Trading Places
Stock markets may look nothing like they used to.
But they still serve the same crucial role.
By SUZANNE MCGEE

It was the hottest IPO of its day. In 1553, The Mysterie and Compagnie of the Merchant Adventurers for the Discoverie of Regions, Dominions, Islands and Places Unknown offered stock to finance a quest for a passage to the riches of the East. The shares were quickly snapped up by a select circle of London merchants.

The venture proved costly for explorer Sir Hugh Willoughby: He and the crews of two ships perished after being trapped in Arctic ice. But the third vessel's crew reached the court of Ivan the Terrible in Moscow and returned home with news of Russia's wealth, as well as a treaty giving England freedom to trade there. The original investors soon reaped rich rewards.



Will Crocker

For centuries -- from the time of the merchant adventurer through that of the robber baron and into today's era of the computer whiz -- financial markets have greased the wheels of commerce. The Muscovy Company, as the Russian venture became known, wasn't the first to issue shares. But its success spawned other large-scale joint-stock companies seeking money for similar ventures, which in turn created a need for an easy way for companies to find wealthy investors, rather than relying on relatives and friends.

The solution: a location where investors could buy and sell shares. In other words, a stock market."Once you had stock exchanges, you had a very efficient way of raising capital and investing," says Ruben Lee, director of Oxford Finance Group in Norwich, England, and author of a book on stock markets."All of a sudden, you had a central market where you could go knowing that there would be other people there interested in buying the same piece of paper you wanted to sell."

Hamburg's Head Start

Trading was nothing new: Ownership shares in French textile mills had been bought and sold as far back as the 1100s, and the Bank of Venice had issued the first government bonds in 1157. But it wasn't until the 16th century that stock exchanges were established. The first was in 1531 in Antwerp, Belgium -- then a major shipping and trading center -- where brokers gathered to trade shares and commodities. Hamburg, Germany, also a hub of European trade and home to many powerful merchants, set up its exchange in 1558. Amsterdam followed, opening an exchange in 1619, ahead of London and Paris, which opened theirs in the late 1600s. In 1792 the New York Stock Exchange, now far and away the world's largest in trading volume, got its start. Refinancing of government debt into tradable bonds, together with a stock issue by the Bank of the United States, had fueled rapid growth in the buying and selling of securities. As a result, 24 brokers who did business from coffee shops up and down Wall Street signed an agreement founding the exchange.

Today, there are some 120 stock markets around the globe, as exchanges have sprung up in such far-flung places as Trinidad and Tobago (whose stock market was founded in 1981), Mauritius (1987), Macedonia (1996) and Kazakstan (1997).

Stock markets, of course, are far more sophisticated than they were hundreds of years ago. In their early days, they were little more than a common place -- in London, a coffeehouse; in Amsterdam, the nave of a church -- where a select group of people could meet to trade stocks in local companies.

Only in the past century did exchanges begin disseminating selected price data on a wider range of companies to a wider range of people. Most trading was still executed on a trading floor, but today there's less and less need for that. Instead, exchange members have access to data on stock prices and order sizes stored on computers, and can buy and sell shares in companies around the globe on a"virtual" exchange.

The founding fathers of Amsterdam's exchange wouldn't recognize the world their descendants deal in. The Amsterdam market occupies an airy atrium inside a turn-of-the-century building. No paper litters the carpeted floors. The only signs this might be a stock exchange are in the back of the room, where two electronic display boards track movements in major markets. While a brass gong is still rung daily to mark the beginning and end of the trading day, trading itself takes places through the computers of banks and brokers scattered throughout Europe's financial centers.

"It took 500 years or more from the time trading started until we had stock markets at all," says Frank Gerstenschlager, a member of the executive board at Deutsche Borse Systems in Frankfurt, Germany."Now technology changes so rapidly that we can have complete revolutions in trading in only a few years."

But if the scale, scope and technology of stock markets has changed dramatically, the fundamentals of their business -- bringing together sellers and buyers -- have changed very little.

