Throughout the early modern period, as communications increased in speed and effectiveness, there were attempts to make larger capital markets, with the end goal being the creation of a global capital market where money can be raised internationally, allowing for greater access by all companies to the same pool of capital regardless of where the company is located, and also free of legislative and other restrictions that apply in some parts of the world.
Historically, the raising of capital involved transactions conducted between governments and private individuals. These processes were fraught with problems for both sides, and by the late 17th century, in western Europe, there was an attempt to formalize the process. This saw the creation of the Bank of England in 1691 (incorporated in 1694), and in the early 18th century the origins of other schemes in other countries, some for city corporations, others for governments.
However with the Industrial Revolution many capitalists wanted to be able to raise capital to embark on their projects and there was no regular system of raising capital and sharing the risk. As a result with the building of the Bridgewater (or Worsley) Canal, Francis Egerton, the 2nd Duke of Bridgewater, had to take the entire risk for the venture himself, and although he did end up very wealthy, it was a move that nearly sent him bankrupt. Similarly some major capitalist ventures could come to create major crises in the countries where the vast majority of the investors lived. Two of the most extreme examples of these came from France—the attempt by the Mexican government of Benito Juarez to abrogate the debts incurred by previous Mexican governments leading to the French military intervention in the country to install Emperor Maximilian in the 1860s; and another being the Panama Canal Crisis in the 1880s when French investors lost fortunes in speculation in the shares of a company which hoped to build the Panama Canal.
By the 20th century, there were numerous banks that were able to lend capital for industrial and other projects. This certainly helped with the needs of the vast majority of borrowers. However there were companies which invested in one country, financed by investment from another. Some of this was to do with the colonial empires, with the capital for the Malayan rubber industry in the 1900s raised in London; but there was also other examples, including the financing of the building of the Argentine railroad system, also financed in London. By the 1900s London had certainly emerged as the main capital market in the world but it was about to be challenged by New York, which started from 1919 to become the dominant center for global capital. With better communications through a regular telephone and telex service, and now with computer systems, it has been possible to link the capital markets around the world and provide, for the customer, wider options and more access to this capital, and for the lenders, a greater ability to spread the risk among capital investors, and also speculators, around the world.
As well as the global capital market which arose in the major financial centers in the world: New York, London and Paris, and later Frankfurt and Tokyo; the oil price rises of the 1970s created a new area of wealth with the availability of what came to be known as “petrodollars.” This led to a number of schemes by which people claimed to have access to a more secretive “global market” with “agents” approaching governments. The most infamous was Tirath Khemlani and his dealings with the Australian government in the early 1970s. The Bank of England warned against these schemes, which profited largely through large cancellation fees which would have to be paid if the government in question wished withdraw from these—there has been no evidence of this hidden “global capital market.”
The need for the global capital market became essential with increasingly larger numbers of companies having cross-listings by which their stock was quoted on a number of stock markets around the world. With the global capital market, it was possible to raise far larger sums of money than had been possible earlier, and this allowed investors and speculators to spread their risks over a wide range of capital investments all over the world.
The End Of The Bretton Woods System
One of the developments that arose from this global capital market was a convergence of real interest rates around the world. This coincided with the end of the Bretton Woods system and the floating of many currencies in the 1970s, coupled with the U.S. government’s suspension of the convertibility of the dollar into gold. This allowed the rates of exchange between most major currencies in the world to be set by the market, albeit with the government able to influence this through altering the exchange rates to increase or decrease demand for a currency.
As a result, if the government of a specific country sought to use macroeconomic instruments such as interest rates, and they were raised, the demand for the currency would create a rise in the value of the currency, after which the real interest rates would be comparable to those in other countries. With open markets, full and audited accounting by governments, and with the free flow of capital into and out of countries, market forces would balance the currency market forming an equilibrium. Economists defined this as the purchasing power parity theory, although similar theories had been around since the Swedish economist Gustav Cassell (1866–1945) suggested that this could become the case as early as 1916.
If the global capital market could cope with balancing out the value of the various currencies, it was soon suggested that widespread speculation could affect the prices of the currencies allowing speculators to make (or lose) vast sums of money. This had led to the Bretton Woods system, which was a deliberate attempt by the United Kingdom, United States, and many other governments to constrain the global capital market in terms of the values of currencies, although it did not stop the two devaluations of the pound sterling to the U.S. dollar in September 1949 and November 1967.
The floating era from 1971 saw a large rise in world interest rates, largely through the rise in the price of petroleum. With the doubling of oil prices in 1978–79 after the Iranian Revolution, the effect was that the economies of North America, Western Europe, and other parts of the world went into recession. George Soros and other operators of hedge funds used the global capital market to raise large sums of money and this in turn resulted in the “Battle for Sterling” in 1992 when Soros fought the Bank of England, and later in 1997 with the Asian Economic Crisis. Since the late 1990s there has also been the increasing role of China in global capital markets, helping create a boom that led to estimates made in 2006 that the global capital market would exceed $228 trillion by 2010, although with the current crisis, this figure now seems improbable.
Thus the result of the global capital market and the spreading of risks can lead to many countries seemingly unconnected to the area at economic risk becoming affected. In 2007 with the start of serious problems in the U.S. subprime home mortgage market, the effects were felt not just by the individual lenders, and especially by Fannie Mae and Freddie Mac, but by banks and financial institutions around the world that had invested their money in Fannie Mae and Freddie Mac and suddenly found themselves exposed to the collapse of the subprime market. The crisis was triggered to a certain extent by undue offering and securitization of low-quality subprime mortgages and other lows in the United States, which were abetted by a certain extent by deregulation in the 1990s and a laxity in enforcement of regulations that continued. Stunned American legislators initiated a bailout coupled with a stream of new regulations.
Another dramatic effect in 2008 was following a crisis in the Icelandic banking system, it was revealed that vast numbers of individuals, companies, town corporations, and public organizations had invested their money in Icelandic banks because of the better returns offered, without realizing that this increased their level of risk. While there was confidence in the global capital market, there were no problems, but as soon as “panic” breaks out, there is a quick flight of capital, leaving those less able to quickly react to take potential or actual losses, and in extreme cases to lose their investments as well.
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