The South Sea and Mississippi Bubbles of 1720
This chapter examines the assumption that there is a relationship between innovations and economic crises, with a special focus on the economic crisis in Britain in 1720. The Mississippi Bubble and the economic crisis in France is described and analysed a
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Introduction The South Sea Bubble is said to be one of the greatest scandals in financial history.1 It has become a metaphor for deceitfulness, illusion and trickery in the financial world.2 It is often explained from the perspective that it typifies the spirit of the times, which was characterised, amongst other things, by speculation and gambling.3 Behavioural theory applied to financial activities4 explains an economic bubble from a rational perspective, saying many may act irrationally, but there will be those who don’t.5 The four “classic” books on the subject of the South Sea Bubble explain the economic bubble in terms of irrational mania6; they view the trading activities of the South Sea Company as being insignificant. Paul disagrees with them, saying that the slave trade brought revenues to the 1
Paul (2011: 1). Mackay adeptly relates bubbles to mania, irrational behaviour, illusion and trickery (Mackay 1995). 3 Dale (2004). 4 “Behavioural finance” uses psychological models to explain financial behaviour (Paul 2011: 5). 5 Rational bubbles have been thoroughly explained by Tirole (1982, 1985); Garber (2000). 6 Scott (1912); Dickson (1967); Mackay (1995); Carswell (1993). 2
© The Author(s) 2017 J.-A. Johannessen, Innovations Lead to Economic Crises, DOI 10.1007/978-3-319-41793-6_4
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company, and that these were substantial and may be an important clue as to why people bought shares in the South Sea Company. Paul’s findings are important because they suggest that investors bought shares on the basis of rational expectations of increasing their income based on the company’s revenues from the slave trade. One reason why the “mania” explanation has had such an impact in all the theoretical writings about economic bubbles—including the case of the South Sea Bubble—may be that neoclassical economic theory is unable to explain the development of an economic bubble. However, it is only when the bubble is viewed “in the rear-view mirror” that people are able to argue that it was an expression of irrational mania,7 even though the reality may well be the opposite.8 The development of the economic bubble was rational, as Paul shows in her use of cliometric9 data. Carlos and Neal, Temin and Voth, and Shea10 have also demonstrated using other cliometric data that the bubble’s development can be justified rationally. Although not everyone may have acted rationally, many did. Most writers today, however, claim that it was an irrational behaviour and a form of gambling mania that led to the bubble’s growth. It may also be the case that the “irrational behaviour” explanation has “face value”, because it is easy to “sell” to the reader. I am not trying to claim here that innovation can explain everything in the development of an economic bubble, but rather that it can be an aspect of the explanation concerning the development of an economic crisis, including both economic bubbles and other types of crises.11 7
The classical works concerning explanations of effective markets are, a
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