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.  

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. 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 dot.com 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.

Many people believe that Abraham Lincoln was the greatest President of the United States. Not only did his steadfast leadership help the United States to survive the Civil War, but as President he pursued his vision of a united country, free from slavery and war. Lincoln’s vision of America went beyond winning the Civil War and freeing the slaves and extended to uniting the East and West by building a transcontinental railroad across the United States. As President, Lincoln was instrumental in approving the three routes that eventually crossed the continent to bring the two halves of the country together and ensure that the United States was a single country from north to south and from east to west. Lincoln approved three railroads, the Northern Pacific, the Central Pacific and the Southern Pacific. The Central Pacific was renamed the Union Pacific during the Civil War and on May 10, 1869, a “golden spike” was driven into the ground at Promontory Summit in the Utah Territory uniting the eastern and western tracks into a single transcontinental railroad. Although few people may realize it, Abraham Lincoln was intimately involved with helping the railroads to cross the continent even before he became President. Lincoln worked for the Illinois Central between 1852 and 1860, defending them in cases that were brought before the district court. He also argued and won three cases for the Alton & Sangamon Railroad, which the Supreme Court found in favor of the railroads. The most important legal case he handled before becoming President was the Rock Island Bridge case in 1856 which brought him into the national spotlight. In 1858, the Lincoln-Douglas debates further enhanced his prestige, and in 1860, Lincoln became President of the United States.  

Dow Jones announced that General Electric (GE) will be removed from the Dow Jones Industrial Average (DJIA) and replaced by Walgreens Boots Alliance Inc. The reason provided for removing GE was its low price. For an index such as the S&P 500, which is capitalization weighted, a stock is removed because its market cap becomes too small. The DJIA is price weighted, so a stock is removed because its price is too low. Apple split its stock 7 to 1 in order to lower its price so it could be added to the DJIA in 2015, but at $12, GE represented only 0.5% of the DJIA by price and so it was removed. If the DJIA had been cap-weighted, GE probably would not have been removed. The market cap of GE is $111 billion while the market cap of Walgreens Boots Alliance is $67 billion. Perhaps a reverse split could have kept GE in the Dow. General Electric was one of the original members of the Dow Jones Industrial Average when the average was introduced on May 12, 1896. GE was removed from the DJIA on September 15, 1898 when it was replaced by United States Rubber (later renamed Uniroyal). GE was put back in the DJIA on April 21, 1899 when the DJIA switched out four stocks in the index. General Electric was removed a second time on March 31, 1901 when five stocks were removed and added to the DJIA. General Electric was added to the DJIA for the third time on November 7, 1907 when GE replaced Tennessee Coal, Iron and Railroad after the latter company was absorbed by U.S. Steel. General Electric was in the DJIA for the next 111 years. General Electric’s decline has been steady during the 21st century. In 2000, GE’s market cap was over $500 billion and as recently as 2005, General Electric was the largest company in the world. Since then, GE has lost over $400 billion in market cap, and today, GE doesn’t even make the top 50 in the world.  

Thomas Edison Founds General Electric

General Electric began as the Edison Electric Light Co. which was founded by Thomas Edison in 1878. When Edison Electric Light Co. shares debuted in 1881, investors had high hopes for the company, and its shares were trading at over $1000 a share, ten times its par value. However, the cost of developing electric power exceeded expectations and the price of the stock steadily declined, falling to $50 by the end of 1884. Edison Electric Light wasn’t even able to pay a dividend until 1888. A chart of the Edison Electric Light Co. is provided below.

Thomas Edison Signature from Edison Storage Battery Company Stock Certificate

 

Edison Electric Co., 1891 to 1889

  Edison General Electric consolidated with the Bergmann Co., the Edison Lamp Co. and the Edison Machine Works into the Edison General Electric Co. in July 1889. The Edison General Electric Co. competed with Westinghouse and the Thomson-Houston Electric Co. to bring electricity to America. Edison favored Direct Current (DC) while Westinghouse and Nikola Tesla favored Alternating Current (AC). As it turns out, Edison made the wrong choice and despite electrocuting elephants and using other publicity stunts to warn people against using alternating current, AC was the more efficient choice. Consequently, Edison General Electric Stock made almost no progress in its three years of existence.  

Edison General Electric Co. 1889 to 1892

  In May 1892, Edison General Electric merged with Thomson-Houston Electric Co. to form the General Electric Co. which still exists today. When the Columbian Exposition took place in Chicago in 1893, Westinghouse won the right to supply power to the exposition, impressing the millions who attended to celebrate the 400th anniversary of the discovery of America. GE stock fell from around 100 at the beginning of the exposition to the 30s by the exposition’s end and stayed at that level for several years. Competition between General Electric and Westinghouse (which was in the DJIA between 1914 and 1925 and between 1928 and 1997) to bring electricity to America was intense. Charles Coffin was instrumental in turning GE into one of the most successful companies of the twentieth century by using efficient management to turn GE into a conglomerate that eventually became the largest company in the world. The chart below shows the steady rise in GE stock from the 1890s to today.  

