Time to hang up the bowler hat?

London is the world's undisputed international financial capital. But recession and technology could

"The City is never likely to collapse suddenly, with a broken mainspring," wrote Anthony Sampson in 1962, in his Anatomy of Britain. "Its danger is that it might, like the Habsburg court, gradually become irrelevant to modern Europe." Such was the City's reputation for complacent, insular mediocrity that this was a perfectly reasonable forecast, from which few would have dissented. Yet even as Sampson wrote, the City was in the midst of reinventing itself - so successfully that, before long, it was entering its second golden age. We are still living in that age. How much longer will it last?

A little ancient history is in order. London had long been an important trading centre, but during the 18th century the position of top international financial centre belonged to Amsterdam. More than 20 years of almost continuous warfare on the Continent changed everything, and London seized its chance, becoming indispensable by 1815. Above all, it attracted gifted, often Jewish, merchants and financiers from abroad, epitomised by Nathan Rothschild.

Between 1815 and 1914, London was top dog. Paris put up a spirited fight in the 1850s and 1860s, before being knocked out by the Franco-Prussian war, while New York was on the rise towards the end, but overall this was indisputably London's century. The sheer reach of the British empire (both formal and informal), the smooth working of the international gold standard, London's position at the centre of a world of largely unfettered flows of trade and capital - all these things came together in an almost miraculously virtuous circle.

The guns of August 1914 destroyed that world and, with it, London's dominance. The baton of top international financial centre passed to New York, crucially helped by America's three years of neutrality; from then until the 1950s - years including a world slump and another world war - there was never a realistic chance of London getting it back. Inevitably, the City became an increasingly inward-looking place, a place of bowler hats, rolled-up umbrellas and, as Sampson also observed, "quasi-sexual fascination with money concealed behind large layers of humbug".

The turning point, noticed by few at the time, was the arrival, in the 1960s, of the Euromarkets. These were mainly dollar-denominated markets that sprang up offshore after being driven away from their natural home, New York, as a result of restrictive measures arising from American anxiety over its balance-of-payments position.

The two major Euromarkets - the short-term Eurodollar money market and the long-term Eurobond capital market - could in theory have gone to Paris or Zurich or Frankfurt, but they settled in London, as much because of its light regulatory touch as anything else. Indeed, the way in which the Bank of England kept everyone else (including the Treasury) off the back of the young Euromarkets was arguably that institution's greatest ever service to the City.

By the 1970s, there were in effect two Cities: the international City centred on the Euromarkets and largely dominated by foreign (especially American) banks and bankers; and the domestic, UK-oriented City centred on the Stock Exchange and still dominated by the natives, only grudgingly becoming more modern and meritocratic. What in essence happened in the 1980s was that the Thatcher government imposed the "Big Bang" upon a reluctant domestic City, thereby simultaneously opening up to all comers the hitherto ring-fenced London securities market and merging the two Cities into one, international City. It was merely a logical sequel that, between 1989 and 2000, most of the City's prestigious merchant banks, once the creme de la creme of the square mile, succumbed to foreign predators.

London (which includes Canary Wharf as well as the City) is now, by most standards, the world's leading financial centre. Its closest rival is New York, but in relative terms that centre exists far more to service its domestic economy than London does. Any young European banker with serious ambitions makes a beeline for London. Deutsche Bank is even thinking of moving its headquarters from Frankfurt to London. Just like the tennis at Wimbledon, we host the event that attracts the world's champions and secure many of the benefits, including jobs, taxes and a major contribution to invisible earnings.

Can anything stop London's grass getting still greener? Quite a lot, as it happens. Three obvious areas of concern - over none of which the City has a significant degree of control - are transport, taxation and regulation. Given the wretched muddle and political grandstanding of the past few years over the future of the chronically sick London Underground, it is hard to see a realistic prospect of improvement in the first of these areas. On the fiscal front, the current tax take amounts to about 37 per cent of the City's GDP - some estimates put it higher. If the recession starts to bite, that proportion is likely to rise, given the government's ambitious spending commitments. As for regulation, there is rising concern among practitioners about increasing cost and inflexibility, especially the apparent reluctance of the Financial Services Authority to distinguish between wholesale and retail markets.

Then there is the euro. So far, the European single currency's effects on the City have been muted. If it has had an impact, it has probably been positive, highlighting London's distinctiveness from rival European financial centres. But what happens if Britain joins? My hunch is that the consequences, although not dramatic either way, would on balance be negative. Not only would there probably be adverse regulatory implications, but Britain becoming part of euroland would run counter to the strongly global character of the City's unique historical trajectory. One of the Treasury's five economic tests would therefore not be passed.

A more unambiguously gloomy prospect is that of the world shortly entering a serious economic downturn. Here, the City faces a double threat. First, a lengthy bear market raises the possibility - some argue probability - of the big, largely American-owned investment banks decisively shifting their centre of operations from London to New York, thereby reducing the status of London to little more than a cluster of branch offices. Second, London is such an international financial centre that any downturn leaves it peculiarly exposed - especially if the downturn involves a retreat from the liberal international economy that has been established since the break-up of the Bretton Woods system in the early 1970s and the ensuing abolition of exchange controls. For the past two decades, we have lived in a globalising world not so far removed from the pre-1914 free-market verities. Any repudiation of those verities would be immensely damaging to the City.

There is one final, generic danger. Are the days of specialist financial districts numbered? It may seem an absurd question to ask - both the Square Mile and Canary Wharf are currently littered with cranes and hard hats - but it is hardly illogical. Financial centres such as the City originally grew up around markets, but communications technology has made face-to-face dealing almost entirely redundant. Indeed, such is the ubiquity of both real-time market information and dealing facilities that, for at least a decade, it has been technically feasible to locate financial services operations anywhere. Will the events of 11 September be the trigger to prompt a diaspora? For what is now a highly intelligent, cosmopolitan and mobile workforce, keenly conscious of the advancement of self, the prospect of personal annihilation may well concentrate minds wonderfully.

David Kynaston is the author, with Richard Roberts, of City State: how the markets came to rule our world, published last month by Profile Books (£17.99)