Financial History of The Dutch Republic - The Stock Market

The Stock Market

Bringing together the savers that accumulated the growing stock of capital in the Republic and the people that needed that capital, like the Dutch and other governments, merchants, industrialists, developers etc. constitutes the formation of a market in the abstract economic sense. This does not require a physical meeting place in principle, but in early modern times markets commonly did come together at certain places. This was necessary, because the main function of a market is the exchange of information (about prices offered and accepted) and in the absence of means of telecommunication people had to meet in the flesh to be able to do that. In other words, abstract markets in the economic sense still had to be linked to physical markets. This applied as well to markets for commodities, as to financial markets. Again, there is no reason why financial markets and commodity markets should share the same physical space, but again, due to the close linkage of trade and finance, they in practice invariably did. We therefore see financial markets emerging in the places where commodities were also traded: the commodity exchanges.

Commodity exchanges probably started in 13th-century Bruges, but they quickly spread to other cities in the Netherlands, like Antwerp and Amsterdam. Because of the importance of the trade with the Baltic area, during the 15th and 16th centuries, the Amsterdam exchange became concentrated on the trade in grain (including grain futures and forwards and options) and shipping. In the years before the Revolt this commodity exchange was subordinate to the Antwerp exchange. But when the Antwerp entrepôt came to Amsterdam the commodity exchange took on the extended functions of the Antwerp exchange also, as those were closely linked.

What changed the Amsterdam commodity exchange to the first modern stock exchange was the evolvement of the Dutch East India Company (VOC) into a publicly traded company. It is important to make a few distinctions here to avoid a number of common misunderstandings. The VOC has been called the first joint-stock company, but this is only true in a loose sense, because its organization only resembled an English joint-stock company, but was not exactly the same. Like other Dutch merchant ventures, the VOC started out in 1602 as a partenrederij, a type of business organization that had by then already a long history in the Netherlands. As in the joint-stock company the investors in a rederij owned shares in the physical stock of the venture. They bore a part of the risk of the venture in exchange for a claim on the profits from the venture.

A number of things were new about the VOC, compared to earlier Dutch companies: its charter gave it a monopoly in the trade on the East Indies, and other than in earlier partenrederijen the liability of the managing partners was limited to their share in the company, just like that of the silent partners. But the innovation that made the VOC really relevant for the history of the emergence of stock markets came about serendipitously, not as part of its charter, but because of a decision by the managing partners in the early years of the company to disallow the withdrawal of paid-in capital by partners. As this had been a right of shareholders in other such partnerships it necessitated a feasible alternative for the direct liquidation of the interest of shareholders in the company. The solution was to enable shareholders that wished to get out to sell their share on the Amsterdam Stock Exchange that had just got a new building, but otherwise was just the continuation of the commodity exchange that existed beforehand.

It is important to recognize that shares were still registered by name in the VOC's register, and that transfer of shares was effected by an entry in that register, witnessed by the company's directors. Such transfers were allowed at infrequent opportunities (usually when a dividend was paid). The "shares" that are presented as "the world's first shares" therefore were in reality what we now would call either stock certificates or else stock options (depending on the concrete circumstances). This secondary market in VOC stock proved quite successful. The paid-in capital of the company, and hence the number of shares, remained the same during the life of the company (about 6.5 million guilders), and when the company proved to be very successful the demand for its shares drove up their price till they reached 1200 percent in the 1720s. Remarkably, the VOC did not raise new capital by issuing new shares, but it relied on borrowing and retained profits for the financing of its expansion. This is remarkable, because previous ventures on the contrary did not borrow, but used additional subscriptions if they needed extra capital

The real innovation therefore was that next to physical commodities henceforth financial rights in the ownership of a company were traded on the Amsterdam exchange. The stock market had come into being. Soon other innovations in financial trading were to follow. A disgruntled investor, Isaac Le Maire (father of Jacob Le Maire), in 1609 initiated financial futures trading, when he tried to engineer a bear market in VOC shares by short selling them. This is the first known conspiracy to drive down share prices (as distinguished from manipulating, and speculating in, commodity prices). The Dutch authorities prohibited short selling the next year, but the frequent renewal of this prohibition indicates that it was usually honored in the breach.

