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London and Paris as International Financial Centres in the Twentieth Century

Author(s):Cassis, Youssef
Bussière, Éric
Reviewer(s):Wilkins, Mira

Published by EH.NET (November 2006)

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Youssef Cassis and ?ric Bussi?re, editors, London and Paris as International Financial Centres in the Twentieth Century. Oxford: Oxford University Press, 2005. xii + 367 pp. $125 (hardcover), ISBN: 0-19-926949-1.

Reviewed for EH.Net by Mira Wilkins, Department of Economics, Florida International University

This book has a truly exciting set of fifteen chapters (sixteen contributors). Youssef Cassis starts off with a brief comparison between London and Paris as international financial centers in the twentieth century. After his introduction, there are four parts (one general and three chronological), with alternate chapters on London and Paris. Part I has the first pair: Ranald Michie and Alain Plessis deal respectively with London and Paris in a “long-term perspective, 1890-2000.” In a splendid essay, Michie insists that London as a financial center took shape as an addition to (not a substitute for) its role as a commercial center. London’s port, its insurers, its activities in the distribution of minerals and metals were complementary to its central position in international finance. Trade finance, short and long-term investments, and the role of stock markets are deftly handled by Michie, who emphasizes the dynamics of the City with its changing and evolving characteristics. World War I proved a “major blow” to London as an international center, but it recouped. With nuances, Michie covers the inter-war and World War II ups and downs in London’s position. World War II was another watershed. With the nationalization of the Bank of England in 1945, government interventions in financial matters became the norm. Yet, throughout, London remained cosmopolitan, in time reviving its position as a major international financial center. In December 1999 the governor of the Bank of England would call London the world’s predominant international financial center. This was perhaps an exaggeration, underestimating New York. Nonetheless, the rebirth of the City at the end of the twentieth century was remarkable. Michie explains why.

Plessis’s eleven pages on Paris do not offer as comprehensive an overview as Michie’s but then Paris was not London. Plessis shows the strengths of Paris as a financial center in the decades before World War I, its “withdrawal 1914-1926″ (including the resales of the best securities abroad and the collapse of loans to Russia and the Ottoman Empire, with France moving from creditor to debtor nation in these years). Plessis’s next sub-headings are “The Great Hope, 1918-1930″ (with the stabilized franc and solid current account surpluses), “An Enduring Eclipse, 1931-1958″ (with the accumulation of negative impacts on Paris as a financial center), and finally “Toward a New International Role for Paris as a Financial Centre” (beginning with France’s participation in the European common market and the re-establishing of external convertibility of the currency in 1958, and then, too rapidly, he rushes through the next two decades, not really bringing the story to 2000, as Michie had).

Part II is on 1890-1914. Here the first pair of British-French chapters is not a symmetrical coupling (nor are the subsequent pairs). Each contribution fills gaps in the overviews. Michie’s summary devoted little attention to empire, to imperialism, in defining London’s role as an international financial center. Niall Ferguson’s controversial, and as is his practice highly stimulating, presentation re-looks at the older familiar literature on capitalism and imperialism (on sinister financial interests) and reviews the range of re-considerations of this equation from the 1960s onward. Ferguson brings back to the table the significance of formal empire in London’s place as a financial center. Taking on Michael Bordo and other recent economic historians, Ferguson claims British rule provided more than the good “housekeeping guarantees” of the gold standard. Ferguson sees empire as highly germane to understanding the City before World War I. Many historians have been appalled by Ferguson’s conservatism, his politically incorrect willingness to maintain that imperialism may not have been such a bad thing after all. The ideological blinders of these critics should not stop them from taking Ferguson’s arguments seriously. Even if one does not share all his arguments, he is convincing as he shows that access to London capital markets for those countries within the empire was lower cost and easier than for most countries outside the formal empire. Yet Ferguson never considers the largest single recipient of British capital in this era, the United States. This omission provides, perhaps, a flaw in Ferguson’s argument, but some may argue far from a fatal one.

The French contribution to this pair is by Marc Flandreau and Fran?ois Gallice; it shifts the tone and orientation. In this important chapter, the authors look at short-term international capital movements, 1885-1913, using data from the records of the Banque de Paris et des Pays-Bas (Paribas). Their contribution reveals the great value of using bank (and more generally) business records. This essay is as much about London as about Paris as an international financial center. Their study offers splendid new data and insights into the characteristics of short-term capital movements; it expands horizons.

The next twin covers banks and international finance, 1890-1914. Cassis supplies a snapshot of the specialized, fragmented London banking institutions along with the financial markets in which they participated and competed. Samir Saul’s approach differs, focusing on alliances between banks within syndicates, seeking to establish the managers and participants in underwriting and issue consortia. His data base consists of 311 issues of foreign governments and companies, as found in Cr?dit Lyonnais’s records, supplemented by other information.

Part III, entitled “From Global Reach to Regional Withdrawal, 1914-1958,” has offerings from P.L. Cottrell on London and Hubert Bonin on Paris banking and finance. Part IV on the “Road to Globalization, 1958-1980,” contains two sets of papers. Catherine Schenk offers keen insights into the policy environment of international banking in the City, while Olivier Feirtag tells of the “international opening up” of the Paris Bourse. The second pair in Part IV comprises contributions from Mae Baker and Michael Collins on “London as an International Banking Centre” and ?ric Bussi?re on “French Banks and the Eurobonds Issue Market during the 1960s.” And, then, completing the chronology (and the volume), in the final part, Part V, there is a very neat study of the last twenty years of the twentieth century by Richard Roberts, who playfully asks of London: “Global Powerhouse or Wimbledon EC2?” — while Andr? Straus speculates on the future of the Paris market as an international financial center from the perspective of European integration.

I missed a chapter on the interaction between London and Paris: how often were issues listed on both exchanges? How much arbitrage was there between the centers? How frequently were issues denominated in both pounds and francs? How often did Frenchmen go through London in their international transactions? To what extent did British and French banks have cross connections? We learn of French banks with outlets in London, but what about vice versa? It would be useful to think about the Lazards, Rothschilds, and Morgans in the context of London and Paris as international financial centers. There is so much to consider vis-a-vis interactions. For example, how did the two centers interact in the Euro dollar market? What did British entry into the European community do to the relationships between London and Paris as international financial centers? Plessis (to a limited extent) and Flandreau and Gallice do discuss associations between the French and British central banks, but neither contribution extends the discussion beyond 1914. How did the two central banks interact during the entire twentieth century?

While this book tells a tale of two cities, there is a third one that hovers in the background: New York. A criticism of this book is not that New York is absent in the presented story (it is there, albeit not in a systematic manner), but there seems to be a lack of awareness by most of the authors of the relevant U.S. literature (for example on British and French participation in the Eurobond markets).

These few reservations should not turn the reader from the high value of this book. This is a well-integrated volume that should be in the library of every economic historian who deals with international banking and finance in the late nineteenth and twentieth century. I read it with great absorption and delight.

Mira Wilkins is professor of economics at Florida International University. Her most recent book is The History of Foreign Investment in the United States, 1914-1945 (Harvard University Press, 2004). It is the second volume in her three volume history of foreign investment in the United States (the first was published in 1989); the third, which will carry the story from 1945 to present, is in progress. Wilkins covers foreign direct investment and, also, the entire range of other long-term foreign investments in the United States.

