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Fragile by Design: The Political Origins of Banking Crises and Scarce Credit

Author(s):Calomiris, Charles W.
Haber, Stephen H.
Reviewer(s):Rockoff, Hugh

Published by EH.Net (September 2014)

Charles W. Calomiris and Stephen H. Haber, Fragile by Design: The Political Origins of Banking Crises and Scarce Credit.  Princeton, NJ: Princeton University Press, 2014.  xi + 570 pp. $35 (cloth), ISBN: 978-0-691-15524-1.

Reviewed for EH.Net by Hugh Rockoff, Department of Economics, Rutgers University.

Charles W. Calomiris and Stephen H. Haber, two of America’s leading financial historians, have written an ambitious and in my view a largely successful book to provide an explanation for the political economy of banking through history and across nations. The central question is why some banking systems provide both abundant credit and financial stability over long periods while others, including unfortunately the financial system of the United States, fail to do so.

Summary

Calomiris and Haber develop their analytic framework in chapters 1 through 3. They do so in words. There are no equations to deter the mathematically challenged and prevent their book from reaching a wide audience. Their main point is that banking systems are always and everywhere a political construct: the outcome of what they call the “game of bank bargains.” The players in this game are the government, the public, and various interest groups including, of course, bankers and would be bankers. Governments want the revenues that can be extracted from the banking system and political support. Interests groups in turn want favors from the banking system, typically cheaper credit. The public wants abundant credit and a stable banking system. The outcome of the game of bank bargains depends on the underlying political system. The most important distinction is between democracies and autocracies.  In some democracies, but by no means all, the outcome of the game of bank bargains is a system that provides stable and abundant credit. A democratic government must provide a system that works in some measure for the general public if it is to stay in power. Sometimes, however, the tendency for the game of bank bargains to end favorably in democracies is undermined by what Calomiris and Haber refer to as populism and in particular agrarian populism. To secure the support of agricultural interests governments may impose restrictions on banks — restrictions on where they can locate, who they can lend to, how much they can charge on loans, on when and how much they can collect on debts, and so on. These restrictions may benefit the agrarian interests that sought them while reducing the overall supply of credit and the stability of the system. But an alliance with agrarians may help the ruling party to stay in power. The story with autocratic governments is different. Here there is a tendency for the government to extract as much revenue as possible from the banking system, even at the cost of the overall growth and stability of the economy.

This thesis (which is developed in considerably more detail) is illustrated with historical studies of banking in three democracies, Britain, the United States and Canada, and two autocracies (during much of their history) Mexico and Brazil, with briefer looks at other countries. Britain is covered in chapters 4 and 5. There is a great deal of historical material in these chapters. Along the way one learns about the gradual evolution of democracy in Britain, the disruptive economic and financial effects of wars, and the gradual and fluctuating transformation of the banking system from one at the service of the state to one responsive to the private sector. Professors of economic history may find themselves skipping parts of the narrative here, but the non-specialist can learn a great deal by reading straight through. In general, the earlier history will be less likely to provoke controversy than the more recent history. Perhaps it is simply the clarity of hindsight. Their story of how Britain relied on inflationary finance during the Napoleonic wars, for example, will raise few eyebrows. The authors’ apparent enthusiasm for Margaret Thatcher’s economic revolution (pp. 147-48) is likely to meet more resistance. The recent crisis, unfortunately, is not analyzed in detail. We learn that British banks were vulnerable to an international crisis because of the boom in the housing market and the high leverage of the banks, but not how these vulnerabilities were the outcome of the game of bank bargains.

The American experience is covered in chapters 6 through 8. Here they address one of the great mysteries of financial history: Why has the United States, a world leader in business, education, and technology lurched from one financial crisis to another through so much of its history? The answer for Calomiris and Haber is, to simplify a complex argument, agrarian populism. Indeed, chapter 6 is called “Crippled by Populism: U.S. Banking from Colonial Times to 1990.” The key for Calomiris and Haber is that farmers, particularly prosperous farmers, did better with local unit banks than they would have with a system of nationwide branch banking. In the short run the rates influential farmers paid might have been higher than they would have been with a nationwide branch banking system, but these farmers knew that the local bank would always be willing to lend to them, even in hard times, because it had no alternatives. The populists, who drew their strength from farmers, then formed an alliance with the unit bankers. Deposit insurance is an important outcome of that alliance. It was pushed by the populists as a protection for the common man, but helped make the unit banks competitive with the large urban banks. The resulting system, with its myriad of local unit banks, was “fragile by design.” Eventually, however, the system of unit banks was broken because of the declining economic role and political power of agriculture.

The crisis of 2008 in the United States is covered in chapters 7 and 8. As with the case of Britain their account of recent events will be more controversial than their account of earlier periods. Chapter 7, “The New U.S. Bank Bargain: Megabanks, Urban Activists, and the Erosion of Mortgage Standards” describes the origins of the subprime mortgage mania. The story they tell draws on a number of accounts, for example Raghuram Rajan (2011), but it fits well with their earlier emphasis on political bargains. As Calomiris and Haber see it, the crisis began with a bargain between regional banks seeking permission from regulators to merge and urban activists seeking credit for people who were too poor to qualify for home mortgages under traditional standards.  By making subprime loans the banks got the approval of activist groups which in turn meant approval by regulators for mergers — the banks were being good citizens — and the activist groups got what they thought they wanted, more credit for low income borrowers. But that was just the beginning. Fannie Mae and Freddie Mac were drawn into the coalition and then subprime loan originators such as Countrywide. Politicians benefitted directly through campaign contributions, and indirectly because they could claim to be helping the urban poor without having to levy higher taxes on the middle class.

Chapter 9 then attacks the question of why regulators didn’t force financial institutions to hold capital appropriate for the risks they were taking. In the opinion of Calomiris and Haber that would have been the key to preventing the inevitable losses on bad loans from becoming a crisis. They argue against the view that the problem was deregulation, particularly the often cited removal of the separation of commercial banking from investment banking that had been in place since the1930s. Here I was completely persuaded, although to be honest, this was my belief going in. Ending the separation of commercial banking and investment banking they show, permitted mergers and conversions that helped ameliorate the crisis. The real problem was that prudential regulators didn’t do their job of demanding capital to match risky lending. In part, the reason they failed was that raising capital requirements would have discouraged subprime lending and that would have meant taking on a powerful political coalition. Not all readers will be convinced that higher capital ratios would have prevented the crisis, but most will agree that this was a part of the story.

In chapter 9 Calomiris and Haber turn from the bad boy, the United States, to the good boy, Canada. Although there have been bank failures in Canada, including large institutions, there has never been a financial crisis, not even during the Great Depression. Why? The answer, according to Calomiris and Haber, is a system of large banks with nationwide branching systems, and the resulting efficiency and diversification of risk. That happy outcome was the result of the authority to charter banks being located, from the very beginning, at the national level. I found few things to disagree with in their discussion of Canada and the contrast with the U.S. Michael Bordo, Angela Redish, and I reach a similar conclusion in a paper forthcoming in the Economic History Review.

In section three, chapters 10 through 13, Calomiris and Haber turn from democracies to authoritarian regimes. Here, not surprisingly, things turn out worse than in the democracies. Chapters 10 and 11 describe the history of banking in Mexico. Haber has written extensively about Mexico and these chapters are wonderfully detailed. Here I will just summarize a few observations that are particularly striking. Under General Porfirio Diaz (1877-1911) the banking system was controlled by favored industrialists closely tied to the government. The industrialists benefitted and the government benefitted by extracting revenues from the banking system, but the resulting system failed to provide abundant credit to fuel widespread economic development. It provided, however, at least a modicum of stability.  During the period of the Mexican Civil War (1911-1929), the banking system deteriorated as rival warlords tried to extract resources from banks in regions they controlled. Under the Partido Revolucionario Institucional (PRI), the government established investment banks that helped finance the coalition that supported this authoritarian regime. Commercial banking remained depressed, even when compared to the Diaz era.

Chapter 11 covers Mexico after 1982, a tumultuous period. Budget problems led to reliance on inflationary finance that undermined the banking system and support for the PRI. This was followed by a misguided privatization of the banking system, with the purpose of raising revenue for the government, a run up of bank credit, and finally a crash and a bailout that created further political problems. This story sounds much like the story of the savings banks in the United States. Since the bailout, a new partnership has arisen between the government and foreign banks that have entered to fill the void left by the collapse of the older system. Although Calomiris and Haber see some positives in the new system, they point out that the amount of bank credit relative to GDP — their favorite measure of the abundance of bank credit — was about the same in 2010 as it was in 1910.

Chapters 12 and 13 cover Brazil. Chapter 12 covers the period up to 1889, and chapter 13, the period after, focusing on the transition to democracy. Much of Brazil’s financial history was characterized by heavy reliance on an inflation tax. Weak autocratic regimes couldn’t tax the wealthy oligarchs who supported them. An inflation tax was the easiest alternative. The transition to democracy has, after many steps forward and backward, produced a system that is more responsive to the general interests of Brazil. Even left-of-center governments, however, have faced the problem that it is hard to tax the wealthy elite in Brazil because of their high international mobility. Calomiris and Haber end on a cautiously optimistic note, but warn that populism in Brazil, like populism in the United States, will produce a banking system that subsidizes influential interest groups at the expense of the public.

Chapter 14 looks briefly at banking in other countries – via cross country empirical studies, and short narrative histories of China, Germany, Japan, and Chile — to test the viability of the conclusions reached on the basis of the detailed case studies. Again the ability of Calomiris and Haber to master and organize a huge amount of material is impressive.

Chapter 15, the concluding chapter, wrestles with the dispiriting implication of their argument that has been growing in the background since the first chapter. If banking is always and everywhere the result of a “game of bank bargains” played by the government and powerful interest groups, what role is there for ideas? Can an economist or historian make a difference? Calomiris and Haber struggle mightily to end on an upbeat note. They argue, for one thing, that there are windows of opportunity: economic crises so severe that people are willing to turn to someone with a new set of ideas. They suggest Alexander Hamilton and Margaret Thatcher as examples. But as these examples illustrate, most of the time economists and financial historians are likely to be chroniclers of events rather than makers of history.

Comment

Calomiris and Haber blame America’s banking troubles before 1990 on “agrarian populism” and its support for unit banking. But I think there was another, albeit related, factor that needs to be added to complete story. After all, although unit banks were popular in some parts of the United States, Americans often showed themselves willing to support branch banking. Before the Civil War many southern states, as Calomiris and Haber note, had branch banking systems (pp. 171-73). And Ohio, Indiana, and Iowa had mutual support systems that Calomiris and Haber (pp.174-75) celebrate. The unique weakness of the American banking system was that branching, even when permitted, ended through much of our history at the state line. But why were state governments able to keep their control over banking for so long? Support for state control of banking was an outcome of the larger battle between the states and the federal government for power. And that battle, of course, was to a great extent about race: the South was always the strongest advocate of state power. Keeping the right to charter and regulate banks at the state level, in other words, was simply one more battle in an ongoing war. The fight over the Second Bank of the United States is a good example. The bill to recharter the Bank passed the House and Senate only to be vetoed by Andrew Jackson. That vote, in itself, shows that there was strong support for nationwide branch banking. Recall that the Second Bank was not simply a banker’s bank on the Federal Reserve model. The Second Bank had branches in all parts of the country that made commercial loans. This was by any definition nationwide branch banking. Was there any opposition to rechartering the Second bank? Or was it just Andrew Jackson who was opposed? New England, the Western States, even the slave states that would remain within the Union in the Civil War all voted to recharter in both the House and Senate. The future Confederate States were different. With the exception of Louisiana, they voted overwhelmingly against recharter (Wilburn 1967, 9). Racism and populism, tragically, became entwined in the South. But the battle over states’ rights and racism, I believe, needs to be brought into the story as one of the reasons for the long delay in the adoption of nationwide branch banking. Racism also helps explain the desire in the United States to find a way to help poor people that did not involve higher taxes and transfers that Calomiris and Haber discuss when they explain the origins of the subprime crisis.

Calomiris and Haber use the term populism to refer simply to all politicians and parties who put great store in the will of the common man. By their definition Thomas Jefferson, Andrew Jackson, Abraham Lincoln, and William Jennings Bryan (p. 150) were all populists. But what about populism more narrowly: the People’s Party and its charismatic leader William Jennings Bryan? The Bryanites, as Calomiris and Haber point out, eventually supported deposit insurance which protected private unit banks. But the main goals of the populists, as can be seen in their party platforms, were nationalist and socialist, which would have ultimately undermined the local unit banks. The populists wanted to end the National banking system and replace its bond-backed currency with fiat paper issued by the federal government. They wanted a postal savings system to provide a safe haven for the deposits of farmers and the urban poor, and they wanted the federal government to provide low interest rate loans to farmers by issuing paper money based on deposits of excess grain: the subtreasury plan.  These goals were all achieved in some measure: the postal savings system was established in 1910, the Federal Reserve with its government-issued currency in 1913, and various agricultural programs that provided federal loans to farmers were enacted in the 1920s and 1930s.

Finally, I would add that Calomiris and Haber focus on only two outcomes for the banking system: abundant credit and stability. These are clearly the most important. Much of the support for unit banking, however, was based on other considerations. One argument, although I have never seen much evidence for it, was that locally owned banks provided and continue to provide credit differently from branches of large national chains. Local bankers know the background of potential borrowers. So a borrower with a sterling character but few assets to put up as collateral would be more likely to get a loan from a locally-owned bank than from a branch of a big chain. There was also the stability and continuity of the local community to think about. A local bank, it might be argued, would be more likely to provide ongoing community leadership than a branch filled with managers hoping to be promoted to the main office in New York or San Francisco as soon as possible. Perhaps it was all a fiction — Jimmy Stewart in It’s A Wonderful Life — but nevertheless it’s a possibility that we shouldn’t dismiss out of hand. Economic progress is not just about real GDP per capita.

Bottom line

This is a beautifully-written book. Calomiris and Haber are always thoughtful, always clear, and they have an eye for the telling metaphor and the thought-provoking fact.  More importantly, the book reflects the authors’ mastery of a vast amount of material on the history of banking. No one will be persuaded by all of their analyses, and there will be some pushback when it comes to their analyses of more recent and controversial events. Nevertheless, Fragile by Design is a must-read for economic historians, a book to be put on the shelf with O.M.W. Sprague’s History of Crises under the National Banking System, Bray Hammond’s Banks and Politics in America from the Revolution to the Civil War, and similar classics.

References:

Bordo, Michael, Angela Redish, and Hugh Rockoff (forthcoming), “Why Didn’t Canada Have a Banking Crisis in 2008 (or in 1930, or 1907, or . . .)?” Economic History Review.

Hammond, Bray (1957), Banks and Politics in America from the Revolution to the Civil War, Princeton: Princeton University Press.

Rajan, Raghuram G. (2011), Fault Lines: How Hidden Fractures Still Threaten the World Economy, Princeton: Princeton University Press.

Sprague, O. M. W. (1910), History of Crises under the National Banking System, Washington: Govt. Print. Office.

Wilburn, Jean Alexander (1967), Biddle’s Bank: The Crucial Years, New York: Columbia University Press.

Hugh Rockoff’s most recent book is America’s Economic Way of War: War and the U.S. Economy from the Spanish-American War to the Persian Gulf War. New York: Cambridge University Press, 2012.

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Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):Asia
Europe
Latin America, incl. Mexico and the Caribbean
North America
Time Period(s):19th Century
20th Century: Pre WWII
20th Century: WWII and post-WWII

The Oxford Handbook of Banking and Financial History

Editor(s):Cassis, Youssef
Grossman, Richard S.
Schenk, Catherine R.
Reviewer(s):Neal, Larry

Published by EH.Net (July 2017)

Youssef Cassis, Richard S. Grossman, and Catherine R. Schenk, editors, The Oxford Handbook of Banking and Financial History. Oxford: Oxford University Press, 2016. xviii + 537 pp., $160 (hardcover), ISBN: 978-0-19-965862-6.

Reviewed for EH.Net by Larry Neal, Department of Economics, University of Illinois at Urbana-Champaign (emeritus).

