Gelderblom, Oscar and Jonker, Joost (2004) “Completing a Financial Revolution: The Finance of the Dutch East India Trade and the Rise of the Amsterdam Capital Market, 1595-1612”, The Journal of Economic History, 64-3, 641-671.
One of the most commonly mentioned innovations of the British Financial Revolution, which occurred under the reign of William III, is the appearance of a secondary market for public and private securities. The earlier Dutch leg of the Financial Revolution, on the other hand, despite the availability of numerous public securities is usually assumed never to have evolve a meaningful secondary market (p.642). But the authors argue that the creation in 1602 of the Verenigde Oostindische Compagnie (the Dutch East India Company or VOC) led to the emergence of such a secondary market and that this market yield some of the advantage associated with the British innovations (p.643).
A business’ history
Bills of exchange were an excellent means of credit and could have enjoyed a lively secondary market, but issuing too many of them was perceived as a sign of weakness (p.644). In the 16th century, longer trade routes developed (to the Mediterranean, West Africa and the Caribbean), unlike the Baltic trade, the ships could only make a single voyage per year and the risks of piracy required heavier investment in defence and insurance. Thus more capital was needed and it would it immobilized longer. To meet these requirements, Dutch merchants commonly resorted to partenrederij (partnerships; p.645). Merchant could also finance their ventures by accepting deposits from family and friends. Finally, the business comunity widely used IOUs, but these required a personal knowledge of the issuer (p.646) and thus never developed into fully negotiable titles (p.647).
When the voyages to Asia developed at the end of the 16th century, it quickly appeared that they were too expensive, risky and long to be handled by individual merchants or even limited partnerships (p.648). “Such project required new ways of safeguarding liquidity while covering the commitment of substantial funds for unusually long periods of time”. Several companies developed to handle the Asian trade: their ownership was divided in fully transferable shares and subshare, the owner enjoyed limited liability but had no say in the management (p.649). This system managed to attract a very large ammount of investment in the Asian trade (p.650). Crucially, the fundraising was not limited to a handful of mighty merchants but spread all over Amsterdam and beyond as “most savers could be reached without the recourse to personal relations” (p.651).
The rise of a secondary market
“Before 1602, very few participants in shipping companies and colonial companies sold their interest”, it was a matter limited to a few dozens of insiders, “for others, gathering information about the true state of affairs was simply too complicated” (p.653). In 1602, when the independent companies were unified into the VOC, interest in the investing in the Asian trade spread even wider, over 2% of Amsterdam’s adult population subscribed. The unifed charter created clear rules that made ownership transfer easier and more transparent (p.654). Speculation quickly kicked in, a month after floatation – in August – share price had soared by 15%.
“By the end of 1607 about a third of the capital of the Amsterdam chamber [of the VOC] had been transferred [and] the turnover of shareholders buying and selling their stock quadrupled from 0.5 to 2 millions guilders” (p.657). And the transfer of shares was not limited to Amsterdam and took place in all chambers: Middleburg, Rotterdam, Delft, Hoorn and Enkhuizen.
Micromotives and macrobehaviors
The VOC shares were very liquid and quickly became a regular collateral for loans on the Amsterdam money market. They were easier to evaluate than commodities, less cumbersome than public debt issues, could be used for long-term loans unlike obligations and tax-free (p.659). “As it turned out, VOC shares offered an ideal loan collateral: a claim on a company known to all; very liquid, so easy to sell in case of default; with daily price quotation for quick valuation; and with ownership easily ascertained” (p.660). Businessmen quickly adapted to the new techniques. It allowed them to borrow more; owning VOC share was a sure access to the money market (p.661). Moreover the rising nominal value of the share made possible for one to safely increase his amount of debt (p.662).
“The creation of a vigorous market in VOC shares coincided with failing interest rates on short-term borrowing.” This is particularly remarkable since it happened during the commercial boom of 1590-1620, i.e. a time when there was no shortage of demand on the money market (p.663). True enough, at the time Amsterdam enjoyed capital inflow both from immigration and retained earnings from trade. But the presence of a secondary market for the VOC shares – which lowered information and enforcement costs – also helped pushing up market volume and lowering interest rates (p.664). This possibility to transfer credit between various circles was pivotal for the rise of a city where so many of the merchants came from foreign countries.
The creation of a secondary market in the Netherland has often been attributed to public bonds, but it seems than it is actually the floatation of the VOC’s shares that created the “crucial breakthrough”. The usage of IOUs had accustomed local merchants to the use and exchange of private debt instruments, the VOC’s innovation grew from this fertile ground. In the light of so much novelty, it is fairly amazing that financial evolution subsequently stalled for 150 years (p.666). Only two other companies were successfully floated: the West Indische Compagnie in 1621 and an insurance company in 1720. Only after 1750 did the Amsterdam market started to innovate anew.