In the 1700S It Took Four Days to Sail a Ship Between London and Amsterdam

A Common Features Analysis of Amsterdam and London Financial Markets During the 18th Century Greg Dempster John M. Wells And Douglas T. Wills* RRH: DEMPSTER, WELLS & WILLS: COMMON FEATURES * The authors would like to thank Robert Hébert, Larry Neal, Farshid Vahid, and an anonymous referee for help with this paper. Chris Wilkins at QMS provided suggestions instrumental in the programs used herein. Wells and Wills are also grateful to the National Science Foundation for financial support and to Sarah Millard at the Bank of England for her assistance. We retain all property rights to any remaining errors. Dempster: Ph.D. candidate, Dept. of Economics, Auburn University, Auburn, AL 36849-5242; phone: (334) 844- 2902; fax (334) 844-4615; E-mail: [email protected] Wells: Corresponding author, Assistant professor, Dept. of Economics, Auburn University, Auburn, AL 36849- 5242; phone: (334) 844-2902; fax (334) 844-4615; E-mail: [email protected] Wills: Assistant professor, Dept. of Economics, Sweet Briar College, Sweet Briar, VA 24595-0103; phone: (804) 381-6203; fax: (804) 381-6173; E-mail: [email protected] JEL Codes: F32, G15, N23 1 A Common Features Analysis of Amsterdam and London Financial Markets During the 18th Century “If one were to lead a stranger through the streets of Amsterdam and ask him were he was, he would answer, ‘Among speculators,’ for there is no corner [in the city] where one does not talk shares.” Joseph de la Vega, 1688 I. INTRODUCTION During the 1700’s the distance between London and Amsterdam was three days travel. Yet the vagaries of wind, sea, and sail often increased this distance to six days or more. Despite these ancient impediments to the flow of information, which saw no technological improvements over the 18th century, this paper demonstrates that the financial link between these two cities was extremely modern. The issues surrounding this financial linkage were also extremely modern, and can be viewed in the context of the recent turmoil in Mexico and Asia. In England of the 1700s, as in our economies of today, it was common for foreign investors to be blamed for dramatic movements in domestic currencies and stock markets. Since arbitrage and speculation between London and Amsterdam was not hindered by capital controls, taxes on dividends, or monetary upheavals at least until the Napoleonic Wars, Dutch investment in English assets grew to tremendous levels. This generated considerable domestic concern over the effects and appropriateness of these international capital flows and fear that such flows destabilized financial markets. Many great economists of the day, such as Jeremy Bentham, David Hume, Adam Smith, and James Steuart, addressed these issues in their writings. More recent work has also addressed Dutch investment in Britain, without reaching any clear conclusions on its effects. Carter [1975] maintains that the Dutch investor was passive and did not respond to price differences between the markets. Ashton [1959] attributes several 2 London financial panics to Dutch speculation, while Carruthers [1996] and Mirowski [1981; 1987] argue that the London market was inefficient. These topics are also addressed in the important work of Neal [1990] and Eagly and Smith [1976] as well as the historical analyses in Riley [1980] and Wilson [1941]. At issue here is the degree to which Dutch speculation can be regarded as active and/or destabilizing. More generally, the causal linkage between the two markets has never been established. These same issues are at the forefront of the economic and development discussions of today, and we attempt to shed light on them by examining a period when two markets were allowed to interact without the governmental interference that characterizes current capital markets. Using the prices of stocks traded simultaneously on both the London and Amsterdam exchanges from 1723 to 1794 in conjunction with recent econometric advances to detect common features and regime shifts between the two markets, we find a level of financial integration that rivals that of our present information age. In particular, the prices of Bank of England, East India Co., and South Sea Co. stocks determined in London appear to share common trends and common cycles with prices of these same stocks determined in Amsterdam on the same day. Moreover, individual shocks to these assets are shown to translate quickly and accurately between the distant markets. We find little evidence that Dutch investment was destabilizing, but considerable indication that the Dutch were active speculators. This paper is organized as follows. Section II addresses the issues surrounding these markets, the data is introduced in Section III, and Section IV discusses the common feature tests with results following in Section V. A final section concludes. II. LONDON AND AMSTERDAM MARKETS IN THE 18TH