The international capital market in the nineteenth century versus the modern era

International Capital Markets

Capital markets provide the means to raise capital for all ventures. The investments in the products available in the capital markets help generate funds and stabilize interest rates. It is also an indicator pertaining to the status of the economy as also the fluctuations in the capital market and lending rates creates far reaching changes in the economy in the short run. In the eighteenth and nineteenth centuries when most countries were the colony of the European countries particularly Britain, the capital markets were institutions of international nature. After the first and Second World War, the fragmentation and independence of nations created institutions in each nation with regulators within the nation. The modern era has seen the emergence of the international capital market which is a creation of globalization, highly advanced technology and increased cooperation between nations. It has been observed that the international market in the nineteenth century was more efficient and active than the current market. The reasons along with the history of the development of the market have to be gone into before professing an opinion on the hypothesis. The integration of the capital market can be assessed in terms of interest rate arbitrage. The transaction cost levels as well as the efficiency of the arbitrage determines the state of the capital market. The interest earned by banks cannot be a measuring rod for identifying the state of the capital market because of the diversity in the institutions and interest rates.

International Capital Market in the Nineteenth Century

The international capital market was a phenomenon that existed as far back as 1700 AD. Research based on computer analysis has proved this fact. ("Review: The Rise of Financial Capitalism: International Capital Markets in the Age of Reason (Studies in Macroeconomic History)," 1993) the activity in the markets were enormous from the centre to the edges, and the London city was that centre. The British exported large shares of capital. The other countries involved were Germany, France and other countries. This increased the British commitment in the global capital market and British investments in colonies grew. Before the First war it was estimated to be over fifty percent. At that time the investments were mostly portfolio investments. Britain purchased stocks and bonds, and this was the major form of fund flow to the Americas and Australia. Direct foreign investment was made into social overheads like railways and development. During the depression of 1920 and the Second World War, the system collapsed. Post war activity was more in direct investment and the United States has emerged as a more powerful player. The post war scenario witnessed the entire capital surplus of the nineteenth and twentieth century evaporates. The capital market has come back to the operative state ever since 1972 and is growing to the state it was in the nineteenth century. The amount of capital flow in the globe in the nineteenth century shows that the market was well organized at that period. The capital market integration was also taking place within the countries that participated during the period. (O'Rourke H; Williamson, 1999) "The integration of capital markets is usually tested with an interest rate arbitrage model even though much different financial assets must be compared.." (Neal, 1985)

The history of the international financial system and the efficiency factor ought to be contrasted and viewed in the current trends after globalization. In the nineteenth century, there were no international institutions to govern the international markets. The flow of capital in the global market was then largely a result of the regulations and market flows of the capital markets of the nations, and the international flow was attempted to be regulated by the creation of central banking systems which failed. After the Second World War, the attempts to create an international capital market were revived, but there was still no consensus on its control. Having given up on the issue, insistence is now on making international fund flow transparent and in line with the globalization. These issues were also present in the nineteenth century markets and are being discussed and negotiated anew in the modern context. (Flandreau; Holtfrerich; James, 2003) the index of the progress and success of the market is the movement of the price index. The price movements in two markets in a time series must be the same. If the random walk is not observed between both the markets then there is still an interest arbitrage to be exploited. In the London and Amsterdam exchanges in the nineteenth century the shares of British companies that were traded there substantially was based on price differentials. American shares traded in the European markets were regularly traded by European market participants after the London market closed. (Neal, 1990)

Transition from the Old to the new

The transition from the capital market of the nineteenth century to the modern market came about during the Great Depression and the Second World War. The capital mobility was a requirement that has expanded globally with different exchange rates that were agreed upon by varying regimes, and the standard rates as in the Gold Standard were followed to bring about the equilibrium. The Great Depression was a significant turning event in international capital markets. Therefore all the events and machinery that was inherent with the system prior to the depression must be considered as that following the earlier market forces and the emerging market that is now current must be seen as the result of the transition that occurred at the time. (Bordo; Goldin; White, 1999)

