Stock Exchanges since 1960
This article is adapted from the book being prepared to commemorate the WFE’s 50th anniversary. The book is based on a dozen essays, reflecting on transformations of various sorts – trading floor to screen, member cooperative to demutualized company, starting a regulated market from scratch, the value of regulation, the effects of deregulation, etc.
The book’s purpose is to examine the various roles exchanges play in public life, and the ways in which they have contributed to the growth of capital markets over these decades.
Essays from the WFE’s jubilee book will be featured in Focus, and publication is due to coincide with the October 2010 General Assembly, to be hosted in Paris by NYSE Euronext.
Exchanges and the World Economy since 1960
‘Singing the praises of Stock Exchanges is a thankless task, and one that falls upon deaf ears. The very nature of its functions makes dull reading. It cannot hope to enlist the lively enthusiasm of the causal observer, nor has it picturesqueness to brighten the pages of history. The layman visits the great exchanges as a matter of course; the scene is animate and diverting; he sees the outward manifestations of energy and movement, but too often he misses the great silent forces at work. The eye has a fine time of it, but the intellect comes away empty.’
W.C. Van Antwerp, The Stock Exchange from Within [New York 1913] p. 387
So wrote W. C. Van Antwerp on the eve of the First World War. He was attempting to justify the role and importance of the New York Stock Exchange to a doubting public, in the wake of recent scandals and crises. Such a task had never been easy, as it met a long-standing suspicion of anything connected with those who stood between the buyer and seller, and a deep-seated antagonism towards those whose business involved money itself.
Countering such suspicions and antagonisms was to become harder in the years to come, in the face of financial and monetary turmoil between the two world wars. No less an economist than Keynes gave legitimacy to views sceptical of the value of stock exchanges. In his General Theory, which appeared in 1936, he equated stock exchanges with casinos. ‘When the capital development of a country becomes the by-product of the activities of a casino, the job is likely to be ill-done.’ He then offered the following advice: ‘It is usually agreed that casinos should, in the public interest, be inaccessible and expensive. And perhaps the same is true of Stock Exchanges.’ This association between speculation and stock exchanges has continued to blight the way they are regarded, as can be seen from the judgements expressed by the eminent US economist, Robert Schiller. To some, exchanges are marginal, as it is banks that occupy the central role in the finance of economic activity along with the interaction of buyers and sellers in a marketplace regulated by governments. To others, exchanges are evil, being places that allow gamblers to bet on the rise and fall of individual stocks. There are also those who regard exchanges as dangerous because of the influence they exerted over the behaviour of business, resulting in short-term profits being given priority over long-term strategy. For these reasons few have been willing to link exchanges and economic growth.
The Nature, Role and Use of Securities
Key to understanding exchanges and the roles that they perform is the nature of the financial instruments for which they provide a market. Though exchanges did host trading in a variety of products and assets, the most specialised and sophisticated were those focussing on financial instruments, especially securities in the form of stocks or bonds, and variations of these. Though often seen as identical, there were fundamental differences between them. Stocks were sold by companies to investors in order to finance their operations, and comprised their capital base. Ownership of stocks gave investors both a degree of control over the management of a company and the right to share in any profits generated. In contrast, bonds were issued by both companies and governments and promised investors a guaranteed rate of interest. As long as that interest was paid, those investors holding bonds had no control over the direction of the company or the actions of a government. However, if the company failed to pay interest on its bonds, then the investors owning them could exercise their legal rights and take control. In the case of a government issuer, forcing the payment of interest was more problematic.
Despite these fundamental differences between stocks and bonds, both are securities sharing important common characteristics. By issuing a stock or bond, the vendor obtained money for immediate use. By buying a stock or bond, a purchaser received a promise of future gain. Compared to a direct investment or loan, the two advantages that securities possessed were divisibility and transferability. Both these characteristics had far-reaching consequences.
Divisibility expanded the absolute amount that could be raised at any one time, through the ability to access the pool of passive investors. This made it possible for companies to finance large and expensive long-term projects. Divisibility also mobilised funds for high risk ventures through the ability to spread the investment among numerous individuals. Transferability changed the time horizon associated with an investment as repayment was replaced by regular interest payments or a share in annual profits. This encouraged long-term investment in such areas as infrastructure.
Transferability also permitted a better matching between investor and investment as investors could exit or enter according to preferences and changing circumstances. This lowered the cost of capital. Transferability also meant that control of a business was divorced from the way it was financed. This permitted the employment of professional management and eased the creation of new business units whether through mergers or subdivisions.
The combination of divisibility and transferability also meant that securities generated constantly changing prices as investors bought and sold according to their circumstances and perceptions. This price information transmitted signals which informed decision making in business, whether regarding investment or control. Pricing signals were also of value in the wider financial community, permitting banks and others to anticipate problems and adjust accordingly, and so contributed to overall stability. Finally, the divisibility and transferability possessed by securities made them highly flexible financial instruments. Through the creation of securities, finance was freed from all spatial and temporal constraints as ownership could be easily changed both over time and between countries, without affecting the management and operation of either governments or businesses. This is why securities became central components of financial systems within advanced economies.