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):Europe
Time Period(s):20th Century: WWII and post-WWII

The Legacy of Milton and Rose Friedman’s Free to Choose: Economic Liberalism at the Turn of the Twenty-First Century

Author(s):Wynne, Mark
Rosenblum, Harvey
Formaini, Robert
Reviewer(s):Taylor, Ranald
Leeson, Robert

Published by EH.NET (November 2006)

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Mark Wynne, Harvey Rosenblum and Robert Formaini, editors, The Legacy of Milton and Rose Friedman’s Free to Choose: Economic Liberalism at the Turn of the Twenty-First Century. Dallas: Federal Reserve Bank of Dallas, 2004. vii + 251 pp. $ (hardback), ISBN: Info: 0-9763494-1-8

Reviewed for EH.NET by Ranald Taylor and Robert Leeson, Department of Economics, Murdoch University.

This book is a collection of papers presented at a conference held at the Federal Reserve Bank of Dallas in October 2003. It is a tribute to Milton and Rose Friedman’s Free to Choose. The papers have a dominant theme: competitive markets can solve many of the problems associated with education, environmental degradation, taxation, cultural diversity, globalization, financial markets and monetary stability. The book is organized into six sessions, each devoted to particular issues which the Friedmans have raised in Free to Choose.

Session one sets the tone of the book by revisiting Milton Friedman’s organizing argument: that competition ensures economic freedom and that the appropriate role of a government in a free society is to ensure that competitive markets function freely. Eric Hanushek and Paul Peterson examine the coexistence of what they believe to be the declining state of the public school system in the U.S. and rising real spending per pupil. Hanushek argues for a competitive market-based funding system in the form of vouchers. Resistance to vouchers, he believes, derives from an old ideology. Hanushek argues that it is easier to defeat communism than to overcome the education establishment’s resistance to meaningful reform of the public school system.

Advocates of ‘sustainable development’ advocate changes in virtually every aspect of consumption and production. In session two Terry Anderson and Laura Huggins argue that sustainable development theory is vague and “operationally vacuous” (p. 58). They challenge the two fundamental pillars of sustainable development: ‘running out’ of resources will leave future generation with less, and market processes are the causes of these depletions. According to Anderson, Huggins and Richard Stroup, the over consumption of natural resources is primarily linked to ill-defined property rights rather than the operation of the market system. Property rights, they argue, provide the structures that are necessary for development, innovation, conservation and the discovery of new resources. They maintain that countries with greater economic freedom and rule of law tend to have higher environmental standards than countries where the rule of law is weak.

One of the themes of Free to Choose was that government has grown far beyond the size necessary for the protection of liberty. In session three, William Niskanen constructs a model to estimate the optimal level of expenditure for government services relative to GDP. His estimate (10 percent of GDP) provides support for smaller governments. Liqun Liu, Andrew J. Rettenmaier and Thomas R. Saving argue that falling birth rates and rising life expectancy have made the current social security system unsustainable. Their analysis of the costs and benefits of a transition to a privately-funded system, suggests that during the transition period there would be a cost involved in the form of lower consumption. However, in the longer term, they argue, the transition would make the country as a whole better off by enhancing the nation’s capital stock.

In session four, Tyler Cowen deals with the implications of Free to Choose for culture, diversity and aesthetics. Globalization and free trade benefit both cultural diversity and the creative arts, Cowan argues: periods of greater freedom in international trade tend to be periods of greater cultural diversity and creativity.

Peter J. Boettke examines the impact of Free to Choose on global movement toward free markets during the period from 1979 to 2003. During this period, communism collapsed in the Second World, the Third World began to reject development planning, and many First World countries reformed their welfare states. Boettke notes that much post-communist privatization was inspired by Friedman’s writings.

Gregory Chow uses the central themes of Free to Choose to examine post-1978 reforms in China, sensing progress in all areas. With reference to education, Chow claims that there is probably a greater degree of freedom of choice in education in China than the U.S. (he argues that about 40 percent of all spending on education in China comes from private sources compared to an average of 12 percent in the OECD countries).

Session five has a topical immediacy given that the Grameen Bank and its founder, Muhammad Yunus, were jointly awarded the 2006 Nobel Peace Prize. Luigi Zingales argues that access to finance is crucial to promote competition and economic freedom. Zingales describes the fate of two Bangladeshi women (one with access to finance, the other without). The second found it extremely difficult to develop her stool making business; the first obtained a small loan from the Grameen Bank to acquire a Nokia cellular phone. The phone made a huge difference in her life and the lives of her fellow villagers by bringing information at low cost to farmers and tradesman. The phone reduced business costs facilitating profits about twice the average national monthly income.

Zingales argues that although financing is a risky and complex activity, riddled with adverse selection and moral hazard, it is government intervention that is the main obstacle: “In spite of the enormous challenges intrinsic to the financing activity, human ingenuity, when allowed to work freely, is able to devise many mechanisms to enlarge access to finance. It cannot, however, overcome the power of the government, when this is determined to block finance. Unfortunately, governments are too often captured by rich incumbents, who stand to gain very little and risk a lot from the development of finance” (p. 188).

Allan H. Meltzer itemizes twenty-five specific policy proposals initiated by Milton Friedman (some of which have been adopted and many of which have not) to minimize government intervention. He looks at some of the successes (ending the military draft, floating the dollar, the abolition of interest rate ceiling on bank deposits) and some partial successes (lowering tariff barriers, deregulation various industries in the U.S., the introduction of a school voucher system in certain U.S. states).

Ben S. Bernanke examines eleven of Friedman’s key monetarist propositions. According to Bernanke, Friedman’s counter-revolution is still very much alive: “one can check to see if an economy has a stable monetary background only by looking at macroeconomic indicators such as nominal GDP growth and inflation. On this criterion it appears that modern central bankers have taken Milton Friedman’s advice to heart” (p. 213).

The last session traces the relationship between economic freedom and growth performance. The Friedmans believe that economically free countries would grow more rapidly and achieve higher income levels than less free countries. To test their hypothesis, they saw the need to develop a scientific instrument that could be used to quantify the degree of economic freedom across a large number of countries. James Gwartney pioneered the construction of indexes to proxy economic freedom. Based on the Economic Freedom of the World (EFW) index (taking into account of private ownership, voluntary exchange, personal choice, and free entry into markets), Gwartney and Robert Lawson report that a one-unit increase in the EFW index enhanced growth by 0.71 percentage points over the period 1980-2000: “Friedman was right” (p. 232).

As a conclusion to the book, Raghuram G. Rajan offers some reflections on whether the free market tide may retreat (in Latin America, for example). Rajan argues that the growing backlash against pro-market reforms is driven by elites who tend to undermine equality of opportunities by opposing widespread access to markets.

This is a fascinating book — a must read for Friedman fans. One of Friedman’s strengths was (and is) his intense curiosity about the strengths and weaknesses of the arguments and unexamined assumptions of his opponents. Some of those who have documented the progress of his ideas have been struck by the initial lack of reciprocity in this respect (in the early days his ideas were often dismissed as Chicago eccentricity). Friedman was a dominant figure among the first generation of post-war libertarians: this salute by some of the second generation provides an insight into the dynamics of the ideas that he developed and propagated.