General Electric Co., 1892 to 2018

 

The Rise of General Electric

During the twentieth century General Electric was involved in many of the innovations that produced the consumer goods that people take for granted today. This included light bulbs, power stations, jet engines, radios, televisions, x-ray machines, CT scanners, MRI machines and thousands of others. GE’s research division had few peers. As was true of Bell Labs, GE’s research division won Nobel Prizes and produced thousands of new products over the course of the twentieth century. GE’s two CEOs in the last quarter of the twentieth century, Reginald Jones and Jack Welch were among the most admired CEOs in the world. While conglomerates fell into disfavor in the 1980s, GE was able to use its managerial skills to grow the GE into being the largest company in the world. Under Jack Welch, however, GE moved away from relying upon its technological innovations and managerial prowess, and it began relying more upon finance as a source of growth. GE Capital began to dominate General Electric and under Welch, GE’s capitalization grew from $14 billion in 1981 to over $500 billion in 2000.  

The Fall of General Electric

GE Capital participated in the growth in the financial sector in the early 2000s, moving into credit card companies, subprime lending and commercial real estate. Financial executives and tax lawyers used their wizardry to borrow in the US and move money to other countries with lower tax rates, both reducing their American tax liability and smoothing out earnings to please investors. When the financial crunch hit in 2008, GE had to be bailed out by the government and sell shares to Warren Buffett to stay afloat. The combination of unwinding GE Capital, making poor acquisitions and slowdowns in its industrial businesses made the shrinking of General Electric inevitable. GE stock was at $158 in May 2000 and the company had a market cap of $517 billion when the company did a 3-for-1 split. Today the stock is at $12 and its market cap is at $111 billion GE’s new CEO, John Flannery is struggling to keep the price from falling into the single digits. During the past decade, GE’s successor has continued to grow. C. K. Walgreen & Co. incorporated in Illinois in 1909 and changed its name to Walgreen Co. in 1916. The stock listed on the New York Curb in 1928 and moved to the New York Stock Exchange in 1934. In 1974, Walgreen stock was back to the point it had been at in 1929, but as Walgreen’s expanded across America in the 1980s and 1990s, the stock rose in price dramatically. Walgreens merged with Alliance Boots in 2014 to form Walgreens Boots Alliance, turning an American company into a global company. Although Walgreens’ growth has slowed since 2000, it didn’t lose $400 billion in market cap as General Electric did. A more logical replacement for General Electric would have been Amazon or Alphabet or Facebook or Berkshire Hathaway. Each one of them is among the ten largest companies in the world, but the problem with each of those companies is that their price is too high to be placed in a price-weighted index like the Dow Jones Industrial Average. At least Walgreens is in the top 100 companies worldwide. Welcome to the Dow, Walgreens.  

Walgreens Boots Alliance, Inc, 1928 to 2018

Many investors are showing an interest in Environmental, Social and Governance (ESG) funds because some researchers believe that these types of funds may offer long-term performance advantages over non-ESG funds. Managers of these funds evaluate companies based upon their corporate behavior and their sustainability over time. Similarly, many funds consider Socially Responsible Investing (SRI) as a criterion for choosing funds to invest in. The goal of socially responsible investing is to consider both financial return and social/environmental factors in choosing firms to invest in. Socially-responsible investors might be concerned over corporations’ impact on climate change or the corporation’s sustainability because of their dependence on depletable natural resources. Social concern over workplace diversity, human rights, animal welfare and consumer rights can also play a role. Corporate governance issues relating to employee relations, executive compensation and the balance of power between the CEO and Board of Directors are also be taken into consideration. Investors may avoid companies that produce products they find offensive, such as tobacco, alcohol or military goods. Interestingly enough, Standard and Poor’s produced indices based upon whether a company produced goods that could be used for war or for peace in the 1940s and 1950s. War stocks included companies in aircraft manufacturing, coal, copper and brass, lead and zinc, machine tools, machinery, metal fabrication, oil, railroad equipment, shipbuilding and steel. Peace Stocks included companies in the business of automobiles, building materials, confectionery, containers, finance, gold and office and business equipment. Because the United States was fighting World War II to defend the country from Axis powers, few people would have objected to investing in war companies, and it should be remembered that Americans were encouraged to buy war bonds to help fund the war. Nevertheless, “war” and “peace” stocks do provide an interesting dichotomy for socially-responsible investors to analyze. The chart below shows the relative performance of war stocks and peace stocks from September 1939 until February 1957. The index begins when Germany invaded Poland in September 1939 precipitating World War II and ends in February 1957 when Standard and Poor’s introduced the S&P 500 and reorganized its indices, eliminating ones such as war stocks and peace stocks which were no longer relevant. So, which was the better investment, the Military-Industrial Complex or Consumer Goods? What is interesting is that neither war not peace stocks outperformed the other until 1944, but as it became apparent that the Allies would win the war, peace stocks began to outperform war stocks and did so until 1946. War stocks outperformed between 1946 and 1949 during the post-war recession, but by June 1950, when the Korean War began, both war and peace stock indices were at the same level. After 1950, however, War stocks were the clear winners. By February 1957, the peace stock index was at 420, and the war stock index was at 542. Peace stocks had provided an 8% annual return while war stocks had provided a 9.5% annual return. It is a pity that Standard and Poor’s discontinued the index in 1957. Eisenhower didn’t give his speech on the Military Industrial Complex until January 1961, the Cuban Missile Crisis occurred in 1962, and the Vietnam War dominated the American economy and politics of the late 1960s and early 1970s. Some commentators have blamed the Vietnam War for contributing to the poor performance of the stock market after 1968. It would have been interesting to see how war and peace stocks performed under those circumstances. Of course, ESG and SRI funds look at a host of issues other than whether a stock promotes war or peace, but the historical data S&P produced provides food for thought.