A Very English Deceit: The Secret History of the South Sea Bubble and the First Great Financial Scandal

The Bank of Amsterdam tackled the problem simply but effectively. It put the coins on the scales and allowed credit according to their real value, their weight, by replacing them with promissory notes. Such pieces of paper were, to all intents and purposes, early banknotes and they became a popular form of currency because their value was guaranteed: they could not be debased. Indeed, they sometimes changed hands at a premium because their value was always honoured. It made Law think: ‘This Bank is a secure place where merchants may give in money and have credit to trade with. Besides the convenience of easier and quicker payments, the banks save the expense of bags and carriage and losses by bad money.’

Law’s eyes were opened to the possibilities such a bank would bring. Why else, he considered, was Holland more prosperous than England or Scotland, even though it had fewer natural resources? Why else did its ships dominate both the North Sea and the South Seas? The reason, surely, was that the Bank of Amsterdam had loaned money to the Dutch East India Company, not in return for coins, duly weighed and bagged, but against its own assessment of the Company’s trading prospects and reputation. Indeed, the Bank actually owned half of the Company; it was effectively creating money by buying ships to carry out trade to bring back goods to make more money. It was a virtuous circle, and one which would not exist without the Bank.

Law began to work out his own theories concerning money, theories he would eventually get a chance to put into practice on a national scale. Holland was Europe’s largest printing centre and books were readily available, so during his exile he had read widely. For the moment, his thoughts were practical ones and confined to his writings. He set out to make his case for a paper currency, for a form of credit that could not be clipped, debased or altered in any form. His great revelation was that money was not intrinsically valuable. It was simply a means to an end, and one which ultimately reflected the strength, or weakness, of a country’s economy. ‘Money,’ he declared, ‘is not the value for which goods are exchanged, but the value by which they are exchanged.’ But Law did not want to remain an idle theoretician. He wanted to put his ideas into practice; and he wanted to return home.

Scotland was still, in 1705, constitutionally separate from England though it was moving towards union; the two countries shared the same crown, but had a separate government and parliament. So Law set his mind on persuading the Scottish Parliament, and by extension Queen Anne and her government, of his intellectual credentials to try to win his pardon. It was a back route out of exile and into London’s thinking.

Scotland’s great weakness was that it had separate commercial arrangements from England, and these arrangements had failed. Its economy had been shattered not by the wars which had eaten into the English coffers, but by overweening ambition and misplaced adventurism. In 1698, a Scottish fleet belonging to the Company of Scotland Trading to Africa and the Indies, known more popularly as the Darien Company, had sailed for Central America, backed by a fair wind, exclusive trading rights granted by the Scottish Parliament, and half the nation’s money. With great difficulty and considerable hardship, the adventurers established a settlement in Darien, in the eastern swamplands of the Isthmus of Panama. It was a disaster waiting to happen. Disease took hold; there wasn’t enough food; the settlers were divided among themselves. Then the Spanish attacked and captured the tiny foothold. Of the two thousand intrepid souls who set out on the Darien venture, only three hundred returned; and of the £400,000 investment, drawn from the Scottish economy, nothing was left. The dream of colonial trade had brought the country to its knees. There was to be no respite from the heavens. At home, the harvest failed again.

The Bank of Scotland, which had been founded a year after the Bank of England in 1695, with only a modest capital base of £100,000 sterling, was faced with a yawning trade deficit and dwindling reserves of gold and silver. It printed £1 notes, in order to meet payments with paper currency rather than metal, but it also revalued its crown coins, which were worth 5s 6d, to make them worth 6 shillings. In doing so, it succeeded only in producing a run on the bank, with so many customers trading in their banknotes for coins that they exhausted its reserves. By December 1704, payments had to be suspended, an ignominious blow to Scottish pride and financial independence.

In the eighteenth century there was little or no understanding of economic cycles, but Law, in exile, provided a full analysis of the problem and his own radical solution: he wanted to increase the money supply to produce full employment. His view was that the Bank should have carried out precisely the opposite process to the one it had implemented: it should, he thought, have devalued its coins by sixpence to make them worth 5 shillings. He predicted that customers would rush to exchange their crowns for paper notes before the rate changed. The vaults would have filled up with coins once more, and the danger would have been averted.