Ranald Taylor is the author of “Can Labour-Savings, Capital-Intensive Production Techniques Reduce Unemployment Rates in Developing Countries?” Australian Journal of Labour Economics (2004). He is currently working on a project tracing the evolution of technological progress since Adam Smith.

Robert Leeson is the co-author (with W.J. Darity and W. Young) of Economics, Economists and Expectations: From Microfoundations to Macroapplications (Routledge: 2004) and is currently editing Milton Friedman’s Collected Writings.

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Subject(s):History of Economic Thought; Methodology
Geographic Area(s):North America
Time Period(s):20th Century: WWII and post-WWII

The Origins of National Financial Systems: Alexander Gerschenkron Reconsidered

Author(s):Forsyth, Douglas J.
Verdier, Daniel
Reviewer(s):Sylla, Richard

Published by EH.NET (March 2005)

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Douglas J. Forsyth and Daniel Verdier, editors, The Origins of National Financial Systems: Alexander Gerschenkron Reconsidered. London and New York: Routledge, 2003. xv + 237 pp. $129.95 (cloth), ISBN: 0-415-30168-8.

Reviewed for EH.NET by Richard Sylla, Stern School of Business, New York University.

In what has been called “the battle of the systems,” so-called bank-based financial systems typified by German-style universal banking compete with so-called market-based financial systems of the Anglo-American variety. Bank-based systems, of course, always had securities markets, just as market-based systems always had large banking components. Indeed, a recent scholarly trend has been to emphasize the similarities of the two types of systems rather than their differences, and to see in contemporary developments — an increased role for securities markets in Germany, and leading U.K. and U.S. banks looking more and more like universal banks — a convergence of financial systems.

Be that as it may, the conference volume reviewed here focuses on why financial-system differences emerged in the first place, meaning in the period 1850-1914 when universal banking emerged in Germany. It spread from Germany to other countries in Europe, while the British and the Americans continued to develop in tandem the banking systems and securities markets they had established earlier in history. As the subtitle of the volume suggests, one of its major purposes is to reconsider Alexander Gerschenkron’s influential contention that universal banking, defined broadly in the introduction to the volume as “banks that accept deposits, and engage in both short- and long-term lending” (p. 7), was a substitute in moderately backward countries such as Germany for missing “prerequisites” of economic modernization. Such missing prerequisites for Gerschenkron included a long history of commercial development and an “original accumulation of capital” available to finance modern industrial technologies at the appropriate moment. Today we might say, as Joost Jonker more or less does in his contribution to the volume, that a financial revolution is also among the missing prerequisites. Countries that had financial revolutions — the Dutch Republic, the U.K., and the U.S. — tended to have commercial banking specializing in short-term lending, as well as securities markets specializing in financing longer-term capital needs of companies.

In his introduction to the volume, co-editor Forsyth (a historian at Bowling Green State University in Ohio) characterizes Gerschenkron’s approach as one that focuses on bank assets and loan demand. In relatively backward countries, capital scarcity creates a demand by firms for long-term loans from banks to take advantage of new, large-scale production technologies. Universal banks emerge is such countries to satisfy the demand for long-term financing that otherwise would not be met. In more advanced economies, by contrast, established firms can rely on retained earnings and securities markets for long-term capital, leaving banks to specialize on short-term commercial lending.

An alternative explanation to Gerschenkron’s, an exploration of which motivates the volume, is that of the other co-editor, Verdier, a political scientist at Ohio State University. Instead of emphasizing loan demand and bank assets, Verdier in earlier writings and the first chapter here focuses on the supply of deposits, liabilities of banks that are one source of funds to finance loans to companies. More than Gerschenkron, Verdier bases his explanation on politics. In decentralized polities such as nineteenth-century Germany, the political power of farmers and small business led the state to sponsor non-profit financial institutions such as savings banks and cooperative institutions. That meant that bigger banks serving large-scale industry found it difficult to capture a large share of bank deposits. So the big banks had to rely more on their own capital and retained earnings to fund loans, and that in turn meant that they were less prone to runs on deposits and could thus make more long-term loans. But such banks could still suffer runs, and were particularly vulnerable to them because of their long-term lending. So successful universal banking required the presence of a central bank that would actively provide liquidity by acting as a lender of last resort in financial crises. In a nutshell, Verdier’s alternative to Gerschenkron holds that universal banking arises when the deposit market is segmented between non-profit and profit-oriented institutions (which is more likely in decentralized polities), and when the central bank is active as a supplier of liquidity and lender of last resort. Deposit-market segmentation and a lender of last resort are thus said to be the necessary and (together) sufficient conditions for the emergence of universal banking. Gerschenkron’s relative backwardness has nothing to do with it.

Conversely in Verdier’s model, centralized polities such as the U.K. and France were less likely to allow non-profit financial institutions to capture large shares of bank deposits. Hence, commercial banks obtained most of the economies’ bank deposits. Relying less on their own capital and retained earnings, and more on deposits that might be withdrawn on short notice, such banks abandoned long-term lending in favor of short-term commercial loans.

The remaining nine chapters of the book subject the Gerschenkron and Verdier models to intense scrutiny, and in general find that both models are lacking. Ranald Michie (Chapter 2) and Joost Jonker (Chapter 3) in effect criticize both models for being too narrow in their focus on banking, slighting the important role of securities markets, which are both competitive with and complementary to banks, in modern financial systems. Michie notes that the value of securities in 1913 was three to four times greater than worldwide bank deposits, which has to make one wonder why banks and banking have received such disproportionate attention from financial historians. He also produces an interesting table showing that the U.S., with its peculiar banking system made up of tens of thousands of unit banks, somehow managed by 1913 to have 30 percent of total world deposits and 36 percent of world commercial bank deposits, both totals being far ahead of those of any other country. Knowledge of that might cause historians of American banking to temper their critiques of it. Jonker compares the financial systems of the Netherlands, Britain, France, and Germany. He sees the first three as relatively sophisticated financial systems with securities markets playing central roles in them, while Germany, which he cleverly describes as “building a boat while sailing it,” was hampered by late state formation and retarded securities-market development. These are provocative chapters.

The rest of the chapters are country case studies. Richard Deeg’s study of Germany and Alessandro Polsi’s of Italy are perhaps most favorable to Verdier’s emphasis on the primacy of political factors in shaping financial systems. Germany and Italy were two pillars of Gerschenkron’s banking edifice, and both Deeg and Polsi think Gerschenkron exaggerated the role of universal banks in these countries. Both countries had segmented deposit markets, central banks, and universal banking as Verdier’s model would predict. The results, however, were far better in Germany than in Italy.

Michel Lescure’s interesting essay places France squarely between Britain and Germany. Like Britain, France as a centralized state had national deposit banks concentrating on short-term commercial lending, and investment banks serving large-scale industry. But like Germany, it had local universal banks serving local, small- and medium-sized firms. The Bank of France aided the latter in the manner Verdier contends was necessary.

