[Global Issue+] When Did the Short Selling That Shook US 'GameStop' Begin?

Started in 1609 by the Dutch East India Company
Newton, the scientist who discovered universal gravitation, also lost his entire fortune

[Image source=Reuters Yonhap News]

[Asia Economy Reporter Hyunwoo Lee] Interest is growing in short selling, which has been identified as the cause of the 'GameStop' frenzy shaking the US and global stock markets. Although short selling has a relatively short history in Korea, having been allowed for institutional investors since the 1990s and thus not widely known, it is said to have started 400 years ago. It is even known that the genius scientist Isaac Newton, who discovered universal gravitation, lost his entire fortune due to it.

According to foreign media such as CNBC on the 30th (local time), the New York Stock Exchange closed sharply down the previous day amid concerns over overheating in the stock market caused by GameStop. The Dow Jones Industrial Average fell 2.03% from the previous trading day to 29,982.62, breaking below the 30,000 mark for the first time in a month and a half. The S&P 500 (-1.93%) and Nasdaq (-2.00%) also closed with sharp declines around 2%. Meanwhile, GameStop's stock price surged again by 67.9%. Since the beginning of this year until that day, GameStop's stock price has soared more than 1600%.

As a result, hedge funds that had engaged in short selling investments in GameStop suffered enormous losses. Due to the nature of short selling?borrowing stocks to sell at a high price and then repurchasing them after a price drop to return the shares?if the stock price soars, short sellers incur huge losses. To cover these losses, major US hedge funds began massive stock sell-offs in the US, European, and emerging markets, causing global stock markets to plunge simultaneously.

Such short selling is often called the villain of the stock market and is frequently criticized in the US as 'Wall Street greed.' It also drew worldwide attention during the 'Occupy Wall Street' protests in 2011 in the US. However, contrary to the perception that short selling became active only in modern society, its history is surprisingly long. It is said to have started 400 years ago.

400-Year History of Short Selling...First Started at the Dutch East India Company in 1609

A pictorial record depicting the Batavia branch (present-day Jakarta) of the Dutch East India Company in Indonesia [Image source: Dutch National Archives]

The history of short selling is known to have first been practiced at the Dutch East India Company. The Dutch East India Company, established in 1602, is recognized as the world's first joint-stock company. This company was famous for amassing enormous wealth through maritime shipping worldwide during the so-called Age of Discovery, which was characterized by long-distance oceanic trade.

At that time, long-distance trading ships were extremely expensive. To assemble a fleet, merchants had to hire trading ships, warships to protect the fleet from pirates and enemy forces, and troops, requiring vast financial resources. Therefore, Dutch merchants raised investment funds by selling shares, which were certificates allowing investors to share profits in dividend form if the trade succeeded after joint investment. This evolved into stock trading. The world's first stock exchange was established in Amsterdam, Netherlands, and various stock trading techniques emerged from this period.

Short selling was one of these trading methods. It was designed as a risk diversification strategy because long-distance maritime trade was fraught with many variables, especially Atlantic trade, which was notorious for Caribbean pirates, Spanish warships (Spain being an enemy country), weather anomalies, and fluctuating tariffs imposed by various countries, making risk diversification essential. Since its origin at the Dutch East India Company in 1609, it has been used as one of the trading methods in many countries.

Because short selling was essentially a trade that profited when others went bankrupt, it was condemned as a very cowardly practice in the Christian societies of Europe at the time. The Dutch authorities banned it, accusing it of inducing market crashes, but it was known to occur frequently. Especially when stock bubbles peaked due to the frenzied investments of individual investors, large institutional investors with ties to government elites often profited from short selling. Among the investors who suffered great losses was a historically well-known figure?the scientist Isaac Newton, known as the father of universal gravitation.

Newton Lost His Entire Fortune... "I Can Calculate the Motions of the Celestial Bodies, But Not the Madness of the Crowd"

Portrait of Isaac Newton [Image source= National Portrait Gallery, London website]

Newton is famous for losing his entire fortune investing in the stock of a company called 'The South Sea Company' in 1720. The social impact caused by this company was so enormous that it is still significantly covered in modern European history. This company was originally a public enterprise established to lead exclusive trade between Britain and its South American colonies. Since the Caribbean islands and the Mexico area between Britain and South America were territories of Britain and its enemy Spain, private trade was impossible, so a public enterprise was separately established to break through Spain's trade blockade and conduct trade alongside the British military.

However, Spain's persistent obstruction caused the South Sea Company to suffer enormous debts, and to resolve this debt problem, the company adopted a new strategy. It publicly sold some of its shares owned by the state to the public and used the investment funds to repurchase British government bonds. The British government actively supported the company's initial public offering (IPO) because it needed huge war budgets preparing for war with France.

The problem began when the South Sea Company excessively promoted advertisements to attract investment funds. They spread baseless fake news, such as the discovery of gold mines in South American colonies and obtaining silver mining rights from Spain and Portugal. As a result, the company's stock price, which started at 100 pounds in June 1720, soared tenfold to 1,000 pounds in less than two months. As the South Sea Company continued issuing new shares and selling stocks, not only ordinary citizens but also government officials began investing eagerly.

Newton, who was then the Master of the Royal Mint, was also tempted and made a huge investment in the company. However, after reaching a peak in August, rumors began circulating within the British government that high-ranking officials were selling their shares. Since the investment funds of the South Sea Company flowed back into British government bonds, many believed government officials would not do such a thing, which led even more individual investors to panic sell. Newton also enthusiastically invested, even borrowing money against his entire fortune.

However, by September, the bubble burst instantly. News spread that only bugs infested the South American colonies, and the stock price plummeted back to 100 pounds. Some high-ranking officials who had colluded with the South Sea Company and prepared short selling made huge profits but were driven out of office or imprisoned amid public outrage. Newton, who lost his entire fortune, left the famous quote, "I can calculate the motions of the celestial bodies, but not the madness of the crowd," which remains a key proverb in stock markets worldwide today.