Law applied his mind to economic problems generally, and to Scotland’s in particular, in a forty-thousand-word document called Money and Trade Considered with a Proposal for Supplying the Nation with Money. It was an overview, written anonymously by a ‘Scots gentleman’ and printed and published in Edinburgh, of the role money played in trade, and the benefits that could accrue from a credit-based economy. But it was also, Law hoped, his ticket home.

Money and Trade is the work of a great thinker, but one who could express himself in everyday language. It is a treatise of startling clarity and economic insight, written by a man who was still just thirty-four. First, John Law established the historical background to the development of money: the use of barter, and the use of silver. Both depended for their basis on an analysis of supply and demand: ‘Water is of great use, yet of little value; because the quantity of water is much greater than the demand for it. Diamonds are of little use, yet of great value, because the demand for diamonds is much greater than the quantity of them. Goods change their value, from any change in their quantity, and in the demand for them. If oats be in greater quantity than last year, and the demand the same, or lesser, oats will be less valuable.’

Law may have been the first economic writer to use the concept of demand – he was certainly one of the first. He wanted to show how economies had outgrown the concept of bartering and even the use of silver. He pointed his readers towards what he considered to be the essential quality that money should have: stability. In contrast, he showed how the value of silver could change if supply outstripped demand, or if its quality was diminished. Sometimes there was too much of it, so its value fell, and sometimes it was debased by European governments. Instead, land was, in Law’s view, a more stable instrument of economic prosperity. Land was, he opined, more valuable than silver because it produced everything, and silver was only a product.

Law then moved on to the lessons he had learned first-hand in Amsterdam. Banks, he declared, offered the best method of improving trade and increasing the supply of money, because of the way they could facilitate credit. To move away from corrupted, debased coinage, he proposed the replacement of metal coins by banknotes: ‘The paper money proposed being always equal in quantity to the demand, the people will be employed, the country improved, manufacture advanced, trade domestic and foreign will be carried on, and wealth and power attained.’

Initially, Law proposed a land bank, where paper money would be backed by the value of land. Notes were to be issued by the bank to the value of land that was sold. As he developed his argument, the colonial ambitions of the trading companies, whose financial aspirations became so entangled with the economies of European countries at that time, were implicitly blown away: their search for foreign booty was effectively deemed by Law to be absurd. France and Spain were ‘masters of the mines’, leaving other nations to buy their silver at high prices even though they had ‘a more valuable money’ of their own – paper, backed by land. Truly, declared Law, ‘the nature of money has not been rightly understood’.

Inauspiciously, it was on Friday 13 July 1705 that the Scottish Parliament, riven by factional fighting, agreed to hear Law’s proposals for a land bank and paper money. But its main business that day, to Law’s misfortune, was to debate the possibilities of the union with England, and here Parliament’s hand was being forced both by the economic straits it found itself in and by the terms of the bill which had been placed before it. The proposed Alien Act was designed to allow the Queen to appoint commissioners to work for the union. But if the Parliament voted to reject the move, the Scots would be deemed to be aliens, and their exports to England banned. With the economy destroyed by the Darien venture, the bill was deliberately framed to concentrate minds. Law’s proposals would inevitably be seen, at best, as a radical alternative to union, and at worst as an irrelevant sideshow. Moreover, it was unlikely that any discussion in the Scottish Parliament could ever be straightforward.

Passions ran high. Two members became so exercised by the issue of paper money that they challenged each other to a duel. Finally, Law’s proposals were rejected: the forcing of paper money upon the country was deemed to be ‘unfit for this nation’. Instead of striking out on a radical solution to its economic difficulties, which arguably might have delivered the financial stability the country needed and with it independence, the Scottish Parliament chose the path of least resistance, concentrating instead on joining the country to England in the Act of Union. Under its terms, one Parliament of Great Britain would replace the two of Scotland and England. Self-rule would be ceded by a piece of paper; it could, just perhaps, have been established by paper banknotes.

