In 1720, the South Sea Bubble arose from what seemed to be good intentions. The South Sea Company was given an exclusive monopoly on the Spanish Americas in exchange for assuming a large part of England’s debt. The debt holders received preferred shares in the South Sea Company that paid 6% interest. The business operators of the South Sea Company seized on their de-facto government backing to continue offering shares to pay off all the country’s debt.
The madness that ensued created delusional visions of the future. The euphoria that overtook England, is to this day, a story for the ages. Robert Walpole, the former Chancellor of the Exchequer, disapproved of what the government was allowing as he could see how it was pushing society into a frenzy. Walpole could see how this would misallocate capital. Here is what he was quoted saying:
The dangerous practice of stockjobbing would divert the genius of the nation from trade and industry. It would hold out a dangerous lure to decoy the unwary to ruin by making them part with the earnings of their labor for a prospect of imaginary wealth. The great principle of the project was an evil of first-rate magnitude; it was to raise artificially the value of the stock by exciting and keeping up a general infatuation and by promising dividends out of funds which could never be adequate for the purpose.
The invisible hand was unable to appropriately allocate capital in society as “trade and industry” were being “diverted” from their finer points. The money being allocated towards this mania was not going to attain the trade that was dreamed of and fantasized about. The investors saw the riches of silver and gold in the New World. The excitement pushed the value of shares higher. Many investors believe the market is there to instruct people. If stocks go up, it tells you something about the future. If the South Sea Company’s stock went up, it was telling you about the future of the Americas and the company.
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