Medieval Roots

Stock markets began as extensions of markets for other types of goods. For ages, merchants have gathered periodically at central locations to trade wares. As economies grew, so did the range of products on offer. In the city-states of medieval Italy, commodity markets in metals, textiles and all kinds of agricultural products flourished. So did trading in instruments of credit, with buyers betting not just on current but prospective values.

A bank that was owed either money or goods by a merchant could accept a piece of paper in lieu of the repayment, and then sell or transfer it to other institutions or individuals. In the 1400s, most securities were tied to government debt (usually sold to finance wars) or commodities. By 1521, formal commodity-trading markets were established in Antwerp and Amsterdam.

Still, what capitalists needed most was capital to start and run their businesses, and stock exchanges facilitated a remarkable acceleration in economic growth. They made assets far more liquid, thus enabling large amounts of money to flow quickly to new business opportunities. At the same time, they allowed newly wealthy merchants to diversify their holdings and investors to own a stake in a business without having to involve themselves in running it.

Initially, most stock was issued by a handful of trading companies. Amsterdam's first widely owned company -- and for centuries, its largest -- was the Dutch East India Co., which dates back to 1599. After driving the Portuguese out of Indonesia, Dutch merchants set up trading posts throughout the Moluccas -- then known as the Spice Islands -- and financed expeditions by selling shares. Eventually, even housekeepers dabbled in the stock, anxiously awaiting news of cargoes of Ming porcelain, indigo, cloves, lacquerware, silk and precious stones. Feverish trading took place on rumors of shipwrecks or sightings of the returning fleet. Investment returns could average 20% annually -- a great inducement at a time when interest rates ranged from 5% to 10%.

By the 18th century, banks and mines, as well as transportation companies that built toll canals and toll highways, were selling stock. By the 19th century, exchanges became the engine of growth for new ventures that needed huge amounts of capital: railroads, steamship companies, steelmakers and other industrial concerns.

'Gambling Hell'

Not that the evolution was always smooth. Along the way, exchanges helped to finance such empty ventures as companies that promised to develop perpetual-motion machines. A treatise in Amsterdam offered a cautionary guide to the"gambling hell" of the exchange."Take every gain without showing remorse about missed profits, because an eel may escape sooner than you think," cautioned Joseph de la Vega, author of"Confusion de Confusiones," published in 1688."These stock-exchange people are quite silly, full of instability, insanity, pride and foolishness. They will sell without knowing the motive; they will buy without reason."

These words were penned in the aftermath of"Tulipmania," the first of many speculative bubbles that beset exchanges in Europe and later in the Americas and Asia. Although tulip"shares" weren't listed on the stock market, traders had used the facilities of the exchange to buy and sell exotic tulip bulbs. By 1636, driven by surging demand, prices of some rare bulbs were doubling weekly, or even daily. Prices reached such heights that people were buying not a whole bulb but shares in a bulb; a single bulb might be traded for a collection of goods headed by a house and land and including a carriage with horses. But in early 1637, some worried investors pulled out of the market, triggering a crash.

Similarly, the South Sea Bubble bankrupted thousands in London. South Sea Co. had been granted a trading monopoly with South America and the Pacific. From January to August 1720, speculators bid up shares nearly tenfold. But many investors, including Britain's king and prime minister, put down as little as 10% to buy their shares, which proved worthless when many realized the company's prospects were hyped.

Leverage also was a culprit in the 1929 stock-market crash in New York. Speculators borrowed funds to invest in the booming market, expecting the return from their stocks to exceed the interest rate on the loan. At first, this seemed logical: Stock in Radio Corp. of America surged to $420 a share from $85 in 1928 despite paying no dividends. But when prices began to fall, creditors found themselves dragged under along with their borrowers.

Market speculation emphasized the importance of timely and accurate information. In 18th-century England, Sir Harry Furness, a well-known speculator who reportedly had better sources of information than the king, was rewarded with a diamond ring for whispering the latest market-moving news into the royal ear. Investors turned to fleets of carrier pigeons or semaphore networks to try to get an edge on their competition.