The Post War economy and globalization

It is to be observed that may of problems in the present day world in the capital market have their origins and counterparts in the nineteenth as well as twentieth century. International mobility of capital removes the relation between investment and domestic savings and help weaker economies profit from the flow. (Bordo; Goldin; White, 1999) the changes that have come about are vast. There has been marked increased of banking institutions by foreign ownership thus creating competition among banking institutions which to some extent has raised the efficiency and optimization. (Mathieson; Schinasi, 2000) International laws are also geared to meet the globalization needs and the municipal laws of the individual nations are being changed to accommodate the changes. The Civil rehabilitation law, for example is a corporate restructuring tool. It can be viewed as a smart way of encouraging risk retaking and the introduction of market to market accounting may be taken as a progressive step forward. (Mathieson; Schinasi, 2000)

The collapse of banks was something that was inherited as a legacy from the nineteenth century international capital market. The collapse of the 'House of Baring', the oldest bank in 1995 highlights the multiple financial catastrophes that was prevalent in the pre-war market. (Davis; Gallman 2001) Three hundred years previous, the same bank was in the same critical situation and in both the situations investments were made overseas in developing countries that were at the earlier times the colonies. The bank was, in 1890 involved Latin America, "particularly Argentina and Uruguay. One hundred and five years later the newspapers reported that Barings was a "strong niche player in the emerging markets of Asia, Latin America, Africa and Eastern Europe." (Davis; Gallman 2001)

The investment patterns in both cases were the same. The fact goes to show that there is not much change in the nature of the market although the terms and the theatre of the trade have become totally different. The institutional changes that occur in the long run bar the study of the market over long periods of time. The economist therefore has to study the short-range effects in the market and therefore very little is known about "the relationship between the institutional structure and the more traditional economic variables or about the way changes in the external environment - economic, political, social, and cultural - affect the institutional structure." (Davis; Gallman 2001) Douglass North makes such an attempt and his opinion is that the economic theories assume a static nature and to understand the transition and the modern market structure dynamic models have to be constructed to understand the institutional change and its effects. (Davis; Gallman 2001)

The modern capital market is more stable and accessible on account of the international treaties, understanding and the removal of the barriers to global trade. The Evolution of the European Union and the end of the cold war has heralded a new economy on the global scale which sees capital investment flow in the same manner as in the previous nineteenth century market, but with more governing and centralized agencies like the World Bank and the International Monetary Fund. Anne O. Krueger who was the First Deputy Managing Director of IMF is of the opinion that the situation is one where we are back to square one. It is very difficult for the third world countries to integrate into the new capital market but the countries can benefit from the integration. Inappropriate exchange rates can spell disaster. A fixed exchange rate is ideal. There are sharp mismatches in the financial and the banking sectors of the countries. The national debts of countries have also become subjects of alarm and controversy. "The global economic upturn seems to be gathering pace -- it certainly is in Asia, now the world's fastest growing region. A period of economic growth offers a chance for governments to get their fiscal affairs in order, to reduce their debts burdens and so reduce the risk of pro-cyclical fiscal tightening later." (Krueger, 2003) the capital flow must be regulated but not restricted. There must be a level playing field for all countries. All these are absent in the modern international capital market. (Krueger, 2003)

Globalization and the International Capital Market

The international capital market played a key role in globalization. It was the need for investment that prompted the growth of investment and technology. The principal reason that the global village concept became a reality is the rapid growth of technology. However there is an argument that "technological changes are of little importance in explaining financial globalization. Rather, the growth of international financial markets is the result of the policy decisions (or, sometimes, non-decisions) that led to the 'deregulation' of global capital flows." (Quiggin, 2005)

The main issue in globalization is the removal of restrictions and the favorable environment for movement of the capital flow to desires investment regions. Globalization may have brought about technical changes in the communication and physical transfer of the asset or communication but not necessarily has changed the functioning and structure of the capital market. It has brought to highlight the inherent problems of the system on a much larger scale. The query is not therefore if the technology or globalization has changed the capital market ever since the nineteenth century but it is the question "whether the world economy will be controlled by the individual and collective actions of governments, as it was during the postwar boom, or by capital markets, as it was in the 19th century. Framed in this way, the debate over globalization is simply an extension, to the international stage, of the debate between the defenders of the social-democratic welfare state associated with John Maynard Keynes and the advocates of free markets." (Quiggin, 2005) the failure of the free nature of the market economy which was present in the nineteenth century as also the parallel of the failure of the emerging markets to the recent international capital flow presents a similar case.