Sweden and Norway were semi-centralized Scandinavian states that do not fit well either the Gerschenkron or Verdier models. In their essay on Sweden, H?kan Lindgen and Hans Sj?gren show that the country had an early development of non-profit savings banks and a central bank, which would lead Verdier to predict the emergence of universal banking. And that may have happened at the turn of the twentieth century, later than Verdier’s model would imply. The explanation may be that Sweden’s savings banks were linked with its commercial banks, so there was not so much deposit-market segmentation. When universal banking did finally come late to Sweden, it may have been for Gerschenkronian reasons, or it may simply have been in imitation of nearby and admired Germany. Sverre Knutsen’s description of Norway make it sound ripe for universal banking under either Gerschenkron’s or Verdier’s model. It didn’t happen. Foreign capital appears to have substituted for Gerschenkronian universal banks, and the Bank of Norway was too timid a supplier of liquidity and lender of last resort to fulfill Verdier’s second precondition for universal banking.

Imperial Russia, according to Don Rowney’s chapter, had British-type commercial banking in Moscow and German-style universal banking in St. Petersburg. Neither Gerschenkron’s nor Verdier’s model seems very helpful in explaining that mixed outcome. Instead the Russian state seems to have sponsored both types of banking, in imitation of Britain in the 1880s (Moscow) and of Germany (St. Petersburg) in the early 1900s.

Jaime Reis’s essay on Portugal ends the volume. Portugal was a centralized state with a weak non-profit banking sector, so Verdier’s model would predict commercial banking, as in Britain. Instead, Portugal had universal banks. But these banks did not make Portugal grow as Germany did. Portugal’s problems seemed to be that it was a poor, underdeveloped country without many bank deposits of any kind, and that the Portuguese national debt, three times larger than the total of bank deposits, crowded out both banks and industrial investment.

The main lesson of this volume is that it is not easy to come up with simple, or even moderately complex, explanations for differences among national financial systems. That said, Daniel Verdier is surely correct in his emphasis on the importance of political factors in producing history’s diverse financial-system outcomes. I also think Gerschenkron, with whom I discussed these matters many times, would have agreed with him on that.

Richard Sylla is Henry Kaufman Professor of the History of Financial Institutions and Markets at New York University’s Stern School of Business. His latest article, with Peter L. Rousseau, is “Emerging Financial Markets and Early U.S. Growth,” Explorations in Economic History 42 (2005).

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Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):Europe
Time Period(s):20th Century: Pre WWII

A Financial History of the United States

Author(s):Markham, Jerry W.
Reviewer(s):Wright, Robert E.

Published by EH.NET (June 2002)

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Jerry W. Markham, A Financial History of the United States. Armonk, NY: M.E. Sharpe, 2002. Volume 1: xxii + 437 pp.; Volume 2: xx + 412 pp.; Volume 3: xx + 449 pp. $349.00 (cloth), ISBN: 0-7656-0730-1.

Reviewed for EH.NET by Robert E. Wright.

Former SEC attorney Jerry W. Markham currently teaches corporate and international law at the University of North Carolina at Chapel Hill. Heretofore, he has written extensively on the history of the regulation of commodity futures trading. The work under review is his first significant foray into the broad study of financial history and, quite frankly, it shows. Given the high costs of purchasing and reading these three volumes, the reviewer feels an obligation to the academic community not to mince words: the thesis of this review is that Markham’s opus is seriously flawed.

Markham clearly wanted his book to be a Narrative in the Grand Olde Style, not an academic monograph seeking to prove a point, so not a single table or equation graces the volume. Moreover, the book does not present a thesis so much as an attitude. Like many Americans, Markham views the financial sector with suspicion. He fails, therefore, to give full credit to the crucial role of finance in U.S. economic development. For instance, he claims that banks issued notes “without limits” (1:132; 1:133), that “speculators” made “vast fortunes” (1:109), and that investors fell easy prey to any old “speculative frenzy” (1:98) that happened to form. “Every advance in finance,” Markham opines, “was accompanied by fraud and over-reaching by the unscrupulous” (1:380). Busy with such hyperbole, he fails to explicate how intermediaries, speculators, and investors interacted to finance the mightiest economy on Earth.

Markham ignores too many important secondary works to be taken seriously as an authority in financial history. For instance in Volume 1, which covers the colonial period to 1900, he fails to cite any of the following economic historians: Howard Bodenhorn, Stuart Bruchey, David Cowen, Thomas Doerflinger, E. James Ferguson, Gary Gorton, Gregory Hunter, Naomi Lamoreaux, Diane Lindstrom, John Majewski, Cathy Matson, John J. McCusker, Ranald Michie, George Rappaport, Winifred Rothenberg, Mary Schweitzer, or Richard Sylla. Moreover, he pays scant attention to the important contributions of Stuart Banner, Edwin Perkins, and Hugh Rockoff, among others. In short, the book is not based on anything approaching a comprehensive review of the extant literature.

Markham also fails to survey significant primary source material. He cites a few court cases, an occasional old legal treatise, some congressional reports, a handful of newspaper articles, and Joseph Martin’s descriptions of the Boston stock market. More maddening still, Markham cites recent articles from the Wall Street Journal, the Washington Post, the New York Times, and the Raleigh News & Observer as authorities on historical subjects! Journalists often rely on the same outdated, often nineteenth-century, secondary sources that Markham also leans upon, including William Gouge’s infamous book on antebellum banks and an array of late nineteenth-century hard money polemicists. Worst of all, many of Markham’s assertions are completely undocumented, allowing him to breathe life into a series of apocryphal stories of questionable origins and unlikely authenticity (see, for example, 1:50, 68).

Historians do not have to uncover new archival sources or re-examine known sources in a fresh manner in order to make a contribution. A good story well told will always be appreciated. Due to the inadequacies of Markham’s prose, however, few readers will come to appreciate financial history’s many good stories. The book reads like a rough draft, not a polished book. Numerous simple declarative sentences, at times virtually unconnected conceptually, and rampant use of the passive voice make the book difficult to read. Consider, for example, the following excerpt, which is all-too-typical of the author’s style: “Wheat farm bonds on Canadian lands were sold in Chicago. Those bonds paid 7 per cent per annum. Spitzer, Rorick & Co. offered municipal bonds that netted from 4.25 to 5.75 percent. Seney, Rogers & Co. sold real estate gold bonds and mortgages on Chicago property. Investments from $100 to $50,000 were sought” (2:62).

Markham regularly incorporates quotations of secondary authors into his own sentence structure, as if the words emanated from an historical figure instead of an historian. Only when the reader turns to the endnote, at the end of the volume and difficult to find because of the book’s odd numbering scheme does it become clear that the ‘great quotation’ is that of Bray Hammond, Paul Studenski, or Margaret Myers, not that of Robert Morris, Alexander Hamilton, or Jay Gould.

Indeed, Markham displays precious little historical sense. He notes that “colonial governments eventually found themselves issuing the paper currency advocated by Franklin and others,” then goes on to describe paper money emissions made decades before Franklin’s birth (1:50). He describes a retail purchase that George Washington made in Maryland in 1770 and bolsters it with Madame Knight’s famous discussion of prices in New England in 1704 (1:53-54). I wonder what a judge would say to the following reasoning: “The worldwide depression in 1765 added to the economic problems encountered by the American colonies. A creditor of Paul Revere sought to attach his property for a debt of ten pounds. Nevertheless, some consumer protection was appearing. A law against usurious loans was adopted in New York in 1661″ (1:56)? Similar examples abound (1:63, 70, 83, 126).

