In last month’s newsletter, Bitcoin & The Gold Standard, I outlined the arrangement to set up the Bank of England following the ascension of the Dutchman, William of Orange, to the throne of England. The result of the ‘Glorious Revolution’.
I also emphasised that the names of those making the loan of £1.25 million to set up the Bank are still a secret. We do, however, know of one individual that was associated with this scheme, and his name was William Paterson. William was a Scottish Trader and Banker who had spent some time living in the West Indies. He eventually (along with a fellow countryman John Law) advocated for the union of Scotland and England in 1707 – to help Scotland out of poverty after his financially disastrous Darien Scheme.
In 1691, William proposed the plan for the Bank of England, which was eventually agreed upon by parliament and established in 1694.
Government Debt
Although the Bank of England began with a debt of £1.25 million, the concept of ‘free money’ clearly went to the heads of some ambitious people at the time, as sources claim that the debt held by the Bank of England rose to £16 million within four years due to the wars that England was fighting. According to Wikipedia, a national debt investigation also determined that the government was in debt to the tune of £9 million by 1711. Presumably, this was in addition to the Bank of England debt, as Robert Harley, Chancellor of the Exchequer, gathered information as individual government departments gradually revealed their expenditure. It is possible that the true debt was obscured, given the nature of records and accounting methods at that time. The amount was staggering, given that the concept of the Bank of England handling government debt was a new innovation.
This debt was an issue as the government was committed to paying interest on the debt, and their most creative efforts at manufacturing money had yet to be devised. Interest due on the debt to the Bank of England was 8% per annum. Wikipedia suggests that the £9 million outstanding was debt for which there were no means of paying and that Bank of England debt had already been consolidated using other means in the previous 17 years.
Joint Stock Companies
At the time, the idea of joint stock companies was reaching a degree of maturity. The first successful one was for the Dutch East India Company, which began in 1602 and was based in Amsterdam. The premise behind a joint stock company was that it enabled combining resources to generate greater profits. Trade with the newly discovered Americas was developing in earnest, but it was expensive. By combining resources, it was easier for those of more modest means to participate in the profits of these new ventures. Indeed this was the beginning of the success of the Dutch empire.
However, unlike gold which in its purest form is incorruptible, arrangements with paper are notoriously open to changes by influential people and, therefore, corruptible. While many of these schemes of the 1700s led to fabulous wealth for some, they led to ruin for others, and this has been the story of our banks and stock markets to this day.
Unlike the Bank of Amsterdam, which was a fully capitalised bank, by establishing itself with a fractional reserve, the Bank of England was essentially a joint stock company with a mandate to issue bank notes. As it had a remit from parliament, this eventually gave it a monopoly on the practice, even though there was some competition from other banks operating similar note issuance schemes at the time.
The essence of sound money began its corruption with the establishment of a fractional reserve by the Bank of England. The shenanigans associated with joint stock companies were just the next iteration of the problem, sending companies and now governments further into debt.
In an age where financial schemes were all the rage, and to meet their obligations in paying the outstanding government debt, the ingenious Mr Patterson came up with another one – The South Sea Company!
The Bank of England tried operating a lottery on behalf of the government to contribute to repaying the debt, but this was failing miserably. John Blunt, the Director of the Hollow Sword Blade Company – an unofficial bank attempting to compete with the Bank of England established in 1700, was more successful by promising a prize to every one of some value. Tickets cost £100, and the top prize was £20,000. The Hollow Sword Blade Company promised every ticket a prize of at least £10. This idea still exists today in the form of UK Premium Bonds.
In cooperation with Robert Harley, then Chancellor of the Exchequer, John Blunt decided to follow through on William Patterson’s suggestion to consolidate the outstanding government debt and arrange to repay it via the newly established South Sea Company.
The South Sea Company
The premise behind this scheme was that all holders of the outstanding debt would be required to surrender their claim to the new South Sea Company, which would issue shares to the same nominal value. The government would make an annual payment to the company of £568,279, equating to 6% interest plus expenses (undercutting the interest paid to the Bank of England), which the bank would then redistribute to the shareholders as a dividend.
The company was also granted a monopoly to trade with South America. This sounded great in principle and potentially lucrative; however, trade with South America was already controlled by Spain. England was only granted permission to send one ship of no more than 500 tons to be sent to the area each year. In addition to that, one-quarter of the profits were reserved for the King of Spain and another quarter for Queen Anne. The main cargo of this one ship was slaves.
