Wind Traders

Amsterdam: Where It All Began

Wind Traders

In his magnificent work, The Birth of Plenty—How the Prosperity of the Modern World Was Created, William Bernstein outlines the four necessary conditions for the massive growth of wealth experienced over the past two centuries: the securing of property rights, the triumph of scientific rationalism, the formation of capital markets, and the emergence of efficient systems of transportation and communication. This article will focus on the third institution—capital markets which connect providers of capital (investors) with users of capital (companies and governments).

Some people may find it surprising that the land of tulips, windmills, and Rembrandt gave us the world's first fully functioning financial market, albeit a very limited one in that all the securities traded derived from one company, the Dutch East India Company, or the VOC (Vereenigde Oost-Indische Compagnie) which as you will no doubt recall from your high school history not only conducted spice trading voyages around the world, but also acted as an arm of the Dutch government with the ability to wage war, imprison and execute convicts, negotiate treaties, coin money, and establish colonies, which they did with extreme prejudice and brutality. The world's first true joint stock company, the VOC raised capital in 1609 by issuing permanent dividend-paying shares to investors who were willing to accept the attendant risks associated with ocean-based trade (e.g., piracy, rogue waves, et. al.), provided that the most they could lose was the purchase price of the shares. One cannot overstate the importance of the concept of limited shareholder liability to the development of corporations and financial markets. That the risks were substantial is evidenced by the generosity of the dividend which averaged around 18% of the nominal share price, although in the early years, shareholders received their payments in the form of spices such as nutmeg and peppercorns.

The second important financial innovation of the VOC was the establishment of an exchange in Amsterdam where VOC stock and bonds could be traded in a secondary market. As noted by Lodewijk Petram1, this nascent securities market facilitated the two vital functions of price discovery and the provision of liquidity. Straightforward as these market functions may seem, they play a very important role for investors: they allow investors to reallocate their asset holdings at a low cost, enabling them to manage their financial risks according to their personal preferences.2 This is exactly what prudent investing is all about—deciding how much risk is right for you and buying that risk at a reasonable cost. Petram documents the remarkably high level of sophistication achieved in areas such as short-selling and futures contracts.

As important as all these innovations were, perhaps the greatest contribution of the Dutch East India Company to the future of finance derived from a splendid exchange of colonies with the British. Because the demand for nutmeg in Holland was virtually insatiable, the VOC acquired the island of Pulo Run (today owned by Indonesia) in exchange for the colony of New Amsterdam, which the British renamed New York.3


2Maureen OHara, 'Presidential address: Liquidity and Price Discovery', Journal of Finance 68 (2003), p. 1335.