The global financial crisis that began in 2007-08 and continued to rattle the Eurozone countries after 2010 has certainly been good for the market for financial history.  The Oxford Handbook of Banking and Financial History is clearly a response to these events.  In their introductory chapter, the editors set out their ambitious agenda, which is to deal with the individual parts of our modern complex financial system and trace how each has evolved over time.  Each chapter ends with some insight into how the current turmoil in global banking and finance might affect part of the global financial system. This broad-ranging approach is very much in keeping with current analysis by policy economists, who have become very sensitive to how our financial system intertwines banks, which specialize in particular niches of the economy; shadow banks, which innovate to find new niches; money markets, which deal with short-term finance; capital markets, which provide long-term finance; and regulators, who attempt to oversee the operation of the financial system for the interest of the public (or the government).  The editors’ goal is to provide anyone concerned with a particular aspect of the financial system an authoritative treatment by an acknowledged expert that is clearly written for the non-specialist combined with a useful bibliography to follow up particular aspects.

The Oxford Handbook is organized into four parts: Part I, Thematic Issues, deals explicitly with the problems that the editors confronted at the outset: how have historians approached the issues in financial history (Youssef Cassis); how have economists dealt with the issues that interest them (John D. Turner); and how have policy makers tried to apply lessons from history for promoting economic development (Gerard Caprio, Jr.).  To pay due attention to historical contingency, economic analysis, and policy relevance in each of the following chapters is, indeed, a daunting task for each author.

Part II, Financial Institutions, takes up these challenges by separating out several categories of distinctly different institutions, a useful distinction too often overlooked in practice and one that illustrates nicely the complexity of any financial system.  Youssef Cassis’s “Private Banks and Private Banking” begins with the initial role models for banks, from their origins in kinship networks in Renaissance Italy to today’s Swiss managers of private wealth.  Gararda Westerhuis’s “Commercial Banking: Changing Interactions between Banks, Markets, Industry, and State” follows by dealing with the nineteenth-century spread of industrialization globally, which led to the rise of universal banks.  By the end of the twentieth century, however, it appeared that commercial banks might be in “a state of terminal decline.” (See Raghuram Rajan, 1998, “The Past and Future of Commercial Banking Viewed through an Incomplete Contracts Lens,” Journal of Money, Credit, and Banking. 30(3), 524.)  The financial crisis of 2008 led many observers to push for a separation of investment and commercial banking once again in the interest of financial stability.  Westerhuis goes on to distinguish the motives for establishing market-based systems (U.S. and England) versus bank-based systems (Germany and Japan).  She posits that the two paths diverged early on due to the differences in government control over banks and then the role played by banks in financing industrialization for follower countries, such as Germany and Japan.  Oddly missing from her overview is any consideration of the experience of Scottish banking, which developed joint-stock banks with national branches early in the eighteenth century.  Only after the financial crisis of 1825 did the English care to look seriously at the Scottish example for improving their commercial banking system!  Further, joint-stock banks did not disappear in the U.S. during the “free banking” period as she asserts. While they were confined within state boundaries, limitations on branching within a state varied considerably.  The wide range of experiments undertaken by various states has stimulated a growing and interesting literature among U.S. scholars, largely omitted from her bibliography.

Caroline Fohlin’s “A Brief History of Investment Banking from Medieval Times to the Present” takes up the most challenging role of banks, how to transform short-term liabilities into long-term assets.  Rather than taking specific organizational forms, she prefers to analyze investment banks as a set of services that help finance the long-term capital needs of business and governments. After briefly looking at merchant banks from medieval times to the early nineteenth century, this loose definition requires her to take up individual countries one by one during the nineteenth century.  Sections follow that deal with England, the European continent, Belgium and the Netherlands, France, Germany, Austria and Switzerland, Italy, Japan, and the United States. Each section highlights the differences in organizational structures created to accomplish basically the same goals, helping governments promote industrialization.  The twentieth century presents more interesting differences, essentially due to the ways various governments regulated, deregulated, and then re-regulated from the 1920s to the present.  She concludes, “even well-known investment banking names that have endured over the centuries bear little resemblance to their ancestors” (p. 159).

Christopher Kobrak’s “From Multinational to Transnational Banking” takes up the complex transformations of the world’s leading banks by size as they successively internalized their international operations.  The availability of huge advances in information technology combined with increasing opportunities for re-allocating domestic savings across foreign investments provided the basis for the growth of today’s megabanks.  Oddly, however, Kobrak takes as archetypes of the new transnational bank two of the worst performers after 2008 — Deutsche Bank and Citibank.  Relying on their respective annual reports in 2007-2010, he touts each of them as “market players” rather than staid fiduciary agents, lauding their scale and scope of activities that are only vaguely related to financial intermediation associated with banks “lending long, while borrowing short.” He dispassionately notes that three-quarters of Deutsche Bank’s two trillion euros in assets in 2007 were securities held for trading, and 40 percent were financial derivatives (p. 183), without disparaging the obvious omission of fiduciary responsibility. Citibank, similarly, by 2007 had “invested huge resources in creating an internal market, in essence warehousing securities and derivatives to build hedged positions and for future sale” (p. 182). All these intra-bank holdings of assets and liabilities enabled such banks to make a lot of money by proprietary trading that remained unobserved by regulators or by publicly accessible financial markets.  He refrains from criticizing the model developed by these two megabanks, each of which has suffered huge losses and justified public acrimony since 2008, confining himself to the anodyne remark that “megabanks may be forced, as they have many times in the past, to find an intertwined institutional and organizational adaptation more sustainable in the modern social order” (p. 185)!

R. Daniel Wadhwani’s “Small-Scale Credit Institutions: Historical Perspectives on Diversity in Financial Intermediation” concludes Part II by lumping together a motley assortment of credit cooperatives, savings banks, industrial banks, pawn shops, and savings and loans associations.  Wadhwani argues their cumulative size makes their impact on their respective economics arguably as great or greater than that made by the commercial, investment, and public banks dealt with in the previous chapters.  Their common origin across many cultures and through past millennia he finds in the ubiquitous presence of ROSCAs (rotating savings and credit associations).  Beginning with small kinship groups desiring to pool their limited resources to enable individual members to acquire a desired goal, perhaps a piece of land, a dwelling, livestock, or even the means to migrate somewhere else for employment, ROSCAs often provide a basis for transition to the more modern forms of intermediation.  These include savings banks, credit cooperatives, and savings and loans, with each evolving quite differently depending on local circumstances.  Critical to their evolution historically is the role of government, whether as regulator (restricting competition), competitor (postal savings banks), or customer (providing sovereign debt as risk-free asset).  The theoretical economic bases for their evolution and persistence are robust, both for their monitoring capability and for their local knowledge of investment possibilities.  Nevertheless, Wadhwani calls attention to more post-modern “theories” that favor the creation of supportive narratives when cultures confront changes in economic regimes.

Part III, Financial Markets, begins with Stefano Battilossi’s “Money Markets,” which emphasizes the importance of access to outside liquidity for banks when they face unanticipated shocks either for increased loans or increased withdrawals of deposits.  Further, Battilossi argues that a key lesson learned by banking theorists and practitioners in the nineteenth century, namely that money markets are essential for a smooth working of the economy but are inherently unstable, was lost over the course of the twentieth century.  The success of the Bank of England in stabilizing the money market at the center of the global economy of the nineteenth century, he argues, was due to a complex combination of close monitoring by the Bank of England and cartel complicity by the major joint-stock banks, each with extensive branching networks domestically and overseas.  U.S. efforts to imitate the British example after creation of the Federal Reserve System in 1913 failed due to irreconcilable differences in institutional structures between the two banking systems and their respective central banks.  It took over a century and a half for the Bank of England to learn how to avoid being a dealer of last resort, a role that the Federal Reserve System in the U.S. had to undertake in the 2008 crisis, and which it has not yet been able to relinquish.  Readers are left to draw the implications for the future of the global financial system for themselves!

Ranald C. Michie’s “Securities Markets” lays out convincingly and clearly the importance of securities markets for a successful financial system.  Divisibility and transferability of a security expands greatly the potential customer base, adding the virtue of diversity in demands for liquidity among the creditors as well.   He distinguishes clearly between “Primary Securities Markets” and “Secondary Securities Markets,” showing their interdependence in layman’s terms.  “Stock Exchanges” provide the effective linkage between the two levels of markets, but fall prey in turn to problems either of monopoly pricing or government repression. His exposition of the underlying theory of securities markets provides the structure for his narrative that follows. From “Early Developments in Securities Markets,” which only mentions briefly the roles of informal markets in the speculative booms of 1720, Michie insists on focusing on the nineteenth century, starting with the London Stock Exchange in 1801.  It’s unfortunate that he ignores recent work on the Amsterdam stock market, (e.g., Lodewijk Petram, The World’s First Stock Exchange, New York: Columbia University Press, 2014), or early work by this reviewer on the precedents for the London Stock Exchange (Larry Neal, The Rise of Financial Capitalism, New York: Cambridge University Press, 1990).  Committed to the importance of formal structures for modern stock exchanges, however, Michie takes up their rise in the advanced capitalist economies of the nineteenth century and then their eclipse from 1914 to 1975.  Thanks to the exigencies of war finance from World War I through the Cold War, stock markets seemed to “appear somewhat irrelevant in a world dominated by governments and banks” (p. 253)  “The Era of Global Banks” did not come to an end in 2008, however, but what had ended was the “self-regulation that had contributed so much to the attractions of stocks and bonds to governments, businesses, and investors through the reduction or elimination of counterparty risk and price manipulation and the certainty that sales and purchases could be made as and when required” (p. 258).  Big banks are bad once again!

Moritz Schularick’s “International Capital Flows” is the most quantitative and instructive of the chapters, as he summarizes succinctly in nine brief tables and one graph, the levels of international capital flows over the nineteenth and twentieth centuries, their size relative to Gross Domestic Product, and the main sending countries and main receiving countries over time.  In sum, rich countries invested in poor countries in the nineteenth century, when international capital flows were highest relative to GDP, and the rich continued to invest in poor countries even when capital flows were severely constrained during the period 1914-1975.  But after the collapse of Bretton Woods, when international capital flows rose sharply once again, the result has been for poor countries to invest in rich countries.  Further, when capital does flow suddenly to emerging economies, financial crises often follow when the flow tapers off, undoing whatever economic advance may have occurred.

Youssef Cassis’s “International Financial Centres” concludes the coverage of financial markets by analyzing the recurring features of international financial centers that lead to their persistence over time.  The physical layout of the dominant cities, the combination of functions they perform (government, communications, education, as well as trade and finance), and their organization may change as the technology of transport, communications, and information change, but, Cassis argues, the network externalities created by the concentration of so much expertise in one location make the existing centers hard to replace.

Part IV, Financial Regulation, takes up the most vexing questions for policy makers, starting with Angela Redish’s “Monetary Systems.”  Redish begins with the complexity of metallic currencies with coins minted in varying combinations of copper, silver, and gold in early modern Europe, and deftly reviews the causes that concerned European policy makers as they sought to maintain coins with fixed legal tender values, whether minted in any or a combination of the three precious metals.  Basically, their concerns were the same as today, “whether nominal change can have real consequence for the balance of trade or level of economic activity?” (p. 327).  Redish goes on to trace out the academic literature that has dealt with the Emergence of the Gold Standard, the Latin Monetary Union, the Cross of Gold, the Classical Gold Standard, and the Good Housekeeping Seal of Approval, highlighting the controversies that have arisen under each rubric.  Next, she divides the End of the Gold Standard into the First World War and the Interwar Period, Bretton Woods and European Monetary Arrangements, and the End of Bretton Woods and the Rise of the Euro.  Reproducing faithfully the graph produced by Eichengreen and Sachs to show that countries that stayed committed to the gold standard after 1929 suffered in terms of industrial production relative to those that devalued, she doesn’t point out that the outliers of Germany and Belgium are readily explained by mistaking their formal exchange rate regimes with the ones they followed in practice (Germany using bilateral trade agreements to increase industrial exports while keeping the nominal exchange rate fixed, and Belgium reducing its nominal exchange rate while being forced to maintain existing trade agreements with France).  She concludes with a brief discussion of both inflation targeting under fiat currency regimes and the rise of crypto currencies such as Bitcoin, Her conclusion is merely that “money is information, a method to enable multilateral clearing of myriad transactions.  It would be surprising if the digital revolution did not lead to a revolution in how this information is managed” (p. 339).

Forrest Capie’s “Central Banking” takes up the baton passed on by Redish to provide a brief synopsis of the issues confronting central banks as they have increasingly taken control of the supply of money over the past two or more centuries.  Monetary stability, their prime responsibility, can be assessed in terms of price stability, but financial stability, which has become a major concern, he notes is more difficult to assess, much less to sustain.  Central bank independence, however defined, does seem to correlate with monetary and price stability, which shows that policy lessons have been learned successfully on that score.  Continued independence of central banks, however, hinges very much on attaining and then sustaining financial stability.  This task, very much underway now among the world’s central banks, 174 at last count, may require expanding their role to include financial regulation as well as oversight of the banking system.

Harold James’s “International Cooperation and Central Banks” makes an interesting argument that central banks in their pursuit of the goal of monetary stability naturally tend to cooperate with other central banks internationally, but without need for formal mechanisms.  Cooperation can then be merely discursive, as it was during the classical gold standard.  Financial crises, however, often do call for international cooperation, but cooperation is difficult, perhaps impossible, to sustain given the priority of strictly national policy concerns.  Large countries, needed to make cooperative efforts successful, are the most reluctant to join in cooperative efforts.  His examples cover episodes during the classical gold standard, the interwar period, the brief Bretton Woods period, and the ongoing travail of the euro-system, which he concludes is “the global test case for both the possibilities and the limits of central bank action” (p. 391). In an interesting aside, he explains why the Bank for International Settlements was resuscitated to manage the European Payments Union in the 1950s.  Top U.S. officials were wary of using the newly-established International Monetary Fund because its staff were largely protégés of Harry Dexter White, then under suspicion as a possible Russian agent!

Catherine Schenk and Emmanuel Mourlon-Droul’s “Bank Regulation and Supervision” develops a sub-theme to the arguments presented by Harold James, namely the recurring problems of regulatory competition, moral hazard, and regulatory capture.   Essentially, “[r]eputation and private information are key bank assets in a market with information asymmetry, but this complicates the ability to engage in transparent prudential supervision” (p. 396).  The U.S. stands out for having the most complicated and unwieldy array of conflicted regulatory agencies, summarized in Table 17.1.  The authors conclude, as do Charles Calomiris and Stephen Haber (Fragile by Design: The Political Origins of Banking Crises and Scarce Credit, Princeton, NJ: 2014), that it is no accident that Canada and the UK, with more coherent approaches to bank regulation have had fewer banking crises.  Much of the remaining chapter focuses on China and the successive efforts of China’s rulers to establish, then regulate, a banking system to enable industrialization and modernization, concluding, perhaps prematurely, that China managed to reduce the problem of non-performing loans after their peak in 2000.  The difficulties of deciding where to locate the regulator of the banking system are highlighted by tracing the successive efforts of the U.S., then the UK to find an ex post regulatory solution to the problems of recurring financial crises.  The efforts of the Basel Committee, established after the collapse of the Bretton Woods System, are described in the context of the European Union’s efforts to move toward regulatory cooperation within a more limited scope of international cooperation.  Prospects for success on that score are still very much in doubt.

Laure Quennouelle-Corre’s “State and Finance” takes a step back to look at the origins of the ongoing dilemma for the Eurozone of the interaction between governments’ sovereign debt and financial fragility of their banks.  The recurring differences between France and the other members of the European Union form the backdrop for his rambling notes on the interactions of private and public financial institutions, ending with the observation that France alone has had to deal with the European Union’s pro-market ideology versus the French tradition of state intervention.

Part V, Financial Crises, opens with Richard Grossman’s “Banking Crises,” which reprises the standard story of boom-bust cycles, exacerbated when new opportunities for speculative investments open up (first globalization after 1848; second globalization after 1979; post-war adjustments after WWI) but then moderated under strict regulation (capital controls, interest rate restrictions from 1945-71).  In his perspective, the Eurozone crisis fits the boom-bust pattern first described by D. Morier Evans in 1859 (The History of the Commercial Crisis, 1857-58, and the Stock Exchange Panic of 1859, New York: Augustus M. Kelley, 1969).

