The Greatest Scam You Never Heard Of
Spoiler alert: It isn't an MLM
Historically speaking, the United States has been the best place for people to start a scam. From the famous P.T. Barnum to the culturally ubiquitous 'snake oil salesman,' even continuing today in the form of MLMs, Americans have been some of the best at coming up with new ways to deceive others into giving them money. However, we shouldn't forget that before the United States was the United States, it was a colony of Great Britain. As such, it shouldn't be a surprise that we received our national affinity for the art of the scam from our progenitor nation across the sea, which concocted the greatest scheme in history just a few decades before the United States became independent.
Background
Let's start by setting the scene: the year is 1711, and the United Kingdom has been at war with a good portion of Europe for at least several decades now. What can you do? It was just that time in history when Europeans liked shooting at each other (mostly at France, but that's a whole other discussion). Anyways, the United Kingdom has been fighting across several continents almost continuously since 1688 and are in pretty bad shape financially, considering that wars are pretty expensive. However, no one in the government truly realized how bad the situation was until Robert Harley, the new Chancellor of the Exchequer (think Secretary of the Treasury), decided to try and figure out just how bad the crisis was. His official verdict: Britain's economy was totally screwed.
Harley's initial goal was to keep the government going for the next few months. But unfortunately, political deadlock made raising taxes impossible, so different solutions would have to be found. Unfortunately, that same political deadlock also prevented the Bank of England from extending more government loans, as the Whigs controlled it, and Harley was a Tory.
Foreign capital was also impossible to obtain since, you know, Britain was fighting most of Europe, and a nation's enemies tend not to want to offer it monetary aid during a war. So, out of desperation, Harley allied with John Blunt, a director of the Hollow Sword Blade Company(unfortunate last name for someone in the sword business, I know), the mastermind behind our scheme. To illustrate Blunt's financial talents and his willingness to do things that were almost certainly illegal, let's talk about ….
Blunt began loaning money to the government through his masterful scheme concerning land in Ireland. Essentially, the English had just seized a bunch of land from the Catholic Church in Ireland and was now trying to sell it; Blunt wanted this land for his company but did not have a lot of cash to buy the land upfront. This was quite the predicament, but Blunt put on his thinking cap and came up with an intricate and very, very illegal plot to get what he wanted.
You see, the army had a habit of issuing what were basically IOUs for all the goods they needed for the war effort. However, since the military is, you know, the army, it was pretty challenging to try and get them to actually pay you back for what was owed, making them basically worthless. So blunt then used the bit of capital his company had to quietly buy up a large quantity of these army vouchers. This might seem a little stupid at first, but that's because you, my friend, are not John Blunt.
You see, Blunt was planning on releasing news to the public that they could swap their army IOUs for stock in his company — a thing that had value. Because of this, the value of the army IOUs would then be directly tied to something with fair value, and the demand for them would increase, and when demand increases, so does price; since Blunt had already bought up a ton of IOUs before this announcement, then their value would begin to increase significantly. The final step of the plan came with one final caveat: since the army is a government institution, their IOUs were government-owned, just like the land in Ireland. Therefore, Blunt could trade Army IOUs to the government in exchange for Irish land at whatever price he had driven the Army IOUs to.
This scheme of Blunt's netted him a significant profit — something along the lines of 58 million 2020 US dollars (this is taking into account the price he drove the IOUs to and how many IOUs were purchased — most of this value was traded directly for the land). However, about 9% of this was cash that Blunt then loaned to the government, which helped protect him from many within the government who wanted to crack down on his illegal activities. Harley had found his partner in crime (and I do mean crime).
However, John Blunt had just gotten started — this Irish land scheme was functionally just the litmus test for the principle he had devised, called the debt-equity swap. It had been a rousing success. Soon, Blunt would put it to use on such a scale that it would make his profits from the Irish land purchase look like pocket change.
An Opportunity in the South Sea
So Blunt's debt-equity swap idea went off exactly as he planned, but he was now working with Harley to set in motion the gears for his next great scheme: The South Sea Company. So, do you remember how the United Kingdom is in massive debt at this time, and the Bank of England is doing nothing to help it due to partisan differences? Well, Harley and Blunt conceived of an institution that would allow them to effectively perform the role of the Bank of England, but under Tory control — an idea that almost certainly made Blunt dream about having a Scrooge McDuck pile of money to jump into.
Their plan was this: they would create a new trading company called the South Sea Company, and similar to how Blunt allowed people to exchange army debt for stock in the Hollow Sword Blade Company previously, they would allow anyone holding any government debt to exchange that debt for stock in the South Sea Company.
In exchange, the government would pay the South Sea Company for holding its debt at a rate lower than the initial interest the government was paying on the debt, which the company would then use to pay its shareholders a dividend.
Now, I know what you're thinking: why would anyone want to swap their government debt for stock in some random company and get paid less money for doing so? That's the thing, no reasonable person would … unless they thought that the value of that company would soon increase dramatically enough to make them more money than they originally loaned to the government. That is where John Blunt came up with his next idea: hype.
