The First Modern Financial Crises: The South Sea and Mississippi Bubbles in Historical Perspective

Abstract

The twin South Sea and Mississippi bubbles of 1720 inaugurated the new age of modern finance. Both of the then recently launched British and French stock markets experienced manic run‐ups and crashes that shook their societies to their cores. While the historical consensus attributes these market bubbles to, in the words of John Kenneth Galbraith, “insanity born of optimism and self‐serving illusion,” the authors present a more nuanced view. Whatever their role in the bubbles, human folly and greed in this account are not allowed to obscure the powerful influences of institutions, interests, ideologies, and government policies both in giving rise to the crises, and in responding to them.The authors draw on past work and recent analysis to answer questions like the following: Were the market manias of 1719‐20 in fact irrational “bubbles?” If not just fear and greed, what triggered the crashes in 1720? Did political and financial leaders respond appropriately? And how did the resolutions of these crises affect the future financial and economic development of the two nations?In viewing the twin crises of 1720 from a broad historical perspective, the authors' aim is to discover and articulate a more general rule about the role of modern financial crises in “bending the arc” of history. Although powerful states and financial authorities have the potential to accelerate valuable innovations that end up increasing national productivity and wealth, such entanglements of politics and commerce are also liable to catastrophic outcomes, both in laying the grounds for crises and then in responding to them with misguided regulation.The effectiveness and long‐run consequences of such state interventions in commerce are shown to depend on the strength and soundness of a nation's political and social institutions. In unstable and inefficient regimes, which are likely to experience misguided interventions in the first place, the social ramifications can be profoundly destructive. The flawed but effective British reaction to its 1720 crisis—and to the series of banking crises that followed in the 19th century—worked to mollify and win over public opinion, and thus contribute to Britain's continued embrace of financial institutions. By contrast, the outrage of the French populace at the corruption led to the abandonment of modern financial institutions and practices for nearly a century, and to a vilification of banks and bankers that persists to this day, all with major consequences for French productivity and wealth.