Peter Temin’s “Currency Crises: From Andrew Jackson to Angela Merkel” takes up the international aspect of the boom-bust paradigm by extending it into national decisions about setting the exchange rate with foreign trading partners and possible investors. To bolster his long-standing conviction that most, if not all, banking crises are really currency crises at heart, he lays out in detail the open macro-economy model developed by Trevor Swan. Swan’s diagram relates a country’s domestic level of production to its real exchange rate.  Internal balance is maintained if production rises with the real exchange rate, while external balance requires the real exchange rate to fall when production increases. The model leads to dire consequences for a country if it does not succeed in maintaining both internal balance (matching domestic investment with domestic supplies of savings) and external balance (matching capital account flows with offsetting trade balances) simultaneously.  Either excessive inflation or long-term unemployment occurs whenever imbalances are sustained due to misguided government policy.  Banking crises then arise as the necessary outcome of such policy failures by governments. The historical evidence to support Temin’s argument starts with Andrew Jackson and the crisis of 1837 in the U.S., continues through the Great Depression in the U.S. in the 1930s, not to mention the concurrent crisis in Germany, and concludes with the ongoing Eurozone crisis, all basically due to misguided political leaders, as named in his sub-title.

Juan H. Flores Zendejas’s “Capital Markets and Sovereign Defaults: A Historical Perspective” concludes the Oxford Handbook.  The first global financial market, arising with the collapse of the Spanish Empire in Latin America after the Napoleonic Wars, saw various devices to cope with the recurring problem of governments defaulting on the sovereign bonds they issued for whatever reason, usually to fight a war or quell a revolution.  Flores recounts the success of the London Stock Exchange in bringing governments to heel if they wanted access to British savers. The monitoring capabilities of the leading merchant bankers, especially the Barings and Rothschilds, put their imprimatur on bonds issued through their firms.  Twentieth century regulatory restrictions on these leading investment banks by their host governments, however, have limited the effectiveness of their “branding” and their intrusive follow-up in monitoring the finances of their customer governments.  Flores casts some doubt as well on the effectiveness of the Council of Foreign Bondholders in the nineteenth century.  He could also have challenged the effectiveness of international financial control committees that served as the model for the League of Nations Financial Commission after World War I if he had cited the recent work of Coskun Tuncer (Sovereign Debt and International Financial Control, The Middle East and the Balkans, 1870-1914, London: Palgrave Macmillan, 2015).  Flores concludes in general that governments that avoided defaulting in times of general crisis did so because they had been excluded from the earlier expansion of international credit.

All in all, the editors did get the compilation in print still in time to be useful for anyone concerned with how the ongoing financial crisis of the early twenty-first century will play out.  Specialists in each topic, however, may be disappointed in the necessary brevity of treatment, not to mention absence of references to their own work, particularly if they worry most about the future of the U.S. financial system.

Larry Neal is the author of A Concise History of International Finance: From Babylon to Bernanke, Cambridge: Cambridge University Press, 2015

Copyright (c) 2017 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator (administrator@eh.net). Published by EH.Net (July 2017). All EH.Net reviews are archived at http://www.eh.net/BookReview.

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):General, International, or Comparative
Time Period(s):18th Century
19th Century
20th Century: Pre WWII
20th Century: WWII and post-WWII

The Evolution of Everything: How New Ideas Emerge

Author(s):Ridley, Matt
Reviewer(s):Coelho, Philip R.P.

Published by EH.Net (October 2016)

Matt Ridley, The Evolution of Everything: How New Ideas Emerge. New York: HarperCollins, 2015. 360 pp. $29 (hardcover), ISBN: 978-0-06-229600-9.

Reviewed for EH.Net by Philip R.P. Coelho, Department of Economics, Ball State University.

This is a well-written and informative book; it consists of a prologue, sixteen chapters, an epilogue and an index. It is written with a point of view (libertarian right) that may grate on some readers, and its flaws may make it inadvisable to assign to lower-level undergraduates for outside reading.

Matt Ridley begins with a bow to the classical Roman author Lucretius’s extended poem, De Rerum Natura (On the Nature of Things). Each chapter starts with a quote from Lucretius pertinent to the chapter’s contents. Chapter topics are diverse; examples are: The Evolution of the Universe (Chapter 1), The Evolution of Religion (Chapter 14), The Evolution of the Internet (Chapter 16), and almost everything in between. Obviously the book’s ambitions are not modest, and, all-in-all it is a formidable introduction to the scientific and intellectual histories of a number of disciplines. As might be expected, some chapters are substantially superior to others.

The chapters on the physical sciences are excellent. These include the evolutions of the universe (Chapter 1), life (Chapter 3) genes (Chapter 4), technology (Chapter 7), and the mind (Chapter 8). These are substantive and informative. Still a major difficulty that I have with these chapters (and the book in general) is the conflation of the word “evolution” with development and/or history.  Change is not synonymous with the scientific or Darwinian meaning of evolution (which Ridley employs in parts of The Evolution of Everything), but, more than occasionally, he treats “evolution” as if it were synonymous with “history” or “development.” For example, when the author speaks of the evolution of societal attitudes toward same-sex marriage (p. 26) he is really talking about the climate of currently accepted opinion in much of the western world. My criticism of Ridley’s usage of “evolution” to describe changing attitudes towards same-sex unions as evolutionary is not normative; the toleration of same-sex unions could, or could not be, “evolutionary desirable,” where evolutionary desirable means leaving more descendants or out-competing rivals for resources.  It is possible that societies tolerant of same-sex unions may have (for whatever reasons) faster rates of growth than societies that are intolerant. The increase in resources may allow tolerant societies to dominate and surpass less tolerant societies. Using the term “evolution” to describe both evolution in a Darwinian context and as synonym for current trends or fashions may confuse readers.

Other faults with the book are that it is not well documented. An egregious example is in the chapter on the evolution (history) of money.  Ridley writes that: “Joseph Stiglitz, and Peter and Jonathan Orszag . . . concluded [in 2002] that the risk to the government from a potential default of Fannie [the Federal National Mortgage Association] or Freddie [the Federal Home Loan Mortgage Corporation] because of sub-prime lending was ‘effectively zero’ – ‘so small that it is difficult to detect.’” (p. 292). Despite the quotations within this passage there is no footnote to the source for the quotations, nor is the source for the quotation mentioned in the “Sources of Further Readings” (pp. 323-341). Because Stiglitz and the Orszag brothers played important roles in advising the Obama administration and the Congressional Democrats (i.e. the Dodd-Frank banking/financial legislation) I was more than mildly curious about the quote’s provenance. The usual data bases had no mention of the aforesaid quote and its source, so I turned to the undergraduate’s favorite tool and Googled the names and terms, and up popped the source. In short, Ridley’s summary was correct.  Similarly, in the chapter on religion Ridley has a direct quote saying: “In the way they rescued the theory from refutation; but they did so at the price of adopting a device which made it ambiguous” (p. 270). There is no citation and the antecedent is ambiguous. (Karl Popper, the author of the quote is mentioned in the paragraph but so are five other surnames, some of which precede the quote.) Once more Google came to the rescue and identified these as Popper’s words.  Readers should not have to depend on Google to verify quotations and sources.

Ridley’s economic discussions are uneven; he has excellent intuition, still his knowledge of economics has some serious deficiencies in the foundational literature of evolutionary economics. Armen Alchian and his seminal article (1950) on the evolutionary basis of economics are not mentioned. Milton Friedman is quoted for his comments on the internet (also undocumented by Ridley; Google was able to track down Friedman’s internet quote), but Friedman’s Essays in Positive Economics (1953), which competes with Alchian’s article as foundational to evolutionary economics, was not mentioned. Here we have Ridley talking about the evolution of various economics subjects, yet ignoring the intellectual foundations of evolutionary theory in economics; the result is intellectual dissonance.

Ridley is also somewhat haphazard in his command of more recent literature. The discussion on money (chapter 15) deals in depth with the recent financial meltdown, yet he appears to be unaware of the work by Calomiris and Haber (2014) that attributes the Great Recession to government policies that affected banking and the home mortgage industry.  Other examples of ignoring the recent literature are in Chapter 11 (population) where he criticizes the Malthusian’s theory on population and vilifies Malthus without considering the Malthusian intuition that associates increased population density with an increased disease burden (which increased both mortality and morbidity, and these reduced productivity). The Malthusian intuition is an offset to the virtuous cycle postulated by Adam Smith — that increasing population increases market size which increases specialization that in turn leads to increased productivity is limited by the [absolute] size of the market. Robert McGuire and I have written (2011) about this.

In spite of omissions, oversights and errors in Ridley’s economic discussions, he does enlighten and entertain, and provides insights into economic processes. I liken this book to a major university; over all it pursues excellence, still there are deficiencies in some disciplines and specialties that could be improved upon substantially. Ridley is an accomplished and talented author and scholar whom I greatly admire. I am glad I read the book and encourage others to read it, yet a more disciplined approach and an unyielding editor would have made a good book better.

References:

Alchian, Armen A. (1950) “Uncertainty, Evolution, and Economic Theory,” Journal of Political Economy 58 (3): 211–21.

Calomiris, Charles W. and Stephen H. Haber. (2014) Fragile by Design: The Political Origins of Banking Crises and Scarce Credit. Princeton, NJ: Princeton University Press.

Friedman, Milton, (1953) Essays in Positive Economics.  Chicago:  University of Chicago Press.

McGuire, Robert A. and Philip R. P. Coelho. (2011) Parasites, Pathogens, and Progress: Diseases and Economic Development. Cambridge, MA. MIT Press.

Copyright (c) 2016 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator (administrator@eh.net). Published by EH.Net (October 2016). All EH.Net reviews are archived at http://eh.net/book-reviews/

Subject(s):Economic Development, Growth, and Aggregate Productivity
Education and Human Resource Development
Financial Markets, Financial Institutions, and Monetary History
Historical Demography, including Migration
History of Technology, including Technological Change
Markets and Institutions
Time Period(s):General or Comparative

The Engine of Enterprise: Credit in America

Author(s):Olegario, Rowena
Reviewer(s):Wright, Robert E.

Published by EH.Net (February 2016)

Rowena Olegario, The Engine of Enterprise: Credit in America. Cambridge: Harvard University Press, 2016. v + 301 pp. $40 (cloth), ISBN: 978-0-674-05114-0.

Reviewed for EH.Net by Robert E. Wright, Thomas Willing Institute, Augustana University.
Rest assured that I did not judge this book by its cover, ugly as the 1940 GMAC advertisement the book designer chose to use appears to my eye. But try as I might, I could not find an appropriate audience for this (perhaps overly) ambitious undertaking after perusing it for several days. There is no preface to help readers to understand the author’s goals or the book’s purpose and the introduction launches directly into the content.

As its title suggests, the thesis of The Engine of Enterprise is that “the United States was built on credit” (p. 1) or, with more nuance, “despite problems with credit that were at times severe, and which Americans have never fully solved, credit has been the invigorating principle that turned potential wealth into national prosperity” (p. 226) (my emphases). The proof comes in the form of five narrative chapters covering the colonial and early national (Chapter 1: “The Foundations of Credit in the New Republic”), antebellum (Chapter 2: “Credit, Enterprise, and Risk in the Antebellum Era”), postbellum (Chapter 3: “Credit in the Reconstructed Nation”), interwar and postwar (Chapter 4: “A Nation of Consumers and Homeowners”), and late twentieth century (Chapter 5: “The Erosion of Credit Standards”) periods, plus a brief postscript (“Creative and Destructive Credit”) on the causes and consequences of the Panic of 2008. The chapters do not follow a cookie cutter format but many cover the same topics, e.g., consumer credit, business credit, bankruptcy, and so forth.

While narrative descriptions of the evolution of different types of credit abound, the book does not show the primal importance of credit in statistically rigorous (e.g., Rousseau and Sylla 2005) or internationally comparative (e.g., Beck, Demirguc-Kunt, Levine 2007) ways, or even cite the finance-led growth literature (see Levine 2005 for a review). Moreover, the finance-led growth hypothesis was tempered by studies (e.g., Martin 2010; Wright 2008) that showed that financial development is just one of a series of growth-inducing economic changes that begin with secure human rights and end with improvements in physical and human capital that drive productivity gains. Because microfinance failed to spur growth in anarchic or dictatorial states, few continue to baldly assert the primacy of finance, let alone just its credit component. Alexander Hamilton had it exactly right when he argued that credit “was among the principal engines of useful enterprise” (p. 4) (my emphasis), i.e., that credit is a necessary but not a sufficient cause of economic growth. It is the fuel injection system, in other words, not the entire engine.

The book is unlikely to appeal to other specialists, either, as it is not based on new or extensive archival research or even novel interpretations of printed primary sources. As a senior research fellow at Said School of Business, author Rowena Olegario lives thousands of miles from scores of archival U.S. bank records that range from underutilized to completely untouched (for a partial list, see New Bedford Whaling Museum 2011), but one would think that Oxford University could afford to pay for the filming of, and/or travel to, at least one set of U.S. banking records. Moreover, although Olegario occasionally alludes to the theory of asymmetric information, the book is largely devoid of pertinent economic theories. So in her narrative, the early economy was “vulnerable to external shocks” (p. 24) due to unregulated banks and banknotes rather than the nation’s solution to the Trilemma or Impossible Trinity, a bimetallic standard demanding free international capital flows and fixed exchange rates in lieu of a central bank with significant monetary policy discretion.

Although The Engine of Enterprise presents more evidence about what people thought than how they behaved, the book is not a compelling “history of thought” either. Olegario, for instance, credits Henry C. Carey with being “the most notable economist of his time” and with anticipating “the new institutional economics by a century and a half” (p. 7). Carey’s life (1793-1879) overlapped those of important American political economists like Edward Atkinson (1827-1905), Alexander Bryan Johnson (1786-1867), and Erasmus Peshine Smith (1814-1882), not to mention numerous European economists of far more probity. Moreover, most of Carey’s ideas merely reiterated the thought of Hamilton and other financial founding fathers and even his own biological father. Olegario herself later (p. 59) admits that Carey was less important than Henry George (1839-1897).

Given its long coverage, from the colonial period to the present, the book might have been designed as a survey text, but for what course and at what level? Graduate students would quickly dismiss The Engine of Enterprise because it does not discuss historiography and glosses over the few debates that it explicitly recognizes without describing the major issues or even mentioning the major contributors. For example, Olegario informs readers that “historians are not in full agreement about how stringently” (p. 28) usury laws were enforced in colonial America but the corresponding note refers only to Geisst (2013). Most other debates are not even hinted at in the notes. For instance, the author blithely asserts that some colonial bills of credit depreciated because they “were insufficiently backed by land or taxes” (p. 21) without mentioning the long debate over “backing theory” (e.g., Michener 2015). Moreover, many endnotes point to a relatively limited set of broad secondary sources, like Wood (1991), Morgan (2000), and Calomiris and Haber (2014), rather than relevant specialized monographs like Kamoie (2007), which details the credit relations of the important Tayloe family in Virginia, or Roney (2014), which describes how NGOs in colonial Philadelphia served as financial intermediaries. Worse, works long since superseded are cited, some with disturbing frequency (e.g., Foulke 1941; Trescott 1963).

I also doubt that anyone teaching a financial history survey would adopt this book as an undergraduate text. The prose, while competent, is pedestrian throughout and hence more likely to bore Millennials than to spur their interest in financial history. Similarly, general readers usually demand ripping yarns like those spun in Kamensky (2008) or Mihm (2009). Lucid sections can of course be found (particularly recommended are the discussions of bankruptcy), but their benefits are outweighed by conceptual flaws and errors of commission and omission. By the latter, I mean missing important supporting data, superior examples, or more telling points. For instance, to make the point that Benjamin Franklin “took for granted that credit was essential to commerce” (p. 2), Olegario adduces mere words, Franklin’s “Advice to a Young Tradesman,” rather than Franklin’s actual actions, most notably his establishment of microfinance institutions in Philadelphia and Boston (Yenawine and Costello 2010). Likewise, the best evidence that the “new banks were meant not just to serve the needs of governments and merchants but also tradesmen, farmers, and manufacturers” (p. 24) is not Pennsylvania’s Omnibus Banking Act of 1814 but studies like Lockard (2000) and Wang (2006) that document actual bank lending patterns, a type of direct evidence that the author suggests does not exist (p. 64).

