ISAAC NEWTON’S $3 MILLION DOLLARS LOSS

South Sea Company: Britain’s greatest financial speculation


Isaac Newton is known as one of the smartest scientists in Physics and Mathematics.
Nevertheless, Newton’s thousands of millions of loss is usually not known. Why did Newton lose
such an amount of money through an investment operation? Was he playing the role of an
intelligent investor or a speculator?

Since many years, common-stocks have been really attractive to all kind of investors, from
the $500 investor to the gorgeous big investing companies. To this matter, we should own up
that many people have become wealthy due to their investments in stocks and bonds. One
clear example is Warren Buffett, who stands as the fourth richest billionaire on earth [1].

The stock market often goes through many insecure periods during the economy cycles,
which have made indeed unexperienced speculators rich. Inflation and the increase of prices
is a big issue to take into consideration in investment theory.

Back in the spring of 1720, Sir Isaac Newton owned shares in the South Sea Company, the
hottest stock in England during that time. What Newton didn’t know was the strong
enthusiasm of the market, which ended in a millionaire loss. But how did all start?

England, 1720. Speculators pay ever-higher prices for shares despite the evidence of
underlying value. The South Sea Company was founded in 1711 by Robert Harley, whose main
purpose was to create political allies. Harley wanted to put an end to the unpopular War of the
Spanish Succession. The South Sea Company had a monopoly to conduct England’s trade
with Spain’s colonies in the West Indies and South America. This was possible due to the
Spanish’s king peace contract.

The purpose of the company was to relieve the government of its burdensome unsecured
public debt, which then amounted to £9,000,000 [2].

 

  South Sea was organized in a way that holders of national debt were obliged to exchange their government securities for shares in the company. In addition, the company would get an annual payment from the Exchequer of £568,279 10s (6% of the debt has taken over).    

The stock market was living an optimistic period. People started with investments operations,
following the news in the newspaper. In 1702 London had only one daily newspaper, but by
1709 there were 18. Harley had propagandists; Jonathan Swift and Daniel Defoe. The
managers of the South Sea Company understood the value of publicity.

At this point, it is assumed that the South Sea Company was a confection of politics,
commerce, and finance. There was only one person who was able to manage financial issues,
as the other ones didn’t have experience of trade. It was John Blunt, who was the company’s
director and also the director of Sword Blade Bank.


John Carswell, former secretary of the British Academy, referred to Blunt as of “powerful
jowl and heavily-lidded eyes, an industrious, domineering man whom it was equally difficult
to like and to resist”.

Once reached the Peace of Utrecht in 1713 [3], a contract to transport and sell annually in
Spanish America 4,800 “piezas de Indias” was signed (a pieza was a black slave). Sadly, the
war with Spain in 1718 established the end of the commercial routes for the South Sea
Company. The Company was considered as an enterprise with vast capital and with any kind
of operations. Within a year and a half, the Company was to become the greatest speculation in English history.

As time gone by, the English government found awkwardly in debt during 1719
period. The £30,981,712 [4] were proposed to be converted to company stock. This way, the
government could save much in annual interest. A fee of £7,500,000 was bringt to South Sea
for the privilege of making the conversion [5].

In early 1720 the Parliament accepted the South Sea Company endeavour. The Company
accepted to pay the £7,500,000 while exchanging South Sea stock for government obligations
at prices far above par 100.

The higher the price of stock at the time of conversion, the greater the profits which the
Company earned. In addition, the directors could create and purchase stock at a low price and
then sell it for an inflated price. They also included fraudulent transactions in nonexistent
stock.


It is important to point out how worked this amazing “financial pump” (as Carswell wrote:
“So Blunt...had constructed a financial pump”). The company first created £2 million in new
shares, at £300 a share. As it was announced, the cash position was so strong that it could
lend shareholders money on the security of their stock. The price rose to £325. The company
issued more stock and made more loans (this was considered as the financial pump). Each
stock was accompanied by cash to stuck it up, leaving the price level even higher than before.
Arriving at this point, the reader should consider the 1719-1720 period, which lived the
London Stock Exchange, as a speculative one with 190 English speculative stocks being
traded.

Following the theory of a Ponzi scheme, the South Sea Company needed both to raise capital
and to keep the price of its stock moving upward, in order to pay out profits to shareholders.

To this matter, on January 1, 1720, the price of a share stood at £128. On June 24 it rose   
£1,050. In September came the crash. By December the stock returned to £128. Many people, including the acclaimed Newton,  declared themselves ruined. They, whose main proposal was to get rich in a fast way through speculative processes, became poor. Corruption made the Bubble burst. As a  result, it had a relevant impact on the economic  growth of the century, concerning the Industrial  
Revolution. 

The South Sea stock distributed wealth to those who were as much avid to sell the stocks at high prices. A clear example of this was Thomas Guy, a British writer turned speculator,  who owned £54,000 of Stock in April 1720 and sold it the following six weeks for £234,000. He sold his £7,000 stock in April for a profit of 100% He indeed reentered the market at the top and lost £20,000. Newton, therefore, stated, “I can calculate the motions of the heavenly bodies, but not the madness of the people”. He forbade anyone to speak the words “South Sea” in his presence [8].

 

 

 

 

By Marc Clotet
September 07, 2019 

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Reference and Endnotes


[1] According to Forbes, Warren Buffett is the fourth richest world’s billionaire with a net
worth of $82.5 billion. Known as the “Oracle of Omaha”, Buffett is one of the most
successful value investors of all time, (05/03/2019, 7:30 AM). For further information, check
the next website: https://www.forbes.com/billionaires/#36db5b7b251c.


[2] Which equals to $11,080,517 Dollars in todays money, 06/09/2019.


[3] Darmanin, M. (2019, April 11). The Treaty of Utrecht was signed. Retrieved August 7,

2019, from https://www.utrechtcentral.com/this-week-in-utrechts-history/the-treaty-of-
utrecht-was-signed-19374/.

[4] Which equals to $38,132,891 Dollars in todays money, 06/09/2019.


[5] For a better comprehension, the reader should take into consideration the actual value of
£200 during 1720, which was enough for the living of a middle-class family at the time.


[6] Reed, C. (1999, May 7). Dividend receipt. Congreve, W. Retrieved August 7, 2019, from
https://harvardmagazine.com/1999/05/damnd.html.


[7] Reed, C. (1999, May 7). Lucipher’s new Row-Barge, 1721. The British Museum, London.
Retrieved August 7, 2019, from https://harvardmagazine.com/1999/05/damnd.html.

Other references


Reed, C. (1999, May 7). The Damn’d South Sea. Retrieved August 7, 2019, from https://
harvardmagazine.com/1999/05/damnd.html.

Bibliography


[8] Graham, B., (1973). Commentary on the introduction. In J. Zweig (Rev. ed), The
Intelligent Investor (pp. 12-13). United States of America: Collins Business Essentials.

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