By the middle of the 17th century many "modern" derivatives apparently already were quite common, as witnessed by the publication in 1688 of Confusion de Confusiones, a standard work on stock-trading and other financial-market practices, used on the Amsterdam stock exchange, by the Jewish Amsterdam banker Joseph Penso de la Vega. In it he describes the whole gamut, running from options (puts and calls), futures contracts, margin buying, to bull and bear conspiracies, even some form of stock-index trading.

Trading in financial instruments, let alone speculation, was not limited to the stock exchange, however. Notorious is the speculative bubble in tulip futures, known as the 1637 Tulip mania. This mostly unfolded in coffee houses throughout the country as a pastime for common people. The stock exchange and its brokers were hardly involved, though the techniques used were quite common on the stock exchange.

Similarly, the Dutch speculative bubble of 1720 (that coincided with John Law's activities in France and the South Sea bubble in England, but had its own peculiarities), for a large part existed outside the formal confines of the stock exchange. Still, this pan-European speculative mania illustrates the way in which by that time the European capital markets were already interconnected. The London Stock Exchange did not yet exist as a separate building, but its precursor operated in the Change Alley, where licensed stock traders did their business in coffee houses. Since the Glorious Revolution the Dutch and English stock exchanges operated in tandem, certain stocks and bonds being quoted on both exchanges. English shares of the Bank of England and the British East India Company were continuously traded in both London and Amsterdam. They communicated via the packet-boat connection between Harwich and Hellevoetsluis that sailed twice a week. Information on stock and bond prices in both markets was regularly published in Dutch price courants (that originated in Amsterdam in 1583, and were published biweekly from 1613 on ).

Analysis of the information from these lists shows that the London quotations were apparently spot prices, whereas the Amsterdam quotations were forward prices, reflecting the fact that Amsterdam traded futures on English stocks. Of course, this need not signify stock speculation, but when the British and French speculative bubbles of 1720 erupted, the Dutch capital market soon got involved also, because Dutch investors were able to participate. The main Dutch bubble came afterward, however. When the bubble burst in France, short-term capital fled to the Netherlands, because this market was seen as a "safe haven." This influx of liquidity helped spark a domestic Dutch speculative bubble in dodgy public companies that burst in due course. Without the dire consequences of the British and French crashes, however, because the Dutch market was more mature. It occasioned a lot of satirical comment, however, as shown in the illustration from a contemporary tract on the follies of speculation, Het Groote Tafereel der Dwaasheid (Great Mirror of Folly).

The great import of this episode is that it shows that by this time the capital market had become truly international, not only for long-term bonds, but now also for short-term capital. Financial crises easily propagated because of this. Examples are the crisis of 1763, after the end of the Seven Years' War in which the Netherlands had remained neutral, occasioned a collapse of commodity prices, and debasements of the currency in Eastern Europe disrupted the bullion trade. Some Amsterdam accepting houses became overextended and failed as a consequence. This caused a brief credit crunch. Ten years later the bursting of a speculative bubble in British-East-India-Company stock, and a simultaneous default of Surinam planters, forced Dutch merchant bankers to liquidate their positions. As a result, acceptance credit evaporated temporarily, causing another credit crunch which brought down a number of venerable banking houses. This time a short-lived Fonds tot maintien van publiek crediet (a kind of bank of last resort) was erected by the city of Amsterdam, but dissolved again after the crisis abated. This experiment was repeated a few times during the crises of the end of the century, but equally without lasting results. The need for them was probably less than abroad, because the Dutch citizens were still extremely liquid, and possessed large cash hoards that obviated the need for a lender of last resort. Besides, the by then extremely conservative Dutch financial community feared that a paper currency beside the metal currency would undermine confidence in the Amsterdam capital market.