You see, the reason the South Sea Company was called that was because the government granted the company the exclusive right to trade in the South Sea, which is what the British referred to the Caribbean and the Atlantic Ocean as— a similar privilege that had been granted to the East India Trading Company regarding trade in the Indian Ocean. Everyone knew how massively wealthy the EITC had made its shareholders. Blunt was now presenting people with the opportunity to invest in the Next Major Trading Company (copyright of John Blunt, probably). Massive advertisement campaigns swept across the nation, with famous writers like Daniel Defoe (Robinson Crusoe) and Jonathan Swift (Gulliver's Travels) adding their voices to the mix. Everyone was ready to risk it all for the South Sea Company, making John Blunt one of the original hypebeasts in history (I'm kidding of course, hypebeasts have existed since the Phoenicians started hyping up Greek wine as the next big thing). For an apt comparison to our modern-day, think about a cryptocurrency: every time a new one launches, many influencers will try to hype it up even though it is useless and worth nothing — it's a dead ringer for the South Sea Company.
Now you might be thinking that this sounds like a legitimate trading business, right? Well, think again! John Blunt was not the kind of man to do things like 'have legitimate businesses' and 'not rip off the entire nation just to make a quick buck.' See, the British were currently involved in the War of the Spanish Succession, meaning they were at war with Spain. I'm sure I don't need to inform you that the Spanish had a massive colonial empire and possessed every major trading port in the Caribbean and Atlantic… making the exclusive right to trade there basically useless.
However, if you thought a silly little decades-long multi-continental war would stop our intrepid heroes from getting mo' money (and causing many mo' problems indeed), you were wrong! After a ton of lobbying, which involved getting John Churchill (a war hero) and Robert Walpole (a real bro who will become very important to this story in part 2) locked in the Tower of London, the British government was finally convinced to make a separate peace with the Spanish and French.
However, this put them in a much weaker negotiating position, as they were making peace separately from all their allies and thus could only secure meager gains from the war. Furthermore, the Spanish permitted the British to send exactly one ship a year to each port concerning trade with its colonies. You don't need to be good at math to know that that is not a lot of boats! And not a lot of ships means not a lot of profit.
But John Blunt had yet another trick up his sleeve! It's called lying. And lie he did, on a massive scale. You see, there was this looming threat of the Jacobites, a Catholic faction loyal to the deposed House of Stuart, and the return of the old monarch that could lead to a civil war. In 1715, James did stage a rebellion in Scotland that was promptly crushed.
Blunt saw an opportunity to get people super excited, so he started distributing rumors that the Old Pretender (James) had been captured. Of course, he had not been caught. But everyone was so excited and filled with patriotism that this threat had been dealt with that celebrations erupted across England, with many celebrations being sponsored by, you guessed it, the South Sea Company and John Blunt! And since everyone was so excited, they might as well buy some of the stock of this lovely little company, right? The price surged upwards from 100 pounds per share to 114 pounds per share.
Now I know what you're thinking: why is that a big deal as part of the scheme? Isn't that just how the stock market operates, with fluctuating prices? Usually, you'd be correct, but the South Sea Company worked a bit differently. Since it was taking on government debt and was essentially used just as a dumping ground for that debt, the government determined how much of their debt could be placed in the hands of the South Sea Company. This leads into the next idea, which is the debt-equity swap we discussed a few paragraphs ago; since people were swapping their government debt for shares in this company, the company needed to issue enough stock such that the total price of the stock issued was equal to the full value of the debt they were taking on.
This makes sense so far, right? Here's where the scheme comes in: the government assumed the price of South Sea stock was static, at only 100 pounds per share when they were doing the math of how much stock the company would be allowed to issue. At 114 pounds per share, they no longer needed nearly as many shares to cover the same amount of debt, so Blunt and his cronies just sold the extra and pocketed the cash for themselves.
This would be the first time they did this and would give them cash equal to approximately 1/7th the value of all the debt they had consolidated (which is a LOT of money). Pretty great plan, right? Herein lies the central plan behind the South Sea Company: the more debt they are allowed to take on, the more stock they can issue; the higher they can push the price of the stock, the fewer shares they need to keep, so they can sell off all the extra and make way too much money off of doing nothing but manipulating the market. The key to this was to let the company take on more and more debt so the scheme would scale up.
We've spent quite a long time discussing this grand scheme, but its story is only just beginning. Since it's getting too long to finish in one go, I'll be writing part 2 of this story, where I will discuss how the South Sea Company became "too big to fail," promptly failed, and how the aftermath of the company reshaped the fate of Great Britain. What dastardly tricks does John Blunt still have up his sleeve? You'll just have to wait and see!
A big thank you to the primary sources I consulted while writing these articles; please check them out if you'd like to learn more about this fascinating event in history!