Olegario has particular difficulty astutely narrating the history of early U.S. finance because she accepts a narrow anthropological literature (e.g., Muldrew 1998) that sees much of the colonial credit system as pre-capitalist, as part of a “moral economy” characterized by “trust” and “barter” (pp. 24-25). But Olegario herself destroys both claims, presumably inadvertently. “Households bartered produce, game, and animal skins to obtain the services of blacksmiths, coopers, and other artisans,” she claims, but then adds that such exchanges were “notated in rough ledgers [sic] using monetary values even though no actual cash changed hands” (p. 24). So such transactions were not barter (trading one good for another without the use of money in any of its forms) at all but rather a form of open account, book credit, or “bookkeeping barter” (Michener 2011). Olegario also subverts the supposed reliance of colonial creditors on “trust” by detailing the widespread use of collateral, co-signers, lawsuits, prison, threats of reputation tarnishing, and other devices designed to induce borrowers to repay their debts. Colonists were certainly more apt to be lax when lending to family and friends, but that does not mean a “noncommercial morality” (p. 25) suffused the economy as family matters stand no differently today.

Other errors abound and many would flummox students and general readers. Olegario claims, for example, that bills of exchange “functioned as currency” (p. 21) by conflating negotiability (via endorsement) and currency (passing from hand to hand without formal assignment). By conflating banknotes with bank loans, she can assert that “entrepreneurial society desired … paper money” (p. 23) when in fact it sought intermediation. Imagine the confusion that would ensue were students to read that retailers “notated the value of purchased goods in a day book or ledger without issuing [sic] formal instruments like notes or bills of exchange” (p. 24). (Borrowers, not lenders, issue debt instruments.) Or that the Bank of the United States (1791-1811) was “rechartered [sic]” (p. 42) to be “in existence … again [sic]” (p. 49) as the Bank of the United States (1816-1836)!

I could continue but won’t for fear of drawing a flag for unscholarly-like conduct. Perhaps some readers will think I deserve a flag already but when the author’s school and publisher are so prestigious I think it incumbent upon reviewers to support negative generalizations with sufficient citations, details, and examples. The dust jacket can be removed if readers don’t like it, but the same can’t be said of the text, so potential readers must be credibly pointed elsewhere, like to the recent works cited below.

References:

Beck, Thorsten, Asli Demirguc-Kunt, and Ross Levine. 2007. “Finance, Inequality, and Poverty: Cross-Country Evidence.” Journal of Economic Growth (March): 27-49.

Calomiris, Charles and Stephen Haber. 2014. Fragile by Design: The Political Origins of Banking Crises and Scarce Credit. Princeton: Princeton University Press.

Foulke, Ray. 1941. The Sinews of American Commerce. New York: Dun and Bradstreet.

Geisst, Charles. 2013. Beggar Thy Neighbor: A History of Usury and Debt. Philadelphia: University of Pennsylvania Press.

Kamensky, Jane. 2008. The Exchange Artist: A Tale of High Flying Speculation and America’s First Banking Collapse. New York: Viking.

Kamoie, Laura Croghan. 2007. Irons in the Fire: The Business History of the Tayloe Family and Virginia’s Gentry, 1700-1860. Charlottesville: University Press of Virginia.

Levine, Ross. 2005. “Finance and Growth: Theory and Evidence.” Handbook of Economic Growth, edited by Philippe Aghion and Steven Durlauf. Amsterdam: Elsevier Science.

Lockard, Paul. 2000. “Banks, Insider Lending, and Industries of the Connecticut River Valley of Massachusetts, 1813-1860.” Ph.D. Dissertation. University of Massachusetts, Amherst.

Martin, Joe. 2010. Relentless Change: A Casebook for the Study of Canadian Business History. Toronto: University of Toronto Press.

Michener, Ron. 2011. “Money in the American Colonies.” EH.Net Encyclopedia, edited by Robert Whaples. http://eh.net/encyclopedia/money-in-the-american-colonies/

Michener, Ron. 2015. “Redemption Theories and the Value of American Paper Money.” Financial History Review (December): 1-21.

Mihm, Stephen. 2009. A Nation of Counterfeiters: Capitalists, Con Men, and the Making of the United States. Cambridge: Harvard University Press.

Morgan, Kenneth. 2000. Slavery, Atlantic Trade and the British Economy, 1660-1800. New York: Cambridge University Press.

Muldrew, Craig. 1998. The Economy of Obligation: The Culture of Credit and Social Relations in Early Modern England. New York: St. Martin’s Press.

New Bedford Whaling Museum. 2011. “Records of the Merchants Bank Finding Aid, Appendix C,” MSS 107, New Bedford, Mass. http://www.whalingmuseum.org/explore/library/finding-aids/mss107#idp10883696

Roney, Jessica Choppin. 2014. Governed by a Spirit of Opposition: The Origins of American Political Practice in Colonial Philadelphia. Baltimore: Johns Hopkins University Press.

Rousseau, Peter and Richard Sylla. 2005. “Emerging Financial Markets and Early U.S. Growth.” Explorations in Economic History (March): 1-26.

Trescott, Paul. 1963. Financing American Enterprise: The Story of Commercial Banking. New York: Harper and Row.

Wang, Ta-Chen. 2006. “Courts, Banks, and Credit Markets in Early American Development.” Ph.D. Dissertation. Stanford University.

Wood, Gordon. 1991. Radicalism of the American Revolution. New York: Random House.

Wright, Robert. 2008. One Nation under Debt: Hamilton, Jefferson, and the History of What We Owe. New York: McGraw Hill.

Yenawine, Bruce and Michele Costello. 2010. Benjamin Franklin and the Invention of Microfinance. London: Pickering & Chatto.

Robert E. Wright is the Nef Family Chair of Political Economy at Augustana University and the author or co-author of seventeen books, including, with Richard Sylla, Genealogy of American Finance (Columbia University Press, 2015).

Copyright (c) 2016 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator (administrator@eh.net). Published by EH.Net (February 2016). All EH.Net reviews are archived at http://eh.net/book-reviews/

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):North America
Time Period(s):18th Century
19th Century
20th Century: Pre WWII
20th Century: WWII and post-WWII

Financial Crises, 1929 to the Present

Author(s):Hsu, Sara
Reviewer(s):Wheelock, David C.

Published by EH.Net (November 2014)

Sara Hsu, Financial Crises, 1929 to the Present. Cheltenham, UK: Edward Elgar, 2013. v + 178 pp. $100 (cloth), ISBN: 978-0-85793-342-3.

Reviewed for EH.Net by David C. Wheelock, Federal Reserve Bank of St. Louis.

In Financial Crises, 1929 to the Present, Sara Hsu of the State University of New York, New Paltz, offers a concise history of several of the world’s major financial crises — from the Great Depression to the subprime mortgage crisis of 2007-08 and European debt crisis of 2009-10.

Financial crises are not easy to define precisely, except perhaps in the context of a stylized model, and different authors have used a variety of quantitative measures to identify and measure the severity of crises. In the first chapter of the book, Hsu explains how different authors define financial crises, focusing especially on the ideas of Hyman Minsky and Charles Kindleberger. Hsu provides neither a precise theoretical nor a quantitative definition of a financial crisis, but aligns herself with Minsky in concluding that unregulated financial systems of capitalist economies are inherently prone to instability and crises with potentially severe macroeconomic repercussions: “Hyman Minsky was right in the sense that given free rein, capitalism has created instability and unanticipated crises” (p. 146).

After a brief summary of how the global financial system has evolved since the 1930s, subsequent chapters review the histories of individual crises, beginning with the Great Depression. Hsu follows John Kenneth Galbraith in tracing the origins of the Great Depression to Wall Street speculation and attributes the eventual market crash to heightened uncertainty and a global credit crunch associated with French claims on British gold and the introduction of the Young Plan in 1929. Although she acknowledges the decline in the money stock and deflation that took hold after the crash, Hsu rejects the view of Friedman and Schwartz (1963) that banking panics and a contracting money supply caused the Great Depression, favoring instead Ben Bernanke’s (1983) emphasis on the nonmonetary effects that financial crises had on the economy.

The Great Depression led to major changes in the regulation of U.S. banks and financial markets, as well as disintegration of the international gold standard and the imposition of capital and exchange controls around the world. Controls became universal during World War II and remained in place for several years after the war under the post-war Bretton Woods system of fixed exchange rates. Hsu nicely summarizes key features of the Bretton Woods System and its breakdown in the 1970s in the book’s third chapter.
The remaining chapters summarize major financial crises, beginning with the debt crises of emerging market economies in the 1980s. Hsu explains how many emerging market economies had borrowed heavily to support economic growth when commodity prices were rising in the 1970s, only to experience difficulty servicing their debts and obtaining new loans when commodity prices fell after the Federal Reserve tightened monetary policy and the U.S. economy went into recession in the early 1980s. This chapter has an especially good summary of how the debt crisis unfolded in different countries and how lenders, governments, and the IMF responded.

Hsu next discusses several crises that occurred in the 1990s, including the Western European exchange rate crisis, Nordic banking crises, Japanese real estate collapse and subsequent “lost decade,” Mexican debt crisis, and Asian financial crisis. A subsequent chapter describes the Russian and Brazilian financial crises of 1998 and the Argentinian crisis of 2000. Like many others, Hsu is highly critical of the “conditionality” requirements imposed by the IMF on nations in crisis. For example, she argues that “The IMF program for Korea went beyond measures needed to resolve the crisis … and, destructively, called for even wider opening(!) of Korea’s capital and current accounts” (p. 91).

The penultimate chapter of the book focuses on the subprime mortgage crisis and recession of 2007-08, which originated in the United States but was felt around the world, and the European debt crisis that emerged in 2009-10. For Hsu, “the crisis showed that all financial markets are unstable and require constant supervision and regulation” (p. 129). She blames “excessive overleveraging” of subprime assets in the form of opaque financial instruments created by a largely unregulated and unsupervised banking system and the trading of those securities “over the counter” rather than through organized and regulated exchanges. She argues that much of the government’s response to the crisis, such as the Troubled Asset Relief Program, was flawed and failed to halt the crisis.

The final chapter considers alternative policies for preventing future crises and for containing and resolving any crises that might occur. Hsu is generally supportive of capital controls, macro-prudential bank regulations, and countercyclical fiscal and monetary policy, as well as greater coordination of policies across countries. Indeed, she argues that “The preeminence of country sovereignty and competitiveness over global financial stability ensures that fault lines will exist and expand, and that crises will continue to occur. Should country priorities shift en masse from economic growth to economic and financial stability, there is a much greater probability that future financial crises might be prevented” (p. 146).

The book could serve as a supplement for undergraduate courses in economic history, international finance, and macroeconomics or as a reference for anyone wishing summaries of the key events and issues surrounding particular crises. However, the book might hold less appeal for courses in U.S. economic history because it does not cover several noteworthy episodes of financial instability in the United States, such as the savings and loan crisis of the 1980s. Further, readers interested in more theoretical explanations of the causes and effects of financial crises or those interested in the interplay of political and economic forces that shape the financial regulatory environment and can promote instability and crises even in highly regulated financial systems, as discussed recently by Charles Calomiris and Stephen Haber (2014), will want to look elsewhere.

References:

Bernanke, Ben S. “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression,” American Economic Review 73(3), June 1983, pp. 257-76.

Calomiris, Charles W. and Stephen H. Haber. Fragile by Design: The Political Origins of Banking Crises and Scarce Credit. Princeton: Princeton University Press, 2014.

Friedman, Milton and Anna J. Schwartz. A Monetary History of the United States, 1867-1960. Princeton: Princeton University Press, 1963.

David C. Wheelock researches U.S. financial and monetary history. His recent publications include (with Michael D. Bordo), “The Promise and Performance of the Federal Reserve as Lender of Last Resort,” in M.D. Bordo and W. Roberds, editors, The Origins, History, and Future of the Federal Reserve: A Return to Jekyll Island. Cambridge University Press, 2013.

Copyright (c) 2014 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator (administrator@eh.net). Published by EH.Net (November 2014). All EH.Net reviews are archived at http://www.eh.net/BookReview

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):General, International, or Comparative
Time Period(s):20th Century: Pre WWII
20th Century: WWII and post-WWII

Antebellum Banking in the United States

Howard Bodenhorn, Lafayette College

The first legitimate commercial bank in the United States was the Bank of North America founded in 1781. Encouraged by Alexander Hamilton, Robert Morris persuaded the Continental Congress to charter the bank, which loaned to the cash-strapped Revolutionary government as well as private citizens, mostly Philadelphia merchants. The possibilities of commercial banking had been widely recognized by many colonists, but British law forbade the establishment of commercial, limited-liability banks in the colonies. Given that many of the colonists’ grievances against Parliament centered on economic and monetary issues, it is not surprising that one of the earliest acts of the Continental Congress was the establishment of a bank.

The introduction of banking to the U.S. was viewed as an important first step in forming an independent nation because banks supplied a medium of exchange (banknotes1 and deposits) in an economy perpetually strangled by shortages of specie money and credit, because they animated industry, and because they fostered wealth creation and promoted well-being. In the last case, contemporaries typically viewed banks as an integral part of a wider system of government-sponsored commercial infrastructure. Like schools, bridges, road, canals, river clearing and harbor improvements, the benefits of banks were expected to accrue to everyone even if dividends accrued only to shareholders.

Financial Sector Growth

By 1800 each major U.S. port city had at least one commercial bank serving the local mercantile community. As city banks proved themselves, banking spread into smaller cities and towns and expanded their clientele. Although most banks specialized in mercantile lending, others served artisans and farmers. In 1820 there were 327 commercial banks and several mutual savings banks that promoted thrift among the poor. Thus, at the onset of the antebellum period (defined here as the period between 1820 and 1860), urban residents were familiar with the intermediary function of banks and used bank-supplied currencies (deposits and banknotes) for most transactions. Table 1 reports the number of banks and the value of loans outstanding at year end between 1820 and 1860. During the era, the number of banks increased from 327 to 1,562 and total loans increased from just over $55.1 million to $691.9 million. Bank-supplied credit in the U.S. economy increased at a remarkable annual average rate of 6.3 percent. Growth in the financial sector, then outpaced growth in aggregate economic activity. Nominal gross domestic product increased an average annual rate of about 4.3 percent over the same interval. This essay discusses how regional regulatory structures evolved as the banking sector grew and radiated out from northeastern cities to the hinterlands.

Table 1

Number of Banks and Total Loans, 1820-1860

Year Banks Loans ($ millions)
1820 327 55.1
1821 273 71.9
1822 267 56.0
1823 274 75.9
1824 300 73.8
1825 330 88.7
1826 331 104.8
1827 333 90.5
1828 355 100.3
1829 369 103.0
1830 381 115.3
1831 424 149.0
1832 464 152.5
1833 517 222.9
1834 506 324.1
1835 704 365.1
1836 713 457.5
1837 788 525.1
1838 829 485.6
1839 840 492.3
1840 901 462.9
1841 784 386.5
1842 692 324.0
1843 691 254.5
1844 696 264.9
1845 707 288.6
1846 707 312.1
1847 715 310.3
1848 751 344.5
1849 782 332.3
1850 824 364.2
1851 879 413.8
1852 913 429.8
1853 750 408.9
1854 1208 557.4
1855 1307 576.1
1856 1398 634.2
1857 1416 684.5
1858 1422 583.2
1859 1476 657.2
1860 1562 691.9

Sources: Fenstermaker (1965); U.S. Comptroller of the Currency (1931).

Adaptability

As important as early American banks were in the process of capital accumulation, perhaps their most notable feature was their adaptability. Kuznets (1958) argues that one measure of the financial sector’s value is how and to what extent it evolves with changing economic conditions. Put in place to perform certain functions under one set of economic circumstances, how did it alter its behavior and service the needs of borrowers as circumstances changed. One benefit of the federalist U.S. political system was that states were given the freedom to establish systems reflecting local needs and preferences. While the political structure deserves credit in promoting regional adaptations, North (1994) credits the adaptability of America’s formal rules and informal constraints that rewarded adventurism in the economic, as well as the noneconomic, sphere. Differences in geography, climate, crop mix, manufacturing activity, population density and a host of other variables were reflected in different state banking systems. Rhode Island’s banks bore little resemblance to those in far away Louisiana or Missouri, or even those in neighboring Connecticut. Each state’s banks took a different form, but their purpose was the same; namely, to provide the state’s citizens with monetary and intermediary services and to promote the general economic welfare. This section provides a sketch of regional differences. A more detailed discussion can be found in Bodenhorn (2002).

State Banking in New England

New England’s banks most resemble the common conception of the antebellum bank. They were relatively small, unit banks; their stock was closely held; they granted loans to local farmers, merchants and artisans with whom the bank’s managers had more than a passing familiarity; and the state took little direct interest in their daily operations.

