The Bear’s Lair: Are we in 1720?

Pessimists about the current state of the markets question whether we are in a stock market bubble, like 2000 or 1929. They are not thinking broadly enough. It is clear that when this nonsense bursts, the consequences of that bursting will be longer lasting and more fundamental than those of the burstings of 2000 or 1929. Those consequences will be much more like those of the burst twin Anglo-French market bubbles of 1720.

In both 1929 and 2000, the economy continued growing after the bubble. There were political changes after 1929 in the U.S. (but not in Britain) followed by a major war, but by the 1950s the U.S. economy had returned to a pattern of rapid growth in an essentially capitalist system. Only leftists called for a re-think of capitalism after 1929 (for example the future British ‘Conservative’ prime minister Harold Macmillan, who published in 1938 a book “The Middle Way” in which he advocated the abolition of the Stock Exchange). After 2000 no such re-think was even attempted. Thus, those two gigantic stock market crashes produced no fundamental re-thinking and delayed capitalism’s increasing prosperity by only a few years.

The outcome of the 1720 bubble was different, both in Britain and France, a fact that has been lost in the mists of time, so long ago did it occur. The crash was well remembered and understood a century later, as evidenced by (former Chancellor of the Exchequer) Lord Bexley’s paper for Lord Liverpool, the prime minister, after the similar 1825 crash: “The crisis which threatened us, and from which we have not yet completely escaped, seems to me more to resemble that of France in 1719, and of England in 1720, than anything which has happened more recently.” Later, for understandable reasons, it faded from institutional memory. However, a series of books since 1970 has to some extent rehabilitated it, albeit at the cost of making John Law, the instigator of the French disaster, a proto-Keynesian hero.

A clue to 1720’s difference comes in the Bexley quotation: the 1720 crash was like nothing seen later for the next century. That immediately separates it from modern crashes, which appear to occur about every ten years. However, the reason for the market’s strange century-long quiescence lies in the political reaction to the crash in its two epicentres, France and Britain.

In France, the Mississippi Scheme had involved a bank, the Banque Royale, which issued bank notes backed theoretically by land in the Mississippi region, recently colonized by France. When the bubble collapsed and the notes were found to be worthless, there was no bailout of any kind. This wrecked French credit (as well as the reputation of the Regent, Philippe d’Orleans) and made it very difficult indeed for France to finance its wars with Britain over the next century.

While its political effect was minor, France being an absolute monarchy (the Regent died shortly afterwards, by which time Louis XV was of age) the Banque Royale’s collapse ruined the French middle class and lower aristocracy who had put their savings either in the bank’s shares or its notes. The result was a hobbling of the French private sector, so that the modest economic development of the next half-century was state-financed with no “take-off” to industrialization. The crash also left a discontent among the politically active classes that led eventually to revolution. It was notable in 1789 that there was little conservative backlash to the revolutionary upheaval; the “ancien regime” had lost its popular legitimacy two generations earlier.

In Britain, the story was different. There was no massive state bank to collapse; the South Sea Company was a private company that had issued shares in exchange for a large portion of the outstanding public debt. There was a partial bailout, in the form of a Bank of England loan to the South Sea Company, that stabilized it and enabled it to continue in existence until 1853, paying modest dividends to shareholders. However, the political effect was considerable. The Bubble Act had been passed during the bubble to deter the South Sea Company’s competitors and remained in force until 1825. More important, the government, which had been a rather open and entrepreneurial Whig/Tory mix since 1688, was solidified into an oligarchic Whig one-party state under Sir Robert Walpole.

The new Whig oligarchy was corrupt and deeply repressive; its legislation included the 1723 Black Acts, which imposed capital punishment for over 100 new working-class crimes. It was also deeply protective of established corporations such as the East India Company, which grew during this period into the corrupt behemoth that Adam Smith so deplored half a century later. The Bubble Act, which to 1825’s Attorney General John Singleton Copley seemed almost meaningless (hence he had no problem with abolishing it) was used to prevent the formation of new public companies, and to suppress the economy into a state of deep senescent slumber. Only after 1760, when a new pro-Tory King George III opened the political system to competition, did new money, new ideas and successful working men begin to emerge. The 40 years of Whig slumber (which was only fully reversed under the Younger Pitt after 1783) successfully prevented the formation of any further full-scale bubbles for over a century (though there was one in the insurance sector in the 1770s). However, it also slowed the emergence of industrialization for around 50 years.

For example, in the most important of all technologies for the early Industrial Revolution, Thomas Newcomen’s “atmospheric engine,” the first steam engine to achieve wide usage, was developed around 1712. However, because of its size and inefficiency, Newcomen’s engine was only truly cost-effective in pumping the water out of mines, using huge amounts of coal (cheap in most mining districts) to do so. Textile mills and railroads, the main early adopters of steam power, were mostly located near mines and could not economically use Newcomen engines. Nevertheless, it was almost 70 years before James Watt developed the condenser, producing his first radical improvement on the Newcomen engine around 1781 that allowed the engines to spread more broadly, being smaller, more fuel-efficient and more flexible. Even after this, engines on the original Newcomen design continued to be installed throughout the 1780s. Overall, only around 450 of the 2,200 engines built in the entire 18th Century were of the improved Watt design; the majority remained Newcomen engines or minor modifications thereof.

Thomas Savery’s engine of 1698 had given way to Newcomen’s engine only 14 years later, and indeed Savery’s patent interfered with Newcomen’s sales. Nevertheless, Newcomen died in obscurity in 1728, and the post-1720 innovative climate in Britain and elsewhere was so dozy that Watt’s technically fairly modest improvement took almost 70 years to appear, delaying full industrialization until the 1790s and beyond. Thus the 1720 crash had a far greater structural impact than the later crashes of 1929 and 2000, freezing existing economic and even technological structures in place for half a century. (It was also somewhat larger, relative to the economy; the South Sea Company’s peak market capitalization was about £200 million, or twice Britain’s 1720 GDP.)

It seems likely that the collapse of the 2020 stock market bubble, which will almost certainly be followed by the bankruptcy of the U.S. social security and Medicare systems in the late 2020s, will lead to a period of political and economic blight lasting several decades, as after 1720. As in 1720, the free market system will be discredited, because millions of people will have lost money in the collapse. As in 1720, major institutions of the government (Social Security and Medicare) will be involved in the collapse, so repairing them will be the primary goal of policymakers.

As in 1720, there is also a good chance, either this year or in one of the 2020s’ subsequent elections, that one party (the Democrats, led by their powerful left faction) will cement itself in power by appealing to public disgust with markets and Millennials’ inchoate attraction for socialism. This will cause economic progress to stall or go into reverse. As in 1720, once the policies of the new regime have been enacted, they will be very difficult to reverse, and some of them (in this case, ultra-high taxes, big government, greenery and unrestricted immigration) will worsen and perpetuate the economic problems. Based on the 18th Century timetable, we cannot expect even the beginnings of a respite before 2060 and will not get the renewal of economic progress in full force until about 2085.

Unlike in the 18th Century, which could console itself with the Hallelujah Chorus and Rule Britannia, we will not even have the benefits of good music to tide us over the multi-decade slump.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)