Over two centuries ago, a single speculator set off a chain reaction that triggered a global financial panic. Perhaps surprisingly, that speculator was reacting to history unfolding thousands of miles away and his bet had effects across continents. Linking these events was a single commodity of great importance to 18th century trade, tea. The Crisis of 1772, as it would become known, led to policies that would change the way tea from India was imported into America. It was a seemingly benign outcome but its severe political and military consequences helped make a new nation.
British East India Company
There were many firms involved in the Crisis of 1772 but perhaps the most important to the background of the panic, if not the firm at its center, was the British East India Company. That company, established in 1600 with a monopoly on British trade with India could be justifiably called the most important firm in the world at the time. It imported valuable spices, textiles, tea and other products from India into Europe with increasingly diminished competition. However, the vast privileges it had came at a cost; the company was required to pay the British government £400,000 annually to maintain its monopoly. Following a treaty where it received the right to tax Indian subjects directly in 1765, it also had to pay the Mughal Emperor in Delhi £260,000 a year.
In addition to a hefty tribute to two states, the British East India Company also had extraordinary expenses. For one, there was the mounting cost associated with defending its rule in India as its private army grew to over 50,000 strong. The First Anglo-Mysore War of the late 1760s caused the company’s expenses to surge to £1.7 million from less than half that a few years earlier. This came just as a glut of tea following the imposition of new taxes in Britain caused sales to fall. Adding to the company’s trouble, a famine in Bengal slashed the tax revenue it expected to collect in India. Despite all this, the firm was regularly increasing its dividend, from 10% of paid-in capital in 1769 to 12.5% in 1771. There were, quite sensibly in the light of all this, some suspicions circulating about the mammoth company’s health.
Neal, James, Fordyce and Down
Whatever the condition of the East India Company, it was not the fuse that ignited the Crisis of 1772, that recognition would go to Alexander Fordyce. An entrepreneurial Scot, Fordyce left the family hosiery business to try his luck in finance, becoming a speculator and banker in London. It was there that he rose from humble clerk to partner at the relatively young banking firm of Neal, James, Fordyce and Down, founded in 1757.
Fordyce was among those who noticed the troubles mounting at the East India Company. Sensing a chance to profit, he used his position at his firm to place massive bets against the East India Company by short-selling its shares. Short-selling a stock, then as now, consists of borrowing a share and selling it at a high price with the intent of buying it back at a low price to return to its owner. If the price does in fact fall, the speculator profits from the difference. Borrowing the security can be costly so time is often of the essence.
In the end, Fordyce’s bet proved ill-timed. True, the East India Company was ailing but the speculator was short the stock just as it bounced in value following the company’s dividend increases. Dividend hikes are doubly troubling for short-sellers because they can both boost the value of the stock and simultaneously make it more expensive to borrow. Those dividends were so costly for the East India Company though that Fordyce would later be proved right about its perilous health. However, this would only be realized by others after any chance for Fordyce to profit had evaporated.
Following the dividend increases, the company’s share price rose to £226 in May 1771 after having fallen to £190 late the previous year. From there, it mostly traded sideways for about a year before a modest rise in the spring of 1772. That increase in the share price, of just around 5%, was enough to force a margin call. Fordyce, whose position lost money as the stock rose, was asked by his lenders to put up 10% more cash to make up for his losses, something he was unable to do. With that, Fordyce was bankrupt.
In the end, the speculator’s short position of somewhere around £1 million resulted in losses which exceeded £150,000 and were likely close to twice as high. Last minute requests for loans were not fruitful and Fordyce was unable to find a rescuer. One banker who refused to save Fordyce quipped “I have known many men ruined by two dice, but I will not be ruined by Four-dice.” It was the end, not just for Fordyce but for his firm. Neal, James, Fordyce and Down closed on June 10th, 1772, just a day after Fordyce fled to France leaving behind debts of perhaps £250,000.