Outright errors also abound. Some of the more technical errors, like confusing “bottomry” loans (on ships) with “respondentia” loans (on cargo), would perhaps be partially understandable were not the author a legal scholar (1:6). Other errors, like calling a tontine “a form of lottery scheme” (1:81), referring to bills of exchange as “currency” (1:48), and confusing banknotes and bills of credit (1:72) suggest that Markham is not conversant with the financial terminology of the era. Other errors probably stem from the volume’s impoverished editing. Consider, for example, his “definition” of a put option: “A put option entitled the option holder to sell stock to the writer of the stock [sic] at a specified price.”

Markham makes little use of financial theory. In numerous places, for instance, he could have explained his anecdotes using basic financial concepts like adverse selection and moral hazard (1:38-39, 55). In other places, Markham makes wild comparisons between past and present practices. For instance, he somehow concludes that the “exchange of flour in one state for flour in another in order to save transportation expenses” is “an early form of a swap transaction” (1:70). He describes U.S. Deferred bonds as “when issued” securities instead of discount (zero coupon) bonds (1:119). Similarly, he fails to see that the market correctly priced convertible bank notes as discount bonds (1:132).

The very subtitle of Volume 2, From J.P. Morgan to the Institutional Investor (1900-1970), is misleading because it implies that Morgan predated institutional investors. In fact, institutional investors, particularly life insurance companies and mutual savings banks, were important players in the nation’s financial markets by the 1860s, not the 1960s. True, institutional investors largely eschewed common stocks until the 1960s, but it is well known that equity investment represents a small percentage of external finance flows. Markham’s assertion that “the first seven decades of the twentieth century witnessed more challenges to American finance than all the years before” seems at best a matter of opinion and, at worst, another example of the author’s lack of historical perspective (2:369).

Outright errors and misleading statements again abound in Volume 2. For instance, Markham claims that the Blue Sky Laws were passed “to stop the sale of worthless securities” (2:370). Law professor Paul Mahoney, however, has shown that commercial banks fought for the passage of those securities regulations in order to disembowel their major competitor, the commercial paper market. Markham also asserts that “the Federal Reserve legislation [of 1913] adopted the concept of ‘open market’ operations in which the Federal Reserve banks bought and sold government securities and eligible private debt issues in order to influence the money supply” (2:46). In fact, the Fed discovered the monetary policy uses of open market operations some years after its establishment (http://minneapolisfed.org/pubs/region/88-08/reg888f.html) and at first favored private paper and municipal warrants over Treasuries (David Marshall, “Origins of the Use of Treasury Debt in Open Market Operations: Lessons for the Present,” Federal Reserve Bank of Chicago Economic Perspectives, 2002 1Q: 45-54).

Time and space limitations prevent a fuller discussion of the shortcomings of Markham’s mammoth book. Volume 3, From the Age of Derivatives into the New Millennium, appears to contain fewer outright errors than the first two volumes, but it too suffers from a lack of focus, editing, evidence, and documentation. Indeed, only six pages of notes support 357 pages of text. The conclusion to the third volume confidently predicts the demise of paper money, paper correspondence, brick-and-mortar stores, and specialized financial services firms. “Undoubtedly, Wal-Mart and its like,” Markham claims, will supply consumers with mortgages, mutual funds, insurance policies, and “a host of other financial services” (3:365). Markham does not make clear, however, why Wal-Mart will fare any better than Sears did.

To conclude, I do not suggest that you use this opus, but if you do, use it with great care. The historical development of U.S. financial markets and institutions is an enormously important and complex topic. A quality, scholarly synthetic overview is still desperately needed.

Robert E. Wright is the author of The Wealth of Nations Rediscovered: Integration and Expansion in American Financial Markets, 1780-1850 (Cambridge, 2002), Hamilton Unbound: Finance and the Creation of the American Republic (Greenwood, 2002), History of Corporate Finance: Development of Anglo-American Securities Markets, Laws, and Financial Practices and Theories (Pickering & Chatto, 2002), Origins of Commercial Banking in America, 1750-1800 (Rowman & Littlefield, 2001), and three forthcoming works tentatively titled Corporate Governance in Historical Perspective: The Importance of Stakeholder Activism (Pickering & Chatto), Mutually Beneficial: The Guardian and Life Insurance in America (New York University Press), and Financing American Economic Growth: The Philadelphia Story (New York University Press).

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):North America
Time Period(s):20th Century: WWII and post-WWII

The London Stock Exchange: A History

Author(s):Michie, Ranald C.
Reviewer(s):Neal, Larry

Published by EH.NET (August 2000)

Ranald C. Michie, The London Stock Exchange: A History. Oxford: Oxford

University Press, 1999. xiii + 672 pp. $110 (cloth), ISBN: 0-19-829508-1.

Reviewed for EH.NET by Larry Neal, Department of Economics, University of

Illinois.

Among financial historians, it is now commonplace to regard the emergence of

today’s global capital market as a resumption of the progress that had been

made toward creating a global market in goods, labor, and capital in the period

from 1850 to 1914. Ranald Michie, the preeminent historian of the London Stock

Exchange in that bygone halcyon era, presents the story of how the London Stock

Exchange rose to preeminence in that earlier international capital market, but

then suffered through the disruptions of the international economy created by

two successive world wars and the financial crises that followed them, and is

now still struggling to retain a reputable place in the new global capital

markets that have emerged over the past thirty years. Written on the basis of

an intensive examination of the records of the London Stock Exchange, his work

will now be the standard reference on the London Stock Exchange, replacing old

classics such as E. V. Morgan and W. A. Thomas, The Stock Exchange: Its

History and Functions, (London, 1961), and even Michie’s earlier work,

The London and New York Stock Exchanges 1850-1914, (London, 1987). The

timing of its appearance is especially fortuitous as the current members of the

London Stock Exchange decide how to vote in September 2000 about the proposed

merger with the German stock exchange. Will the smaller members lose their

livelihood from the competition of the more efficient German firms? Or will the

merger preserve their incomes from the competition of electronic market makers

not constrained by the rules of a formal exchange? Or will the largest firms be

willing to buy them out on favorable terms in any event?

These are the questions today, but they have been faced in much the same terms

any number of times over the past two hundred years, as Michie documents. The

answers, though, have varied depending on both the nature of the external

competition and the nature of the internal composition of the exchange. Michie

argues that his kind of study, focusing on the decisions taken over time by the

members of the London Stock Exchange, can reveal much about the role of the

financial system in shaping the course of the real economy. It is not the

securities market in Britain as such, then, that concerns him, but rather the

specific role of the self-governing organization called the London Stock

Exchange in the securities market. This is certainly a worthy endeavor and

modern finance scholars are increasingly concerned about the implications of

what they call “market microstructure” in determining the efficiency of price

discovery processes as well as overall efficiency in financial intermediation.

