How Britain Built the Modern World

In previous articles, we have traced the growth in the market capitalization of shares in the world back to 1900 and in the United States back to 1791. This article traces the trends in both the market capitalization of shares and of British government debt in Great Britain since 1690. During the 200 years from 1690 to 1900, the market cap of shares listed in the United Kingdom was larger than in any country in the world, with a significant portion of the market capitalization occurring because of companies that operated in the British Empire, but outside of the United Kingdom. There was very little change in the market cap of British shares in the 1700s when most of the Britain’s capital went to funding the debt incurred by Britain’s wars with France, but in the 1800s, as peace settled over Europe, British debt declined and equity capital grew. The 1900s saw a rollercoaster ride as wars, inflation and government restrictions on equity capital imposed their toll on the United Kingdom. However, during the 1800s, as the size of British government debt declined, this freed up capital which the United Kingdom used to build the modern world, funding railroads, bank, utilities, mining and other industries throughout the world.  

A Century of War

As William Robert Scott illustrated in The Constitution and Finance of English, Scottish and Irish Joint-Stock Companies to 1720, many corporations that were established in England before 1720 gave British companies the right to trade in colonies such as India, Canada and the United States, but also gave these companies the right to trade with Russia, Africa and other parts of the world. Very few of these companies were large enough for their shares to trade regularly, but some of these companies laid the foundations for the London stock market as we know it today. Shares were traded in coffee houses before the London Stock Exchange was established in 1801 and The Course of the Exchange kept track of the prices of stocks that were traded. Most of the stocks that were bought and sold in London in the 1690s were foreign companies. This included the East India Company, The Royal African Company, the Hudson’s Bay Company and the South Seas Co. Foreign companies also dominated the stock markets of Amsterdam (East India Co. and West India Co.) and France (Compagnie des Indes). In 1694, the Bank of England was established after providing a non-repayable loan to the English crown. In the first 20 years of the 18th Century, both British government debt and the capitalization of the stock market increased. Government debt increased as a result of the War of the Spanish Succession between 1701 and 1714. In 1720, the British government attempted to convert its debt into shares of the South Sea Co., creating the South Sea bubble. The value of outstanding British government debt had risen to 60% of GDP (see Figure 2) by 1720 and as a result of the South Sea bubble, equity capitalization rose to 40% of GDP in 1720 (see Figure 1). Thereafter, the level of outstanding government debt and equity capitalization diverged. Britain fought a number of wars over the next 100 years, which significantly increased its debt. The principal wars were the Seven Years’ War (1754-1763), the American Revolutionary War (1775-1783), and the French Revolutionary Wars and Napoleonic Wars (1792-1815). As Figure 2 shows, this increased the ratio of British government debt to GDP to 230%. Many other countries, including France, the Netherlands, Russia and Austria defaulted on their debts during the Napoleonic Wars, but Great Britain did not. Investors in the 18th Century wanted a source of steady income from the securities they held, and British government consols provided a reliable source, paying 3% in interest each year. However, Britain’s wars absorbed all of the available capital at the expense of the stock market. The British stock market in the 1700s was dominated by the “three sisters,” the Bank of England, the South Seas Co. and the East India Co. Virtually all of the trading in corporate securities in England in the 1700s was focused on those three companies. The result was a gradual decline in the market capitalization of English shares from 1720 to 1800, declining to almost 10% of GDP in 1800 while government debt rose to 230% of GDP by 1815.

Figure 1. British Stock Market Capitalization as a Share of GDP, 1690 to 2017    

A Century of Peace

Once Napoleon was defeated at Waterloo in 1815, the Napoleonic wars were over, and the century from 1815 to 1914 saw short and insignificant wars. Consequently, Britain not only paid off a significant portion of its outstanding debt, but as GDP grew in those hundred years, the debt/GDP ratio shrank from 230% in 1815 to 30% in 1914. This freed up capital to flow into shares and with this capital, Britain was able to help build the modern economy not only in Britain, but around the world. Money first started flowing into equity in the 1790s during the canal boom in which some company share prices doubled, tripled, or even quadrupled in price, but soon fell back. A second canal bubble occurred in the 1810s and a mining bubble occurred in the 1820s. Please remember that before 1801, no London Stock Exchange existed. All share trading was carried out in coffee houses and elsewhere, and most of the trading that was done was in British government consols, not company shares. The canal boom of the 1790s occurred in the middle of Britain where these companies operated, not in London. Shares were usually bought and sold at auction. A broker would announce in a local newspaper that certain canal shares would be sold at auction the following day. People would show up and someone would buy the shares. Unfortunately, newspapers announced the auction of the shares, but almost never printed the results, so almost no data of the canal bubble of the 1790s is available. Beginning in 1806, brokers began publishing share lists in magazines and newspapers which we can use to track the prices of shares offered for sale, and in 1811, The Course of the Exchange began printing share prices of canals and other companies that were traded on the London Stock Exchange. The canal bubble of the 1810s and mining bubble of the 1820s had no long-term impact on the ratio of stock market capitalization to GDP.
The railroad bubble of the 1840s, however, initiated a steady increase in the capitalization/GDP ratio that would continue for the next 75 years as the peace of the 1800s freed up capital to invest in Britain and the world. Whether it was railroads in Britain, France, India, the United States, Argentina or dozens of other countries and colonies, Britain provided the capital to build the railroads which modernized the world. Britain also invested in banks, utilities, mining and other industries essential to the modern economy. Shares issued by French and American railroads were eventually repatriated to those countries, but shares in India, Argentina and other countries were owned by the British up until World War I began.  

