the Bubble period in much the same way as during the dot.com boom.
The events of 1720, as presented here, offer insights into the nature of financial markets that, being independent of place and time, deserve to be considered by today's investors everywhere. This book is therefore aimed at all those with an interest in the behavior of stock markets.
COFFEE HOUSES, THE PRESS AND MISINFORMATION
The South Sea Bubble coincided with the rapid development of financial markets in the late seventeenth and early eighteenth centuries. This period saw the introduction of an active secondary market in both debt and equity securities, the appearance of a new type of financial intermediary known as the ''stock-jobber'', and the emergency of a breed of ''monied men'' whose recently amassed City fortunes were viewed both with disdain and envy by the landed classes. But before considering the trading practices and techniques of the new class of financiers, it is necessary to understand the communications network on which their operations were based.
In the absence of Reuters, Bloombergs and other screen-based information services, eighteenth century traders and investors had to rely very largely on the coffee house and the press for information about investments and market movements. These two sources of information were interdependent, since journalists obtained much of their news from the coffee house, and one of the main attractions of the latter were the newspapers provided to its clientele.
Coffee Houses
London's coffee houses proliferated in the sixteenth century, one pamphleteer remarking that ''Coffee and the Commonwealth came in together''. By 1700, there were over 2000 coffee houses in London, representing a revolution in drinking and social habits that did not, however, go unchallenged.1 In 1673, a petition was presented arguing for the prohibition of tea and coffee in favour of beverages using home-grown barley, malt and wheat; in 1674 ''The Women's Petition Against Coffee'' complained that coffee made men idle and impotent; and in December 1675 a Proclamation of Charles II called for the suppression of all coffee houses (whether selling coffee, chocolate, sherbert or tea) on the grounds that ''many tradesmen and others, do herein mis-spend much of their time, which might and probably would be employed in and about their lawful calling and affairs; but also for that in such houses... divers false, malicious and scandalous reports are devised and spread abroad to the defamation of his Majesty's Government...''.2 The royal proclamation was issued on 29 December but had to be recalled eleven days later (with face-saving licensing restrictions) so great was the anger of men of all parties and social classes at the prospect of being deprived of their accustomed haunts. The episode marks an important victory for freedom of speech, bearing in mind that prior to 1695 there was no free press.
In time, individual coffee houses came to be associated with a particular clientele or profession. There were houses for literary ''wits'' (notably Wills in Covent Garden), learned scholars and scientists (the Grecian in Devereux Court), politicians (Whigs at the St James, Tories at the Cocoa-Tree, near Pall Mall), lawyers (Nandos in Fleet Street) and clergy (Child's in St Paul's). Similarly, for the commercial classes there were specialist coffee houses catering for, inter alia, marine underwriters (Lloyds in Lombard Street), life insurance (Tom's in Exchange Alley) regional trading interests (The Jamaica, Jerusalem and Pennsilvania in Exchange Alley) and, as discussed in more detail below, stock-jobbers (Garraways and Jonathan's in Exchange Alley).
The London coffee houses fulfilled several important functions. First and foremost, they were a source of political, economic and financial information. Indeed, prior to the liberation of the press through the expiry of the Licencing Act in 1695, they were perhaps the main source of news: several houses made their own news sheets available to patrons, much to the chagrin of the government which tried to suppress even this restricted form of ''publication''. In the words of the seventeenth century ditty:3
You that delight in Wit and Mirth
And long to hear such News
As comes from all Parts of the Earth...
Go hear it at a Coffee House
It cannot but be true.