For them, Michie describes and appraises the creation, operation and evolution

of the microstructure of what is still one of the world’s leading stock

exchanges and was the undisputed leader during the gold standard era. He does

not, however, deal with these arcane issues of market efficiency, to the

disappointment of some readers, but no doubt the relief of most. (The awkward

term “microstructure” never appears in the 642 pages of text.) But neither does

he entertain with stories of rascal behavior by the more opportunistic

participants of the “House,” to the disappointment of most readers and no doubt

his publisher hoping for more robust sales. Rather, he concludes each chapter

with a table showing the number and capitalization of the securities listed on

the London Stock Exchange for a benchmark date. These together show the

changing scale and scope of the exchange’s market over time. This is a solid

work of original historical research that gives the reader many interesting

insights and raises important questions for practitioners and policymakers as

well.

Michie begins his story, “From Market to Exchange, 1693-1801,” with an overview

of the rise of an informal, unorganized, secondary market in government debt.

This begins, in his view, in 1693 with the establishment of permanent debt that

could be transferred. As the amount of debt increased with each successive war,

so did the number of investors, encouraged by the government’s ability to

continue servicing at least the regular interest payments promised on the debt

issues. Gradually, specialists arose, both brokers and jobbers, both very

important to the operation of an efficient secondary market for any set of

products. Brokers made their money from commissions they charged to their

principals, who desired to buy or sell an amount of a particular security

within a specified price range. Jobbers provided the brokers the counterparties

to their principals, offering to sell to their buyer or to buy from their

seller the particular security. They made their money on the difference between

the prices they bid or asked, and saved the broker the time and expense of

finding a specific counter party to his original client. Both made more money,

the greater the volume of transactions. Brokers made a commission charged to

their principals; jobbers made a “turn” on the bid-ask spread always intending

to buy low and sell high. By the end of the eighteenth century, the number of

investors was large and a number of specialized brokers and jobbers seemed to

be making a living from their respective trading activities. Nevertheless,

asserts Michie, this was just a market, not an organized exchange that could

affect by its own rules and enforcement decisions the way the security market

would develop in the future. In 1801, however, the informal London stock market

ceased to be shaped strictly by outside forces and henceforth could determine

in part its own destiny through the decisions taken by its governing bodies.

These were the Committee for General Purposes for the Members and the Trustees

& Managers for the Proprietors.

How they operated vis-?-vis each other to solidify the tradition and prestige

of the “House” is detailed in “From Money to Capital, 1801-1851.” Readers

familiar with Michie’s earlier comparison of the London and New York stock

exchanges, the two classic examples of financial capital marketplaces, will

find a familiar theme in his emphasis in this book upon the importance of the

governance structure of the London Stock Exchange as it coped with the

successive changes in monetary regimes, government controls and policies, new

communications technologies, and international and domestic competition.

Responding to the pressures of war finance in 1801 at the outset of the

Napoleonic Wars with France, one group of traders became the Proprietors of the

building that housed the market place for the Members engaged in actual

trading. The Proprietors, as owners of the market place, but not of the

products of the market place, were strictly interested in maintaining a large

membership paying annual subscriptions for the use of the facility while

keeping operating costs as low as possible. The Members, as users of the market

place, were concerned strictly with generating a large volume of trading while

keeping their own costs of business as low as possible. Faced with outside

competition from time to time, the Members would try to restrict access, while

the Proprietors would try to co-opt it into the House. Members, however, had

complete control over who could become a Member, although Proprietors set the

annual entrance fee that individuals had to pay to take up their membership and

determined the hours of operation and physical amenities provided. Once in

place, this method of operation proved self-sustaining and it endured through

all the travails and opportunities that ensued over the next two centuries.

In the first half century, the governance structure was challenged by two

shocks, the brief but intense interest in foreign government debt and foreign

mining shares in the early 1820s and then the longer and even more intense

investor enthusiasm for railroad securities starting in the late 1830s. In both

cases, the users of the exchange wanted to keep out competition by traders

specializing in the new securities but the owners of the exchange accommodated

them as soon as possible to prevent an alternative exchange from arising in

London. The resulting expansion of business benefited all members and

solidified their operating rules and governance procedures.

In the rest of the nineteenth century, which Michie labels “From Domestic to

International, 1850-1914,” the British success with financing domestic

railroads led to providing finance for foreign railroads and then for large

commercial and industrial firms both at home and overseas. The continued

expansion of the number and variety of securities listed on the exchange led to

enlarged memberships and increased pressure on the physical facilities of the

exchange. To finance a new building in the 1870s, the Proprietors increased

fees on the Members, who responded by demanding more voice in management. The

conflicting interests were resolved through expanding the capital stock of the

Stock Exchange by requiring all future members to become shareholders as well

as subscribers. The number of shareholders grew, as a consequence, from only

268 in 1876 to 2,366 in 1914 so that there gradually occurred an overlap

between Proprietors and Members. In his earlier work, Michie has argued that

the increasing voice of broker members in the governance of the Stock Exchange

was gradually undermining its flexibility in responding to competitive

challenges and its responsiveness to technological advances in communications.

Now, his appraisal is that the exchange was remarkably flexible and responsive,

especially, one infers, by contrast with its continued dithering over the

period 1945 to 1986, which came dangerously close to eliminating it entirely as

an organization.

What accounts for this earlier success? Internally, one factor was that dual

control by Proprietors and Members continued to be effective in offsetting

tendencies towards restricting access to the exchange; another was the

continued importance numerically of jobbers within the membership of the

exchange. Externally, the most important factor was the central role played by

the Stock Exchange in the money market of London. The ever-expanding joint

stock banks in London found that their loanable funds could be employed

profitably for short periods of time by lending to so-called money brokers who

were members of the Stock Exchange. They, in turn, could lend on security of

shares and stocks held by jobbers to allow them to settle differences at the

fortnightly settlements or to continue their positions to the next account.

Specialization in function within the Stock Exchange thus occurred that allowed

further specialization in function among the financial intermediaries of

Lombard Street. These nested specializations increased efficiency in the use of

funds by all concerned. They also allowed, however, increased efficiency within

the growing number of provincial stock exchanges, who could tap into the London

money market easily through the branches of the joint-stock banks.

Whatever the dynamics of the emerging structure of finance and industry would

have created for the future of the British economy, the impact of World War I

changed everything, and mostly for the worse in Michie’s opinion. First of all,

it eliminated the foreign business of the Stock Exchange bringing that under

the control of the Treasury, now concerned only with raising money for war

finance. Second, it eliminated the money market role of the Stock Exchange by

eliminating dealing in options and even for account. Finally, it created a

comfortable source of easy commissions by the huge increase in government debt

traded on the Stock Exchange. Wartime restrictions on membership created by

military service for younger members and expulsion of foreign, especially

German, members were formalized by rule changes when peace returned. Minimum

commissions were rigidly enforced. In short, the war changed permanently all

the external conditions that had created prosperity for the members of the

Stock Exchange before the war. But it also strengthened the rigidity of

internal rules that protected the incomes of the surviving members.

