Famously, Sir Isaac Newton lost nearly his entire net worth--20,000 pounds, equivalent to about $4 million in today’s U.S. dollars--investing in one of the earliest stocks available. The South Sea Company was granted a monopoly by the British Crown in trade with Spanish South America in exchange for assuming the country’s war debt. Newton profited initially but kept buying on the way up, as the stock appreciated sharply, which cost him dearly when the shares collapsed to their original price.
Newton’s response, “I can calculate the motions of heavenly bodies, but not the madness of men,” tells half the story. Yes, investor irrationality does not lend itself to mathematics. Newton could not measure the temporary sanity of those who bought South Seas shares. But his math challenge went deeper than that. He also had no tools with which to gauge South Sea’s business prospects. The calculus solves many problems--but not that of estimating how much trade will be generated with the colonies of an opposing superpower.