Of the banking systems put in place in the antebellum era, New England’s is typically viewed as the most stable and conservative. Friedman and Schwartz (1986) attribute their stability to an Old World concern with business reputations, familial ties, and personal legacies. New England was long settled, its society well established, and its business community mature and respected throughout the Atlantic trading network. Wealthy businessmen and bankers with strong ties to the community — like the Browns of Providence or the Bowdoins of Boston — emphasized stability not just because doing so benefited and reflected well on them, but because they realized that bad banking was bad for everyone’s business.

Besides their reputation for soundness, the two defining characteristics of New England’s early banks were their insider nature and their small size. The typical New England bank was small compared to banks in other regions. Table 2 shows that in 1820 the average Massachusetts country bank was about the same size as a Pennsylvania country bank, but both were only about half the size of a Virginia bank. A Rhode Island bank was about one-third the size of a Massachusetts or Pennsylvania bank and a mere one-sixth as large as Virginia’s banks. By 1850 the average Massachusetts bank declined relatively, operating on about two-thirds the paid-in capital of a Pennsylvania country bank. Rhode Island’s banks also shrank relative to Pennsylvania’s and were tiny compared to the large branch banks in the South and West.

Table 2

Average Bank Size by Capital and Lending in 1820 and 1850 Selected States and Cities

(in $ thousands)

1820

Capital

Loans 1850 Capital Loans
Massachusetts $374.5 $480.4 $293.5 $494.0
except Boston 176.6 230.8 170.3 281.9
Rhode Island 95.7 103.2 186.0 246.2
except Providence 60.6 72.0 79.5 108.5
New York na na 246.8 516.3
except NYC na na 126.7 240.1
Pennsylvania 221.8 262.9 340.2 674.6
except Philadelphia 162.6 195.2 246.0 420.7
Virginia1,2 351.5 340.0 270.3 504.5
South Carolina2 na na 938.5 1,471.5
Kentucky2 na na 439.4 727.3

Notes: 1 Virginia figures for 1822. 2 Figures represent branch averages.

Source: Bodenhorn (2002).

Explanations for New England Banks’ Relatively Small Size

Several explanations have been offered for the relatively small size of New England’s banks. Contemporaries attributed it to the New England states’ propensity to tax bank capital, which was thought to work to the detriment of large banks. They argued that large banks circulated fewer banknotes per dollar of capital. The result was a progressive tax that fell disproportionately on large banks. Data compiled from Massachusetts’s bank reports suggest that large banks were not disadvantaged by the capital tax. It was a fact, as contemporaries believed, that large banks paid higher taxes per dollar of circulating banknotes, but a potentially better benchmark is the tax to loan ratio because large banks made more use of deposits than small banks. The tax to loan ratio was remarkably constant across both bank size and time, averaging just 0.6 percent between 1834 and 1855. Moreover, there is evidence of constant to modestly increasing returns to scale in New England banking. Large banks were generally at least as profitable as small banks in all years between 1834 and 1860, and slightly more so in many.

Lamoreaux (1993) offers a different explanation for the modest size of the region’s banks. New England’s banks, she argues, were not impersonal financial intermediaries. Rather, they acted as the financial arms of extended kinship trading networks. Throughout the antebellum era banks catered to insiders: directors, officers, shareholders, or business partners and kin of directors, officers, shareholders and business partners. Such preferences toward insiders represented the perpetuation of the eighteenth-century custom of pooling capital to finance family enterprises. In the nineteenth century the practice continued under corporate auspices. The corporate form, in fact, facilitated raising capital in greater amounts than the family unit could raise on its own. But because the banks kept their loans within a relatively small circle of business connections, it was not until the late nineteenth century that bank size increased.2

Once the kinship orientation of the region’s banks was established it perpetuated itself. When outsiders could not obtain loans from existing insider organizations, they formed their own insider bank. In doing so the promoters assured themselves of a steady supply of credit and created engines of economic mobility for kinship networks formerly closed off from many sources of credit. State legislatures accommodated the practice through their liberal chartering policies. By 1860, Rhode Island had 91 banks, Maine had 68, New Hampshire 51, Vermont 44, Connecticut 74 and Massachusetts 178.

The Suffolk System

One of the most commented on characteristic of New England’s banking system was its unique regional banknote redemption and clearing mechanism. Established by the Suffolk Bank of Boston in the early 1820s, the system became known as the Suffolk System. With so many banks in New England, each issuing it own form of currency, it was sometimes difficult for merchants, farmers, artisans, and even other bankers, to discriminate between real and bogus banknotes, or to discriminate between good and bad bankers. Moreover, the rural-urban terms of trade pulled most banknotes toward the region’s port cities. Because country merchants and farmers were typically indebted to city merchants, country banknotes tended to flow toward the cities, Boston more so than any other. By the second decade of the nineteenth century, country banknotes became a constant irritant for city bankers. City bankers believed that country issues displaced Boston banknotes in local transactions. More irritating though was the constant demand by the city banks’ customers to accept country banknotes on deposit, which placed the burden of interbank clearing on the city banks.3

In 1803 the city banks embarked on a first attempt to deal with country banknotes. They joined together, bought up a large quantity of country banknotes, and returned them to the country banks for redemption into specie. This effort to reduce country banknote circulation encountered so many obstacles that it was quickly abandoned. Several other schemes were hatched in the next two decades, but none proved any more successful than the 1803 plan.

The Suffolk Bank was chartered in 1818 and within a year embarked on a novel scheme to deal with the influx of country banknotes. The Suffolk sponsored a consortium of Boston bank in which each member appointed the Suffolk as its lone agent in the collection and redemption of country banknotes. In addition, each city bank contributed to a fund used to purchase and redeem country banknotes. When the Suffolk collected a large quantity of a country bank’s notes, it presented them for immediate redemption with an ultimatum: Join in a regular and organized redemption system or be subject to further unannounced redemption calls.4 Country banks objected to the Suffolk’s proposal, because it required them to keep noninterest-earning assets on deposit with the Suffolk in amounts equal to their average weekly redemptions at the city banks. Most country banks initially refused to join the redemption network, but after the Suffolk made good on a few redemption threats, the system achieved near universal membership.

Early interpretations of the Suffolk system, like those of Redlich (1949) and Hammond (1957), portray the Suffolk as a proto-central bank, which acted as a restraining influence that exercised some control over the region’s banking system and money supply. Recent studies are less quick to pronounce the Suffolk a successful experiment in early central banking. Mullineaux (1987) argues that the Suffolk’s redemption system was actually self-defeating. Instead of making country banknotes less desirable in Boston, the fact that they became readily redeemable there made them perfect substitutes for banknotes issued by Boston’s prestigious banks. This policy made country banknotes more desirable, which made it more, not less, difficult for Boston’s banks to keep their own notes in circulation.

Fenstermaker and Filer (1986) also contest the long-held view that the Suffolk exercised control over the region’s money supply (banknotes and deposits). Indeed, the Suffolk’s system was self-defeating in this regard as well. By increasing confidence in the value of a randomly encountered banknote, people were willing to hold increases in banknotes issues. In an interesting twist on the traditional interpretation, a possible outcome of the Suffolk system is that New England may have grown increasingly financial backward as a direct result of the region’s unique clearing system. Because banknotes were viewed as relatively safe and easily redeemed, the next big financial innovation — deposit banking — in New England lagged far behind other regions. With such wide acceptance of banknotes, there was no reason for banks to encourage the use of deposits and little reason for consumers to switch over.

Summary: New England Banks

New England’s banking system can be summarized as follows: Small unit banks predominated; many banks catered to small groups of capitalists bound by personal and familial ties; banking was becoming increasingly interconnected with other lines of business, such as insurance, shipping and manufacturing; the state took little direct interest in the daily operations of the banks and its supervisory role amounted to little more than a demand that every bank submit an unaudited balance sheet at year’s end; and that the Suffolk developed an interbank clearing system that facilitated the use of banknotes throughout the region, but had little effective control over the region’s money supply.

Banking in the Middle Atlantic Region

Pennsylvania

After 1810 or so, many bank charters were granted in New England, but not because of the presumption that the bank would promote the commonweal. Charters were granted for the personal gain of the promoter and the shareholders and in proportion to the personal, political and economic influence of the bank’s founders. No New England state took a significant financial stake in its banks. In both respects, New England differed markedly from states in other regions. From the beginning of state-chartered commercial banking in Pennsylvania, the state took a direct interest in the operations and profits of its banks. The Bank of North America was the obvious case: chartered to provide support to the colonial belligerents and the fledgling nation. Because the bank was popularly perceived to be dominated by Philadelphia’s Federalist merchants, who rarely loaned to outsiders, support for the bank waned.5 After a pitched political battle in which the Bank of North America’s charter was revoked and reinstated, the legislature chartered the Bank of Pennsylvania in 1793. As its name implies, this bank became the financial arm of the state. Pennsylvania subscribed $1 million of the bank’s capital, giving it the right to appoint six of thirteen directors and a $500,000 line of credit. The bank benefited by becoming the state’s fiscal agent, which guaranteed a constant inflow of deposits from regular treasury operations as well as western land sales.

By 1803 the demand for loans outstripped the existing banks’ supply and a plan for a new bank, the Philadelphia Bank, was hatched and its promoters petitioned the legislature for a charter. The existing banks lobbied against the charter, and nearly sank the new bank’s chances until it established a precedent that lasted throughout the antebellum era. Its promoters bribed the legislature with a payment of $135,000 in return for the charter, handed over one-sixth of its shares, and opened a line of credit for the state.

Between 1803 and 1814, the only other bank chartered in Pennsylvania was the Farmers and Mechanics Bank of Philadelphia, which established a second substantive precedent that persisted throughout the era. Existing banks followed a strict real-bills lending policy, restricting lending to merchants at very short terms of 30 to 90 days.6 Their adherence to a real-bills philosophy left a growing community of artisans, manufacturers and farmers on the outside looking in. The Farmers and Mechanics Bank was chartered to serve excluded groups. At least seven of its thirteen directors had to be farmers, artisans or manufacturers and the bank was required to lend the equivalent of 10 percent of its capital to farmers on mortgage for at least one year. In later years, banks were established to provide services to even more narrowly defined groups. Within a decade or two, most substantial port cities had banks with names like Merchants Bank, Planters Bank, Farmers Bank, and Mechanics Bank. By 1860 it was common to find banks with names like Leather Manufacturers Bank, Grocers Bank, Drovers Bank, and Importers Bank. Indeed, the Emigrant Savings Bank in New York City served Irish immigrants almost exclusively. In the other instances, it is not known how much of a bank’s lending was directed toward the occupational group included in its name. The adoption of such names may have been marketing ploys as much as mission statements. Only further research will reveal the answer.

New York

State-chartered banking in New York arrived less auspiciously than it had in Philadelphia or Boston. The Bank of New York opened in 1784, but operated without a charter and in open violation of state law until 1791 when the legislature finally sanctioned it. The city’s second bank obtained its charter surreptitiously. Alexander Hamilton was one of the driving forces behind the Bank of New York, and his long-time nemesis, Aaron Burr, was determined to establish a competing bank. Unable to get a charter from a Federalist legislature, Burr and his colleagues petitioned to incorporate a company to supply fresh water to the inhabitants of Manhattan Island. Burr tucked a clause into the charter of the Manhattan Company (the predecessor to today’s Chase Manhattan Bank) granting the water company the right to employ any excess capital in financial transactions. Once chartered, the company’s directors announced that $500,000 of its capital would be invested in banking.7 Thereafter, banking grew more quickly in New York than in Philadelphia, so that by 1812 New York had seven banks compared to the three operating in Philadelphia.

Deposit Insurance

Despite its inauspicious banking beginnings, New York introduced two innovations that influenced American banking down to the present. The Safety Fund system, introduced in 1829, was the nation’s first experiment in bank liability insurance (similar to that provided by the Federal Deposit Insurance Corporation today). The 1829 act authorized the appointment of bank regulators charged with regular inspections of member banks. An equally novel aspect was that it established an insurance fund insuring holders of banknotes and deposits against loss from bank failure. Ultimately, the insurance fund was insufficient to protect all bank creditors from loss during the panic of 1837 when eleven failures in rapid succession all but bankrupted the insurance fund, which delayed noteholder and depositor recoveries for months, even years. Even though the Safety Fund failed to provide its promised protections, it was an important episode in the subsequent evolution of American banking. Several Midwestern states instituted deposit insurance in the early twentieth century, and the federal government adopted it after the banking panics in the 1930s resulted in the failure of thousands of banks in which millions of depositors lost money.

“Free Banking”

Although the Safety Fund was nearly bankrupted in the late 1830s, it continued to insure a number of banks up to the mid 1860s when it was finally closed. No new banks joined the Safety Fund system after 1838 with the introduction of free banking — New York’s second significant banking innovation. Free banking represented a compromise between those most concerned with the underlying safety and stability of the currency and those most concerned with competition and freeing the country’s entrepreneurs from unduly harsh and anticompetitive restraints. Under free banking, a prospective banker could start a bank anywhere he saw fit, provided he met a few regulatory requirements. Each free bank’s capital was invested in state or federal bonds that were turned over to the state’s treasurer. If a bank failed to redeem even a single note into specie, the treasurer initiated bankruptcy proceedings and banknote holders were reimbursed from the sale of the bonds.

Actually Michigan preempted New York’s claim to be the first free-banking state, but Michigan’s 1837 law was modeled closely after a bill then under debate in New York’s legislature. Ultimately, New York’s influence was profound in this as well, because free banking became one of the century’s most widely copied financial innovations. By 1860 eighteen states adopted free banking laws closely resembling New York’s law. Three other states introduced watered-down variants. Eventually, the post-Civil War system of national banking adopted many of the substantive provisions of New York’s 1838 act.

Both the Safety Fund system and free banking were attempts to protect society from losses resulting from bank failures and to entice people to hold financial assets. Banks and bank-supplied currency were novel developments in the hinterlands in the early nineteenth century and many rural inhabitants were skeptical about the value of small pieces of paper. They were more familiar with gold and silver. Getting them to exchange one for the other was a slow process, and one that relied heavily on trust. But trust was built slowly and destroyed quickly. The failure of a single bank could, in a week, destroy the confidence in a system built up over a decade. New York’s experiments were designed to mitigate, if not eliminate, the negative consequences of bank failures. New York’s Safety Fund, then, differed in the details but not in intent, from New England’s Suffolk system. Bankers and legislators in each region grappled with the difficult issue of protecting a fragile but vital sector of the economy. Each region responded to the problem differently. The South and West settled on yet another solution.

Banking in the South and West

One distinguishing characteristic of southern and western banks was their extensive branch networks. Pennsylvania provided for branch banking in the early nineteenth century and two banks jointly opened about ten branches. In both instances, however, the branches became a net liability. The Philadelphia Bank opened four branches in 1809 and by 1811 was forced to pass on its semi-annual dividends because losses at the branches offset profits at the Philadelphia office. At bottom, branch losses resulted from a combination of ineffective central office oversight and unrealistic expectations about the scale and scope of hinterland lending. Philadelphia’s bank directors instructed branch managers to invest in high-grade commercial paper or real bills. Rural banks found a limited number of such lending opportunities and quickly turned to mortgage-based lending. Many of these loans fell into arrears and were ultimately written when land sales faltered.

Branch Banking

Unlike Pennsylvania, where branch banking failed, branch banks throughout the South and West thrived. The Bank of Virginia, founded in 1804, was the first state-chartered branch bank and up to the Civil War branch banks served the state’s financial needs. Several small, independent banks were chartered in the 1850s, but they never threatened the dominance of Virginia’s “Big Six” banks. Virginia’s branch banks, unlike Pennsylvania’s, were profitable. In 1821, for example, the net return to capital at the Farmers Bank of Virginia’s home office in Richmond was 5.4 percent. Returns at its branches ranged from a low of 3 percent at Norfolk (which was consistently the low-profit branch) to 9 percent in Winchester. In 1835, the last year the bank reported separate branch statistics, net returns to capital at the Farmers Bank’s branches ranged from 2.9 and 11.7 percent, with an average of 7.9 percent.