Michie then treats the interwar period in two separate chapters, “Challenges

and Opportunities, 1919-1939,” and “The Changing Market Place Between the

Wars.” The first chapter details how “the rules of the Stock Exchange, designed

to create an orderly market, were increasingly used by the membership to limit

the competitive environment within which they operated. This was true both in

terms of outside competition, with restrictions on admissions, and internally,

with minimum commissions and other controls. The end result was a lessening of

those forces for change that had forced the membership in the past to respond

to challenges and to seize opportunities” (p. 234). This is exactly the

conclusion one expects, given Michie’s earlier study. The second chapter argues

that, nevertheless, the ossification of the Stock Exchange was not the key

problem for the finance of British industry during the interwar period. Rather,

the increased rate of taxation needed to service the huge increase in

government debt, the decline of profitability of older industries, and London’s

diminished international role all limited the potential supply of finance,

irrespective of the reduced efficiency of the Stock Market in providing

financial intermediation. While researching the current book, Michie has become

more sympathetic to the efforts of the Stock Exchange as an organization and

more critical of the external forces that limited its potential service to the

British economy.

In “New Beginnings: The Second World War, 1939-1945,” the changes that the

exigencies of war finance had inflicted upon an unsuspecting and unprepared

Stock Exchange in 1914 were now adopted quickly as a matter of course. The

Stock Exchange willingly became an administrative arm of the government,

helping the Treasury to market its burgeoning debt issues and receiving in turn

the protection of the government against competitive forces in the government

debt market. Dual control was finally ended informally, as the Committee for

General Purposes for the users and the Trustees and Managers Committee for the

owners were combined into a Council, dominated by the members, or users, of the

Stock Exchange for the duration of the war. This streamlined governance

structure made the postwar Stock Exchange an effective arm of the government,

but ossified the responsiveness of the organization to the competition of

provincial exchanges and of the joint stock banks in dealing on the securities

markets in Britain. It did, however, enable the members to buy out the

proprietors and formally end dual control in 1948. Thereafter, the business of

the Stock Exchange was not to make a profit for the owners, but to render

services to the existing members. On the expense side, however, it was

committed to pay out ?160,000 annually to buy out the previous Proprietors and

committed to enlarging its salaried staff to carry out the regulatory functions

it believed the government expected of it. On the revenue side, members were

not willing to vote increased subscriptions fees, much less stock assessments,

on themselves, especially as the incomes of many firms fell after the war.

“Drifting towards Oblivion, 1950-1959,” “Failing to Adjust, 1960-1969,” and

“Prelude to Change, 1970-1979,” are the chapter titles that follow and they

convey well the encompassing malaise that overcame the Stock Exchange and most

of its members, steadily declining in number and consolidating into fewer and

fewer firms in each succeeding decade. During the 1950s, however, the London

Stock Exchange found a new role despite its hidebound governance and

administrative structure. This was serving as a market place for the rising

volume of domestic corporate shares. These were not, Michie argues, a new

source of finance, but a substitute for business debt with fixed interest,

which was increasingly unattractive to British investors in the persistently

inflationary climate of the 1950s. These didn’t match in total volume the size

of government debt, but in terms of trading commissions earned by member firms

they were just as important as those earned on placing and trading issues of

government debt. Moreover, government debt trading became increasingly

concentrated among fewer firms while corporate equities could provide niche

markets for a variety of the member firms. In the 1960s, this trend established

in the 1950s continued to the benefit of the Stock Exchange and its members.

But it also elicited increasing interest from foreign investors, whose demands

were quickly met by foreign firms, both banks and investment houses, located in

London, rather than by the Stock Exchange. Further, provincial exchanges and

non-member stockbroking firms found it easy to enter this growing market,

especially as the Stock Exchange became increasingly restrictive in its listing

requirements for corporate equities. As a quasi-regulatory arm of government,

the London Stock Exchange felt it was important to protect outside investors

from the risks of smaller firms in new industries, but this was precisely where

the largest potential profits could be made. The circumstances of the 1970s at

first confirmed the wisdom of this strategy to the leadership of the Stock

Exchange when the equities market collapsed in 1974. This led to a formal

merger with the provincial exchanges, enlarging the membership of what was now

called the International Stock Exchange within the same rigid set of rules as

before. The country jobbers were forced to become single-capacity brokers, so

they helped strengthen the support within the membership for enforcing minimum

commissions. Moreover, the Stock Exchange was now a much more effective

regulator of the British securities marketplace. But the cost of this

consolidation was that the Stock Exchange was further constrained from

responding to challenges by foreign exchanges and firms, and from initiating or

even imitating financial innovations taking place within non-member firms and

the major financial intermediaries in the City of London.

The breakthrough that eventually led to the “Big Bang” (chapter 12) in 1986,

the once for all elimination of minimum commissions and restrictions on the

size and functions of member firms, Michie argues, was the elimination by the

Thatcher government of exchange controls in 1979. Now the customers of the

brokerage houses, increasingly the banks, insurance companies, and investment

houses, could readily invest abroad with foreign exchanges and stockbroking

firms. Foreign banks and brokerage houses in London could now bypass the high

costs of the Stock Exchange without incurring the penalties imposed by exchange

controls. The response of the Stock Exchange to this challenge was delayed

until 1986, however, not because of the rigidity of the governance structure,

but because of the Thatcher government’s attack on the privileges of the Stock

Exchange brought before the Restrictive Practices Court. While this action was

on the docket, the Stock Exchange officers felt compelled to defend the entire

corpus of Rules and Regulations that had accreted over the decades, according

to Michie. Not until the case was dismissed by the government in 1983, did the

officers feel free to move forward to modernize the rules of the Stock

Exchange.

In the penultimate chapter, “Black Hole,” Michie begins by stating that “On 3

March 2001 the London Stock Exchange, as a formally organized securities

market, will have existed for two centuries.” That, we now know, remains to be

seen! Michie documents the difficulties faced by the venerable institution for

survival, but seems to think they stem mostly from continued hassling of the

securities market in general by government regulators. Given the City’s success

previously in attracting the business of foreign international banks, mainly to

deal in the Euro-dollar and Euro-bond market that developed outside the Stock

Exchange, the Big Bang’s removal of restrictions on membership allowed the

entry of the most innovative firms and practices from around the world. At his

most optimistic, Michie opines, “In fact, what emerged from Big Bang was akin

to the dual control which had worked so well in the past, with responsibility

now shared between the Stock Exchange, representing its members, and the

regulatory authorities, reflecting the needs of the wider financial community”

(p. 634). General readers could more easily share this optimism if they had

confidence that the regulatory authorities would reflect the needs of the

financial community rather than the needs of their political masters to be

re-elected within five years. Indeed, Michie’s final lesson that he draws from

his historical account is “that self-regulation without monopoly power has

produced the most satisfactory solution in the past. Otherwise governments

operate to their own agendas, distorting the market and destroying innovation

in the process, while self-regulating monopolies abuse their power for their

own self-interest” (p. 642). The challenge is clear; how it will be met is not!

Larry Neal is Professor of Economics at the University of Illinois at

Urbana-Champaign and Director of the European Union Center at Illinois. He is

past president of the Economic History Association and the Business History

Conference. From 1981 through 1998, he was editor of Explorations in

Economic History. He is author of The Rise of Financial Capitalism:

International Capital Markets in the Age of Reason, Cambridge University

Press, 1990 and The Economics of the European Union and the Economies of

Europe, Oxford University Press, 1998 as well as numerous articles in

American and European economic history.