Comparison of both the Markets

In the eighteenth and nineteenth centuries most countries were the colony of the European countries particularly Britain, the capital markets were institutions of international nature. That is because all regulations were from a central sourcing place, namely London. To argue that the international market in the nineteenth century was more efficient and active than the current market is based on a wrong comparison scale. By identifying the problems that were similar we can attain some knowledge how the present market and the earlier ones tried to adjust to it and what market forces played key roles in determining the outcomes. "The problem with this analysis is that the 19th century was also an era of global capitalism. The progressive social reforms that aimed to 'civilize capital' during the 20th century rested on an assertion of state control over the economy, including over previously unrestricted global capital movements. Conversely, the resurgence of global capital has, since the 1970s, been closely entwined with the retreat of the social-democratic welfare state." (Quiggin, 2005) We also have agreed that the amount of capital flow in the globe in the nineteenth century shows that the market was well organized at that period. The capital market integration was also taking place within the countries that participated during the period. (O'Rourke; Williamson, 1999)

We may argue that the world in 1914 was considered to be more integrated compared to what it is today. Further there have been lesser countries, and fewer restrictions relating to the movement of goods or that of capital. The colonies relied on the colonizer for development. The international transfer of labor was an important feature. This movement still continues, but at a token rate. There is no option of unrestricted migration available today. Therefore to make a comparison we will not have a common yardstick. In the reverse, the "global integration of manufacturing was less advanced in the 19th century than it is today. But these are differences of degree. The important point is that before 1914, national economies were, as they are now, significantly constrained by the demands of global markets, albeit in different ways." (Quiggin, 2005)

The integration of capital markets is usually tested with an interest rate arbitrage model even though much different financial assets must be compared. The history of the international financial system and the efficiency factor ought to be contrasted and viewed in the current trends after the war rather than globalization. The standards during the earlier era were gold standard. "Currencies were freely convertible into gold at fixed rates, and the exchange rate between any two currencies was simply the ratio of their values in gold. Gold was, in effect, a global currency, and exchange rates were fixed." (Quiggin, 2005)

The only bank that had any say was the bank of England and the interest rate was dictated by it in the modern economy it is impossible to have a fixed exchange rate, or currency parity. The stability of the nineteenth century market resulted from the trust in the gold standard which is not feasible now. Now there is no agreement on the issues and therefore the gold standard is sought to be replaces by regulations which are also the subject matter of controversies and international disagreements. No doubt the current international capital market scene appears to be in shambles, and more volatile than the one found in the earlier century. However it is not all lost situation and there is a modern consensus evolving in the scenario. What we wished to establish is that the comparison is futile in terms of the problems and the contexts. The nineteenth century world did not have the political and geographic divisions of the world and the frigidity of the cold war in between to contend with. (Quiggin, 2005)

Today there is no centralized agency to dictate and control the capital market. Although the World bank and the IMF do attempt at regulating the lending and utilization of the capital that flows into the economy, states who are the members of the system stand divided and autonomy of the states have created anomalies in bringing about a uniform functioning of the capital market. The Great Depression which was a turning point in international capital markets system has irreversibly altered it and there thus cannot be any comparison between the two. The argument that the pre- depression capital market was better than the prevalent one is based on the assumption that globalization is a new phenomenon and it has therefore brought in a new set of problems that were non-existent at the earlier time. "What is crucial to realize, though, is that the process of globalization went into reverse for most of the 20th century." (Quiggin, 2005)

