How Isaac Newton Lost $3 Million Dollars in the “South Sea Bubble” of 1720: Even Geniuses Can’t Prevail Against the Machinations of the Markets

The Aris­totelian notion of “man” as a “ratio­nal ani­mal” has seen its share of detrac­tors, from the Cyn­ics to Bertrand Rus­sell to near­ly the whole of Post­struc­tural­ist thought. Leave it up to Oscar Wilde to com­press the debate between intel­lect and pas­sion into a pithy apho­rism: “Man is a ratio­nal ani­mal who always los­es his tem­per when he is called upon to act in accor­dance with the dic­tates of rea­son.”

We no longer need clever ver­bal barbs to refute too-opti­mistic assess­ments of human behav­ior. Eco­nom­ics is catch­ing up: we have the lan­guage of neu­ro­science and psy­chol­o­gy, which con­sis­tent­ly tells us that humans decid­ed­ly do not behave ratio­nal­ly very often, but are dri­ven by bias and biol­o­gy in inex­plic­a­ble ways. And for over a hun­dred years now, we’ve known that the clock­work New­ton­ian view of the phys­i­cal uni­verse turns out be a much messier and inde­ter­mi­nate affair, as does the uni­verse of the human mind.

Why, then, has so much eco­nom­ic the­o­ry oper­at­ed with a kind of dogged Aris­totelian­ism, insist­ing that the units of cap­i­tal­ist soci­ety, the work­ers, man­agers, investors, con­sumers, own­ers, renters, spec­u­la­tors, etc. behave in pre­dictable ways? We have case after case show­ing that intel­li­gence and crit­i­cal rea­son­ing often have lit­tle to do with suc­cess or fail­ure in the mar­ket. In such cas­es, how­ev­er, one often hears the “mad­ness of crowds” or oth­er clich­es invoked as an expla­na­tion.

To illus­trate, mar­ket reporters and busi­ness writ­ers have seized upon the sto­ry of Isaac Newton’s spec­tac­u­lar rise and fall in the so-called “South Sea Bub­ble” of 1720. We find the sto­ry in Ben­jamin Graham’s 1949 clas­sic The Intel­li­gent Investor, a wide­ly-read book that attrib­ut­es the irra­tional­i­ty of mar­ket sys­tems to an anthro­po­mor­phic enti­ty named “Mr. Mar­ket.”

Gra­ham writes,

Back in the spring of 1720, Sir Isaac New­ton owned shares in the South Sea Com­pa­ny, the hottest stock in Eng­land. Sens­ing that the mar­ket was get­ting out of hand, the great physi­cist mut­tered that he ‘could cal­cu­late the motions of the heav­en­ly bod­ies, but not the mad­ness of the peo­ple.’ New­ton dumped his South Sea shares, pock­et­ing a 100% prof­it total­ing £7,000. But just months lat­er, swept up in the wild enthu­si­asm of the mar­ket, New­ton jumped back in at a much high­er price — and lost £20,000 (or more than $3 mil­lion in [2002–2003’s] mon­ey. For the rest of his life, he for­bade any­one to speak the words ‘South Sea’ in his pres­ence.

The quo­ta­tion in bold may or may not have been uttered by New­ton, but the events Gra­ham describes did indeed hap­pen. As the Wall Street Jour­nal’s Jason Zwieg relates, Uni­ver­si­ty of Min­neso­ta pro­fes­sor Andrew Odlyzko found that “New­ton had shift­ed from a pru­dent investor with his mon­ey spread across sev­er­al secu­ri­ties to a spec­u­la­tor who had plunged essen­tial­ly all of his cap­i­tal into a sin­gle stock. The great sci­en­tist was chas­ing hot per­for­mance as des­per­ate­ly as a day trad­er in 1999 or many bit­coin buy­ers in 2017.” (Odlyzko esti­mates New­ton’s loss­es clos­er to $4 mil­lion.) Per­haps it was not a metaphor­i­cal “Mr. Mar­ket” who cost New­ton up to 77% “on his worst pur­chas­es,” nor was it wide­spread “wild enthusiasm”—the mass move­ment of pas­sion that Enlight­en­ment philoso­phers so feared.