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):Europe
Time Period(s):20th Century: WWII and post-WWII

Blue Skies and Boiler Rooms: Buying and Selling Securities in Canada 1870-1940

Author(s):Armstrong, Christopher
Reviewer(s):Michie, Ranald C.

EH-NET BOOK REVIEW

Published by H-Business@cs.muohio.edu (March, 1998) Christopher Armstrong. Blue Skies and Boiler Rooms: Buying and Selling Securities in Canada 1870-1940. Toronto: University of Toronto Press, 1997. x + 390 pp. Photographs, appendix, and index. $39.95 (cloth), ISBN 0-8020-4184-1.

Reviewed for H-Business by Prof Ranald C. Michie , University of Durham

Usually with an academic book, the main title is designed to attract the attention of potential readers–even purchasers–while the subtitle is a more accurate description of the content. In this case, the reverse is true. Instead of being a history of the Canadian Securities market from 1870 to 1940, which I was expecting, this book concentrates, almost exclusively, upon the high pressure and/or fraudulent techniques employed to sell speculative mining securities to the investing public, and the measures employed by Canadian federal and provincial governments to stop them. Certainly there is much material on the various Canadian Stock Exchanges and their members, but this is a back drop to their participation in a process whereby large numbers of credulous investors were sold vast numbers of shares in numerous worthless mines year after year by manipulative promoters. Consequently, in reviewing this book one must be always conscious of what it is about, not what one might expect it to be about. However, judging from the introduction, there is the presumption that this book did begin as a history of the securities market in Canada, for it is stated that it “is one of two volumes dealing with the evolution of public securities markets in Canada” (p. 3). Volume II presumably takes the account from 1940 to the present. Quite quickly, the reader is informed that there is little of interest in the buying and selling securities, and thus one can hardly inflict upon the public an account of the evolution of the Canadian Securities market. Instead, it is considered much more rewarding to focus on “crooks and shysters” (p. 8) as that will result in a far more interesting book. Though I disagree with the author’s view that there is little to say about the development of securities markets–even that of Canada–he is probably right in his assumption that a book that concentrates upon fraud, corruption, and human greed has more appeal than one about the institutional arrangements of stock exchanges.

The first and third chapters do deal with the beginnings of Canada’s securities markets, but no distinction is made between the creation of a formal exchange and the existence of an open market, and thus there is no discussion of why the latter leads to former. If there had been such a discussion, the author might have been more aware of the extent and limitations of a stock exchange’s jurisdiction. A Stock Exchange can enforce discipline among its own members, ensuring that deals take place in an environment of trust, but it cannot be expected to police all aspects of the securities business, including the initial sale of securities, or to provide investor protection. The more an exchange is drawn into areas such as these the more likely it is to face competition from over-the-counter (OTC) markets devoid of such rules and regulations. At the same time there is no attempt to explore the relationship between the Canadian Stock Exchanges and those in New York and London, which had such an important influence on the Canadian securities market before 1914 and subsequently.

With Chapters Two and Four, the author settles into the theme of the book–the promotion of Canadian mining companies and the methods used to persuade investors to buy shares in them. Initially, the principle of “caveat emptor” applied, but even before the First World War various provincial legislatures, beginning with the Prairie Provinces, began to restrict such activities. This speculation in mining shares died away with the outbreak of the First World War. The exchanges were even closed for a number of months, and when they did re-open they were subject to government control while their business switched to trading Canadian government debt. During the period 1915-19 the Canadian government raised $2.1 billion domestically, rather than in London as had been the pre-war practice. In turn, trading in bonds on the Montreal and Toronto stock exchanges rose from $6.1 m in 1913 to $132 .1 m in 1919. Clearly, the Canadian securities market was transformed as a result of the First World War. Unfortunately, the book then ignores the post-war bond market, though, from the statistical appendix, it is clear that it had become an established feature. Instead, the chapters dealing with the 1920s (Six and Seven) concentrate on the miss-selling of mining securities, the lack of stock exchange regulation, and the role played by government. This then leads into the Wall Street crash of October 1929, which was felt heavily in Canada, where investors blamed the exchanges and their members for their losses. Again the focus is almost entirely on the mining market and its practices with little on industrial or utility stocks and nothing on government bonds.

What emerges as interesting from these chapters (Eight and Nine) is the author’s conclusion that Britain’s departure from the Gold Standard in September 1931 had no more damaging impact on the Canadian securities market than the Wall Street Crash of October 1929. The former undermined the confidence of banks, and this their lending policies, whereas the latter was an inevitable market correction. This to me is worthy of wider discussion.

As a result of the crises of 1929 and 1931, Canadian governments became very concerned with practices in the securities markets, which were seen as bearing a heavy responsibility for what had taken place. A Security Frauds Prevention Act was passed in 1930, but its effectiveness was hampered by provincial/federal rivalry. Thus, instead of following the United States in creating a Securities and Exchange Commission, in Canada the provincial authorities were left as sovereign in regulating securities. The experience of Ontario in particular is extensively chronicled as they attempted to curb fraudulent excesses in mining securities, especially when the market boomed in 1933/4, on the back of the revaluation of gold by the United States (Chapters Eleven through Thirteen). As part of this process, increasing pressure was placed on the stock exchanges to tighten up their own regulations. What thus emerged was growing co-operation in the 1930s both between the major stock exchanges in Montreal and Toronto and the various provincial authorities. What consequences this had for the securities market, both generally and individually, is never really explored. It would have been interesting to know if exchanges flourished best under a lax regime or in a more regulated environment providing greater investor protection.

The final chapter (Chapter Fourteen) sketches in the years immediately before the outbreak of the Second World War. With war being so widely predicted, investors adopted a more cautious attitude and so the level of stock activity was low. The book then draws to a close with a short conclusion and a valuable statistical appendix giving turnover on the Montreal and Toronto Stock Exchanges between 1901 and 1936. From this data, it appears that Toronto’s participation in the bond market virtually disappears after 1923, leaving the field to Montreal. Turnover in bonds in Montreal then collapses after 1931. Why all this took place is never explained in the book, which is a pity, for in it may lie part of the explanation of how Toronto came to dislodge Montreal as the financial center of Canada.

Overall this is a long, carefully researched book that weaves together financial, political, legal and social history to present an account of the problems encountered in protecting the human race–even Canadians–from their own stupidity. However, to consider it a history of the Canadian securities market would be a grave mistake. The securities of new mining companies, in their exploration phase, were always regarded as speculative counters and so attracted the gambling instincts of investors. However, these were not the only securities held by Canadian investors and traded on organized markets there. Throughout the period there was a regular business in the stocks of Canadian banks, insurance companies, railways, utilities and industrials as well as a significant bond market from 1916 onwards. The author’s own appendix makes this clear. This trading reflected the varied influences of the domestic and international capital and money markets, as well as changing investor sentiment, as with events like the First World War, the Wall Street Crash, and Britain’s departure from the Gold Standard in 1931. For me, this would have made a much more interesting book than the one delivered here, for I did tire of the endless repetition of mining scams. Finally, I do wonder why the author ignored my 1988 article in Business History Review entitled “The Canadian Securities market, 1850 to 1914.” Judging from his comments in the introduction to this book, he probably found it too boring!! I am sure many would agree with him!!

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Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):North America
Time Period(s):20th Century: Pre WWII