The Development of a National Financial System: 1863-1914
National Bank Acts -- 1863, 1864, 1865
Aim was to "nationalize" the State Banks and "forcefeed" them
State Banks were to be recharted by the Federal Government
Stiff Reserve Requirements
Required 1/3 of Reserve be Invested in U.S. Bonds
U.S. Notes Issued to Banks at 90% of face value of Bonds
Notes Made Legal Tender
10% Tax on State Bank Notes to Drive Them from Circulation
National Bank Acts extended Free Banking to Entire Country
By 1900 There were about 9000 State Banks and 3731 National Banks
Why So Many State Banks? Barriers to Entry Into National Banking
High Capital Requirements
Prohibition Against Mortgage Loans by National Banks
Ceiling on Total U.S. Note Issue Prevented Many State Banks From
Switching when it would have been profitable.
Advantages of Non-National Banks
Low Capital Requirements
Could Make Mortgage Loans
Lax Local Regulation
Development of Demand Deposits
Someone Hit upon the idea of making loans via individual Bills
of Exchange -- Checks!
Instead of receiving a stack of Bank Notes in exchange for an IOU plus
collateral, the borrower is given a checkbook!A check is a Bill of Exchange -- Whey you write a check you are issuing
an order (you are the principal) to your agent (the bank) to pay
a third party.
Provided Business and individuals accepted the checks, they are
The Currency: Politics vs. Economics, Silver & Gold Prices
Deflation: Prices fell from 1867 to 1896
Deflation caused great Political-Economic strain. Debtors, especially
farmers, demanded that steps be taken to inflate the money supply mainly through
the coining of silver.
In the 1840s and 1850s Gold was plentiful and Silver relatively scarce
The "Crime of 73" -- Silver was demonetized by an act of Congress just
as the Western mines came on lineBland-Allison Act of 1878. Passed with the support of a coalition of
farmers and mining interests. Obligated the Treasury to purchase $2m to $4m
of silver bullion per month and coin it into dollars. Treasury always purchased
the minimum amount and the price of silver kept falling.
Sherman Silver Purchase Act of 1890 -- Passed as the result of a deal
to get the McKinley Tarrif Bill passed. Obligated the Treasury to purchase
4.5m ounces of silver per month (essentially the entire output of the silver
mines). The silver bullion was paid for with U.S. Notes. The Notes were
redeemable in either gold or silver coin. Because the price of silver was
falling relative to gold, the arbitrage opportunity was too good to pass up: Sell
silver to get the notes; cash the notes for gold; use gold to buy silver; etc.
Sherman Silver Purchase Act repealled in 1893. The Depression and
the outflow of gold came very close to bankrupting the U.S. Government.
Beginning in 1896 the development of the cyanide leaching process
and discoveries of gold in the Yukon, South Africa, and Australia produced a
sharp increase in the world-wide supply of gold.
Railroads and Economic Growth after the Civil War
U.S. Long on Resources and Short on Population -- Result, capital
The Creation of the modern economy during the 1840s to the 1890s
was due to cheap energy in the form of coal, mass transportation in the form of
the railroads, and mass communication in the form of the telegraph.
Growth of the RRs
First railroads were built 1831-32
By 1840 railroad mileage and canal mileage were about equal --
Between 1850 and 1860 22,500 miles of railroad were built and by
1860 there were about 30,000 miles of railroad. By 1854 Chicago was the leading
rail center in the U.S. and by 1860 the major trunk lines -- the New York Central,
the Pennsylvania, the Erie, and the B&O all had lines into Chicago. By 1860
a railroad passenger could travel from St. Louis to Boston in 48 hours or from
New York City to Charleston, S.C. in 62 hours.
Railroads quickly became the dominate form of transportation because:
Greater Speed -- First form of transportation that was faster than
a galloping horse on land.
Open year around -- all weather transportation. Resulted in businesses
being open year around!
Railroads were the first big businesses.
The trunkline railroads were spread out over a vast territory --
shops, terminals, stations, warehouses, office buildings, bridges, roadbeds,
telegraph lines -- all had to be administered and maintained.
The flow of coin was unprecedented. Each day a river of coin was
collected from passengers and had to be handled in an efficient and orderly
way so it ended up in the Railroad's bank account and not in the pockets of the
The coordination was complex. Each day stations on the line loaded
and unloaded a wide variety of cargo. This had to managed and carefully tracked.
Cargos could go from any point on the line to any other point on the line.
These complexities required that complex organizational structures
be developed to solve the problems. These complex organizational structures
evolved into the modern line and staff form of business organization that most
big businesses use to this day.
The Nature of Railroad Competition
High Fixed Costs -- at least 2/3 of total costs
These fixed costs created inexorable pressure to attract traffic.
Railroads set prices in relation to cost rather than demand
This inexorably led to the setting of rates that discriminated
against persons, places, and types of traffic.