For Law, this was a bitter blow. His theories remained academic and his future once more lay in exile. Without a royal pardon, he could not even return to Scotland if it was to be formally united to the English nation. Once more he appealed to the Queen; once more, on her government’s advice, she turned him down. Within weeks of the Scottish Parliament rejecting his scheme, it voted to appoint commissioners to arrange the union with England. Law was at heart a patriot who wanted to use his intellect to benefit his homeland. Thwarted, he could only turn his thoughts abroad, destined to circulate his economic theories among more accommodating heads of state who admired his genius and were content to ignore the youthful duel which had forced him into exile.

Within a few years, Harley’s new government in England, faced with the burden of its ever-growing war debt, turned to a man with no intellectual convictions whatsoever, but a burning desire to make money for himself.

CHAPTER III

Blunt Advice

George Soros became frustrated because his huge wealth seemed to give him no political influence in the West. He realized he needed to become a public personality. In the late summer of 1992, a time of great pressure on European institutions, he didso with a vengeance. He shorted, betting that the pound would not be able to hold its value against other currencies traded within the Exchange RateMechanism. On Sept. 16, with Soros and others selling pounds, the British government responded by raising interest rates 2 percentage points to attract buyers. By evening sterling had been forced from the ERM. Soros scooped up $1 billion from that escapade and became known all over the world as the Man Who Broke theBank of England. ‘I had no platform,’ he says today. ‘So I deliberately [did] the sterling thing to create a platform. Obviously people care about the man who made a lot of money.’Time.com, 1 September 1997

John Blunt was not a handsome man. He was fat and pompous, and a very different character from John Law. Unlike with Law, there would be no madcap chase for the wilder things in life, nor any occasion when, through gambling, he would have to sell his family home or be bailed out by his mother. He had one aim in life, which was to better himself through business. His would be a focused search for wealth and power. Unlike Law, he had no intellectual backbone – he simply had a desire to get rich quick.

But John Blunt did have one redeeming quality. Whilst he was loud and overbearing, he possessed great self-confidence, even charisma; he was on the make but charming – a man bursting with ideas and energy, who dominated any group. His gift was for making money, and he would prove himself to be an inspired promoter of companies. Within a decade he would become rich from backing a project to bring water into London, despite the rivalry of the New River Company, and another for the manufacture of linen. Within a decade, too, he would move closer to the political world, winning election in the City as a councillor in the Cornhill ward, which included Exchange Alley. Blunt was religious, a Baptist by faith, and as the years went by the three worlds of business, politics and religion would merge seamlessly to his advantage.

Blunt was the son of a reasonably well-off shoemaker in Rochester; but he had come up, if not the hard way, then via a route that was tougher than Law’s relatively privileged upbringing in Scotland. He had started his working life as a humble member of the Worshipful Company of Scriveners, serving his apprenticeship in Holborn, London. Fittingly, for someone who wanted to aim high, his company’s coat of arms was an eagle, coloured gold, standing on a red book, its wings raised, poised to soar. Blunt’s choice of profession may have been a deliberate step in his planned path to power and influence. The scriveners were originally a kind of legal assistant, calligraphers with a monopoly on the paperwork for buying and selling houses. Gradually this gave them inside knowledge of the business affairs of merchants and landowners, and they became brokers who negotiated loans, an early type of merchant banker or land speculator. Such was the range of their financial activities that they seemed to occupy no firm place in society; one scrivener might tidy up the legal affairs of large estates, to the chagrin of the lawyers, while another might make his living by acting as a moneylender.

