Sunday 13 October 2019

Special Update 13/10/2019 Bubbles, A Reminder From 1720.


Baltic Dry Index. 1924 -05  Brent Crude 60.51  Spot Gold 1489

Never ending Brexit now October 31, maybe. 18 days away.
Trump’s Nuclear China Tariffs Now In Effect.
The USA v EU trade war starts October 18. Just 5 days away.

In reading The History of Nations, we find that, like individuals, they have their whims and their peculiarities, their seasons of excitement and recklessness, when they care not what they do. We find that whole communities suddenly fix their minds upon one object and go mad in its pursuit; that millions of people become simultaneously impressed with one delusion, and run after it, till their attention is caught by some new folly more captivating than the first.

Charles Mackay. Extraordinary Popular Delusions and the Madness of Crowds

With our global stock markets so bubbly, trading near the top on gross over optimism about the benefits of a new Trumpian trade deal with China, it’s time for reminder from the past of over optimism, in unlikely ventures, schemes, and bubbles. 
Unlike 1720, we don’t hold failed stock schemes and bent banksters to account. In the 21st century, we get the central banksters to bail them out. Is that what the Fed’s doing now with all the billions of repos every day? If so, who blew up and why? Who’s next?

Among the many companies to go public in 1720 is—famously—one that advertised itself as "a company for carrying out an undertaking of great advantage, but nobody to know what it is".

Charles Mackay. Extraordinary Popular Delusions and the Madness of Crowds

South Sea Company

The South Sea Company (officially The Governor and Company of the merchants of Great Britain, trading to the South Seas and other parts of America, and for the encouragement of fishing)[3] was a British joint-stock company founded in 1711, created as a public-private partnership to consolidate and reduce the cost of national debt. The company was also granted a monopoly to trade with South America and nearby islands, hence its name (the modern use of the term "South Seas" to refer to the entire South Pacific was unknown in England at the time). When the company was created, Britain was involved in the War of the Spanish Succession. Spain and Portugal controlled most of South America. There was no realistic prospect that trade would take place, and the company never realised any significant profit from its monopoly. Company stock rose greatly in value as it expanded its operations dealing in government debt, peaking in 1720 before collapsing to little above its original flotation price; the economic bubble became known as the South Sea Bubble.

The Bubble Act 1720 (6 Geo I, c 18), which forbade the creation of joint-stock companies without royal charter, was promoted by the South Sea company itself before its collapse.

In Great Britain, a considerable number of people were ruined by the share collapse, and the national economy greatly reduced as a result. The founders of the scheme engaged in insider trading, using their advance knowledge of when national debt was to be consolidated to make large profits from purchasing debt in advance. Huge bribes were given to politicians to support the Acts of Parliament necessary for the scheme.[4] Company money was used to deal in its own shares, and selected individuals purchasing shares were given loans backed by those same shares to spend on purchasing more shares. The expectation of profits from trade with South America was used to encourage the public to purchase shares, but the bubble prices reached far beyond the profits of the slave trade.[5]

A parliamentary inquiry was held after the crash to discover its causes. A number of politicians were disgraced, and people found to have profited unlawfully from the company had assets confiscated proportionate to their gains (most had already been rich men and remained so). The company was restructured and continued to operate for more than a century after the Bubble. The headquarters were in Threadneedle Street, at the centre of the financial district in London. At the time of these events, the Bank of England was also a private company dealing in national debt, and the crash of its rival consolidated its position as banker to the British government.[6]

---- The national debt investigation had concluded that a total of £9,000,000 was owed, without any allocated income to pay it off. Edward Harley and John Blunt together had devised a scheme to consolidate this debt in much the same way that the Bank of England had consolidated previous debts, although the Bank still held the monopoly on operating as a bank. All holders of the debt would be required to surrender it to a new company, the South Sea Company, which in return would issue shares to the same amount. The government would pay the company £568,279 10s 0d (6% interest plus expenses) annually, which would be distributed as a dividend to shareholders. The company was also given a monopoly to trade with South America, a potentially lucrative enterprise, but one controlled by Spain, with whom Britain was at war.[10]