There's nothing done in all the World
From Monarch to the Mouse
But every Day or Night 'tis hurl'd
Into the Coffee House
So great a Universitie,
I think there ne're was any;
In which you may a Scholar be
For spending of a Penny
After 1695, the newspaper industry began to flourish and the coffee houses responded by providing an ever wider range of publications for their clientele. The coffee house then became not just a place of discourse but a library where journals could be studied by a news-hungry public. The foreign visitor Saussure observed in 1726:
What attracts enormously in these coffee houses are the gazettes and other public papers. All Englishmen are great newsmongers. Workmen habitually begin the day by going to coffee-rooms in order to read the latest news. I have often seen shoeblacks and other persons of that class club together to purchase a farthing paper. Nothing is more entertaining than hearing men of this class discussing politics and topics of interest concerning royalty. You often see an Englishman taking a treaty of peace more to heart than he does his own affairs.4
The proliferation of newspapers evidently led the coffee house proprietors to agree among themselves to limit their subscriptions. A new paper called the Projector reported in 1721 that:
... the author of this paper being inform'd that it cou'd not, tho' given, be suffer'd to lye on the coffee-house tables had inquired, and finds that the coffee-house men have met in form, and agreed to receive no new papers. The confederates in excuse pretend expence, that papers given at first, are not always given, and that some coffee-men are at £150 per ann charge or more for papers of all kinds.5
Subsequently tensions between the coffee houses and the newspaper proprietors developed into a full-blown confrontation. In 1728, the coffee men complained that the cost of subscribing to newspapers was ''more than the trade and profits of one half of the Coffee-Men will allow'', while the newspaper proprietors took the view that the availability of newspapers was one of the chief attractions of coffee houses.6 In the ensuing pamphlet war, the coffee men accused the newspaper men of harassing customers and eavesdropping on their private conversations:
The same persons hang and loiter about the Public Offices, like house breakers, waiting for an interview with some little Clerk, or a Conference with a Doorkeeper, in order to come at a little news, for which the fee is a shilling, or a pint of wine.7
The coffee house men also complained about the cost (put at £10-20 per annum) of subscribing to the growing number of newspapers which they felt obliged to take in for the benefit of their customers. Finally, they argued that in providing a readership for the newspapers, the coffee houses indirectly contributed to the papers' advertising revenues, which, in the case of the Daily Post for example, they estimated at £3 15s for a single day's notices.8
Based on these complaints the coffee house representatives distributed a circular to all coffee house men in London and Westminster outlining a proposal for setting up their own newspapers.9 The paper would be published twice daily, morning and evening, at a price of 1 1/2 d. The business would be funded by coffee house men (only) who were asked to subscribe 1 guinea for this purpose. Every subscriber would put up a notice in his coffee house desiring customers to acquaint the owner of newsworthy events. These offerings would then be written up and collected twice per day for compilation and editing at the newspaper's office. Coffee men who introduced advertising to the paper would be remunerated at a rate of 6d per advertisement. The break-even circulation of the paper was estimated at around 300 and beyond this level any profits were to be distributed to subscribers.
This unprecedented challenge to the newspaper industry elicited an immediate response from newspaper proprietors.10 They ridiculed the idea that coffee house men, whom they characterised as illiterate and servile tradesmen of the lowest kind, were capable of producing a readable newspaper. It was also pointed out that the proposed method of gathering news from customers would destroy the privacy of coffee house conversation. Is it seriously to be understood, the pamphleteer asks, that the coffee men should become a ''vehicle of Publick Intelligence, and that whatever [customers] shall think fit to talk among themselves, he will take great Care to furnish them with next Day, for their entertainment, at Second Hand, after it has passed the thick Clouds of his dull Apprehension and the Refining Fire of his Compiler's Digestion''.11
On the substantive economics of the two businesses, the newspaper proprietors came up with detailed figures.12 They pointed out that the coffee houses had raised their benchmark price for a dish of coffee first from 1d to 1 1/2 d, allegedly to cover an increase in the price of imported coffee, and subsequently from 1 1/2d to 2d to take account of the stamp duty imposed on newspapers and the associated 1/2d rise in newspaper prices. The newspapers, for their part, had to pay out 1/2d on stamp duty and 1 1/2d on distribution costs, leaving them only 1/2d (excluding advertising revenues) from their 1 1/2d cover price to defray the costs of printing, paper, etc. The newspaper proprietors also argued persuasively that the coffee houses, far from doing them a favour by providing newspapers to customers, were depriving them of subscription revenues by allowing multiple readership of a single newspaper.
In a coup de grâce, the newspaper proprietors' response to the coffee house men culminated in a proposal to set up their own chain of coffee houses. These would undercut the established coffee men by charging only 1 1/2d for a dish of coffee and they would hang a sign outside stating'' All the Papers taken in Here''.13 Threat had been met with counter-threat. In the event there was a stand off and neither threat appears to have been realized but the episode illustrates the pivotal role of coffee houses in news gathering and news dissemination.
In addition to their role as a source of information, the London coffee houses also formed part of the delivery and collection system for the Penny Post, which was introduced as a private venture in 1680 before being displaced by a government service two years later. The Post Office directed those who wrote letters on Holydays ''to leave them at those Coffee Houses, known to be appointed by the Office, that they may be collected and delivered in due time...''.14
t seems that alongside the official postal service, there was an informal private post developed by the coffee houses themselves. According to Lilly, the historian of London coffee houses, bags to receive letters destined for overseas were openly hung in coffee houses where the coffee men had made arrangements for onward despatch in the care of shipmasters. For many years these private arrangements were evidently more efficient than those of the Post Office.15 Closely related to their role as post offices, coffee houses provided the equivalent of newspaper box numbers. Lost property advertisements, in particular, made use of this service; for instance, the Beadle at Goldsmiths Hall regularly listed lost and stolen items stating the amount of reward payable on a ''no questions asked'' basis for return of the items to a named coffee house.
