How Did Stock Markets Develop

Figure 1. The Dutch East India Company was the first publicly traded in the first stock market established in Amsterdam in 1602.

Stock markets developed over the last few centuries into companies issuing shares and investment opportunities to shareholders. Stock markets very much drive modern economies, but the ideas behind them are a few centuries old. Nevertheless, the concept of investing in firms or organizations that reap the rewards for shareholders engaged in trading is an ancient one and goes back millennia.

Early History

Investments and shared ownership ideas have been around for millennia. Already in the Old Assyrian period, about 4000 years ago in Turkey and Northern Iraq, investment families were living in the city of Ashur. In northern Mesopotamia (Iraq), who conducted trade transactions with representatives, often from the same family, in Anatolian towns such as Kanesh. These family firms would also have investors who would pool money that would then fund trade caravans. Successful trade would bring great rewards for investors, but risks included raiding or natural disasters that could lead to financial ruin.

Similarly, in the Roman and Classical periods, enterprise, often dealing with long-distance trade, would involve wealthy families jointly investing and holding shares in trade endeavors. This would include financing trade excursions and investments in different businesses.

In the Medieval period around the 12th century, in France, debt held by banks would be traded. Similarly, the Venetians in the 13th century traded government securities, similar to bond markets. Soon, companies began to issue shares as a means also to finance their enterprises, somewhat similar to the Old Assyrian trade colonies allowing broader participation and financing of trade. This practice continued to spread in Western Europe, with England and Holland creating trade houses that would issue shares for companies during the 16th century.

This led to the emergence of the idea that companies can also be owned by shareholders, and not just leading families borrowing money from others, creating formal joint-stock companies that would have many individuals rather than a single-family business. However, the most significant changes occurred in the early 17th century, when the Dutch East India Company issued shares that were distributed to the public for purchase and investment (Figure 1). While having claims in a company goes back to antiquity, this development was pioneering because it was a persistent trade of shares in a public format that enabled a market around shares to develop.

Amsterdam soon became a new entrepreneurial center that developed the idea of a market where shares would be traded and developed other forms of investments that we have today, including options and more speculative growth investments about the direction in which the company may go. The emerging stock market in Amsterdam began to have formal trading hours and soon even a book, called Confusion de Confusiones, written in 1688 by Joseph de la Vega, described how to actively trade in the stock market as they attempted to understand how this market worked.

Later Developments

Figure 2. The Buttonwood Agreement helped establish what would become the New York Stock Exchange.

The idea of a stock market began to spread throughout Europe. London soon emerged as a critical center, with traders at the first meeting in a coffeehouse in the early 18th century. The coffee house became very active for trade and soon was wholly taken over by traders who formalized "stock exchange" in the English language. In the 18th century, as English explorers began to spread across North America, many of their expeditions, including trading for furs and other exotic products, began to be financed by stock exchange trading. Perhaps the most significant turning point for the early stock market in establishing itself as a solid link to the broader economy occurred during the Industrial Revolution from the late 18th century through the early 19th century.

The London stock market was seen as where startup enterprises would be financed, and new companies would seek venture capital and financing from stock investors. New industries now could develop quickly, and the pace of industrial and economic change greatly quickened as stocks financed enterprise.

In the United States, in 1792, on the corner of Walled Street and Broadway in New York, that country's first stock exchange was set up. It was formalized through the Buttonwood Agreement at 68 Wall Street underneath a buttonwood tree (Figure 2). In 1817, the same organization moved to 40 Wall Street and formally changed its name to the New York Stock and Exchange Board, the same word used today. Government bonds and the First Bank of the United States, a government bank, were initially traded. The first private company to be traded was the Bank of New York. Soon afterward, the Bank of North America also became among the early companies trading at the New York Stock Exchange.

Throughout the 19th century, other cities, such as Philadelphia, also established stock markets to trade securities and stocks in companies. Philadelphia became one of the main competitors to New York's stock market. However, in the early to mid 19th century, panics became common, significantly affecting traders. Among the relatively resistant markets was the New York Stock Exchange, which made it more favorable for companies and brokers to conduct trades.

The telegraph also meant that every city did not need a stock market, as a single trading exchange could conduct transactions for many companies. Trades slowly transformed from single calls sent by message to transactions sent by telegraph to speedup trading across distant areas. This helped to now consolidate markets to several key cities such as New York.

Modern Stock Markets

Throughout the late 19th century and early 20th century, stock markets became more directly linked with the major companies in countries, often rail, coal, and steel industries. Financing came from stock exchanges, and company success began to depend on the increasing growth of stock values. This increasingly made the economy vulnerable to panic selling, and there was no regulation to stop runaway selling. The Black Thursday and Black Tuesday crash of October 24 and 29, 1929 is widely seen as the triggers for the Great Depression of the 1930s. These were examples of panic selling that significantly reduced financial flows to significant companies.

New rules were introduced in the 1930s to prevent panic such as these significant crashes. The creation of the U.S. Securities and Exchange Commission in 1934 helped regulate financial markets, particularly the New York Stock Exchange. The Great Depression also demonstrated that the global economy, and not just the economy of the United States, began to become more linked, so that panic selling in one stock market began to affect other stock markets and economies. Markets such as London and New York, with now both these exchanges increasingly playing a dominant role in the global economy, had also begun to use stock exchanges to invest in other countries' businesses. This created links that led to the panics and triggers in other countries that precipitated a global depression in the 1930s.

The 1980s saw innovations such as electronic trading and by the 1990s, electronic trading services made trades almost instantaneous, a far cry to the pre-1980s system where open calls and shouting were used as the main way in which trade was conducted.

Throughout the 20th century, the primary trend has been increased stock market expansion on the broader economy, where it even touched average consumers since the World War II era. Pensions and retirement funds are typically invested in stock markets in the United States and some developed economies. This has increased the level of funding in stocks, but it is now seen as a standard way to manage one's retirement as average life expectancy progressively increased in the 20th century. As stock markets have spread and increased to most countries today, their primary purpose has not significantly shifted. Stock markets are mainly seen as a way for companies to raise funding and trade debt.

More regulation increased after the 1930s; however, deregulation occurred in the 1980s to stimulate trade that made stock transactions not only easier but put fewer limits to market trading requirements and fluctuations. Some limits were reintroduced in the 1990s to limit single, large drops in the stock market on a given day of trade.

Summary

Stock markets extend the ancient idea of investments in ventures by groups of individuals to the broader public. This idea of making companies public proved so popular in the 17th century that stock markets spread throughout Europe from that time. However, as stock markets increasingly became important in raising funds for firms, this also made the broader economy more vulnerable to panic selling and speculation. Many well-known and relatively old stock markets are still located near or where they were first established, including the stock markets in London and New York. For better or worse, today's global economy would be impossible to develop without major financial centers and smaller stock exchanges that fund local businesses.