A HISTORICAL REVIEW OF STOCK EXCHANGE OPERATIONS

(This journey down the memory lane has some lessons for the stock investors)

SHAMSUL GHANI
Nov 05 - 11, 2007

WHY THESE STOCK EXCHANGES?

TREACHEROUS BUILDINGS

Michael Rowbotham, in his book "The Grip of Death" writes:

"Stock markets-institutions whose prime purpose was once to fund industrial investment - have degenerated into arenas of predatory, volatile speculation, engaged in the parasitic extraction of wealth from the productive economy, where the profit drives, not from a maturing productive investment, but from wild fluctuations in asset values".

The question is; then what is the justification for existence of these imposing masonry structures in world capitals with such a dubious credibility. Can't we scratch this subject from the books of economics and finance? Can't someone implode (or even explode) these buildings to save entire world from their treacherous influence. The dilemma of the economists is that they can't veto the existence of stock exchanges like we, despite its highly destructive powers, can not eliminate fire from our lives. It is the use of fire and management of these fire brand buildings that has to be subtle and informed.

Besides allowing us a chance to burn our fingers, the stock exchanges give the economic and finance mangers an option to integrate actions towards positive achievement of their goals. These exchanges are the barometer of economy and speedometer of country's economic progress.

BAROMETER OF THE ECONOMY :

At the stock exchange, share prices rise and fall depending, largely, on market forces. Share prices tend to rise or remain stable when companies and the economy are performing well. These are the periods of stability and growth. On the other hand an economic or financial crisis triggered either by country's political turmoil or any other destablizing factor could eventually lead to a stock market crash. Therefore the movement of share prices and in general of the stock indices can be an indicator of the general state of country's economy.

II. MAJOR STOCK EXCHANGES OF THE WORLD

Established in 1602 by the Dutch East India Company, the Amsterdam Stock Exchange is considered to be the oldest stock exchange in the world. It began with dealings in printed stock and bonds and was first to formally begin trading in securities. It merged in 2000 with the Brussels Stock Exchange and the Paris Stock Exchange to form Euronext.

The 30 main stock exchanges in the world include

American Stock Exchange
Australian Stock Exchange
Bolsa Mexicana de Valores
Bombay Stock Exchange
Euronext
Frankfurt Stock Exchange
Helsinki Stock Exchange
Hong Kong Stock Exchange
Istanbul Stock Exchange
JASDAQ
Johannesburg Securities Exchange
Karachi Stock Exchange
Korea Stock Exchange
Kuwait Stock Exchange
London Stock Exchange
Madrid Stock Exchange
Milan Stock Exchange
Nagoya Stock Exchange
National Stock Exchange of India
NASDAQ
New York Stock Exchange
Osaka Securities Exchange
Sao Paulo Stock Exchange
Shanghai Stock Exchange
Singapore Exchange
Stockholm Stock Exchange
Taiwan Stock Exchange
Tokyo Stock Exchange
Toronto Stock Exchange
Zurich Stock Exchange

III. THE INFAMOUS HISTORY

The predatory and speculative forces at work in stock markets have produced some of the worst events in the history of economic and finance. Few of these are briefly reproduced

THE TULIP MANIA OF 17TH CENTURY

During the build up of the tulip market the participants were not making money by growing tulips. They were doing so by using tulips as a medium of speculation. It is not established whether the build up of tulip prices attracted new investment or the new investment caused the build up of prices. As the build up continued more and more people were drawn into highly speculative investment. There was no correlation between the prices of the tulip and the comperative value of other goods. The people during the period from mid 1500 to 1636 took the tulip trade as sure thing investment. They became too confident that this show item would always bring profits to them. Then the inevitable happened in 1637. Tulip bulbs having a market price of tens of thousands of US dollars became worthless within a few months time. The question is often asked, does the tulip market crash holds any relevance to our todays' stock markets?, the answer should be yes! It definitely does.

THE SOUTH SEA BUBBLE OF 18TH CENTURY

The event is known as the first big stock market crash in England. The South Sea Company was given monopoly rights of all trade to South Sea ports. The theme song was composed on an anticipated trade that would open up with the rich Spanish colonies of South America. In return for this monopoly the company would assume a portion of the national debt of England. Later the South Sea directors made a proposal to assume the entire public debt of England. The offer was accepted and the company started to raise the price of the shares through artificial means. The 100 share of the company soared to 1000 and then abruptly crashed back to 135. Majority of the people had bought the shares on credit or margin. Thousands of fortunes were lost. The crash huanted the minds of the Western world for the rest of the 18th century.

THE GREAT CRASH OF 1929

The growth and prosperity of the booming countries ended with the great crash of October 1929. The Great Depression that followed put 13 million Americans out of work. Two thousand investment firms liquidated and the American banking industry under went the biggest structural change of its history. As happens in almost all of such events, the crash was unfrozen by the economists of that era. Irvin Fischer, America's famous economist and professor at Yale university said before 14 days of the crash In a few months, I except to see the stock market much higher than today". Even after the crash the economists failed to realize the severity of the event . Harvard economist society informed its subscribers," A severe depression such as 1920-21, is outside the range of probability. We are not facing a protracted liquidation".

