Legends of the Mississippi and South Sea Bubbles have endured today as warnings against the fatality of irrational exuberance in financial markets. However, as details of these first financial crises are somewhat exaggerated, it has proven difficult for historians to separate fact from myth. The question remains as to whether investors behaved irrationally or sensibly in response to these events in the early eighteenth century.
It appears that a lack of investor sophistication and the adverse effects of herding are partly to blame for the unsustainable prices increases. Some argue that ‘irrational exuberance is the psychological basis of a speculative bubble’. However, many historians have rejected that investors acted in a fit of ‘irrational exuberance’, instead determining that they responded sensibly to the information available to them. It seems that a combination of these two theories would best explain the initial extraordinary popularity of these two schemes
It is important, before examining the events of the Mississippi and South Sea Bubbles, to approach the various definitions of the word ‘bubble’. According to the Dictionary of Political Economy (1926), the early modern definition of a bubble is as follows, ‘any unsound undertaking accompanied by a high degree of speculation’. This suggests that the investor basis his undertaking on an unwise or irrational assumption. However, Kindleberger appears to remove the presence of irrationality from the equation, defining a bubble as ‘an upward price movement over an extended range that then implodes’. It is therefore primarily unclear as to whether the very manifestation of a bubble presupposes the existence of investor irrationality.
Before categorising the victims of the earliest bubbles as either fundamentally sound or irrational, it is necessary to consider on what basis the speculators made their investments in the first instance. In economic booms, fraudulent behaviour increases and ‘swindlers’ come to the fore to exploit the greed of others. The primary purpose of the investment, genuine or fraudulent, could be an important factor in assessing levels of investor rationality. Speculators may have acted in irrational exuberance if they were susceptible to obvious swindles as opposed to those who participated in schemes that had (initially) honourable intentions.
Charles MacKay’s seminal work on popular delusions claimed that many historians of the time regarded John Law of the Mississippi bubble as ‘knave or madman’. Modern historians would argue otherwise and Kindleberger in particular maintains that the Mississippi bubble was not a swindle. Before his experimentation with paper money in France, Law had intentions for the same in his native Scotland. In Law’s Money and Trade Considered, he outlines the proposed supervision of the transition from specie to notes by a commission, accountable to parliament, with limited powers to coin notes, aided by a system of fraud...