The company depended on the government’s goodwill, and as the political seas changed, so did the directors. In the meantime, although parliament formed the company to consolidate government debt, it failed to make the required interest payments for two years.
The new parliament granted permission to issue more shares to the value of the missing payments. At around £10 million, this represented half the share capital issued in the entire country.
The first sign of difficulty came when the South Sea Company announced that it would defer its Christmas 1719 dividend for 12 months. The keep up appearances, the Company embarked on a show of gratitude to its friends. The Company sold select individuals a parcel of company stock at the current price. Without exchanging cash, the individual received an option to sell his stock back to the Company at any future date at whatever market price might apply. Lord Sunderland would gain £500 for every pound that stock rose; George I’s mistress, their children and Countess Platen £120 per pound rise, Chancellor of the Exchequer John Aislabie £200 per pound and Lord Stanhope £600 per pound.
John Law
In the meantime, one of William Patterson’s fellow compatriots, another Scot named John Law, an evolving financial genius and all-around scoundrel by many accounts, escaped prison in London after killing a man in a duel. He ended up in France and, with his charm, persuaded the Duke of Orleans, Philippe II, that he could solve the financial problems of France with a new bank. France was crippled with debt following expensive wars and the lavish expenditure of Louis XIV on the Palace of Versailles. His death in 1715 left his 5-year-old son Louis XV to rule under Philippe’s guardianship.
Drawing on the idea of the Bank of England, John Law suggested to the Duke of Orleans a bank that would issue paper money against the value of silver and gold. With this ‘guarantee’ of silver and gold value and the royal guardian’s seal of approval, the concept took off.
John Law then set up the Mississippi Company, which had trading rights in Louisiana. This company then issued shares to the public, which they could purchase with the newly distributed paper money.
Then instead of using the money raised to mine for gold in Louisiana as he said he would, John Law used the money to buy up massive amounts of government debt, offering the French government an interest rate discount.
In 1718 John Law then took over the French trade in Africa, and in 1719 he acquired the French trading rights to China, controlling all French trade outside of Europe.
John Law then persuaded the Duke of Orleans to take over the new bank making the King of France a principal shareholder and establishing the newly issued paper money as officially guaranteed by the crown. As CEO of this new bank, John Law sought the right to mint coins and the right to collect taxes. He also sought to buy all the debt of the French Empire. To afford all this, the Mississippi company issued more and more stock.
In 1720 John Law became France’s Controller General and Superintendent of Finance.
Given its assets, the Mississipi company must have seemed like a no-brainer investment to much of the French public. As such, shares in the company rose from 500 livres in May 1719 to 10000 livres in October 1719.
With more and more issuance of stock, the Banque Royale issued more and more paper money. Some holders of paper money wanted the reassurance of metal and so tried to convert their paper money back to silver and gold coins. However, by this time, the bank would need more than all the gold and silver in the French empire to cover the paper money that the bank had printed. The bank stopped converting the cash to gold and silver. It offered to convert the paper money to stock in the Mississipi company instead—the dramatic printing of money and paper money to share conversion led to rapid inflation. Average inflation rates went to an average of 23% per month by July 1720.
The End is Nigh
Back in England, the Directors of the South Sea Company looked on with interest and devised further schemes to reissue stock and buy up government debt. In fact, most of Europe was in a frenzy, buying up the stock of obscure companies. One famously advertised “a company for carrying out an undertaking of great advantage but nobody to know what it is”.
The South Sea Company stock’s price increased over a year in 1720 from £100 to almost £1000 per share. There was a feverish interest in investing, the likes of which many had never seen before. But then, as the situation in France started to deteriorate, those who saw an opportunity to cash out on their investment in South Sea Company Stock began to sell, including those who had bought shares on credit and those who were bribed with company stock at multiples of their face value. The price came crashing down.
Isaac Newton, then Warden of the Royal Mint, is famously meant to have said, “I can calculate the movement of the stars, but not the madness of men.” Numerous sources report that Newton lost £20,000 (equivalent to £3.68 million in 2023), but it is difficult to establish if this is true.
The collapse of the Mississippi bubble was the downfall of John Law, who ended up escaping from France in disgrace and dying in Venice as a pauper.