Per­haps it was New­ton him­self who, Ele­na Holod­ny writes at Busi­ness Insid­er, “let his emo­tions get the best of him, and got swayed by the irra­tional­i­ty of the crowd.” Maybe it’s more accu­rate to say New­ton suc­cumbed to greed when the bub­ble expand­ed. “Through­out his­to­ry,” Bar­bara Kollmey­er writes at Mar­ket Watch in her inter­view with author Richard Dale, “people—especially those at the top rung of society—have been greedy and gullible par­tic­i­pants in finan­cial bub­bles. And Sir Isaac New­ton was only human, after all.” (How many at the top rung of soci­ety fell prey to Bernie Madoff’s schemes? And a cen­tu­ry before the South Sea Bub­ble, hun­dreds of wealthy investors lost their shirts in the Dutch Tulip Bulb craze.)

Some busi­ness writ­ers, like invest­ment edi­tor Richard Evans at The Tele­graph, rec­om­mend a cal­cu­la­ble for­mu­la to avoid los­ing a for­tune in bub­bles, advice that takes ratio­nal agency for grant­ed. Per­haps it should not. In addi­tion to cit­ing the con­ta­gion of crowds, near­ly every dis­cus­sion of Newton’s fol­ly allows that a fail­ure of emo­tion­al dis­ci­pline played a sig­nif­i­cant role. Ben­jamin Gra­ham invokes anoth­er Aris­totelian notion—the idea that “char­ac­ter” counts as much or more than intel­li­gence when it comes to invest­ing. “The investor’s chief prob­lem,” he writes, “and even his worst enemy—is like­ly to be him­self.”

Far few­er com­menters note that the South Sea ven­ture was itself a fail­ure of char­ac­ter from its incep­tion. The com­pa­ny had secured an exclu­sive monop­oly on trade with South Amer­i­ca; much of that trade involved sell­ing slaves. It is also the case that the com­pa­ny arti­fi­cial­ly inflat­ed its stock prices, and col­lud­ed with sev­er­al MPs in insid­er trad­ing schemes. The so-called “Bub­ble Act” of Par­lia­ment in 1720, pre­sum­ably passed to pre­vent crash­es like the one that dev­as­tat­ed New­ton, turned out to be cor­po­rate give­away. The terms of the act had been dic­tat­ed by the South Sea Com­pa­ny in order to pre­vent oth­er com­pa­nies from poach­ing their investors. Although these cir­cum­stances are well-known to eco­nom­ic his­to­ri­ans, they rarely make their way into com­men­tary on Newton’s great loss.

Econ­o­mists instead tend to blame abstrac­tions for eco­nom­ic events like the South Sea Bub­ble, or they blame the over­reach­ing prof­it-seek­ing of investors, and maybe for good rea­son. The oth­er expla­na­tions haunt the mar­gins: the inher­ent­ly exploita­tive nature of most forms of cor­po­rate cap­i­tal­ism, and the cor­rup­tion and col­lu­sion between the state and pri­vate enter­prise that inhibits fair com­pe­ti­tion and makes it impos­si­ble for investors to eval­u­ate the sit­u­a­tion trans­par­ent­ly. For all of his sci­en­tif­ic and math­e­mat­i­cal genius, Isaac New­ton was no exception—he was just as sub­ject to irra­tional greed as the next investor, and to the preda­to­ry machi­na­tions of “mar­ket forces.”

Relat­ed Con­tent:

In 1704, Isaac New­ton Pre­dicts the World Will End in 2060

Isaac New­ton Cre­ates a List of His 57 Sins (Cir­ca 1662)

Sir Isaac Newton’s Papers & Anno­tat­ed Prin­cip­ia Go Dig­i­tal

Josh Jones is a writer and musi­cian based in Durham, NC. Fol­low him at @jdmagness

by | Permalink | Comments (0) |

Sup­port Open Cul­ture

We’re hop­ing to rely on our loy­al read­ers rather than errat­ic ads. To sup­port Open Cul­ture’s edu­ca­tion­al mis­sion, please con­sid­er mak­ing a dona­tion. We accept Pay­Pal, Ven­mo (@openculture), Patre­on and Cryp­to! Please find all options here. We thank you!

Leave a Reply

Open Culture was founded by Dan Colman.