Value Based Pricing -- Freight rates for bulk products such as
lumber, coal, and ore were less than freight rates for finished goods.
Assymetric Traffic -- If more freight was moved from city A to city B
than vice versa, freight rates from B to A were less than from A to B to avoid
Volume -- Discounts were given for carload lots.
Complexity -- The Oyster example.
The Perversity of Railroad Rate Competition
By 1873 most major lines had excess capacity. Consequently, prices
on competitive through traffic fell way below non-competitive (usually local)
traffic. The result was severe rate wars between competing railroads.
Railroads with high bonded debt would cut rates to generate cash
to pay the interest on the debt. The stronger roads would match and the weaker
roads would go into bankruptcy.
Problem -- The Courts Rarely Liquidated a Railroad!
Result, the weak railroad under bankruptcy protection from its creditors
could cut rates again!
The response of the railroads to this perverse competitive situation
was to try to control competition through various mechanisms of fixing rates. The
most common was the formation of freight pools. Later in the 1890s
a wave of consolidation took place that solved much of the problem (temporarily).
Rebates and Drawbacks
Because of the competitive nature of the railroad business, large
shippers early on insisted, and got, price breaks (a rebate) from the
Rebates were pervasive and a source of complaint both from shippers --
who always thought that their competitors got better rates than they did -- and
the railroads -- who did not like being "blackmailed".
The most perverse from of a rebate was a drawback.
A drawback was, in effect, a tax on a competitor. For example,
Company A pays $1.00 a pound to ship a certain item and its smaller competitor
pays $1.50 a pound to ship the identical item. If Company A is powerful
enough, it can demand a drawback of, say, $.50 from Company B! That is,
the railroad collects the $1.50 from Company B and gives $.50 to Company A
and keeps the remaining $1.00 for itself.
The rebate system favored cities with multiple railroad lines. This
had the effect of promoting industrial consolidation in major cities because
the railroad rates were cheaper. For example, it is no accident that Standard Oil's base
of operations, Cleveland, Ohio, gave it an early advantage over Pittsburgh.
Cleveland had two railroads, Pittsburgh had one.
Railroads and Agriculture
The expansion of the railroads into the Midwest lead to the
expansion of market based agriculture. Production climbed rapidly from
1850 to 1870 and the U.S. was exporting large quantities of grain to Europe
by the early 1870s.
The steady price deflation during the 1869 - 1896 period resulted
in farmers getting less for their crops (in nominal dollars). Consequently,
especially when times were bad, the farmers agitated for inflation and tended
to blame part of their problems on railroad freight rates.
The railroads were popular villains (a view that still persists
in many quarters). But was it true that the railroads were "gouging" the
farmers? Were their complaints justified?
No. Careful scholarship by economic historians during the 1960s and
1970s could find no evidence of "unfairness". Robert Higgs looked at the
ratio of prices received by farmers for the grains as a percentage of a
railroad freight index that he computed. He found no increase.
Jeffrey Williamson looked at the spot price differentials between
New York City and Iowa/Wisconsin grain markets. These differentials are an
excellent objective measure of railroad freight rates. These rates, as a percentage of
the price the farmer received for various grains, fell steadily through
the 1870-1900 period. In other words, it got cheaper to ship grain.
Why did the farmers complain so much if there is so little
evidence for their grievances?
Farming is an inherently risky business. Yields, prices, and
incomes can fluctuate wildly from year to year.
The beginning of their complaints and political activity coincided
with the widespread switch from self-sufficiency to commercialization
Farmers in the Midwestern plains were drawn into a system of crop
specialization and borrowing from lenders to finance commercial agriculture. This
was a relatively new lifestyle for them. The stresses and strains of
this new lifestyle was a recipe for political-economic problems.
Robert McGuire in his paper "Economic Causes of Late-19th Century
Agrarian Unrest" hit upon the idea of correlating the incidence of protest
activity by farmers with the variability of measures of price, yield, and income
of 4 major crops -- wheat, corn, oats, and hay. He computed Spearman rank-order
correlations across states and found that those states most active in the protest
movements usually had the highest variability of prices, yields, and incomes.
The correlations where between .73 and .81.
Railroads and Industrialization
In 1874 about 150 tons of iron was used per mile of railroad (rails
and rolling stock).
The American iron industry was backward and inadequate. Most railroad
rails were imported from England.
Andrew Carnegie changed the industry when he applied the system of
railroad cost accounting to the iron and steel business. Carnegie had learned
and had helped perfect the system when he worked for the Pennsylvania Railroad
Carnegie's innovations resulted in the mass production of cheap
high quality Bessemer steel railroad rails by the late 1870s.
By 1890 over 80% of rails were steel and railroad productivity
greatly increased due to the availability of cheap steel not only for rails,
but also for rolling stock.