The Dutch were trading futures, options and indexes long before you were. In fact, the Dutch had created exceptionally complex capital markets nearly 200 years before disgruntled American colonists started a revolution in North America. Today, however, the history of capital markets seems to have been forgotten. Market participants are immersed in the here and now and fail to appreciate the history of the game. They have forgotten that "indexing", futures, options, leverage, booms and busts, are in fact as "old as the hills". Knowing this, particularly that indexing is hardly a new innovation, can provide market participants a useful guide to the future.
The Dutch were great capitalists. They pioneered the art of speculation. They literally invented the funded debt system which is so vital to debt obsessed governments today. Dutch investment bankers were also behind the VOC or Dutch East India Trading Company, the first company to float shares. Ever. They also invented futures, options and the act of "indexing".
In 1602, VOC shares were floated and traded on the newly formed Amsterdam Stock Exchange. In 1632, VOC stock holders were beginning to sell calls and buy puts to hedge their risks. Many also took their 10X profits in VOC and plunged them into newly formed open outcry options and futures pits. Dutch traders bought spices, coffee, and textile futures contracts and exercised them. Dutch traders would even hoard precious commodities and drive prices up.
In the midst of this complex system arose the infamous tulip craze. Everybody knows the story of the tulip bubble and bust. Many people, however, do not know that the trade in tulips brought about the act of indexing. According to Joseph de La Vega, in Confusion of Confusions, the first book ever written on markets, speculation in the tulip market began much like the trade in coffee or Asian textiles. Future were sold, exercised, and commodities were delivered. But, as the trade in tulips became more popular, retail traders and investors began to "index" their holdings. Speculators did so by buying up shares in investment baking houses that possessed diverse tulip holdings. In effect, traders were diversifying their tulip holdings by holding the shares of one single brokerage company. Traders were spreading their risk in tulips but simultaneously trusting a single provider to keep them diversified.
Just as indexing was becoming popular among "coffee house traders" ( retail investors) the bubble burst, leaving a whole lot of Dutch poorer. The innovation of indexing made a whole lot of tulip brokers, investment houses and farmers rich but it came at the cost of the average investor. Granted, Dutch speculators should have known there was no to little tangible value to a tulip. Nevertheless, they took the risk and suffered for it.
The Dutch were pretty deep in the speculation game in the 17th century. Their financial innovations, creations if you will, form the foundation of American and global finance. But as I ponder their doings, I think their gravest mistake was thinking they could de-risk by indexing. Tulips, like stocks, are largely conceptual in nature. Trying to postpone an inevitable collapse and crisis in tulips by indexing only lead to a more drawn out collapse. How are we, then, to say that indexing won't cause yet another bubble to burst? If we think we are de-risking by indexing, we are dead wrong. We are just postponing another crisis.
I'm not saying markets will burst anytime soon, but I think it is important to remember that the last time indexing boomed, it was followed by an epic collapse that will be remembered forever.
I'll leave you with some Livermore:
" There is nothing new in Wall Street. There can't be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again."
Joseph de la Vega, 1688
Fred Anderson, University of Colorado, Boulder
Peter Veru, Phd Candidate, University of Colorado, Boulder