The low profits at the Norfolk branch represent a net subsidy from the state’s banking sector to the political system, which was not immune to the same kind of infrastructure boosterism that erupted in New York, Pennsylvania, Maryland and elsewhere. In the immediate post-Revolutionary era, the value of exports shipped from Virginia’s ports (Norfolk and Alexandria) slightly exceeded the value shipped from Baltimore. In the 1790s the numbers turned sharply in Baltimore’s favor and Virginia entered the internal-improvements craze and the battle for western shipments. Banks represented the first phase of the state’s internal improvements plan in that many believed that Baltimore’s new-found advantage resulted from easier credit supplied by the city’s banks. If Norfolk, with one of the best natural harbors on the North American Atlantic coast, was to compete with other port cities, it needed banks and the state required three of the state’s Big Six branch banks to operate branches there. Despite its natural advantages, Norfolk never became an important entrepot and it probably had more bank capital than it required. This pattern was repeated elsewhere. Other states required their branch banks to serve markets such as Memphis, Louisville, Natchez and Mobile that might, with the proper infrastructure grow into important ports.

State Involvement and Intervention in Banking

The second distinguishing characteristic of southern and western banking was sweeping state involvement and intervention. Virginia, for example, interjected the state into the banking system by taking significant stakes in its first chartered banks (providing an implicit subsidy) and by requiring them, once they established themselves, to subsidize the state’s continuing internal improvements programs of the 1820s and 1830s. Indiana followed such a strategy. So, too, did Kentucky, Louisiana, Mississippi, Illinois, Kentucky, Tennessee and Georgia in different degrees. South Carolina followed a wholly different strategy. On one hand, it chartered several banks in which it took no financial interest. On the other, it chartered the Bank of the State of South Carolina, a bank wholly owned by the state and designed to lend to planters and farmers who complained constantly that the state’s existing banks served only the urban mercantile community. The state-owned bank eventually divided its lending between merchants, farmers and artisans and dominated South Carolina’s financial sector.

The 1820s and 1830s witnessed a deluge of new banks in the South and West, with a corresponding increase in state involvement. No state matched Louisiana’s breadth of involvement in the 1830s when it chartered three distinct types of banks: commercial banks that served merchants and manufacturers; improvement banks that financed various internal improvements projects; and property banks that extended long-term mortgage credit to planters and other property holders. Louisiana’s improvement banks included the New Orleans Canal and Banking Company that built a canal connecting Lake Ponchartrain to the Mississippi River. The Exchange and Banking Company and the New Orleans Improvement and Banking Company were required to build and operate hotels. The New Orleans Gas Light and Banking Company constructed and operated gas streetlights in New Orleans and five other cities. Finally, the Carrollton Railroad and Banking Company and the Atchafalaya Railroad and Banking Company were rail construction companies whose bank subsidiaries subsidized railroad construction.

“Commonwealth Ideal” and Inflationary Banking

Louisiana’s 1830s banking exuberance reflected what some historians label the “commonwealth ideal” of banking; that is, the promotion of the general welfare through the promotion of banks. Legislatures in the South and West, however, never demonstrated a greater commitment to the commonwealth ideal than during the tough times of the early 1820s. With the collapse of the post-war land boom in 1819, a political coalition of debt-strapped landowners lobbied legislatures throughout the region for relief and its focus was banking. Relief advocates lobbied for inflationary banking that would reduce the real burden of debts taken on during prior flush times.

Several western states responded to these calls and chartered state-subsidized and state-managed banks designed to reinflate their embattled economies. Chartered in 1821, the Bank of the Commonwealth of Kentucky loaned on mortgages at longer than customary periods and all Kentucky landowners were eligible for $1,000 loans. The loans allowed landowners to discharge their existing debts without being forced to liquidate their property at ruinously low prices. Although the bank’s notes were not redeemable into specie, they were given currency in two ways. First, they were accepted at the state treasury in tax payments. Second, the state passed a law that forced creditors to accept the notes in payment of existing debts or agree to delay collection for two years.

The commonwealth ideal was not unique to Kentucky. During the depression of the 1820s, Tennessee chartered the State Bank of Tennessee, Illinois chartered the State Bank of Illinois and Louisiana chartered the Louisiana State Bank. Although they took slightly different forms, they all had the same intent; namely, to relieve distressed and embarrassed farmers, planters and land owners. What all these banks shared in common was the notion that the state should promote the general welfare and economic growth. In this instance, and again during the depression of the 1840s, state-owned banks were organized to minimize the transfer of property when economic conditions demanded wholesale liquidation. Such liquidation would have been inefficient and imposed unnecessary hardship on a large fraction of the population. To the extent that hastily chartered relief banks forestalled inefficient liquidation, they served their purpose. Although most of these banks eventually became insolvent, requiring taxpayer bailouts, we cannot label them unsuccessful. They reinflated economies and allowed for an orderly disposal of property. Determining if the net benefits were positive or negative requires more research, but for the moment we are forced to accept the possibility that the region’s state-owned banks of the 1820s and 1840s advanced the commonweal.

Conclusion: Banks and Economic Growth

Despite notable differences in the specific form and structure of each region’s banking system, they were all aimed squarely at a common goal; namely, realizing that region’s economic potential. Banks helped achieve the goal in two ways. First, banks monetized economies, which reduced the costs of transacting and helped smooth consumption and production across time. It was no longer necessary for every farm family to inventory their entire harvest. They could sell most of it, and expend the proceeds on consumption goods as the need arose until the next harvest brought a new cash infusion. Crop and livestock inventories are prone to substantial losses and an increased use of money reduced them significantly. Second, banks provided credit, which unleashed entrepreneurial spirits and talents. A complete appreciation of early American banking recognizes the banks’ contribution to antebellum America’s economic growth.

Bibliographic Essay

Because of the large number of sources used to construct the essay, the essay was more readable and less cluttered by including a brief bibliographic essay. A full bibliography is included at the end.

Good general histories of antebellum banking include Dewey (1910), Fenstermaker (1965), Gouge (1833), Hammond (1957), Knox (1903), Redlich (1949), and Trescott (1963). If only one book is read on antebellum banking, Hammond’s (1957) Pulitzer-Prize winning book remains the best choice.

The literature on New England banking is not particularly large, and the more important historical interpretations of state-wide systems include Chadbourne (1936), Hasse (1946, 1957), Simonton (1971), Spencer (1949), and Stokes (1902). Gras (1937) does an excellent job of placing the history of a single bank within the larger regional and national context. In a recent book and a number of articles Lamoreaux (1994 and sources therein) provides a compelling and eminently readable reinterpretation of the region’s banking structure. Nathan Appleton (1831, 1856) provides a contemporary observer’s interpretation, while Walker (1857) provides an entertaining if perverse and satirical history of a fictional New England bank. Martin (1969) provides details of bank share prices and dividend payments from the establishment of the first banks in Boston through the end of the nineteenth century. Less technical studies of the Suffolk system include Lake (1947), Trivoli (1979) and Whitney (1878); more technical interpretations include Calomiris and Kahn (1996), Mullineaux (1987), and Rolnick, Smith and Weber (1998).

The literature on Middle Atlantic banking is huge, but the better state-level histories include Bryan (1899), Daniels (1976), and Holdsworth (1928). The better studies of individual banks include Adams (1978), Lewis (1882), Nevins (1934), and Wainwright (1953). Chaddock (1910) provides a general history of the Safety Fund system. Golembe (1960) places it in the context of modern deposit insurance, while Bodenhorn (1996) and Calomiris (1989) provide modern analyses. A recent revival of interest in free banking has brought about a veritable explosion in the number of studies on the subject, but the better introductory ones remain Rockoff (1974, 1985), Rolnick and Weber (1982, 1983), and Dwyer (1996).

The literature on southern and western banking is large and of highly variable quality, but I have found the following to be the most readable and useful general sources: Caldwell (1935), Duke (1895), Esary (1912), Golembe (1978), Huntington (1915), Green (1972), Lesesne (1970), Royalty (1979), Schweikart (1987) and Starnes (1931).

References and Further Reading

Adams, Donald R., Jr. Finance and Enterprise in Early America: A Study of Stephen Girard’s Bank, 1812-1831. Philadelphia: University of Pennsylvania Press, 1978.

Alter, George, Claudia Goldin and Elyce Rotella. “The Savings of Ordinary Americans: The Philadelphia Saving Fund Society in the Mid-Nineteenth-Century.” Journal of Economic History 54, no. 4 (December 1994): 735-67.

Appleton, Nathan. A Defence of Country Banks: Being a Reply to a Pamphlet Entitled ‘An Examination of the Banking System of Massachusetts, in Reference to the Renewal of the Bank Charters.’ Boston: Stimpson & Clapp, 1831.

Appleton, Nathan. Bank Bills or Paper Currency and the Banking System of Massachusetts with Remarks on Present High Prices. Boston: Little, Brown and Company, 1856.

Berry, Thomas Senior. Revised Annual Estimates of American Gross National Product: Preliminary Estimates of Four Major Components of Demand, 1789-1889. Richmond: University of Richmond Bostwick Paper No. 3, 1978.

Bodenhorn, Howard. “Zombie Banks and the Demise of New York’s Safety Fund.” Eastern Economic Journal 22, no. 1 (1996): 21-34.

Bodenhorn, Howard. “Private Banking in Antebellum Virginia: Thomas Branch & Sons of Petersburg.” Business History Review 71, no. 4 (1997): 513-42.

Bodenhorn, Howard. A History of Banking in Antebellum America: Financial Markets and Economic Development in an Era of Nation-Building. Cambridge and New York: Cambridge University Press, 2000.

Bodenhorn, Howard. State Banking in Early America: A New Economic History. New York: Oxford University Press, 2002.

Bryan, Alfred C. A History of State Banking in Maryland. Baltimore: Johns Hopkins University Press, 1899.

Caldwell, Stephen A. A Banking History of Louisiana. Baton Rouge: Louisiana State University Press, 1935.

Calomiris, Charles W. “Deposit Insurance: Lessons from the Record.” Federal Reserve Bank of Chicago Economic Perspectives 13 (1989): 10-30.

Calomiris, Charles W., and Charles Kahn. “The Efficiency of Self-Regulated Payments Systems: Learnings from the Suffolk System.” Journal of Money, Credit, and Banking 28, no. 4 (1996): 766-97.

Chadbourne, Walter W. A History of Banking in Maine, 1799-1930. Orono: University of Maine Press, 1936.

Chaddock, Robert E. The Safety Fund Banking System in New York, 1829-1866. Washington, D.C.: Government Printing Office, 1910.

Daniels, Belden L. Pennsylvania: Birthplace of Banking in America. Harrisburg: Pennsylvania Bankers Association, 1976.

Davis, Lance, and Robert E. Gallman. “Capital Formation in the United States during the Nineteenth Century.” In Cambridge Economic History of Europe (Vol. 7, Part 2), edited by Peter Mathias and M.M. Postan, 1-69. Cambridge: Cambridge University Press, 1978.

Davis, Lance, and Robert E. Gallman. “Savings, Investment, and Economic Growth: The United States in the Nineteenth Century.” In Capitalism in Context: Essays on Economic Development and Cultural Change in Honor of R.M. Hartwell, edited by John A. James and Mark Thomas, 202-29. Chicago: University of Chicago Press, 1994.

Dewey, Davis R. State Banking before the Civil War. Washington, D.C.: Government Printing Office, 1910.

Duke, Basil W. History of the Bank of Kentucky, 1792-1895. Louisville: J.P. Morton, 1895.

Dwyer, Gerald P., Jr. “Wildcat Banking, Banking Panics, and Free Banking in the United States.” Federal Reserve Bank of Atlanta Economic Review 81, no. 3 (1996): 1-20.

Engerman, Stanley L., and Robert E. Gallman. “U.S. Economic Growth, 1783-1860.” Research in Economic History 8 (1983): 1-46.

Esary, Logan. State Banking in Indiana, 1814-1873. Indiana University Studies No. 15. Bloomington: Indiana University Press, 1912.

Fenstermaker, J. Van. The Development of American Commercial Banking, 1782-1837. Kent, Ohio: Kent State University, 1965.

Fenstermaker, J. Van, and John E. Filer. “Impact of the First and Second Banks of the United States and the Suffolk System on New England Bank Money, 1791-1837.” Journal of Money, Credit, and Banking 18, no. 1 (1986): 28-40.

Friedman, Milton, and Anna J. Schwartz. “Has the Government Any Role in Money?” Journal of Monetary Economics 17, no. 1 (1986): 37-62.

Gallman, Robert E. “American Economic Growth before the Civil War: The Testimony of the Capital Stock Estimates.” In American Economic Growth and Standards of Living before the Civil War, edited by Robert E. Gallman and John Joseph Wallis, 79-115. Chicago: University of Chicago Press, 1992.

Goldsmith, Raymond. Financial Structure and Development. New Haven: Yale University Press, 1969.

Golembe, Carter H. “The Deposit Insurance Legislation of 1933: An Examination of its Antecedents and Purposes.” Political Science Quarterly 76, no. 2 (1960): 181-200.

Golembe, Carter H. State Banks and the Economic Development of the West. New York: Arno Press, 1978.

Gouge, William M. A Short History of Paper Money and Banking in the United States. Philadelphia: T.W. Ustick, 1833.

Gras, N.S.B. The Massachusetts First National Bank of Boston, 1784-1934. Cambridge, MA: Harvard University Press, 1937.

Green, George D. Finance and Economic Development in the Old South: Louisiana Banking, 1804-1861. Stanford: Stanford University Press, 1972.

Hammond, Bray. Banks and Politics in America from the Revolution to the Civil War. Princeton: Princeton University Press, 1957.

Hasse, William F., Jr. A History of Banking in New Haven, Connecticut. New Haven: privately printed, 1946.

Hasse, William F., Jr. A History of Money and Banking in Connecticut. New Haven: privately printed, 1957.

Holdsworth, John Thom. Financing an Empire: History of Banking in Pennsylvania. Chicago: S.J. Clarke Publishing Company, 1928.

Huntington, Charles Clifford. A History of Banking and Currency in Ohio before the Civil War. Columbus: F. J. Herr Printing Company, 1915.

Knox, John Jay. A History of Banking in the United States. New York: Bradford Rhodes & Company, 1903.

Kuznets, Simon. “Foreword.” In Financial Intermediaries in the American Economy, by Raymond W. Goldsmith. Princeton: Princeton University Press, 1958.

Lake, Wilfred. “The End of the Suffolk System.” Journal of Economic History 7, no. 4 (1947): 183-207.

Lamoreaux, Naomi R. Insider Lending: Banks, Personal Connections, and Economic Development in Industrial New England. Cambridge: Cambridge University Press, 1994.

Lesesne, J. Mauldin. The Bank of the State of South Carolina. Columbia: University of South Carolina Press, 1970.

Lewis, Lawrence, Jr. A History of the Bank of North America: The First Bank Chartered in the United States. Philadelphia: J.B. Lippincott & Company, 1882.

Lockard, Paul A. Banks, Insider Lending and Industries of the Connecticut River Valley of Massachusetts, 1813-1860. Unpublished Ph.D. thesis, University of Massachusetts, 2000.

Martin, Joseph G. A Century of Finance. New York: Greenwood Press, 1969.

Moulton, H.G. “Commercial Banking and Capital Formation.” Journal of Political Economy 26 (1918): 484-508, 638-63, 705-31, 849-81.

Mullineaux, Donald J. “Competitive Monies and the Suffolk Banking System: A Contractual Perspective.” Southern Economic Journal 53 (1987): 884-98.

Nevins, Allan. History of the Bank of New York and Trust Company, 1784 to 1934. New York: privately printed, 1934.

New York. Bank Commissioners. “Annual Report of the Bank Commissioners.” New York General Assembly Document No. 74. Albany, 1835.

North, Douglass. “Institutional Change in American Economic History.” In American Economic Development in Historical Perspective, edited by Thomas Weiss and Donald Schaefer, 87-98. Stanford: Stanford University Press, 1994.

Rappaport, George David. Stability and Change in Revolutionary Pennsylvania: Banking, Politics, and Social Structure. University Park, PA: The Pennsylvania State University Press, 1996.

Redlich, Fritz. The Molding of American Banking: Men and Ideas. New York: Hafner Publishing Company, 1947.

Rockoff, Hugh. “The Free Banking Era: A Reexamination.” Journal of Money, Credit, and Banking 6, no. 2 (1974): 141-67.

Rockoff, Hugh. “New Evidence on the Free Banking Era in the United States.” American Economic Review 75, no. 4 (1985): 886-89.

Rolnick, Arthur J., and Warren E. Weber. “Free Banking, Wildcat Banking, and Shinplasters.” Federal Reserve Bank of Minneapolis Quarterly Review 6 (1982): 10-19.

