The Corner

{This is the third in a four part series on the development of stock exchanges.}

Most stock markets have quite a few dramatic stories to tell. In the Netherlands wild speculation with tulip bulbs—the bubble burst in the space of a few weeks. In those days (like today) many inexperienced investors lost their money. The crisis that was triggered in 1720 by the collapse of the Banque de France, which was even more serious than the tulip bulb crash. The head of the bank, John Law, a shrewd Scotsman, had proposed a risky theory of money.

Unrestrained creation of capital with the help of the printing press was his method. The failure of the bank brought down many other money houses with it. England experienced its first major securities scandal between September 1719 and August 1720—long before the founding of the official stock exchange there in 1762. That was exactly the time when John Law’s erroneous monetary theory brought calamity to the continental financial markets as England was seized by feverish speculation.

Then there was the scandal of the South Sea Bubble. The profit opportunities in the South Sea were claimed to be very good for companies of all kinds. New issues with a nominal capital of 220 million pounds were emitted. By comparison: the total share capital of the joint-stock companies existing in 1717 only amounted to 20 million pounds. The South Sea Bubble wasn’t much different from other bubbles and the whole scheme collapsed with many people duped in the deal. Most of the South Sea companies had no clearly defined business purpose at the time of the issue and the capital was subscribed for companies that were “soon to be named.”

The trading of future contracts was always one of the traditions at exchanges. At a time before phones, cars and rapid transportation, it was even more important because the movement of goods, just like the transport of documents and other post, could take an exceptionally long time. All those stock market traders not only wanted payment on the same day, but also by an appointed time in order to protect themselves against price fluctuations between delivery of the goods and the date of payment. This provided an opportunity to make above-average profits, while the risk of sustaining a loss became calculable.

The first actual stock exchanges were founded at a time when independent trading with interest notes was on the increase. Bonds issued by public debtors, so-called obligations, constituted the mainstay of trade. For states, countries and cities, the capital markets represented a completely new and anonymous source of money. In earlier times, they were always dependent on banking families such as the Fuggers. At the end of the 16th century Amsterdam started to overtake its not-so-distant counterpart, Antwerp. It was here that the first fixed-rate securities, as we understand them today, were traded.

The year 1602 saw a key event in stock exchange history: the founding of the Dutch East India Company and the “first ever share issue.” The shares in this company were traded publicly for the first time at differing prices in Amsterdam. In addition, the returns on the investment varied: this was a dividend, not an interest payment. In those days, the shares could not be traded so rapidly and easily as most shares nowadays—they were registered shares, not anonymous bearer papers—and trading was only conducted in the rooms adjacent to the Amsterdam goods exchange.

The first stock exchange in London was a goods market like that in Amsterdam: the Royal Exchange, which was founded between 1566 and 1570. Originally it was called “The Bourse” but then this term, imported from the European mainland, was replaced by the word “exchange” throughout the English-speaking world. The securities dealers gathered for many years in coffeehouses like Jonathan’s, Garraway or Berry Brothers. Coffeehouses were well suited places; traders have a reputation for sometimes needing something to increase their cruising speed.

But they did not just meet anyone and everyone over a cup of coffee: the members of the Royal Exchange refused admission to the securities dealers they didn’t like, namely the brokers—who speculated at their own risk. It was not until 1773 that the London Stock Exchange was built. Until that time the securities dealers had lived in a trading paradise because their activities were not regulated in any way.

In the late 1700s the London Stock Exchange, which, like almost every important institution in England, was a club that administers itself, imposed strict statutes upon itself. The number of stock exchange scandals declined as a result. But they still took place and are important in the public consciousness. In 1850 there was a collapse in railroad shares, in 1890 mining shares slumped and Barings Bank would have collapsed that same year if the Bank of England had not intervened. By 1900 many brokers and stock exchange member went bankrupt.

Quote of the Week: “The first eighth and the last eighth are the most expensive eighths.”—Jessie Livermore (referring to the attempt by many investors to buy a stock exactly at its bottom price and sell it at its top price.)

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

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