The Medieval Capital Markets

The West's economies are kept rolling along by money from millions of individual investors, and in the postwar years most of it has come from the U.S.--a big factor in the drain of gold from American coffers. Europe, despite its boom, has failed to generate enough investment capital to meet even its own needs, let alone to play its long-overdue role in world financing.

U.S. Treasury officials have urged European governments for months to enact reforms that would make it easier to raise capital in their financial centers, but genuine progress has been negligible. Last week Washington finally took an unusual step to prod the Europeans. The Treasury issued a book-size document that draws highly critical comparisons between Europe's creaking, suspicious and medieval bond and stock markets and the wide-open, well-heeled U.S. markets. Europe's capital markets, said Treasury Secretary Douglas Dillon, "are not as efficient and as effective as they might be, and as they will need to be, to play the role in the financing of European economic growth of which they are potentially capable."

The Troubles. That was something of an understatement. The troubles of Europe's capital markets are many--government meddling, restrictive taxes on new securities, overcharges for handling stock issues, heavy interest rates on bonds, a clubby atmosphere among bankers, and an extreme financial secrecy among corporations that keeps the wary public from investing. Only the British, Swiss and Dutch financial centers operate with any degree of freedom. France permitted no foreign security issues until late last year. A German tax on foreign bond sales makes costs almost prohibitive, even though Germany attracts so much foreign investment capital that last week it moved to curb the inflow.

To grow at all, many European firms are forced to take out expensive and sometimes risky short-term loans, to try to finance growth out of dwindling profit margins and to offer rights at bargain-basement prices just to make their stock attractive. But more often they turn to U.S. investors. The tide of their U.S. borrowings ran so high in the first half of last year that President Kennedy shocked Europe and Wall Street by proposing an "interest equalization tax" on foreign stocks and bonds floated in the U.S. by 22 leading industrial nations; the tax would have the effect of raising interest rates by a crucial 1% . The bill has yet to pass Congress, but it has caused such uncertainty that foreign bond sales from the countries affected have just about evaporated. Wall Street bankers have chased customers in vain; last week they lost a $15 million bond issue from The City of Oslo to London bankers. One result: foreign dollar bond sales in European markets rose from $10 million in the whole year before the tax proposal to nearly $100 million in the half year afterward.

The Solution. Some Wall Streeters ar gue that the tax, which is expected to pass by spring, will seriously weaken New York's carefully cultivated role as the leading international money market. Other bankers in the U.S. and Europe disagree, believing that borrowers will have to come back despite the higher rates simply because there is not enough ready capital in Europe to satisfy world demand. Probably no U.S. action--other than the unthinkable step of ending the nation's free capital market tradition by closing out foreigners altogether--can stem the outflow of investment capital from the U.S. The solution lies in Europe's meeting the new financial responsibilities its prosperity has forced upon it.

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