Rolnick, Arthur J., and Warren E. Weber. “New Evidence on the Free Banking Era.” American Economic Review 73, no. 5 (1983): 1080-91.

Rolnick, Arthur J., Bruce D. Smith, and Warren E. Weber. “Lessons from a Laissez-Faire Payments System: The Suffolk Banking System (1825-58).” Federal Reserve Bank of Minneapolis Quarterly Review 22, no. 3 (1998): 11-21.

Royalty, Dale. “Banking and the Commonwealth Ideal in Kentucky, 1806-1822.” Register of the Kentucky Historical Society 77 (1979): 91-107.

Schumpeter, Joseph A. The Theory of Economic Development: An Inquiry into Profit, Capital, Credit, Interest, and the Business Cycle. Cambridge, MA: Harvard University Press, 1934.

Schweikart, Larry. Banking in the American South from the Age of Jackson to Reconstruction. Baton Rouge: Louisiana State University Press, 1987.

Simonton, William G. Maine and the Panic of 1837. Unpublished master’s thesis: University of Maine, 1971.

Sokoloff, Kenneth L. “Productivity Growth in Manufacturing during Early Industrialization.” In Long-Term Factors in American Economic Growth, edited by Stanley L. Engerman and Robert E. Gallman. Chicago: University of Chicago Press, 1986.

Sokoloff, Kenneth L. “Invention, Innovation, and Manufacturing Productivity Growth in the Antebellum Northeast.” In American Economic Growth and Standards of Living before the Civil War, edited by Robert E. Gallman and John Joseph Wallis, 345-78. Chicago: University of Chicago Press, 1992.

Spencer, Charles, Jr. The First Bank of Boston, 1784-1949. New York: Newcomen Society, 1949.

Starnes, George T. Sixty Years of Branch Banking in Virginia. New York: Macmillan Company, 1931.

Stokes, Howard Kemble. Chartered Banking in Rhode Island, 1791-1900. Providence: Preston & Rounds Company, 1902.

Sylla, Richard. “Forgotten Men of Money: Private Bankers in Early U.S. History.” Journal of Economic History 36, no. 2 (1976):

Temin, Peter. The Jacksonian Economy. New York: W. W. Norton & Company, 1969.

Trescott, Paul B. Financing American Enterprise: The Story of Commercial Banking. New York: Harper & Row, 1963.

Trivoli, George. The Suffolk Bank: A Study of a Free-Enterprise Clearing System. London: The Adam Smith Institute, 1979.

U.S. Comptroller of the Currency. Annual Report of the Comptroller of the Currency. Washington, D.C.: Government Printing Office, 1931.

Wainwright, Nicholas B. History of the Philadelphia National Bank. Philadelphia: William F. Fell Company, 1953.

Walker, Amasa. History of the Wickaboag Bank. Boston: Crosby, Nichols & Company, 1857.

Wallis, John Joseph. “What Caused the Panic of 1839?” Unpublished working paper, University of Maryland, October 2000.

Weiss, Thomas. “U.S. Labor Force Estimates and Economic Growth, 1800-1860.” In American Economic Growth and Standards of Living before the Civil War, edited by Robert E. Gallman and John Joseph Wallis, 19-75. Chicago: University of Chicago Press, 1992.

Whitney, David R. The Suffolk Bank. Cambridge, MA: Riverside Press, 1878.

Wright, Robert E. “Artisans, Banks, Credit, and the Election of 1800.” The Pennsylvania Magazine of History and Biography 122, no. 3 (July 1998), 211-239.

Wright, Robert E. “Bank Ownership and Lending Patterns in New York and Pennsylvania, 1781-1831.” Business History Review 73, no. 1 (Spring 1999), 40-60.

1 Banknotes were small demonination IOUs printed by banks and circulated as currency. Modern U.S. money are simply banknotes issued by the Federal Reserve Bank, which has a monopoly privilege in the issue of legal tender currency. In antebellum American, when a bank made a loan, the borrower was typically handed banknotes with a face value equal to the dollar value of the loan. The borrower then spent these banknotes in purchasing goods and services, putting them into circulation. Contemporary law held that banks were required to redeem banknotes into gold and silver legal tender on demand. Banks found it profitable to issue notes because they typically held about 30 percent of the total value of banknotes in circulation as reserves. Thus, banks were able to leverage $30 in gold and silver into $100 in loans that returned about 7 percent interest on average.

2 Paul Lockard (2000) challenges Lamoreaux’s interpretation. In a study of 4 banks in the Connecticut River valley, Lockard finds that insiders did not dominate these banks’ resources. As provocative as Lockard’s findings are, he draws conclusions from a small and unrepresentative sample. Two of his four sample banks were savings banks, which were designed as quasi-charitable organizations designed to encourage savings by the working classes and provide small loans. Thus, Lockard’s sample is effectively reduced to two banks. At these two banks, he identifies about 10 percent of loans as insider loans, but readily admits that he cannot always distinguish between insiders and outsiders. For a recent study of how early Americans used savings banks, see Alter, Goldin and Rotella (1994). The literature on savings banks is so large that it cannot be be given its due here.

3 Interbank clearing involves the settling of balances between banks. Modern banks cash checks drawn on other banks and credit the funds to the depositor. The Federal Reserve system provides clearing services between banks. The accepting bank sends the checks to the Federal Reserve, who credits the sending bank’s accounts and sends the checks back to the bank on which they were drawn for reimbursement. In the antebellum era, interbank clearing involved sending banknotes back to issuing banks. Because New England had so many small and scattered banks, the costs of returning banknotes to their issuers were large and sometimes avoided by recirculating notes of distant banks rather than returning them. Regular clearings and redemptions served an important purpose, however, because they kept banks in touch with the current market conditions. A massive redemption of notes was indicative of a declining demand for money and credit. Because the bank’s reserves were drawn down with the redemptions, it was forced to reduce its volume of loans in accord with changing demand conditions.

4 The law held that banknotes were redeemable on demand into gold or silver coin or bullion. If a bank refused to redeem even a single $1 banknote, the banknote holder could have the bank closed and liquidated to recover his or her claim against it.

5 Rappaport (1996) found that the bank’s loans were about equally divided between insiders (shareholders and shareholders’ family and business associates) and outsiders, but nonshareholders received loans about 30 percent smaller than shareholders. The issue remains about whether this bank was an “insider” bank, and depends largely on one’s definition. Any modern bank which made half of its loans to shareholders and their families would be viewed as an “insider” bank. It is less clear where the line can be usefully drawn for antebellum banks.

6 Real-bills lending followed from a nineteenth-century banking philosophy, which held that bank lending should be used to finance the warehousing or wholesaling of already-produced goods. Loans made on these bases were thought to be self-liquidating in that the loan was made against readily sold collateral actually in the hands of a merchant. Under the real-bills doctrine, the banks’ proper functions were to bridge the gap between production and retail sale of goods. A strict adherence to real-bills tenets excluded loans on property (mortgages), loans on goods in process (trade credit), or loans to start-up firms (venture capital). Thus, real-bills lending prescribed a limited role for banks and bank credit. Few banks were strict adherents to the doctrine, but many followed it in large part.

7 Robert E. Wright (1998) offers a different interpretation, but notes that Burr pushed the bill through at the end of a busy legislative session so that many legislators voted on the bill without having read it thoroughly or at all.

Monetary Unions

Benjamin J. Cohen, University of California at Santa Barbara

Monetary tradition has long assumed that, in principle, each sovereign state issues and manages its own exclusive currency. In practice, however, there have always been exceptions — countries that elected to join together in a monetary union of some kind. Not all monetary unions have stood the test of time; in fact, many past initiatives have long since passed into history. Yet interest in monetary union persists, stimulated in particular by the example of the European Union’s Economic and Monetary Union (EMU), which has replaced a diversity of national monies with one joint currency called the euro. Today, the possibility of monetary union is actively discussed in many parts of the world.

A monetary union may be defined as a group of two or more states sharing a common currency or equivalent. Although some sources extend the definition to include the monetary regimes of national federations such as the United States or of imperial agglomerations such as the old Austro-Hungarian Empire, the conventional practice is to limit the term to agreements among units that are recognized as fully sovereign states under international law. The antithesis of a monetary union, of course, is a national currency with an independent central bank and a floating exchange rate.

In the strictest sense of the term, monetary union means complete abandonment of separate national currencies and full centralization of monetary authority in a single joint institution. In reality, considerable leeway exists for variations of design along two key dimensions. These dimensions are institutional provisions for (1) the issuing of currency and (2) the management of decisions. Currencies may continue to be issued by individual governments, tied together in an exchange-rate union. Alternatively, currencies may be replaced not by a joint currency but rather by the money of a larger partner — an arrangement generically labeled dollarization after the United States dollar, the money that is most widely used for this purpose. Similarly, monetary authority may continue to be exercised in some degree by individual governments or, alternatively, may be delegated not to a joint institution but rather to a single partner such as the United States.

In political terms, monetary unions divide into two categories, depending on whether national monetary sovereignty is shared or surrendered. Unions based on a joint currency or an exchange-rate union in effect pool monetary authority to some degree. They are a form of partnership or alliance of nominal equals. Unions created by dollarization are more hierarchical, a subordinate follower-leader type of regime.

The greatest attraction of a monetary union is that it reduces transactions costs as compared with a collection of separate national currencies. With a single money or equivalent, there is no need to incur the expense of currency conversion or hedging against exchange risk in transactions among the partners. But there are also two major economic disadvantages for governments to consider.

First, individual partners lose control of both the money supply and exchange rate as policy instruments to cope with domestic or external disturbances. Against a monetary union’s efficiency gains at the microeconomic level, governments must compare the cost of sacrificing autonomy of monetary policy at the macroeconomic level.

Second, individual partners lose the capacity derived from an exclusive national currency to augment public spending at will via money creation — a privilege known as seigniorage. Technically defined as the excess of the nominal value of a currency over its cost of production, seigniorage can be understood as an alternative source of revenue for the state beyond what can be raised by taxes or by borrowing from financial markets. Sacrifice of the seigniorage privilege must also be compared against a monetary union’s efficiency gains.

The seriousness of these two losses will depend on the type of monetary union adopted. In an alliance-type union, where authority is not surrendered but pooled, monetary control is delegated to the union’s joint institution, to be shared and in some manner collectively managed by all the countries involved. Hence each partner’s loss is simultaneously also each other’s gain. Though individual states may no longer have much latitude to act unilaterally, each government retains a voice in decision-making for the group as a whole. Losses will be greater with dollarization, which by definition transfers all monetary authority to the dominant power. Some measure of seigniorage may be retained by subordinate partners, but only with the consent of the leader.

The idea of monetary union among sovereign states was widely promoted in the nineteenth century, mainly in Europe, despite the fact that most national currencies were already tied together closely by the fixed exchange rates of the classical gold standard. Further efficiency gains could be realized, proponents argued, while little would be lost at a time when activist monetary policy was still unknown.

“Universal Currency” Fails, 1867

Most ambitious was a projected “universal currency” to be based on equivalent gold coins issued by the three biggest financial powers of the day: Britain, France, and the United States. As it happened, the gold content of French coins at the time was such that a 25-franc piece — not then in existence but easily mintable — would if brought into existence have contained 112.008 grains of gold, very close to both the English sovereign (containing 113.001 grains) and American half-eagle, equal to five dollars (containing 116.1 grains). Why not, then, seek some sort of standardization of coinage among the three countries to achieve the equivalent of one single money? That was the proposal of a major monetary conference sponsored by the French Government to coincide with an international exposition in Paris in 1867. Delegates from some 20 countries, with the critical exception of Britain’s representatives, enthusiastically supported creation of a universal currency based on a 25-franc piece and called for appropriate reductions in the gold content of the sovereign and half-eagle. In the end, however, no action was taken by either London or Washington, and for lack of sustained political support the idea ultimately faded away.

Latin Monetary Union

Two years before the 1867 conference, however, the French Government did succeed in gaining agreement for a more limited initiative — the Latin Monetary Union (LMU). Joining Belgium, Italy, and Switzerland together with France, the LMU was intended to standardize the existing gold and silver coinages of all four countries. Greece subsequently adhered to the terms of the LMU in 1868, though not becoming a formal member until 1876. In practical terms, a monetary partnership among these countries had already begun to coalesce even earlier as a result of independent decisions by Belgium, Greece, Italy, and Switzerland to model their currency systems on that of France. Each state chose to adopt a basic unit equal in value to the French franc — actually called a franc in Belgium and Switzerland — with equivalent subsidiary units defined according to the French-inspired decimal system. Starting in the 1850s, however, serious Gresham’s Law type problems developed as a result of differences in the weight and fineness of silver coins circulating in each country. The LMU established uniform standards for national coinages and, by making each member’s money legal tender throughout the Union, effectively created a wider area for the circulation of a harmonized supply of specie coins. In substance a formal exchange-rate union was created, with the authority for management of participating currencies remaining with each separate government.

As a group, members were distinguished from other countries by the reciprocal obligation of their central banks to accept one another’s coins at par and without limit. Soon after its founding, however, beginning in the late 1860s, the LMU was subjected to considerable strain owing to a global glut of silver production. The resulting depreciation of silver eventually led to a suspension of silver coinage by all the partners, effectively transforming the LMU from a bimetallic standard into what came to be called a “limping gold standard.” Even so, the arrangement managed to hold together until the generalized breakdown of global monetary relations during World War I. The LMU was not formally dissolved until 1927, following Switzerland’s decision to withdraw during the previous year.

Scandinavian Monetary Union

A similar arrangement also emerged in northern Europe — the Scandinavian Monetary Union (SMU), formed in 1873 by Sweden and Denmark and joined two years later by Norway. The Scandanavian Monetary Union too was an exchange-rate union designed to standardize existing coinages, although unlike the LMU the SMU was based from the start on a monometallic gold standard. The Union established the krone (crown) as a uniform unit of account, with national currencies permitted full circulation as legal tender in all three countries. As in the LMU, members of the SMU were distinguished from outsiders by the reciprocal obligation to accept one another’s currencies at par and without limit; also as in the LMU, mutual acceptability was initially limited to gold and silver coins only. In 1885, however, the three members went further, agreeing to accept one another’s bank notes and drafts as well, thus facilitating free intercirculation of all paper currency and resulting eventually in the total disappearance of exchange-rate quotations among the three moneys. By the turn of the century the SMU had come to function, in effect, as a single unit for all payments purposes, until relations were disrupted by the suspension of convertibility and floating of individual currencies at the start of World War I. Despite subsequent efforts during and after the war to restore at least some elements of the Union, particularly following the members’ return to the gold standard in the mid-1920s, the agreement was finally abandoned following the global financial crisis of 1931.

German Monetary Union

Repeated efforts to standardize coinages were made as well by various German states prior to Germany’s political union, but with rather less success. Early accords, following the start of the Zollverein (the German region’s customs union) in 1834, ostensibly established a German Monetary Union — technically, like the LMU and SMU, also an exchange-rate union — but in fact divided the area into two quite distinct currency alliances: one encompassing most northern states, using the thaler as its basic monetary unit; and a second including states in the south, based on the florin (also known as the guilder or gulden). Free intercirculation of coins was guaranteed in both groups but not at par: the exchange rate between the two units of account was fixed at one thaler for 1.75 florins (formally, 14: 24.5) rather than one-for-one. Moreover, states remained free to mint non-standardized coins in addition to their basic units, and many important German states (e.g., Bremen, Hamburg, and Schleswig-Holstein) chose to stay outside the agreement altogether. Nor were matters helped much by the short-lived Vienna Coinage Treaty signed with Austria in 1857, which added yet a third currency, Austria’s own florin, to the mix with a value slightly higher than that of the south German unit. The Austro-German Monetary Union was dissolved less than a decade later, following Austria’s defeat in the 1866 Austro-Prussian War. A full merger of all the currencies of the German states did not finally arrive until after consolidation of modern Germany, under Prussian leadership, in 1871.