The Value of Exchanges: Markets and Regulation
For securities to be able to play this central role in a financial system, there had to be a market in which they could be readily bought and sold. Their value lay in the rights the owner of the securities possessed, as well as the ease with which they could be acquired or disposed of. To achieve that, there needed to be a high level of confidence among actual or potential holders that any transfers of ownership would be fully honoured in terms of the amount, price, time, type and location. Such transfers were often part of a rapid sequence of buying and selling that was integrated into other financial transactions and so a high level of inter-dependency existed.
This made securities and the market in which they were traded reliant on each other, with the growth in the use of the former being dependent upon the development of the latter. As securities came into more common use, they were traded by informal means, often in the mercantile exchanges which existed in towns and cities across the world. These mercantile exchanges had evolved to serve a market in which numerous buyers and sellers operated and few intermediaries existed. What was required under those circumstances was a single location where all interested parties could congregate, gain access to current market information, and conduct face-to-face negotiations on a basis of mutual trust.
However, there were important differences between securities, and both commodities and other assets. Unlike commodities or property, securities were of a relatively standardised nature, especially bonds paying a fixed rate of interest. Each bond issued by a particular government or company was identical as long as it was part of the same series, which was not the case with either commodities or property for which considerable variations existed. The same was true of stocks as long as they had the same rights to receive dividends and exert control.
Consequently, though mercantile exchanges did provide securities with a means through which they could be bought, this proved to be increasingly inadequate as securities developed in economic importance and generated a specialist set of intermediaries in the process of doing so. What these intermediaries required, whether they were brokers or dealers, was a market in which transactions could be completed quickly with those who could be relied upon. This required a set of rules and regulations governing the conduct of business so that all involved could buy and sell in the certainty that the counterparty to any deal would honour the bargain made. Enforcing these rules and regulations was achieved through the power to deny entry to those who actions might create unacceptable risks, and to punish those who broke the rules.
Achieving this meant the creation of a specific organisation, and that involved costs relating to the provision of an exclusive space in which trading could take place and staff to supervise and police that activity. This is what stock exchanges provided through self-regulation. They charged a fee for access and enforced a mutually agreed set of rules and regulations, which were continually evolving as new opportunities and challenges arose. By doing so, stock exchanges differentiated themselves from both the mercantile exchanges and the informal securities markets out of which they had grown. Once established, there was a constant interaction between the issue of securities and the sophistication of the markets upon which they were traded, to the mutual benefit of both. The certainty that agreements to buy and sell would be enforced acted as a powerful stimulus to the growth of business, the creation of more sophisticated financial instruments, and the improvement in trading facilities.
However, stock exchanges were not alone in this. In all types of exchanges, the move to a situation where admission and trading was governed by a transparent set of rules and regulations, which were strictly enforced, created conditions encouraging the creation of ever more complex products. In particular, this meant that contracts covering future delivery and payment became both increasingly feasible and less risky, as they could be constantly adjusted in the light of reliable information derived from the market. Instead of being places where buyers and sellers met to match current supply and demand, exchanges provided a means of either reducing risk or profiting from risk taking. It was not the law of the land that was critical in this, but the rules under which trading took place on exchanges, because these rules applied to all participants and ensured compliance.
This self-regulation, which became a characteristic of exchanges around the world, contributed generally to economic growth through the certainty it provided to future values. Through the use of derivatives, such as warrants, options and future contracts, buyers and sellers could fix prices into the future whether for stock and bonds or commodities. In turn, the counterparties to such deals could generate profits from the difference between current and future prices and any charges made. This meant that production and consumption and borrowing and lending were stimulated because the risks involved were reduced as future prices, payment and delivery was guaranteed. To the public, the whole process could be dismissed as speculation bordering on gambling whereas, in reality, it made a major contribution to the growth of trade and finance. Banks, for example, were encouraged to lend because, not only were current prices known, but so were those many months into the future, with any variations producing either profits or losses for the market participants and those who backed them. Exchanges were not just a formalisation of existing practices. The codification and standardisation of existing practices into rules and regulations that were mandatory for all participants transformed the market from a passive facility into a dynamic element within advanced economies.
This can be seen in the case of stock exchanges. Through the provision of an orderly market, stock exchanges encouraged the issue of securities by those seeking to raise finance and the purchase of securities by those with savings to invest, as they provided the liquidity required by all participants. Without that liquidity, the advantages possessed by securities over direct forms of finance and direct ownership of assets would be reduced or even eliminated.
One consequence of the orderly market provided by stock exchanges was authoritative and continuous price determination. Those buying and selling securities required the assurance that the price they paid or received reflected current market conditions. As stock exchanges imposed a charge upon those permitted to use their trading floor, determining these prices was not a free good but one that cost money to create in the form of the infrastructure and staffing of a stock exchange. Essentially the price generated by trading on the floor of an exchange was a piece of intellectual property that arose from the interaction between buyers and sellers in a regulated marketplace. The costs involved in creating the market that generated this price were borne by those who paid for access to the exchange in order to buy and sell, whether on their own account or as agents for their customers. These costs were accepted by those using the exchange, because it gave them privileged access to the trading forum and knowledge of current prices, both of which were denied to others. In this sense, the prices generated by trading on exchanges were entitled to an equivalent form of protection as that afforded to inventors through patents and authors with copyright, though of a much briefer duration.
