Stock markets appear to have begun with the Italian city-states during the Renaissance as a result of municipal and papal debt issued to finance the defense of the cities and their trade routes. Florence established a Monte Commune and Genoa the Banco di San Giorgio in the fifteenth century for the regular payment of interest on the forced loans extracted from the leading citizens. In lieu of repayment of the loans, the cities kept ledgers to allow the original creditors to cash out by selling their claim to a third party. Notarial records in both cities show that a secondary market in city debt existed, but was tightly controlled by city authorities and probably confined to local citizens and institutions. The rise of specialized traders catering to a diverse customer base definitely occurred in Amsterdam when the shares issued by the Dutch United East India Company (Vereenigde OostIndische Compagnie, or VOC) in 1602 were made unredeemable by the directors of the company in 1609. Even though the capital stock of 6.44 million florins was dispersed among the six Dutch cities participating in the East Indian trade, half was allotted to Amsterdam, which became the stock market of choice for dealing in the largest single security available to investors throughout Europe. As no voting rights were given to shareholders, there was no reason for the authorities to restrict trading in the shares. The shares rapidly became valuable as collateral that could be posted by merchants for loans of varying duration for any kind of venture. Lenders holding VOC shares as collateral then purchased options from stock traders to ensure the future value of the collateral in case of default by the borrower. By the middle of the seventeenth century regular cash dividends began to be paid, adding another incentive for outside investors to purchase the shares and maintain their value. Despite the profitability of the VOC over the nearly two centuries of its existence (an average annual dividend of 25%), its capital stock was never increased due to the company's diffused governance structure.
In 1688 the Glorious Revolution in England brought William III (1650–1702) to the throne of England, along with his Dutch advisors and financiers. To meet the pressures of war finance, William chartered the Bank of England in 1694 and then a New East India Company in 1698, both on the model of the VOC in Amsterdam in terms of accounting for transfers of stock and payment of semiannual dividends. These two large chartered companies created the basis for a stock market in London similar to what existed in Amsterdam. The South Sea Bubble in 1720 further increased the marketability of government debt issued in unprecedented quantities in the War of the Spanish Succession (1701–1714), by converting various fixed-term annuities paid to specific individuals into easily traded shares of the South Sea Company. Government debt in the form of tradable, perpetual annuities bearing fixed interest was issued in 1723 after the collapse of the South Sea Company, paving the way for expansions of government debt in each succeeding war of the eighteenth century in the form of Three Per Cent Consolidated Annuities.
STOCK EXCHANGES FROM THE EIGHTEENTH CENTURY
The three conditions necessary for viable stock markets—a large mass of homogeneous tradeable financial assets, a large and diverse set of customers, and an effective set of rules for trading among specialists who service the needs of the customer base—first emerged in Britain at the end of the eighteenth century. Foreigners were specifically allowed to hold shares in all the chartered companies as well as to own British national debt. The process culminated with the Napoleonic Wars at the beginning of the nineteenth century, when a formal organization that became known as the London Stock Exchange was created in 1801.
From an initial membership of 540 members the London Stock Exchange grew to a peak of over 7,500 members in 1907. Its success in marketing the British government debt that financed eventual victory over Napoleon Bonaparte (1769–1821) by 1815 led to numerous imitators in countries whose governments were involved in expensive wars. Most striking was the forerunner of the New York Stock Exchange (NYSE), whose informal origins date to 1792 when twelve brokers agreed to deal only with each other for minimum commissions when trading the new U.S. Federal Government debt created by Alexander Hamilton (1755–1804). After the restoration of Louis XVIII (1755–1824) in France, the Paris Bourse was reorganized to create a market in the new Five Per Cent Rentes created by the French parliament—finally taking up the British financial innovation a century later. Even the kingdom of Prussia created a stock market in Berlin that was limited to dealing only in Prussian government debt during the Napoleonic Wars.
As the government debts that formed the basis for active trading on the Atlantic world's stock exchanges at the beginning of the nineteenth century were paid down from 1815 to 1848, the various exchanges encouraged the appearance of new financial assets, most importantly the debt issued by governments in new states emerging in Central and East Europe and out of the remains of the Spanish Empire in Latin America, and by the individual states in the United States to finance internal improvements. Subjected to frequent and sometimes widespread defaults, the new government debts formed a dubious basis for the major stock exchanges. The railroad boom of the late 1840s in Britain, however, created the basis for continued expansion of the London Stock Exchange for the remainder of the nineteenth century, especially as railways were built around the world in areas of British settlement. The Paris market expanded as well, focusing more on railroads in continental Europe culminating in the trans-Siberian railway. By 1914 railroad securities dominated most stock exchanges, with U.S. railroad stocks and bonds traded actively across regional exchanges in the United States and across most European exchanges.
MARKETS SINCE WORLD WAR I
The outbreak of World War I, however, forced all the stock exchanges in the world to close during the last week of July 1914, signaling the end of the first global capital market that had arisen fitfully over the previous century. As the markets gradually reopened to meet the needs of war finance for the various belligerents, they were subjected to strict controls on foreign exchange and dealings with foreigners. The great increases in government debt by the main powers meant that the business of stockbrokers, especially in London, Paris, and Berlin, reverted back to the practices of Napoleonic times. The main business again was dealing in fresh issues of government debt; interest in railroad, industrial, or commercial securities waned, save for sectors expanding to meet the demands of military expenditures. New York, by contrast, benefited from the large-scale repatriation of U.S. securities, especially railroad securities. Alone among the world's leading exchanges during the interwar period, the NYSE actually increased its membership, adding 25 percent to its 1,100 seats in 1929. The crash of October 1929 and the resulting government regulation of the U.S. stock exchanges limited further growth of the NYSE while forcing many regional exchanges to close.
The massive expenditures of World War II and the continuation of high levels of government debt afterwards maintained prosperity for the stock exchanges of the United States and Western Europe in the 1950s and 1960s. But due to general controls on the export of capital under the Bretton Woods system, national stock exchanges did little to promote international flows of capital. Rather, they served as the focal point for mergers of domestic companies to create national champions. With the breakup of the Bretton Woods system of fixed exchange rates in 1971 to 1973, however, disintermediation in the form of massive withdrawals from domestic banks, led to financial innovations that focused on bringing new financial products to the various stock exchanges, starting in the United States. Technological changes also led to the rise of a computer-linked, nationwide over-the-counter market in a wide range of securities that quickly came to rival the NYSE in volume and efficiency.
SEE ALSO Capital Flows; Finance, Credit and Money Lending.
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