Economics, 3rd Edition

786  PART 15  INTERNATIONAL MACROECONOMICS

The South Sea Bubble

In 1720, Isaac Newton is quoted as saying ‘I can calculate the motions of the heavenly bodies but not the 

madness of people’. Newton had made a profit of 

£7,000 (about £800,000 or €937,500 in today’s values) 

selling shares of the South Sea Company in April of that year. Along with many other people, however, 

Newton believed that the value of the company would continue to rise and he purchased more shares as the 

price of the company continued to rise. Newton ended up losing 

£20,000 (about £2.3 million or €2.7 million).

The South Sea Company was formed in 1711. It entered into an agreement to assume part of the 

debt of the government, which at the time was financing the War of Spanish Succession, in return for a 

monopoly on the trade to Spanish colonies in South America. The Treaty of Utrecht was signed in 1713 to 

end the war. Its terms were not favourable to the South Sea Company as it limited trade opportunities to 

the Spanish colonies. A further debt conversion was announced in 1719 where the South Sea Company 

became just one of three corporations, including the Bank of England, which owned around 36 per cent 

of the total national debt. Despite the fact that the company had no real evidence of trading success, the 

directors of the company continued to make claims to shareholders of the wealth and riches that trade 

promised, not least large quantities of gold and silver just waiting to be brought back to Europe.

In January 1720, the South Sea Company’s share price was 

£128. The claims by the Company pushed 

up the share price and more dabbling in debt conversion with Parliament saw its price rise to 

£330 by 

the end of March. Newton sold his shares in April; by May the price had risen further to 

£550. In June 

Parliament passed the Bubble Act which was introduced by the South Sea Company and required all 

joint-stock companies to acquire a royal charter. Part of the reason for the legislation was to help control 

the explosion of companies entering the market all making claims for their ventures which were sending 

prices rising causing mini-bubbles. Cynics would argue that the South Sea Company also used the legisla-

tion to manage the growing threat of competition it faced. Having received its royal charter, shareholders 

took this as being a sign that the company’s claims were sound and demand for its shares continued to 

rise. By the end of June the share price had risen to 

£1,050.

For some reason (and this perhaps is where Newton’s lament over the madness of people is most per-

tinent), some people began to sell their shares and the share price began to fall in July. For those that had 

come in near the top of the market (like Newton’s second purchase) the imperative to sell became more 

urgent. The price continued to fall quickly and by September stood at around 

£175. The collapse affected 

thousands of people and a number of institutions. Subsequent investigations into the collapse revealed 

bribery and corruption practices and prosecutions of company officials and members of the government.

The South Sea Bubble was an example of how asset prices can rise way above their true market value. 

It seems that history can repeat itself and in many ways, the issues that existed then (a lack of knowledge 

by participants in the market) is similar to today. The complexities of how markets operate may be far 

greater and the technolo-

gies far more sophisticated, 

but the success of markets 

relies to a large extent on 

participants having good 

information on which to base 

their decisions. No matter 

how intelligent an individual 

is, it seems, if they do not 

have access to all avail-

able information then poor 

decisions can be made as 

Newton found out to his cost.

I 1720 I