The panic of 1825, the Sovereign Debt of a Made Up Country and Vampire Bats

From Winton Group:

In Quest of Aztec Gold
The panic of 1825 was the culmination of several years of euphoric investment in sovereign debt and precious metals that included one of the most remarkable swindles of all time: bonds sold in the name of a made-up country, called Poyais.

Armed with cheap banknotes and a romantic disposition, British speculators ventured deep into the jungle of Latin American investments during the early 1820s in the quest for the continent’s legendary treasure mines. Yet all they found were profit-sucking leeches and accursed pyramid schemes .

We fear that the folly of man is not subject matter for legislation.

Benjamin Disraeli

Tropical Delight After the Napoleonic Wars, the British government and Bank of England followed deflationary economic policies to restore the convertibility of Bank of England banknotes to gold at pre-war (1797) levels.

Parliament passed the Resumption Act in 1819 and the convertibility of BoE notes resumed in 1821, but country banks continued to issue unbacked paper notes. This surplus of cheap, unbacked credit fuelled domestic speculative investments in Latin American sovereign debt and mining stocks, and domestic joint-stock companies.

Nathan Rothschild

Nathan Rothschild, born in Frankfurt in 1776, emigrated to England in 1799 and spent the first ten years exporting textiles back to Germany. In 1809 he moved into banking and wholeheartedly dedicated himself to his new career, claiming ‘I do not read books, I do not play cards, I do not go to the theatre, my only pleasure is business.’ 

His big break came in 1815 when he was commissioned by the British government to help finance the renewed war effort against Napoleon, though this very nearly proved his undoing.

Anticipating a lengthy war, Rothschild had supplied Wellington’s forces on the Continent with vast quantities of gold for the purpose of buying provisions. So when Wellington vanquished Napoleon at Waterloo, ending the war sooner than had been expected, Rothschild’s gold became redundant and started to decline in value. 

Facing ruin, Rothschild took a desperate gamble by staking all the gold on a rise in Consols. The gamble paid off, allowing Rothschild to establish a bank and set himself up as a dominant player in London’s increasingly international bond market.

After gaining independence from Spain, several South American nations, starting with Colombia, issued bonds in March 1822. These became very popular amongst British investors as they paid much higher rates on interest than British government Consols and were issued at steep discounts. However, many of these issues were Ponzi schemes, whose proceeds went primarily to British ‘contractors’ with what remained often being frittered away on fighting wars with neighbouring countries.

Moreover, investors found it difficult to distinguish the more trustworthy issuers, so all the issues were similarly priced at punitively low levels. This meant that the market was dominated by low quality sovereign issuers such as Peru, rather than higher quality issuers such as Brazil which could resort to internal sources of funds or borrow more cheaply from a narrower group of knowledgeable investors.

Indeed, there was such little information on the issuers that in 1822 a fictitious country called Poyais was able to float a loan successfully on the London market, priced at almost the same level as the issues of real countries such as Chile and Colombia.

A Royal Stitch Up

Poyais royalty in quad, or the cacique waiting for bail’, satire on Gregor MacGregor

The Scottish adventurer Gregor MacGregor set himself up as the leader of a small, fictitious territory called Poyais (modern-day Nicaragua). His Highness MacGregor visited London in early 1821, intending to sell land rights and titles of nobility and encourage emigration to his country.

Finding a growing appetite for foreign loans, MacGregor arranged to float a £600,000 Poyaisian loan with a 6% coupon. The issue was a tremendous success, and the bonds sold at a hefty premium. In early 1823, 200 colonists arrived in St Joseph, the Poyaisian capital. Instead of the promised grand Baroque city, they found a malarial swamp surrounded by belligerent Indians. Only 50 colonists got back to Britain. MacGregor, meanwhile, fled to France with his family and the proceeds of the bond issue.

Montezuma's Mines

From 1824, there was also a boom in the securities of Latin American gold and silver mines. Investors were sanguine about what the application of British capital and mining expertise in these newly established countries could achieve, believing they had not been developed to their full potential under the Spanish, and were tickled pink by the claims of company prospectuses that neglected gold nuggets could be found lying everywhere.

Investors were also animated by a sense of the romance of those far-off lands; ‘When the grey haired merchant grew eloquent by his fireside about the clefts of Cordillera, where the precious metals glitter to the miner’s torch, it was not his expected gains alone that fired the eye’.

Britain’s recognition of the independence of Mexico, Buenos Aires and Colombia on 31 December took the mining boom to a new level. Writers were commissioned by mining companies to pen pamphlets which lavished praise upon their respective mines.

One of the most prolific pamphleteers was the future Prime Minister, Benjamin Disraeli, who confidently proclaimed on April Fools’ Day 1825 that ‘an immense and permanent rise is to be looked to’ in the mining market. By that time, however, mining stocks had become dangerously overvalued....

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