At that time, when continental America was being explored and colonized, Europeans applied the term "South Seas" only to South America and surrounding waters. The concession both held out the potential for future profits and encouraged a desire for an end to the war, necessary if any profits were to be made. The original suggestion for the South Sea scheme came from William Paterson, one of the founders of the Bank of England and the financially disastrous Darien Scheme.[10]

Harley was rewarded for the scheme by being created Earl of Oxford on 23 May 1711, and was promoted to Lord High Treasurer. With a more secure position, he began secret peace negotiations with France. Commercially, since the lotteries were discredited, some of the debt intended to be consolidated under the scheme was available in the open market before the scheme was announced, at a discounted rate of £55 per £100 nominal value. This allowed anyone with advance knowledge to buy debt cheap and sell at an immediate profit, and made it possible for Harley to bring further financial supporters into the scheme, such as James Bateman and Theodore Janssen.[11]

Daniel Defoe commented:[12]

Unless the Spaniards are to be divested of common sense, infatuate, and given up, abandoning their own commerce, throwing away the only valuable stake they have left in the world, and in short, bent on their own ruin, we cannot suggest that they will ever, on any consideration, or for any equivalent, part with so valuable, indeed so inestimable a jewel, as the exclusive trade to their own plantations.

The originators of the scheme knew that there was no money to invest in a trading venture, and no realistic expectation that there would ever be a trade to exploit, but the potential for great wealth was widely publicised at every opportunity, so as to encourage interest in the scheme. The objective for the founders was to create a company which they could use to become wealthy, and which offered future scope for further government deals.[13]

---- The 1719 scheme was a distinct success from the government's perspective, and they sought to repeat it. Negotiations took place between Aislabie and Craggs for the government and Blunt, Cashier Knight and his assistant and Caswell. Janssen, the Sub Governor and Deputy Governor were also consulted but negotiations remained secret from most of the company. News from France was of fortunes being made investing in Law's bank, whose shares had risen sharply. Money was moving around Europe, and other flotations threatened to soak up available capital (two insurance schemes in December 1719 each sought to raise £3 million).[25]

Plans were made for a new scheme to take over most of the unconsolidated national debt of Britain (£30,981,712) in exchange for company shares. Annuities were valued as a lump sum necessary to produce the annual income over the original term at an assumed interest of 5%, which favoured those with shorter terms still to run. The government agreed to pay the same amount to the company for all the fixed term repayable debt as it had been paying before, but after seven years the 5% interest rate would fall to 4% on both the new annuity debt and also that taken over previously. After the first year, the company was to give the government £3 million in four quarterly installments. New stock would be created at a face value equal to the debt, but the share price was still rising and sales of the remaining stock, i.e. the excess of the total market value of the stock over the amount of the debt, would be used to raise the government fee plus a profit for the company. The more the price rose in advance of conversion, the more the company would make. Before the scheme, payments were costing the government £1.5 million per year

---- The purpose of this conversion was similar to the old one: debt holders and annuitants might receive less return in total, but an illiquid investment was transformed into shares which could be readily traded. Shares backed by national debt were considered a safe investment and a convenient way to hold and move money: far easier and safer than metal coins. The only alternative safe asset, land, was much harder to sell and it was legally much more complex to transfer ownership.

The government received a cash payment and lower overall interest on the debt. Importantly, it also gained control over when the debt had to be repaid, which was not before seven years but then at its discretion. This avoided the risk that debt might become repayable at some future point just when the government needed to borrow more, and could be forced into paying higher interest rates. The payment to the government was to be used to buy in any debt not subscribed to the scheme, which although it helped the government also helped the company by removing possibly competing securities from the market, including large holdings by the Bank of England.[26]

Company stock was now trading at £123, so the issue amounted to an injection of £5 million of new money into a booming economy just as interest rates were falling. Gross Domestic Product (GDP) for Britain at this point was estimated as £64.4 million.[2]