The failure of Neal, James, Fordyce and Down kicked off a series of bank runs in Britain, leading to the collapse of at least two dozen other banks. At least ten financial firms in London failed within a week. The crisis damaged those banks with the most speculative investments; one of these was the Ayr Bank in Scotland, formally known as Douglas, Heron & Co. In fact, Scotland was particularly affected by the meltdown, in part because Fordyce’s firm was a large buyer of the short-term debt of Scottish firms, buying up £4 million in bills over the previous five years. In the ensuing credit crunch, a dozen banks in Edinburgh closed as did a few others in provincial Scotland.
Indeed, the Ayr Bank, which supplied Neal, James, Fordyce and Down with financing, was among the largest victims of the Crisis of 1772. It was a terrific loss to Scottish banking, being the largest bank in Scotland at the time and a creative one too. In response to whispers concerning its health, the bank offered a £100 reward to anyone who found the source of rumors about the bank’s solvency. Surely, a £1,000 pound reward would have done more to dispel the gossip. It was all for naught though as the firm closed on June 25th following a bank run, just two weeks after Fordyce’s firm was shut. Like Neal, James, Fordyce and Down, it was unable to find an emergency lender. It was very nearly too big to rescue; the bank had liabilities of £1.25 million, comprised 40% of total Scottish bank assets and 25% of the country’s bank deposits.
Among the factors contributing to the bank’s end was the curious nature of its equity capital. As part of the way it was established, the Ayr Bank’s investors were given credit lines by the bank in an amount equal to their paid-in capital. This blurred the line between debt and equity capital and made the bank more leveraged. The arrangement also meant that many of the firm’s shareholders were bankrupted by its collapse, having lost a lenient lender as well as their equity investment. Given that banking firms did not have limited liability in the 18th century, shareholders in firms like the Ayr Bank lost more than the value of their shares and had to make good on their banks’ losses by liquidating personal property if necessary.
The crisis had wider economic consequences as well. The failure of the banks meant that Britain’s nascent money markets froze. Great difficulty was encountered by merchants and industrialists trying to obtain short-term credit. This in turn caused trade to fall; imports to England and Scotland fell 14% from 1772 to 1773. Because many long-term projects were financed on the rolling of short-term debts, many investments in infrastructure like toll roads and canals, booming in Britain at the time, were put on hold.
Predictably given the financial and economic conditions, the credit crunch led to a notable rise in bankruptcies. Rather curiously, George Colebrooke, the Chairman of the East India Company itself, was another of the casualties. He was a failed speculator himself, and like Fordyce went bankrupt and fled to France, not exactly the most obvious hiding place for runaway tycoons today but evidently so in the 18th century.
“We are here in a very melancholy Situation: Continual Bankruptcies, universal Loss of Credit and endless Suspicions … even the Bank of England is not entirely free from Suspicion … The Carron Company is reeling, which is one of the greatest Calamities of the whole; as they gave Employment to near 10,000 people.” – the philosopher David Hume in a June 1772 letter to Adam Smith
The Crisis also has the distinction of being the first major banking panic faced by the Bank of England, which was then eighty years old. It was at very least the largest financial panic since the collapse of the South Sea Bubble fifty years earlier and many at the time thought this an even bigger crisis. The Bank did not see itself in those days as a lender of last resort. Though it did extend credit, it did so sparingly with an eye on its own capital. It did not save the Ayr Bank nor did it adjust interest rates, keeping its discount rate steady at 5% through the crisis. Nonetheless, by allowing precious metals to be drawn against securities posted as collateral, the Bank did provide crucial support.
The panic was no doubt felt most acutely in Britain but it had international repercussions too. The financial systems of neighboring countries were also affected, particularly in Sweden and the Netherlands. In the other great mercantile and financial center of Northern Europe, Amsterdam, the crisis took a similar shape to that in Britain. The country was faced with dwindling credit and sinking trade. Events there came to a head with the failure of the Anglo-Dutch bank Clifford and Sons, which had a history longer than even that of the Bank of England. The situation improved when the city of Amsterdam set up a cooperative fund backed by the Bank of Amsterdam and other Dutch banks to stem the crisis.