CENTURY 3 The London Market The financial developments in England during the last decade of the 17th century are well documented.1 By the early 1700s, the financial market in London matched in sophistication and liquidity those of Amsterdam and by the end of century it was the financial center of Europe. The state was now able to borrow more, both short-term and long-term, at lower interest rates. This improved ability to raise capital quickly and cheaply allowed the state to finance wars without plunging the country into financial crises. Concurrent with the growth of an active market in government debt instruments was an active market in the shares of the major joint-stock companies of the time. Shares of the Bank of England were actively traded in London markets from its inception in 1694. From an initial capital of £1.2 million, the capital of the bank rapidly grew to nearly £9 million within 30 years. The East India Company shares also began to be actively traded during this period and its capital stock grew to £3.2 million by 1723. With capital of £9.2 million at its creation in 1711, the South Sea Company took on much of the government debt accumulated during the War of Spanish Succession in exchange for a monopoly on south sea trading rights. This infamous company never seriously participated in trade but was so bold in its financial dealings that it sparked a speculative frenzy in 1720. After 1 See both Dickson [1967] and Neal [1990] for detailed studies of the impact and operation of English capital markets. The institutional changes that brought about these developments are examined in North and Weingast [1989] and Wells and Wills [1997]. 4 its reorganization following the "Bubble of 1720" its capital was approximately £17 million with a similar amount of transferable annuities.2 The parallel growth in the liquidity of capital markets, government debt, and joint-stock firm's capital was not coincidental. Each of these firms was intimately involved in the public finances of the British government. The government's "funded" debt came in two forms, loans from joint-stock companies and general public loans that were primarily perpetual annuities. By the middle of 18th Century, the Bank of England was responsible for £11.6 million of government debt, East India Company for £4.2 million, and the South Sea Company for £27 million.3 Until the War of Austrian Succession (1739-48), these three firms held nearly all of the government's funded debt. However, when the government required large amounts of revenue to fund military activity for wars in 1739-48 and 1756-63, it began obtaining loans directly from the public. By the end of the 18th Century, total government indebtedness topped £400 million, up from £72 million in 1755. By this time, perpetual annuities accounted for almost 90% of the funded debt. This growth in government debt and in the capitalization of private firms took place along with increasing public support and confidence. The transfer books and ledgers used to 2 See Clapham [1945] on the Bank of England, Sutherland [1952] and Keay [1994] on the East India Company, and Sperling [1962] on the South Sea Co. Scott [1910] is the most authoritative account of the early English joint-stock companies. 3 The British historical documents use the term 'funded debt' or 'the funds' to indicate that the debt was backed by a special duty, initially on beer, ale, and other liquors. The unfunded debt mainly consisted of promissory bills that carried interest and often circulated at considerable discount (History of the Earlier Years of the Funded Debt, 1898). On these points, and what follows, see an extremely useful survey in Carter [1975, 123-41]. 5 record trades of stock show an increasing volume of transactions over the century, and also reveal the name, status, and place of residence of the shareholders. They indicate that by mid- century there were over 60,000 total stockholders, and at least 600,000 by 1815. Most of these investors held less than £1,000 in several stocks, traded without the assistance of a broker, and most lived in and around London. The Amsterdam Market While the London market only began to develop after the events following 1688, Amsterdam had a lively and mature speculative market in securities as early as 1630. Joseph de la Vega, writing in 1688, describes in detail daily life on the Amsterdam Bourse indicating that this market had developed hedging, options for puts and calls, time contracts, and an organized role for “bears” and “bulls”. However, the transfer of shares in the Dutch East and West India companies was, despite the well developed Bourse, quite cumbersome compared to transfers in London. In addition, high taxes, relatively low rates of interest, increased competition facing Dutch shipping, and a sizable trade surplus with Britain all caused Dutch merchants to invest in English funds.

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