It was, in all, a fitting profession for a man on the make. During his long apprenticeship to Daniel Richards in Birchin Lane, on the perimeter of Exchange Alley, where he wrote letters for a groat (or sixpence), Blunt built up a view of English society, steeping himself in the knowledge of who was rich and who was poor, and those who seemed well-to-do but were just keeping up appearances. But few scriveners became as rich as the goldsmith-bankers like John Law’s father, who could lend large sums on credit, and make much more in return. The motto of the scriveners through the years was Scribite scientes – ‘Write, learned men.’ For Blunt, this was just a means to an end. He wanted to be the exception to the rule that few scriveners rose to great wealth or eminence in the City. In 1689, at the age of twenty-five, he left his apprenticeship to seek out new opportunities. Within four months of leaving his apprenticeship, he was married, a first step on the ladder towards social respectability – the string of affairs which John Law had enjoyed was not for Blunt. His choice of bride was Elizabeth Court, who came from a solid Warwickshire family. Blunt had married above himself, but not indecently so. A second marriage further up the social scale, to the daughter of a former Governor of Bengal, would come later.

Blunt was seeking his fortune in an England humming with new ideas. In the 1690s, the moneyed-men, grown rich on lending to the government, had begun to promote an extraordinary range of companies. The catalyst had been the success of a sea captain, one Captain Phipps, who had salvaged Spanish silver by the ton and precious jewels by the sackful from the bottom of the sea off the island of Hispaniola in the West Indies. He returned to England in triumph and to an instant knighthood: his backers had made an extraordinary 10,000 per cent profit on the adventure, a sum close to £200,000 – many millions of pounds today. Inspired by the captain’s success, copycat diving companies had arisen by the dozen, many of which came to London to show off their new deep-sea devices in a public demonstration on the Thames. The novelist and pamphleteer Daniel Defoe invested, and lost, £200 in one diving firm; he also owned a brick and tile factory on marshland near Tilbury, and, more quixotically, seventy civet cats – a leading scientist had once advocated breeding them for the secretion of their glands, which was a basic essence in the manufacture of perfume. The many other projects calling for investors to back them ranged from the Night Engine Company, which patented a burglar alarm, to the ‘Company for the Sucking-Worm Engines’ which had invented a machine to put out fire. Until 1697 when the impecunious government debased the coinage, puncturing investor confidence and putting many firms out of business, the stock market thrived. One coffee trader, John Houghton, published a twice-weekly paper listing share prices, taking care to explain to his readers the mysteries of the new profession: ‘The manner of the trade is this: the monied-man goes among the brokers and asks how stocks go? And upon information, bids the broker buy or sell so many shares of such and such stocks if he can, at such and such prices. Then he tries what he can do among those that have stocks, or the power to sell them, and if he can, makes a bargain.’

In such a speculative age, Blunt, with his glib personality and gift of the gab, was a man of his time, just as Law was far ahead of it. His initial route to power was through a company whose original business matched the bellicose nature of the times: the Sword Blade Company.

At the turn of the century, the Sword Blade Company had spotted a gap in the arms market. The English rapier, heavy and flat, was considered both by combatants and by those who wished, more peaceably, merely to make a fashion statement, to be less effective and less pleasing on the eye than the French equivalent, which had a grooved blade. From 1691 the Sword Blade Company, helped by some imported Huguenot craftsmen, was granted a charter to make French blades in England. But the company was soon to widen its horizons and change direction. It moved to Birchin Lane, and John Blunt became its company secretary. Working with him were three men who would play leading roles in the development of the South Sea Company: the goldsmith Elias Turner would become the Governor of the Company; Jacob Sawbridge, the Deputy Governor; and the third was George Caswall, whose family had held the Leominster seat in Parliament for more than a hundred years.

The Sword Blade Company was a child of its aggressive times, an exploiter of the government’s financial difficulties, and the progenitor of the most corrupt financial institution the country was ever to spawn. The company’s first step was to buy up large tracts of Ireland, at the bottom of the market, acquiring for about £200,000 land worth £20,000 a year in rents. To bankroll its purchase, it decided to issue stock in the company. It did so in a complicated but highly profitable manner, announcing that it would exchange its stock not for money but for government debts called ‘army debentures’. Debentures were slips of paper given to people who had lent money to the government, a type of IOU issued by the Paymaster of the Forces to raise money for the constant state of war. The debts were unsecured, however, and had fallen in value since they first came on the market.

