DEFINITION of ‘South Sea Bubble’
The South Sea Bubble, one of the largest stock scams of all time, occurred when the shares of the U.K.-based South Sea Company appreciated enormously based on rumor, speculation and false claims before plummeting and eventually becoming worthless.
BREAKING DOWN ‘South Sea Bubble’
The scam occurred in 1720 when South Sea’s stock soared in the wake of speculation about the company’s perceived monopoly to trade with Mexico and certain countries in South America.
With nothing to prevent it from doing otherwise, South Sea Company’s management continued to issue shares in response to seemingly insatiable demand and to publicize the trading opportunity as often as possible. As a result, the stock’s price soared, defying all fundamental sense, and enabling early shareholders to profit off the hype-fueled drive in market price.
Eventually, the truth was exposed: the company was making virtually no profit. There wasn’t much trade between Britain and South America because the region was controlled by Spain, whom with Britain was fighting in the War of Spanish Succession. In the wake of the news, which was leaked after management sold its shares upon realizing the stock was overvalued, the bubble popped and the share price plummeted as investors fled, costing thousands of people their life savings and weighing heavily on the British economy.
In the post-Enron investing world, some have dubbed the South Sea scam the “Enron of England” because of the way its creators preyed on regular people by feeding them misrepresentations.
South Sea Bubble vs. Mississippi Bubble
European investors in the early 18th century were eager to get their hands on corporate stock shares, which led to a frenzied buying environment detached from economic reality that expanded beyond the South Sea Company. Around this time, the Mississippi Company increased demand in its shares by playing up its French government-backed monopoly over trading with certain French colonies in North America, notably Louisiana.
In what would later be referred to as the Mississippi Bubble, the Mississippi Company exaggerated the potential market demand for trade in Louisiana by feeding off land development speculation in the still-being-colonized U.S. The hype caused the company’s stock to soar on an uptick in demand, which prompted the French government to authorize the printing of additional paper bank notes, which were used to pay out profits to investors.
In 1720, however, the French government admitted that the paper notes exceeded the value of its metal coinage and the stock price plummeted.