Friday, April 27, 2012

The Original Cato on Crony Capitalism

In some previous posts, I alluded to a series of essays by Thomas Gordon and John Trenchard on the general topic of liberty. Originally written for magazines between 1720 and 1723, these essays were later collected and published in book form. They became immensely popular among our nation's founders. They not only make great reading supporters of the "Tea Party" movement, but also establish a good Presidential campaign theme that Mitt Romney should wisely adopt--liberty verses power.

The series began, coincidentally enough, because of an eighteenth century financial meltdown caused by an early example of "crony capitalism" involving the British treasury and the South Sea Company.

South Sea Company was formed in 1711 by British Lord Treasurer Robert Harley. The company received a charter from Parliament granting the company a monopoly on trade in the South Seas, which in those days referred to the Spanish colonies of  Latin America. (The British government commonly chartered trade monopolies in that era. The East India Tea Company of the infamous 1773 Boston Tea Party remains the most well-known.) In return, the British government planned to secure revenue from duties collected on goods imported into Britain from South America by the South Sea Company.

The whole arrangement rested on securing favorable trade concessions from Spain in the peace treaty ending the Wars of Spanish Succession. The company expected Spain to open its South American provinces to trade. When that treaty ended the war in 1713, however, the resulting terms proved to be not very favorable. The treaty permitted only one trading ship annually from the South Sea Company.

Robert Harley had less innocent intentions for the company as well. He planned on using the company to fund part of Britain's national debt. The plan worked like this:

The company issued new stock. The government persuaded holders of £10 million of the national debt to exchange their notes for this company stock, transferring their holdings of government debt to the South Sea Company.

In this way, the company not only earned money from the sale of imports from South America., but also secured a steady income in the form of payment of interest on the debt by the British government. This initially amounted to over £500,000 a year of government payments added to the company's books.

Shareholders in company stock received profit from the company earnings derived from trade and the interest earned as the government paid down its debt. Or they could sell their shares if the stock price increased.

Finally, the government raised money through duties collected on imports from South America. The government planned to use the revenue to pay down the debt owed to the South Sea Company and to other holders of government debt.

The plan appeared to be working well enough for the South Sea Company to take on an additional £2 million of government debt in 1717.

The South Sea Company and the British government made a fatal calculation, however, in 1720. The company arranged with Chancellor of the Exchequer John Aislabie to transfer half the government debt—an amount exceeding £30 million to the South Sea Company in exchange for new issues of stock shares. This proved to be the beginning of the “South Sea Bubble.”

The company “loaned” shares to stock to members of Parliament to secure their continued support. The company featured the names of prominent investors in its publicity campaign to attract more investors in the company. As the shares of company stock soared throughout 1720  from £150 per share to over £1000 per share, many investers came aboard with borrowed money.

Of course, anyone can guess what happened next. The spike in stock price eventually sparked a massive sell-off. This caused the value of the stock to plummet, ruining thousands of investors. Parliament began an investigation while treasury officials attempted to restore public credit.

On 12 Novermber 1720, Thomas Gordon published the second of Cato's Letters. The became the first in a series condemning company officials and government ministers for the debacle.

Gordon wrote,

"I think it would have been a symptom of wisdom in us to have chosen rather to fall by the hand of God, than by the execrable arts of stock-jobbers: That we are fallen, is a sorrowful truth, not only visible in every face which you meet, but in the destruction of our trade, the glory and riches of our nation, and the livelihood of the poor."

Gordon demanded vengence without mercy on the company executives involved:

"As never nation was more abused than ours has been of late by the dirty race of money-changers; so never nation could with a better grace, with more justice, or greater security, take its full vengeance, than ours can, upon its detested foes"

And what sort of vengence? The gallows!

"Sometimes the greatness and popularity of the offenders make strict justice unadvisable, because unsafe; but here it is not so, you may, at present, load every gallows in England with directors and stock-jobbers, without the assistance of a sheriff’s guard, or so much as a sigh from an old woman, though accustom’d perhaps to shed tears at the untimely demise of a common felon or murderer. A thousand stock-jobbers, well trussed up, besides the diverting sight, would be a cheap sacrifice to the Manes of trade; it would be one certain expedient to soften the rage of the people; and to convince them that the future direction of their wealth and estates shall be put into the hands of those, who will as effectually study to promote the general benefit and publick good, as others have, lately, most infamously sacrificed both to their own private advantage."

Gordon suggested that until such justice is measured out, public confidence and a restoration of commerce and industry will lag.

"The resurrection of honesty and industry can never be hoped for, while this sort of vermin is suffered to crawl about, tainting our air, and putting every thing out of course; subsisting by lies, and practising vile tricks, low in their nature, and mischievous in their consequences."

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