One wonders if the modern world economy would have existed if the Britain had been at war between 1815 and 1914 the way it had fought wars with France between 1700 and 1815. Capital would have shifted from peacetime building of the global economy by Britain to fighting wars which would have wasted both blood and treasure. Certainly, the railroad networks that crisscross the European continent and Britain would have been built, but to insure victory at war, not to trade goods and allow people to travel freely to any country they want. Neither the American Civil War nor World War I would have been as destructive as they were without railroads to feed the battle lines that existed. Had wars been fought in Europe between 1850 and 1914, they would have been as destructive as either the American Civil War or World War I and the global economy could have been set back for decades.  

Seventy-Five Years of War

World War I began in August 1914 and every stock market in Europe closed. The London Stock Exchange remained closed until January 1915 and reopened with restrictions on trading. The British government placed restrictions on the issue of new capital by companies so all available funds could be directed at purchasing the bonds needed to pay for the war. At the same time, the British government sold foreign shares, such as American railroads, which were listed on the London Stock Exchange in order to use the capital to fund the war. Inflation further reduced the value of equities relative to GDP. Consequently, the capitalization/GDP ratio fell from 150% in 1914 to under 70% by 1920 while the government debt/GDP ratio rose from 30% to 180%. During the twenty years between the end of World War I and the beginning of World War II, the ratio of government debt/GDP fell to 125% while the market cap/GDP ratio rose to 160%. After World War II began, Britain’s debt/GDP ratio soared again, rising from 125% to 240% by 1945, higher than it had been at the end of the Napoleonic Wars. Meanwhile, the market cap/GDP ratio plunged from 160% to 50% of GDP. During the 40 years after World War II, Labour and the Conservatives battled over the right economic policy for post-war Britain. Labour wanted to plan the economy and the Conservatives wanted to leave more of the economy to the private sector. Industries were nationalized, privatized and then renationalized. Labour governments wondered why businesses couldn’t just follow the directives of government as they had done during World War II. The dénouement to this process came in the 1970s under Harold Wilson when a significant recession and inflation caused the greatest stock market crash in British history. Few people realize that the 1973-1974 decline in the British stock market was even worse than the decline during the Great Depression. While the FTSE Index declined 47% between 1929 and 1932, the British index declined by 73% between 1972 and 1974, and after adjusting for inflation, fell over 80%. The good news is that the inflation reduced the government debt/GDP ratio, with it reaching 40% in the 1970s and 20% by 1990. Meanwhile, the ratio of market cap/GDP plunged to under 20% during the 1972-1974 bear market, reaching levels that hadn’t been seen since the early 1800s.  

The Big Bang and Recovery

In 1979, Margaret Thatcher became the new prime minister of Britain and she redirected the economy toward economic freedom and away from government intervention. The Big Bang freed up capital markets on October 27, 1986 and capital controls were eventually eliminated in Britain. Industries were privatized and the market cap/GDP ratio soared from 20% in 1974 to 175% in 1999 before falling back after the bubble burst. Although central government debt has risen to 80% of GDP today, it remains below 100%, and certainly way below the 200% that occurred after the Napoleonic Wars and World War II. Although Britain’s role in the global economy has shrunk significantly since the 1700s and 1800s, the impact of war on the availability of capital and Britain’s ability to build the modern world economy in the 1800s cannot be dismissed. If the capital that flowed into British government debt in the 1700s had been available to the private sector, could the Industrial Revolution and the spread of railroads have occurred in the 1700s and not the 1800s? If Britain, France and Germany had fought wars with each other between 1815 and 1914 instead of enjoying a century of peace, would the global economy be as advanced as it is today? Would British capital have been tied up in paying for useless wars rather than using its capital to build the modern economy? How much more advanced would the world be if World War I, World War II and the Cold War hadn’t absorbed capital that could have been reinvested in the economy? No one wants wars, but nationalism has often gotten the better of common sense in the past and as anyone who looks at the flows of capital in Britain in the 1700s, 1800s and 1900s can see, wars imposed significant long-term costs on the British and the global economy. Anyone promoting a military war, trade war or currency war in the future should keep this in mind.

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