The Corner

This is the first in a four-part series on the development of stock exchanges.

Stock markets exert a fascination over everyone. Outsiders watch with bewildered awe how share prices move up and down of no apparent rhyme or reason. Many consider stock market players to be mad, to a greater or lesser extent. Some economic theories regard the stock exchange as a close to ideal market. They believe that the interplay of supply and demand creates a just price, or so they tell us, a price undistorted by governmental or fiscal intervention. In any case, this perception is thought to apply at the world’s leading stock exchanges, where supply and demand is sufficiently large. For those who enjoy mathematics and statistics because of the link with the mysticism of numbers, the stock market has unbeatable attractions: they can immerse themselves in the arcane doctrine of chart analysis and attempt to make reliable predications about the short and medium-term movement of shares on the zigzags and curves they followed in the recent past. Reliable? Skeptics and rationalists — they are most commonly found among the analysts who closely follow the fortunes of companies and industries — point out the inaccurate forecasts of the chartists, their favorite enemies, but with whom they work together rubbing shoulders.

In Charles Geisst’s book “Wall Street: A History” he states, “Wall Street has a long and varied history, full of colorful vignettes and wheeling-dealing. Almost from the moment that the market was organized out-of-doors in the eighteenth century, it has been a symbol of the best and worst finance has had to offer. It has become known for its scandals, avarice and greed on the one hand and ingenuity and even patriotism on the other. At times, it is impossible to live with, while at others, impossible to live without.”

For those who like aphorisms, the stock exchange has enough to offer: “If you want to eat well, buy shares; if you want to sleep well, buy bonds,” “Sell on good news,” “Sell in May and go away.” For every situation there’s a wise or not so wise saying. It seems appropriate at this point to draw attention to a previously unnoticed fact: trading in shares has, with the passage of time, entered a close symbiosis with biology. That involves not only zoology — the stock exchange is where “bulls” fight, speculating on rising stocks and “bears” who put their money on the opposite — but also botany.

How this relationship came about cannot be easily explained. It is certain that the traders developed a liking for large trees at their place of business. In many towns stock trading was transacted under the protection of trees. In 1792, 24 traders came together in New York and agreed to meet regularly under a tree at 68 Wall Street in order to do business. Four hundred years earlier something very similar occurred in Flanders (Belgium); the traders there met in front of the house of the Van der Buerse family in Bruges. Trading under an open sky, exposed to the elements and a risk of getting soaked probably made them all appreciate the wisdom of being on one’s guard, of establishing fall back positions, and of being able to abandon positions rapidly.

There was not only danger from the market itself: The business community in all the countries of the Christian western world always had outside influences to contend with. The most important of these was the provisions of usury by the church. In theory, this outlawed all interest payments even if they were not usurious at all. But religions are powerless in the face of fundamental principles of business: if there’s no interest, there’s no capital to lend. Moreover, interest payments always represented an incentive to compensate for the sometimes considerable hazards that existed along both major and minor trade routes in the form of pirates, robbers, swindlers, natural disasters and the effects of war.

Resourceful merchants in northern Italy thus developed the bill of exchange. The value of this invention cannot be overestimated. It originated in the 12th century and consequently this period is referred to as the “century of the commercial revolution.”

The bill of exchange grew in the Middle Ages to become the most important financial instrument in international trade. The underlying idea is a simple one: the buyer of, say, a cart load of wheat, gives the seller a bill of exchange. The latter then goes to his “bank” — in the 12th century the leading traders were also bankers — and requests that the sum agreed be paid to him. Because the banker takes a proportion of the total as a handling fee, this means that bill of exchanges are “discounted.” At the end of a specific period, generally 90 days, the issuer of the bill of exchange has to pay the full sum to the bank.

If the bank is in, say, Milan, and the buyer has resold the wheat in Barcelona, he can go to a partner bank of the Milan banker in Barcelona and redeem the bill of exchange. This was an important step in the development of the stock market for it has two consequences: firstly, there is a huge transfer of money between current accounts, with credits and debits being constantly balanced against each other as cashless transactions. Secondly, the bills of exchange result in a completely new kind of debt note that can also be traded independently: securities.

To do business, you need credit. This became possible in a simple, standardized way with the bill of exchange. It formed an essential part of the history of the stock market. At the main trade centers in Europe. More next week.

Quote of the week: “The basic objective of every account should be to first show a net profit. To retain profits you must sell and take them” —Joe Kennedy

Bart Ward is the chief executive officer of Ward & Co. Ltd. an Anoka-based registered investment adviser – specializing in the management of stock and bond portfolios in companies which are listed on the NYSE.

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