The Sword Blade’s idea was to call in as many debentures as it could from the people who had lent the government money, by offering them what looked like a profitable exchange deal. The debentures stood at 85 on the stock market, and their holders were offered, in return, Sword Blade shares worth 100. How then could the company make a profit? The answer was that it had, effectively, rigged the market through what today would be called ‘insider trading’. It simply bought up as many debentures as cheaply as it could before announcing its plans, knowing that the scale of its share-swap scheme would cause their price to rise. By this method, the company made an estimated profit of around £25,000. The government, too, was satisfied. As well as buying land from it, the company lent it some £20,000 at a low level of interest as a ‘sweetener’ to facilitate the business between them. Through its financial adventures it became the Sword Blade Bank. It was a key moment in its history, the turning point in what became a growing, and corrupt, entanglement with affairs of state.

The Bank of England looked on unamused. Its banking monopoly had been enshrined in an Act of 1697, and now it seemed the Sword Blade Company was acting as a land bank, not just as a land corporation. Treasury lawyers pored over the case, and pronounced in favour of the Bank, but no action was ever taken. The deal had been too profitable for the government. But there was worse to come for the Bank of England. A mysterious syndicate, its backers unknown but almost certainly including partners from the Sword Blade Company, offered to lend the government £1.5 million. The Bank could clearly see the danger of such a manoeuvre by its unknown rival. Its charter had only three more years to run, and only by offering to match the size of the loan, and by cutting interest rates to 4.5 per cent, did it see off the threat to its position. Its reward was the extension of its charter to 1732.

This early skirmish between the two rivals presaged what would be in 1720 their all-out hostility, and the government seemed to be the beneficiary, paying less for its money than before. But the charter’s extension still proved to be a problem for the Chancellor, Robert Harley. The government had, by confirming the Bank’s monopoly, tied itself to a single banking institution to raise money for its conflicts and, over the next three years, the Bank increasingly struggled to deliver. What else could Harley do?

In 1710, battling with the nation’s finances, he was impressed by the acumen of John Blunt, and the profit he was making. Harley began to discuss the issue of the national debt with Blunt in the hope of finding a radical solution. The first proposal that his new ally put forward, however, was distinctly traditional. Just five years after John Law had produced what would turn out to be one of the greatest analyses of the eighteenth century as a possible cure for Scotland’s economic ills, Blunt persuaded Harley to resurrect the old Whig solution of the lottery; and to let him run a far bigger game than the one which had captured von Uffenbach’s attention in the Banqueting House back in 1710, one which offered even bigger cash prizes and was more a game of chance. It would capitalise on the general fever for gambling and have the delightful side-effect, if it succeeded, of wresting some financial control from the Whig-dominated Bank of England. On 3 March 1711, the new lottery was launched.

Ostensibly, it was the traditional way of raising loans, to be paid back through yearly payments, or annuities, at a guaranteed rate of interest. One hundred and fifty thousand numbered tickets, costing £10 each, were to be sold, inscribed with the legend: ‘This ticket entitles the bearer to ten Pounds to be paid in due course with Interest to commence from the Nine and twenty Day of September One thousand seven hundred and eleven or a better chance’ – that is, a prize. Interest was to be paid at 6 per cent. But Blunt had made big changes to the scale of the prize money. There were 25,000 prizes to be won, with the smallest at £20 and the largest at a staggering £12,000. The first and last tickets drawn out of the box would win an extra £500. In total, more than £678,000 – nearly as much as it cost to build St Paul’s Cathedral – was to be given away in prize money. Not surprisingly, the lottery was a tremendous success. One knight of the realm complained to a friend who asked him to buy tickets: ‘You may assure yourself that I used my endeavours to have put your money in the Lottery, but it was impossible to do it though I was very early that morning in the City, and a vast number of persons was disappointed as well as myself … As for buying up tickets, I cannot tell how to advise you, such advantage is made of them by the stock-jobbers.’