Resolution
Rumour has it that John Law was more disturbed by the failure of his ideas than the loss of his money. This has merit; after all, he was only trying to repeat in France what was already achieved in England – establishing an English Bank using a fractional reserve. The difference in Britain, though, was that the owners of the Bank of England had a longer-term vision and plan; and so were more moderate with their implementation. When the South Sea Company was set up to compete with them over government debt management, they watched cautiously as their competitor drove themselves to penury before the Bank of England was finally rewarded with 50% of the spoils (the outstanding debt) when the drama was over.
On the other hand, John Law was too reckless and ambitious and squandered his advantage too quickly and ruinously. He didn’t just try to manage the debt of France with a new bank but wanted to own the Mississippi company AND the entire debt of France. In England, the ruin of one (South Sea Company) meant the ultimate success of the other (Bank of England). If a monopoly on the issuance of currency was the goal, it was untenable in the grand plan for both schemes to win.
Although the collapse of the South Sea bubble followed the destruction of the Mississippi bubble, matters in England were handled much more cleverly. At the height of the crisis, company failures were extending to banks and goldsmiths, and the country was on the brink of ruin, including many members of the British elite. With investors outraged, The Prime Minister recalled parliament, and an investigation began, revealing widespread fraud and corruption. The newly appointed First Lord of the Treasury, Robert Walpole, successfully restored public confidence in the financial system. He removed all 33 company directors and stripped them of 82% of their wealth. The money went to the victims, and the stock of the South Sea Company was divided between the Bank of England and the East India Company. Walpole ensured King George and his mistresses were protected, and by a margin of three votes, he managed to save several key government officials from impeachment. By doing this, he rescued the government and the newly installed Hanoverian dynasty from total disgrace.
The South Sea Company consolidated its debt and continued operating under royal patronage to manage government debt until it was disestablished in 1853 when Gladstone again reconsolidated the debt.
Impact Today
Reconsolidating government debt appears to have become standard operating procedure since the establishment of the Bank of England. Today UK Government debt now stands at £2.5 trillion and is increasing exponentially. The scale of this debt creates less of a scandal today, though, as the situation has normalised in most people’s minds. The traumas of continuing wars and financial crashes have numbed the senses of the citizens of the world to the real issues as they try to handle their own complex lives.
George Osbourne finally paid off the debt of the South Sea Company (amounting to just under £2.5 billion) on 5 July 2015. By this time, the interest rate on the consolidated debt amounted to 2%. Even at this low-interest rate, compounded over 300 years, this debt will have made a tidy profit for the owners of the Bank of England and their heirs, whoever they are…
How Bitcoin Fixes This
When the price of Bitcoin was rising aggressively in 2017, many financial pundits were likening the price rise of Bitcoin to a ‘Tulip Bubble’ – a reference to a similar scandal which occurred in Holland 50 years before the South Sea Bubble. Detractors use such comparisons to deride those who compete to buy assets with no intrinsic value or those designed for more nefarious purposes through deceit, corruption and greed.
If we look carefully, however, we see that both the Tulip Bubble and the South Sea Company were the product of ‘legal’ agreements that could be superseded by other agreements which weren’t always fair or transparent but had a powerful narrative.
Bitcoin has a powerful narrative, and unusually for a new asset, unlike those in the past, it is the most fair and transparent asset that has ever been available in our known history. This fairness and transparency can only be appreciated – through an understanding of how the technology works – something I have attempted to explain in my book ‘Truth Decay – How Bitcoin Fixes This’ and in my video – ‘A Simple Guide to Bitcoin’.
Those who don’t understand how the technology works have their thinking tainted by some of these scandals of history, which were pertinent lessons. Ultimately they led to laws that crippled industry for a while – but that is another story…
What these scandals didn’t do, however, was change the newly established underlying nature of money. By this time, The Bank of England was well on its way to establishing its monopoly on the nation’s coinage and as bank notes were more convenient to transact with than gold and silver – their scheme was a success. If the population became aware of the unfairness of the situation, their options were remarkably limited; typically, they could only rely on trying to change the law to rectify the situation.
Not any more, however; Bitcoin finally gives us a chance to undo the monopoly and fractional reserve created by central Banks, and I will be exploring more of this story in the months ahead. In the meantime, though, do what you can to educate others and make them aware of these scandals, we may now have the power to rectify the situation, but our reasons to do so have been lost to our memories of the past.
Until next time enthusiasts
Victoria
Bitcoin Chat - August 2023
The development of Bitcoin is constantly evolving – In this latest video, I discuss some of the current issues surrounding Bitcoin with some of my colleagues on The World Crypto Network.