Inevitably, exchanges suffered competition from those who traded on the prices they generated but did not pay the costs incurred in their creation or accept the rules governing conduct in the market, whether to prevent manipulation or maintain equality among buyers and sellers. Their protection was to delay the dissemination of prices and to restrict entry to the market to only those willing to pay and obey the rules. Thus a balance was created between the need to maintain an orderly market generating trusted prices and the need to disseminate those prices for the information of investors and as a check on abuse.
The consequence of that balance was that, on the one hand, exchanges as institutions could charge those using their facilities for the services they provided and so maintain and improve those services. On the other hand, those services meant that securities possessed a constant and reliable market in which they could always be bought and sold at or close to a price that was widely known and considered accurate and free from manipulation. What prevented an exchange from abusing the position it was in was the possibility or even reality of competition, because a rival exchange could always be formed by those denied access.
Nevertheless, there is in this new century a widespread perception that exchanges as institutions are irrelevant. This can be clearly seen in the work of economists, as in the prize winning 1999 article by Jorion and Goetzman. This article focuses solely on the market for stocks and ignores the form it took, the variations over time, differences between countries, and the consequences of government action. The result is akin to a description of the human body that deals only with the skeleton and ignores its functioning as a complex living organism.
Although all exchanges serve the same basic function of providing a fair and transparent market, exchanges were neither identical nor unchanging. There were always different typologies in existence, reflecting what was traded, the influence of government, the role played by those who used them, and the ownership structure adopted. In turn, the need to devise sophisticated rules and regulations, and adapt them to meet changing commercial and technological circumstances, constantly created differences between exchanges; there was never a perfect solution followed by all or adaptable by all. Exchanges were human constructions devised to meet the needs of advanced economies. As such they both arose from economic growth and contributed to it.
 This chapter is based on a lifetime’s research into securities markets and stock exchanges. What is attempted here is an examination of the role played by exchanges within the context of complex financial markets, how that has changed over the last 50 years, the reasons why, and the implications this had for the world economy. It is only with the Credit Crunch of 2007/8 that it has it become possible to fully appreciate the importance of self regulation as a key component within national and global financial systems.
 See J.P.Raines, Economists and the Stock Market: Speculative theories of stock market fluctuations [Cheltenham 2000]
 J.M.Keynes, General Theory of Employment, Interest and Money [London 1936]
 R.J.Schiller, Irrational Exuberance [New York 2001]
 For the origin of securities in medieval Italy see G. Felloni and G. Laura, Genoa and the History of Finance: A series of firsts? [Genoa 2004]. For the recent debate on financial systems and economic growth see R. Levine and S. Zervos, “Stock markets, Banks, and Economic Growth”; T. G. Rajan and l. Zingales, “Financial Dependence and Growth” in American Economic Review 88 (1988); P.L.Rousseaux and R.Sylla, “Financial systems, economic growth, and globalization” in M.D.Bordo, A.M.Taylor and J.G. Williamson,(eds.), Globalization in History [NBER./Chicago 2003].
 The same process can be observed in sport where the codification and standardisation of the rules of game led to professionalisation and commercialisation, and the transformation of a pastime into an industry.
 P. Jorion and W. N. Goetzman, ‘Global Stock Markets in the Twentieth Century’ Journal of Finance, 54 (1999).
About Ranald Michie
Ranald Michie's research interests all fall into the broad area of financial history. Though primarily focused on the history of the British financial system, his work takes a global perspective. This is driven by a belief that no national financial system can be adequately understood in isolation. While banks and stock exchanges are traditionally studied as distinct financial institutions, he is equally concerned with their interaction through the money and capital markets. He similarly seeks to study both the internal workings and external connections of financial systems. As a result, his research has increasingly concentrated on two aspects. The first is the history of global securities markets, extending his publications on the London Stock Exchange to work on stock exchanges around the world. The second is the history of the City of London as a financial centre as it moved from trade to finance, and from domestic to global orientations.
- 2009 Guilty Money. The City of London in Victorian and Edwardian Culture 1815-1914, Pickering and Chatto, 288 pp.
- 2006 The Global Securities Market: a History, Oxford University Press, 399 pp. (Additional information) (View publication online)
- 1999 The London Stock Exchange: A History, Oxford University Press, 672 pp.
- 1992 The City of London: Continuity and Change since 1850, Macmillan, xi, 238 pp.
- 1987 The London and New York Stock Exchanges 1850 - 1914, Allen & Unwin, xv, 312 pp.
- 1981 Money, Mania and Markets: Investment, Company Formation and the Stock Exchange in Nineteenth-Century Scotland, John Donald, ix, 287 pp.