After the 2nd World War, the conference at Bretton Woods was considered to be the initial attempt made to have control over the capital flow which was present in the new economy. "The Bretton Woods conference created the International Monetary Fund -- IMF and the International Bank for Reconstruction and Development, now the World Bank. The IMF was to provide short-term assistance to countries experiencing balance-of-payments problems. The World Bank was to provide long-term finance for development projects." (Quiggin, 2005) Inflation that followed however stemmed the progress of the unification. The reason was the creation of the diversity between the U.S. And Europe, and later in the sixties the inflation caused the gold standard to collapse and compelled the abandoning of the fixed interest and value theory. The gold convertibility itself was abandoned in 1971. "The Vietnam War would have eventually forced the convertibility of the U.S. dollar into gold to be abandoned. The process was accelerated, however, by the increased capacity of participants in international financial markets to speculate against currencies which were seen as being overvalued." (Quiggin, 2005)

The later phase of the 20th century went by the principles of Keynesian economics and the political climate was suited to the situation. "The move to floating exchange rates was associated with a reaction against Keynesianism. The standard Keynesian framework offered no prescription for a combination of inflation and unemployment. The briefly fashionable monetarist approach, advocated most effectively by Milton Friedman, appeared to offer a solution which could work well in the context of floating exchange rates." (Quiggin, 2005) the technology brought about speed to the transactions the value of instruments trades today is one hundred times more. "Computers and telecommunications have permitted an increase in the complexity of financial transactions, but they have not fundamentally changed the situation. The increase in financial 'churning', as measured by the ratio of the volume of financial transactions to the volume of real transactions, has been widely noted with respect to international markets. It is important to observe, however, that a similarly massive increase in churning has taken place in domestic financial markets, such as stock markets." (Quiggin, 2005) the problems of taxation on these instruments and wages also loom large.

Conclusion

We can see and easily agree that the nineteenth century capital market did not have the chaos that we see now, and nor was it beset with the problems that are seen in the real world today. The construing authority was a single bank. However the comparison is not proper or justified because of the great historical gap and settings between the markets. While it was said to be simple the nineteenth century markets also had similar troubles as witnessed in the collapse of the bank that has a history of three hundred years. The modern capital market is more stable and accessible on account of the international treaties, understanding and the removal of the barriers to global trade. There is more flow of funds to the emerging markets and colonies have been replaced by independent nations with various wants and ideologies. To try and equate the modern market with the one that was a century ago is to turn the clock back out of context. Many new developments like the e European Union and the end of regionalization and opening of economies tend to take the world trade scenario back to the similar times of the nineteenth century.

Superficially there has been a great change in the market as observed from the nineteenth century market, the underlying problems are still the same, and have similar connotations. Formerly there was a disparity between the captors and the colonies and fund and good s flowed through the regulation of the so called free market which corrected the equilibrium automatically. The gold standard and the fixed rates of exchange proved to be the stabilizers of that system. However, today the scenario has been changed. There is no central mechanism that can control and create the arbitrage. We may therefore say that the new capita market is evolving and growing. The current phase is the experimental phase, and in future it will evolve from the chaos and ideally evolve into a similar one as in the nineteenth century. The only bank that had any say was the bank of England and the interest rate was dictated by it. It was arbitrary and was never challenged. In the modern economy it is impossible to have a fixed exchange rate, or currency parity.

The stability of the nineteenth century market resulted from the trust in the gold standard which is not feasible now. The modern capital markets that are internationally integrated play a very crucial role in the financial stability of a country. Unlike in the colonial past the modern economies that are developing need directed developmental investment and special care about the effects of the capital on the states labor and employment sand other economic factors were not prevalent in the earlier state. Thus borrowers and investments are more political and based on ideological percepts. This in turn has a telling effect on the international capital market. Today it appears and is factually true that the present international capital market is in chaos and therefore the market in the nineteenth century appears in comparison to be better. However, to make such an assertion we have to close our eyes to the vast historical differences between the two. Other wise we conclude that while the modern international capital markets has crisis an d great problems, it is unique to the modern times, and cannot be in any way compared to the economy that was based on a colonial world. Both have a great chasm between them. In conclusion we say that the capital market of today is in the infancy. It is totally new, and is being suited to a new world. It cannot be compared to the past in anyway, although some economic features seem to be common in both.