In Britain, there was still another problem, namely that of the East India Company, the very company whose perilous position helped set the stage for the pandemonium. Faced with a glut of tea and all the other problems previously mentioned, the firm was facing a cash shortage. To provide some breathing room, the directors of the company cut its dividend to 6% in late 1772, validating Fordyce’s investment thesis but offering him no other consolation. While the share price tumbled by a third over the next few months, the move occurred far too late for Fordyce.
As in Holland, the authorities in Britain resorted to government intervention, enacting policies that would have far reaching and perhaps unforeseen consequences. Among the legislation passed to save the ailing trading company was the Tea Act of 1773. Under the Act, intended to address the tea glut in Europe, the East India Company was allowed to directly ship and sell tea to the American colonies without taxation and without middlemen, giving them preferential access to a new market. This valuable concession was accompanied by a loan of £1.4 million at a low 4% rate provided to the company by the Bank of England.
The measures worked in stemming the crisis though, at least in Europe where the economic situation improved in 1773. However, in America, where the Tea Act would have extraordinary political consequences, the situation was only beginning to deteriorate. In the British colonies, economic conditions were already weak given the reduced trade and unavailability of credit caused by the banking crisis. This caused great harm to the agrarian elite in the Southern colonies as they relied most on credit and the trade in cash crops like tobacco. Indeed, many of America’s founding fathers were heavily reliant on credit from English and Scottish bankers who were now unable to simply roll over their obligations. Some regarded the imminent revolt in the colonies as a violent attempt at debt cancellation.
“Those vaunted demagogues, who nobly rose; From England’s debtors to be England’s foes; Who could their monarch in their purse forget; And break allegiance but to cancel debt.” – Irish poet Thomas Moore
The Crisis of 1772 had its more memorable effect in the Northern colonies however. In Boston, merchants were protesting the Tea Act, which in their view was a dire threat to their livelihoods. Prior to the Tea Act, much of the tea in the colonies was smuggled from the Netherlands to avoid taxation. With tea able to be imported tax-free by the East India Company, not only the smugglers but even legal importers were facing ruin. In revolt, merchants and other protesters disguised as Mohawk Indians boarded three ships, the Dartmouth, Eleanor, and Beaver, and tossed nearly 350 chests of tea into the frigid Boston Harbor. That event in December 1773 only decades later became known as the Boston Tea Party, but its ramifications revealed themselves far more immediately.
The events in London and elsewhere in 1772 are about more than just tea. The Crisis, one of the earliest banking crises in world history, reveals just how globalized the world was, even two and a half centuries ago. It revealed how a stock trade gone wrong triggered damage to economies on both sides of the Atlantic. The events leading up to and following the panic took place in Bengal, England, Scotland, Holland, and America, parts of the world thousands of miles apart. Naturally, the speed with which these events transpired were not as quick where oceans separated the parties involved, but these economies were undeniably intertwined nonetheless and provided an early lesson in financial contagion.
More from the Tontine Coffee-House
1. Book, Joakim. “What’s the Difference Between Michael Burry and Alexander Fordyce?” AIER.com, American Institute for Economic Research, 12 Nov. 2019.
2. Goodspeed, Tyler Beck. Legislating Instability: Adam Smith, Free Banking, and the Financial Crisis of 1772. Harvard University Press, 2016.
3. Kosmetatos, Paul. “Financial Contagion and Market Intervention in the 1772-3 Credit Crisis.” Cambridge Working Papers in Economic and Social History, 2014.
4. Kosmetatos, Paul. The 1772–73 British Credit Crisis. Palgrave Macmillan, 2018.
5. Robins, Nick. The Corporation That Changed the World: How the East India Company Shaped the Modern Multinational. Pluto Press, 2012.
6. Rockoff, Hugh. “Upon Daedalian Wings of Paper Money: Adam Smith and the Crisis of 1772.” National Bureau of Economic Research, Dec. 2009.
7. Smith, Adam. An Inquiry into the Nature and Causes of the Wealth of Nations. W. Strahan and T. Cadell, London, 1776.