Another general feature of such crashes is that they never happen when things look bad. On the contrary macro economic outlook is very good. Before every crash, economists are caught saying some nice words about the state of the economy. Every thing looks rosy, stock markets go up and up and macro economic indicators improving further and further. The political mood before the 1929 crash was very optimistic. In November 1928 Hebert Hoover was elected president of the US and his election induced greatest increase in stock buying.

The post crash studies reveal that the boom of 1928 and 1929 was driven by the entry into the stock market of a large number of uninformed investors who invested in favourite stock with the result that the prices of the stock went far beyond their fair market values. It is quite possible that the crowd psychology played a role in the rise of the market and its subsequent crash.

BLACK MONDAY OF 1987

Alan Green span's eyes widened incredulously behind his thick frame eye glasses, "508?"

These lines have been taken from "The Confidence Game" by Steven Solomon.

On 19th October 1987 the market lost 508 points on a volume of 608 million shares- sellers out numbering buyers 40 to 1. Newyork Stock Exchange's Dow Jones Index falling by 22.6%. The crash was seen by many as more precipitous than the 1929 crash. As always happens, the Great Crash was preceded by an extra ordinary boom in the stock market. One of the great forces that caused the US stock market to soar in 1987 was the inflow of foreign capital primarily from Japan, who diverted funds from bonds into equity in the wake of the April bond market crash. In the first half of 1987 foreign investment in the stock market was just equal to the domestic investment. At the close of the market on October 19th 1987 the situation was so serious that the US president was requested to intervene and to make a statement. The Newyork Stock Exchange Chairman was of the view that the stock market be closed on Tuesday and onwards. Finally, the Feds Chairman Alan Greenspan issued one sentence classic statement which was considered by the Bank Chief of Staff Howard Baker as "best lines since Shakespeare". The statement read "The Federal Reserve, consistant with its responsibilities as the nation's central bank, affirms today its readiness to serve as a source of liquidity to support the economic and financial system ".

The post crash studies came up with a number of reasons for the crash. Some of those were

* A weakening Dollar.

* Alan Green span's indirect hint to devalue the Dollar.

* The April 1987 Bond crash when the Bond found its way into the Equity market.

* The slowdown in Japanese capital flows.

The last one seems to be the most probable as suggested by Paul Volcker whom Alan Greenspan succeeded. He said : The market went up 30% this year and it has gone back down 30%. Nothing has happened in the economy to drive stocks down. Did anything happen between January and August, I can ask, to justify 30% higher stock prices?"

He further says: because of the US unhealthy dependence on the Japanese money, the slow down in Japanese capital flows may have weakened the dollar and pushed up US interest rates, possibly triggering the crash."

Later on when Setsuya Tabuchi Chairman of Nomura Securities of Japan checked the records he confirmed Paul Volcker's view. Tabuchi found that Japan had been purchasing US bonds and equities of $10-$14 billion every quarter since mid 1985. it had invested $8 billion in June 1987 alone. Which fell sharply to $4.1 billion in July, $2.8 billion in August, $0.84 billion in September and to a net sale of $0.04 billion in October.

TREMORS IN PAKISTAN

In 1995 the Karachi Stock Market Index soared as high as 2500 plus- the highest in the history of Karachi Stock Exchange till that time. Those were the days of free rise and free fall. The lower and upper circuits to limit the reise and fall of stock prices in a day to a certain percentage were not in vogue. All of a sudden the market took a downward plunge and lost about 600-700 points. The highly inflated prices were cut to size and so were the uninformed exuberant common investors. Millions of common man's money found its way to the pockets of the con men. No arrests. No FIRs. That is the beauty of the white collar crime. After the financial companies and co-operatives scams, the stock market robbery was another feather in the caps of the con men.

In 1999 Pakistan went for the nuclear blast announcing its gate crashing into the World Nuclear Club. The stock market imploded with a ear splitting silence. The Index came down to 760 points. The share prices were at their rock bottom. Name any blue chip and you get it dozen a dime. In real sense it was the buying time, as they say buy when there is blood on the streets even if it is your won blood". When the nuclear dust settled down there were signs of recovery, but the then government indiscretely opted for action against Hub Power Company and the stock market went into tailspin again. Once again the common investor lost a fortune. Who gained how much is still shrouded in mystery.

Now came 9/11 in 2001. Thanks to the upper and lower circuits introduction that the market was saved of a bigger crash. Later on Pakistan's government decision to side with US in its war on terror resulted in a steady recovery. Another development was that the country was deluged with heavy inflow of foreign remittances. This money got its way into the stock market. The State Bank indulged in the spree of discount rate reduction ( from 13% to 9%).

The two new speculative forces emerged namely the coporate sector who got cheap credit from banks and diverted it to the stock market, and the banking sector itself whose excess liquidity resulting from foreign remittances also got its way into the stock market. A mass stock investment hysteria was created and the prices started to soar in total disregard of their fair economic value. Every day dawned with fresh news of foreign investment.

In Jan 2005 the Index was as high as 6747 , in Feb 2005 it soared to 8260 and at the beginning of March it went further up. Then came the ides of March and the Index slided down unabatedly. The high low of 2005 was 10300 and 6400. The gap of 4100 points was the highest in the history of KSE for any particular year. The saddest part of this episode is that the middle class was hit most hard. In the wake of steep falling profit rates on government securities, people disinvested their savings and finding no other suitable venue of investment diverted their life long savings to the stock market.

The parliament ordered an investigation into the crash. A million dollar probe was carried out by a foreign firm but nothing substantial could be established.