The London coffee house was also a place of business. The great trading companies (the East India, Hudson's Bay, African, Russian and Levant Companies) all made use of coffee houses for their meetings, as did the livery companies. And at a time when few merchants had their own offices (although they might frequent the Royal Exchange), the coffee house became an informal office for transacting one-to-one business. Indeed, merchants, doctors, factors and other service providers would advertise their availability at named coffee houses where they would keep regular hours for business purposes. As one observer remarked in 1721, coffee houses were ''extremely convenient. You have all Manner of News there: You have a good fire, which you may sit by as long as you please: You have a Dish of Coffee, you meet your friends for the Transaction of Business, and all for a Penny, if you don't care to spend more.''16
The renowned story of Lloyds Coffee House shows how the provision of commercial information to a specialised clientele tended to generate business activity. After opening near the docks in 1687, Edward Lloyd moved his coffee house to Lombard Street in 1691 where, five years later, he began to publish ''Lloyds List'' of ship arrivals and departures. Backed by its mercantile and shipping connections, Lloyds coffee house soon became the headquarters for marine ''underwriters'' who wrote their names under the terms of the insurance contract to denote their acceptance as risk-takers. Ship auctions, too, were conducted with regularity at Lloyds. Such auctions, like those for a wide variety of goods held at coffee houses all over London, were typically advertised as being ''by the candle'', that is, while an inch of candle burned.
In summary, the coffee houses of late seventeenth and early eighteenth century London could be viewed as an amalgam of open-plan office, internet café, post office, pub and newspaper library. It was in this environment that securities trading began in a few specialised coffee houses in Exchange Alley, a development that was given further impetus when, in 1698, dealers in stock were removed from the more august surroundings of the Royal Exchange.
John Houghton, writing in 1694, tells as that ''the Monied Man goes among the brokers (which are chiefly upon the Exchange, and at Jonathan's Coffee House, sometimes at Garraway's and at some other Coffee Houses), and asks how stocks go?...''.17 Other coffee houses mentioned in connection with trading in stocks are Sam's in Exchange Alley, and Powell's and the Rainbow in Cornhill, but Jonathan's and Garroway's were evidently the main trading venues at the time of the South Sea Bubble, Jonathan's achieving more elevated status half a century later as the London Stock Exchange. Writing some forty years after the Bubble, Thomas Mortimer, author of the best-selling text ''Every Man His Own Broker'', describes how those wishing to deal in stocks might make use of the facilities provided by Jonathan's coffee house.
Continues...
Excerpted from The First Crash by Richard Dale Excerpted by permission.
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Introduction 1
Chapter One: Coffee Houses, The Press and Misinformation 7
Chapter Two: Exchange Alley and the Evolution of London's Securities Market 22
Chapter Three: Origins of the South Sea Company 40
Chapter Four: John Law and the Mississippi Bubble 56
Chapter Five: The South Sea Scheme 73
Chapter Six: The Bubble 96
Chapter Seven: The Crash 125
Chapter Eight: Crisis Resolution 140
Chapter Nine: Lessons from the South Sea Bubble 155
Appendix I: Hutcheson's South Sea Parable 171
Appendix II: Technical Note on Stock and Subscription Price Data 172
Chapter Ten: Conclusion 178
Glossary 185
Bibliography 187
Index 195
"In this gripping tale of the South Sea scam, Richard Dale describes personal and corporate greed, creative accounting, and financial malpractice. He writes about events from three centuries ago, but his analysis is relevant to today's investors, traders, and policymakers."—Elroy Dimson, London Business School, author of Triumph of the Optimists
"This book represents an important piece of new scholarship focused almost exclusively on the South Sea Bubble. The author's tireless research yields a wonderful historical document that brings the reader into the center of financial markets in the early 1700s, and then reveals much about the South Sea Bubble that has previously gone undetected. Dale's work brings so much new evidence, and interweaves it with the old so skillfully, that The First Crash will certainly become a must read for scholars and is likely to be relied upon heavily in university classes as well. The author is to be congratulated."—Kevin Hassett, American Enterprise Institute, author of Bubbleology
"This extremely useful contribution to the field serves to remind nonhistorians, and particularly most financial economists, that almost all of what is thought of as modern financial analysis today was available 300 years ago."—Forrest Capie, City University Business School, London, author of Depression and Protectionism
Anonymous
Posted August 18, 2005
This is a fascinating book about a fascinating time, the early eighteenth century. You will find greed, corruption, romance, duels, kings, regents and stock-jobbing scoundrels, often described by such astute contemporary chroniclers as Daniel Defoe. But this book rests on a foundation, sometimes a little too evident, of solid and painstaking financial analysis. It is perhaps the first book, certainly the first recent book, to present in great detail the analysis of Archibald Hutcheson. Hutcheson seems to have been a lone voice for sobriety and reason in the mad epoch of the South Sea Bubble. Author Richard Dale carefully draws a remarkable number of clear parallels between the first bubble in history and the most recent - the tech splat of the 1990s. We believe that anyone who is involved in the financial markets should read this book. It is particularly timely in bull markets.
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Overview
For nearly three centuries the spectacular rise and fall of the South Sea Company has gripped the public imagination as the most graphic warning to investors of the dangers of unbridled speculation. Yet history repeats itself and the same elemental forces that drove up the price of South Sea shares to dizzying heights in 1720 have in recent years produced the global crash of 1987, the Japanese stock market bubble of the 1980s/90s, and the international dot.com boom of the 1990s....