On 21 January the plan was presented to the board of the South Sea Company, and on 22 January Chancellor of the Exchequer John Aislabie presented it to Parliament. The House was stunned into silence, but on recovering proposed that the Bank of England should be invited to make a better offer. In response, the South Sea increased its cash payment to £3.5 million, while the Bank proposed to undertake the conversion with a payment of £5.5 million and a fixed conversion price of £170 per £100 face value Bank stock. On 1 February, the company negotiators led by Blunt raised their offer to £4 million plus a proportion of £3.5 million depending on how much of the debt was converted. They also agreed that the interest rate would reduce after four years instead of seven, and agreed to sell on behalf of the government £1 million of Exchequer bills (formerly handled by the Bank). The House accepted the South Sea offer. Bank stock fell sharply.[27]

---- The company then set to talking up its stock with "the most extravagant rumours" of the value of its potential trade in the New World; this was followed by a wave of "speculating frenzy". The share price had risen from the time the scheme was proposed: from £128 in January 1720, to £175 in February, £330 in March and, following the scheme's acceptance, £550 at the end of May.

What may have supported the company's high multiples (its P/E ratio) was a fund of credit (known to the market) of £70 million available for commercial expansion which had been made available through substantial support, apparently, by Parliament and the King.

Shares in the company were "sold" to politicians at the current market price; however, rather than paying for the shares, these recipients simply held on to what shares they had been offered, with the option of selling them back to the company when and as they chose, receiving as "profit" the increase in market price. This method, while winning over the heads of government, the King's mistress, et al., also had the advantage of binding their interests to the interests of the Company: in order to secure their own profits, they had to help drive up the stock. Meanwhile, by publicising the names of their elite stockholders, the Company managed to clothe itself in an aura of legitimacy, which attracted and kept other buyers.

Top reached

The price of the stock went up over the course of a single year from about £100 to almost £1000 per share. Its success caused a country-wide frenzy—herd behavior[31]—as all types of people, from peasants to lords, developed a feverish interest in investing: in South Seas primarily, but in stocks generally. Among the many companies to go public in 1720 is—famously—one that advertised itself as "a company for carrying out an undertaking of great advantage, but nobody to know what it is".[32]

The price finally reached £1,000 in early August, and the level of selling was such that the price started to fall, dropping back to £100 per share before the year was out.[33] This triggered bankruptcies amongst those who had bought on credit, and increased selling, even short selling (i.e., selling borrowed shares in the hope of buying them back at a profit if the price fell).[citation needed]

Also, in August 1720, the first of the installment payments of the first and second money subscriptions on new issues of South Sea stock were due. Earlier in the year John Blunt had come up with an idea to prop up the share price: the company would lend people money to buy its shares. As a result, many shareholders could not pay for their shares except by selling them.[citation needed]

Furthermore, a scramble for liquidity appeared internationally as "bubbles" were also ending in Amsterdam and Paris. The collapse coincided with the fall of the Mississippi Company of John Law in France. As a result, the price of South Sea shares began to decline.[citation needed]

Recriminations

By the end of September the stock had fallen to £150. Company failures now extended to banks and goldsmiths, as they could not collect loans made on the stock, and thousands of individuals were ruined, including many members of the aristocracy. With investors outraged, Parliament was recalled in December and an investigation began. Reporting in 1721, it revealed widespread fraud amongst the company directors and corruption in the Cabinet. Among those implicated were John Aislabie (the Chancellor of the Exchequer), James Craggs the Elder (the Postmaster General), James Craggs the Younger (the Southern Secretary), and even Lord Stanhope and Lord Sunderland (the heads of the Ministry). Craggs the Elder and Craggs the Younger both died in disgrace; the remainder were impeached for their corruption. The Commons found Aislabie guilty of the "most notorious, dangerous and infamous corruption", and he was imprisoned.
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Every age has its peculiar folly: Some scheme, project, or fantasy into which it plunges, spurred on by the love of gain, the necessity of excitement, or the force of imitation.

Charles Mackay.  Extraordinary Popular Delusions and the Madness of Crowds

The monthly Coppock Indicators finished September

DJIA: 26,917 +57 Up. NASDAQ: 7,999 +62 Up. SP500: 2,977 +61 Up.

Another inconclusive month, but all three moved up weakly.   I would not rely on nor take such a weak buy signal.

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