Access to information led, inevitably, to efforts to manipulate markets. English satirist Jonathan Swift, himself an avid investor, blasted stock traders in a 1719 pamphlet for"coining false news...whispering imaginary terrors, frights, hopes, expectations." In February 1814, a man claiming to be an aide-de-camp to the armies fighting Napoleon landed in Dover and claimed that Cossacks had butchered Napoleon at a large battle and that Paris had fallen. He distributed the"news" on his coach trip to London. Stock prices soared, and he and fellow conspirators sold shares, capturing a 15% profit before the fraud was unmasked.

Exchanges Keep Growing

But the bubbles and market manipulation -- and the economic damage they left in their wake -- didn't prevent stock exchanges from growing."What happened after each speculative attack on the market is that the infrastructure of an exchange, its regulation, became much bigger and more effective," says Cherelt Kroeze, manager of the archives at the Amsterdam Stock Exchange.

By the late 19th century, rapid technological advances had already improved communications and were beginning to dramatically alter the way in which stocks were traded. In 1867, the New York Stock Exchange introduced its first ticker, quoting stock prices. A transatlantic telegraph cable had been completed the previous year, allowing traders in New York and London to communicate. Improved communication increased trading volume: In 1886, the exchange had its first million-share day; 25 years earlier, the average daily volume had been only about 1,500 shares.

In the 20th century, a continuing surge in volume has required exchanges to embrace ever more sophisticated technology to keep running efficiently. Even on a hectic day in Frankfurt -- the world's fifth-largest stock market -- the exchange's floor shows no sign of a trading frenzy, because more than 80% of Frankfurt's trading takes place on a computer screen.

The New York Stock Exchange is one of few exchanges that still cling to the tradition of floor trading. Computers have crept in everywhere, of course -- they distribute prices to traders, while specialists tap orders into an electronic trading book. But at the end of an average day, after 650 million shares have changed hands, exhausted traders still leave behind a floor ankle-deep in paper.

Indeed, NYSE trading still has much in common with 17th-century trading in Amsterdam: Mr. de la Vega wrote in his treatise that ritual handshakes confirming trades quickly degenerated into a manic display of hand slapping"followed by shouting, insults, impudence, pushing and shoving."

But this remaining link with the past may be doomed on the venerable Big Board, too. Some pundits believe that stock exchanges, at least as they have existed for nearly 500 years, may be headed for obsolescence.

"There's no longer any logic to the way exchanges are structured today," argues Benn Steil, director of the international- economics program and the Royal Institute of International Affairs in London.

Cyberspace Exchange

Stock markets were created as places where stockbrokers and traders could gather to conduct business. But what if another place -- cyberspace, in the form of increasingly sophisticated computer trading systems -- proves more efficient than a physical location? Investors of all sizes and, eventually, from all parts of the world would be able to"meet" directly via computer. Companies wanting to raise money by offering stocks or bonds could link up with them directly, too.

If exchanges were to evolve into virtual markets that exist only electronically -- overseen by a small coterie of executives and computer wizzes -- the intermediaries who buy and sell on behalf of shareholders would probably become redundant.

Ways would have to be found, of course, to regulate such a global cyber-market. If an investor in Malaysia can use a direct-access, computerized trading system to trade stocks in New York or London, could securities regulators establish jurisdiction to guard against manipulation and other types of fraud?

Still, the economics of new-age stock markets are compelling -- just as they were back in the 1500s when companies and investors needed a more efficient method. Electronic trading systems accessible to institutional investors already charge commissions as low as a cent a share, compared with about six cents on the floor of the New York Stock Exchange."Maybe the exchanges of the future will just be trading systems," says Mr. Steil."There won't be any members, just clients on each side of the transaction."

--Ms. McGee is a staff reporter in The Wall Street Journal's London bureau.

http://www.wsj.com/public/current/articles/SB915727719755335000.htm

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