The only truly successful monetary union in Europe prior to EMU came in 1922 with the birth of the Belgium-Luxembourg Economic Union (BLEU), which remained in force for more than seven decades until blended into EMU in 1999. Following severance of its traditional ties with the German Zollverein after World War I, Luxembourg elected to link itself commercially and financially with Belgium, agreeing to a comprehensive economic union including a merger of their separate money systems. Reflecting the partners’ considerable disparity of size (Belgium’s population is roughly thirty times Luxembourg’s), Belgian francs under BLEU formed the largest part of the money stock of Luxembourg as well as Belgium, and alone enjoyed full status as legal tender in both countries. Only Belgium, moreover, had a full-scale central bank. The Luxembourg franc was issued by a more modest institution, the Luxembourg Monetary Institute, was limited in supply, and served as legal tender just within Luxembourg itself. Despite the existence of formal joint decision-making bodies, Luxembourg in effect existed largely as an appendage of the Belgian monetary system until both nations joined their EU partners in creating the euro.

Monetary Disintegration

Europe in the twentieth century has also seen the disintegration of several monetary unions, usually as a by-product of political dissent or dissolution. A celebrated instance occurred after World War I when the Austro-Hungarian Empire was dismembered by the Treaty of Versailles. Almost immediately, in an abrupt and quite chaotic manner, new currencies were introduced by each successor state — including Czechoslovakia, Hungary, Yugoslavia, and ultimately even shrunken Austria itself — to replace the old imperial Austrian crown. Comparable examples have also been provided more recently, after the end of the Cold War, following fragmentation along ethnic lines of both the Czechoslovak and Yugoslav federations. Most spectacular was the collapse of the former ruble zone following the break-up of the seven-decade-old Soviet Union in late 1991. Out of the rubble of the ruble no fewer than a dozen new currencies emerged to take their place on the world stage.

Outside Europe, the idea of monetary union was promoted mainly in the context of colonial or other dependency relationships, including both alliance-type and dollarization arrangements. Though most imperial regimes were quickly abandoned in favor of newly created national currencies once decolonization began after World War II, a few have survived in modified form to the present day.

British Colonies

Alliance-type arrangements emerged in the colonial domains of both Britain and France, the two biggest imperial powers of the nineteenth century. First to act were the British, who after some experimentation succeeded in creating a series of common currency zones, each closely tied to the pound sterling through the mechanism of a currency board. With a currency board, exchange rates were firmly pegged to the pound and full sterling backing was required for any new issue of the colonial money. Joint currencies were created first in West Africa (1912) and East Africa (1919) and later for British possessions in Southeast Asia (1938) and the Caribbean (1950). In southern Africa, an equivalent zone was established during the 1920s based on the South African pound (later the rand), which became the sole legal tender in three of Britain’s nearby possessions, Bechuanaland (later Botswana), British Basutoland (later Lesotho), and Swaziland, as well as in South West Africa (later Namibia), a former German colony administered by South Africa under a League of Nations mandate. Of Britain’s various arrangements, only two still exist in some form.

East Caribbean

One is in the Caribbean, where Britain’s monetary legacy has proved remarkably durable. The British Caribbean Currency Board evolved first into the Eastern Caribbean Currency Authority in 1965 and then the Eastern Caribbean Central Bank in 1983, issuing one currency, the Eastern Caribbean dollar, to serve as legal tender for all participants. Included in the Eastern Caribbean Currency Union (ECCU) are the six independent microstates of Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines, plus two islands that are still British dependencies, Anguilla and Montserrat. Embedded in a broadening network of other related agreements among the same governments (the Eastern Caribbean Common Market, the Organization of Eastern Caribbean States), the ECCU has functioned without serious difficulty since its formal establishment in 1965.

Southern Africa

The other is in southern Africa, where previous links have been progressively formalized, first in 1974 as the Rand Monetary Area, later in 1986 under the label Common Monetary Area (CMA), though, significantly, without the participation of diamond-rich Botswana, which has preferred to rely on its own national money. The CMA started as a monetary union tightly based on the rand, a local form of dollarization reflecting South Africa’s economic dominance of the region. But with the passage of time the degree of hierarchy has diminished considerably, as the three remaining junior partners have asserted their growing sense of national identity. Especially since the 1970s, the arrangement has been transformed into a looser exchange-rate union as each of South Africa’s partners introduced its own distinct national currency. One of them, Swaziland, has even gone so far as to withdraw the rand’s legal-tender status within its own borders. Moreover, though all three continue to peg their moneys to the rand at par, they are no longer bound by currency board-like provisions on money creation and may now in principle vary their exchange rates at will.

Africa’s CFA Franc Zone

In the French Empire monetary union did not arrive until 1945, when the newly restored government in Paris decided to consolidate the diverse currencies of its many African dependencies into one money, le franc des Colonies Françaises d’Afrique (CFA francs). Subsequently, in the early 1960s, as independence came to France’s African domains, the old colonial franc was replaced by two new regional currencies, each cleverly named to preserve the CFA franc appellation: for the eight present members of the West African Monetary Union, le franc de la Communauté Financière de l’Afrique, issued by the Central Bank of West African States; and for the six members of the Central African Monetary Area, le franc de la Coopération Financière Africaine, issued by the Bank of Central African States. Together the two groups comprise the Communauté Financière Africaine (African Financial Community). Though each of the two currencies is legal tender only within its own region, the two are equivalently defined and have always been jointly managed under the aegis of the French Ministry of Finance as integral parts of a single monetary union, popularly known as the CFA Franc Zone.

Elsewhere imperial powers preferred some version of a dollarization-type regime, promoting use of their own currencies in colonial possessions to reinforce dependency relationships — though few of these hierarchical arrangements survived the arrival of decolonization. The only major exceptions are to be found among smaller countries with special ties to the United States. Most prominently, these include Panama and Liberia, two states that owe their very existence to U.S. initiatives. Immediately after gaining its independence in 1903 with help from Washington, Panama adopted America’s greenback as its national currency in lieu of a money of its own. In similar fashion during World War II, Liberia — a nation founded by former American slaves — made the dollar its sole legal tender, replacing the British West African colonial coinage that had previously dominated the local money supply. Other long-time dollarizers include the Marshall Islands, Micronesia, and Palau, Pacific Ocean microstates that were all once administered by the United States under United Nations trusteeships. Most recently, the dollar replaced failed local currencies in Ecuador in 2000 and in El Salvador in 2001 and was adopted by East Timor when that state gained its independence in 2002.

Europe’s Monetary Union

The most dramatic episode in the history of monetary unions is of course EMU, in many ways a unique undertaking — a group of fully independent states, all partners in the European Union, that have voluntarily agreed to replace existing national currencies with one newly created money, the euro. The euro was first introduced in 1999 in electronic form (a “virtual” currency), with notes and coins following in 2002. Moreover, even while retaining political sovereignty, member governments have formally delegated all monetary sovereignty to a single joint authority, the European Central Bank. These are not former overseas dependencies like the members of ECCU or the CFA Franc Zone, inheriting arrangements that had originated in colonial times; nor are they small fragile economies like Ecuador or El Salvador, surrendering monetary sovereignty to an already proven and popular currency like the dollar. Rather, these are established states of long standing and include some of the biggest national economies in the world, engaged in a gigantic experiment of unprecedented proportions. Not surprisingly, therefore, EMU has stimulated growing interest in monetary union in many parts of the world. Despite the failure of many past initiatives, the future could see yet more joint currency ventures among sovereign states.

Bartel, Robert J. “International Monetary Unions: The XIXth Century Experience.” Journal of European Economic History 3, no. 3 (1974): 689-704.

Bordo, Michael, and Lars Jonung. Lessons for EMU from the History of Monetary Unions. London: Institute of Economic Affairs, 2000.

Capie, Forrest. “Monetary Unions in Historical Perspective: What Future for the Euro in the International Financial System.” In Ideas for the Future of the International Monetary System, edited by Michele Fratianni, Dominick Salvatore, and Paolo Savona., 77-95. Boston: Kluwer Academic Publishers, 1999.

Cohen, Benjamin J. “Beyond EMU: The Problem of Sustainability.” In The Political Economy of European Monetary Unification, second edition, edited by Barry Eichengreen and Jeffry A. Frieden, 179-204.Boulder, CO: Westview Press, 2001.

Cohen, Benjamin J. The Geography of Money. Ithaca, NY: Cornell University Press, 1998.

De Cecco, Marcello. “European Monetary and Financial Cooperation before the First World War.” Rivista di Storia Economica 9 (1992): 55-76.

Graboyes, Robert F. “The EMU: Forerunners and Durability.” Federal Reserve Bank of Richmond Economic Review 76, no. 4 (1990): 8-17.

Hamada, Koichi, and David Porteous. L’Intégration Monétaire dans Une Perspective Historique.” Revue d’Économie Financière 22 (1992): 77-92.

Helleiner, Eric. The Making of National Money: Territorial Currencies in Historical Perspective. Ithaca, NY: Cornell University Press, 2003.

Perlman, M. “In Search of Monetary Union.” Journal of European Economic History 22, no. 2 (1993): 313-332.

Vanthoor, Wim F.V. European Monetary Union Since 1848: A Political and Historical Analysis. Brookfield, VT: Edward Elgar, 1996.

Citation: Cohen, Benjamin. “Monetary Unions”. EH.Net Encyclopedia, edited by Robert Whaples. February 10, 2008. URL http://eh.net/encyclopedia/monetary-unions/

Antebellum Banking in the United States

Howard Bodenhorn, Lafayette College

The first legitimate commercial bank in the United States was the Bank of North America founded in 1781. Encouraged by Alexander Hamilton, Robert Morris persuaded the Continental Congress to charter the bank, which loaned to the cash-strapped Revolutionary government as well as private citizens, mostly Philadelphia merchants. The possibilities of commercial banking had been widely recognized by many colonists, but British law forbade the establishment of commercial, limited-liability banks in the colonies. Given that many of the colonists’ grievances against Parliament centered on economic and monetary issues, it is not surprising that one of the earliest acts of the Continental Congress was the establishment of a bank.

The introduction of banking to the U.S. was viewed as an important first step in forming an independent nation because banks supplied a medium of exchange (banknotes1 and deposits) in an economy perpetually strangled by shortages of specie money and credit, because they animated industry, and because they fostered wealth creation and promoted well-being. In the last case, contemporaries typically viewed banks as an integral part of a wider system of government-sponsored commercial infrastructure. Like schools, bridges, road, canals, river clearing and harbor improvements, the benefits of banks were expected to accrue to everyone even if dividends accrued only to shareholders.

Financial Sector Growth

By 1800 each major U.S. port city had at least one commercial bank serving the local mercantile community. As city banks proved themselves, banking spread into smaller cities and towns and expanded their clientele. Although most banks specialized in mercantile lending, others served artisans and farmers. In 1820 there were 327 commercial banks and several mutual savings banks that promoted thrift among the poor. Thus, at the onset of the antebellum period (defined here as the period between 1820 and 1860), urban residents were familiar with the intermediary function of banks and used bank-supplied currencies (deposits and banknotes) for most transactions. Table 1 reports the number of banks and the value of loans outstanding at year end between 1820 and 1860. During the era, the number of banks increased from 327 to 1,562 and total loans increased from just over $55.1 million to $691.9 million. Bank-supplied credit in the U.S. economy increased at a remarkable annual average rate of 6.3 percent. Growth in the financial sector, then outpaced growth in aggregate economic activity. Nominal gross domestic product increased an average annual rate of about 4.3 percent over the same interval. This essay discusses how regional regulatory structures evolved as the banking sector grew and radiated out from northeastern cities to the hinterlands.

Table 1
Number of Banks and Total Loans, 1820-1860

Year Banks Loans ($ millions)
1820 327 55.1
1821 273 71.9
1822 267 56.0
1823 274 75.9
1824 300 73.8
1825 330 88.7
1826 331 104.8
1827 333 90.5
1828 355 100.3
1829 369 103.0
1830 381 115.3
1831 424 149.0
1832 464 152.5
1833 517 222.9
1834 506 324.1
1835 704 365.1
1836 713 457.5
1837 788 525.1
1838 829 485.6
1839 840 492.3
1840 901 462.9
1841 784 386.5
1842 692 324.0
1843 691 254.5
1844 696 264.9
1845 707 288.6
1846 707 312.1
1847 715 310.3
1848 751 344.5
1849 782 332.3
1850 824 364.2
1851 879 413.8
1852 913 429.8
1853 750 408.9
1854 1208 557.4
1855 1307 576.1
1856 1398 634.2
1857 1416 684.5
1858 1422 583.2
1859 1476 657.2
1860 1562 691.9

Sources: Fenstermaker (1965); U.S. Comptroller of the Currency (1931).

Adaptability

As important as early American banks were in the process of capital accumulation, perhaps their most notable feature was their adaptability. Kuznets (1958) argues that one measure of the financial sector’s value is how and to what extent it evolves with changing economic conditions. Put in place to perform certain functions under one set of economic circumstances, how did it alter its behavior and service the needs of borrowers as circumstances changed. One benefit of the federalist U.S. political system was that states were given the freedom to establish systems reflecting local needs and preferences. While the political structure deserves credit in promoting regional adaptations, North (1994) credits the adaptability of America’s formal rules and informal constraints that rewarded adventurism in the economic, as well as the noneconomic, sphere. Differences in geography, climate, crop mix, manufacturing activity, population density and a host of other variables were reflected in different state banking systems. Rhode Island’s banks bore little resemblance to those in far away Louisiana or Missouri, or even those in neighboring Connecticut. Each state’s banks took a different form, but their purpose was the same; namely, to provide the state’s citizens with monetary and intermediary services and to promote the general economic welfare. This section provides a sketch of regional differences. A more detailed discussion can be found in Bodenhorn (2002).

State Banking in New England

New England’s banks most resemble the common conception of the antebellum bank. They were relatively small, unit banks; their stock was closely held; they granted loans to local farmers, merchants and artisans with whom the bank’s managers had more than a passing familiarity; and the state took little direct interest in their daily operations.

Of the banking systems put in place in the antebellum era, New England’s is typically viewed as the most stable and conservative. Friedman and Schwartz (1986) attribute their stability to an Old World concern with business reputations, familial ties, and personal legacies. New England was long settled, its society well established, and its business community mature and respected throughout the Atlantic trading network. Wealthy businessmen and bankers with strong ties to the community — like the Browns of Providence or the Bowdoins of Boston — emphasized stability not just because doing so benefited and reflected well on them, but because they realized that bad banking was bad for everyone’s business.

Besides their reputation for soundness, the two defining characteristics of New England’s early banks were their insider nature and their small size. The typical New England bank was small compared to banks in other regions. Table 2 shows that in 1820 the average Massachusetts country bank was about the same size as a Pennsylvania country bank, but both were only about half the size of a Virginia bank. A Rhode Island bank was about one-third the size of a Massachusetts or Pennsylvania bank and a mere one-sixth as large as Virginia’s banks. By 1850 the average Massachusetts bank declined relatively, operating on about two-thirds the paid-in capital of a Pennsylvania country bank. Rhode Island’s banks also shrank relative to Pennsylvania’s and were tiny compared to the large branch banks in the South and West.

Table 2
Average Bank Size by Capital and Lending in 1820 and 1850 Selected States and Cities
(in $ thousands)

1820
Capital
Loans 1850 Capital Loans
Massachusetts $374.5 $480.4 $293.5 $494.0
except Boston 176.6 230.8 170.3 281.9
Rhode Island 95.7 103.2 186.0 246.2
except Providence 60.6 72.0 79.5 108.5
New York na na 246.8 516.3
except NYC na na 126.7 240.1
Pennsylvania 221.8 262.9 340.2 674.6
except Philadelphia 162.6 195.2 246.0 420.7
Virginia1,2 351.5 340.0 270.3 504.5
South Carolina2 na na 938.5 1,471.5
Kentucky2 na na 439.4 727.3

Notes: 1 Virginia figures for 1822. 2 Figures represent branch averages.

Source: Bodenhorn (2002).

Explanations for New England Banks’ Relatively Small Size

Several explanations have been offered for the relatively small size of New England’s banks. Contemporaries attributed it to the New England states’ propensity to tax bank capital, which was thought to work to the detriment of large banks. They argued that large banks circulated fewer banknotes per dollar of capital. The result was a progressive tax that fell disproportionately on large banks. Data compiled from Massachusetts’s bank reports suggest that large banks were not disadvantaged by the capital tax. It was a fact, as contemporaries believed, that large banks paid higher taxes per dollar of circulating banknotes, but a potentially better benchmark is the tax to loan ratio because large banks made more use of deposits than small banks. The tax to loan ratio was remarkably constant across both bank size and time, averaging just 0.6 percent between 1834 and 1855. Moreover, there is evidence of constant to modestly increasing returns to scale in New England banking. Large banks were generally at least as profitable as small banks in all years between 1834 and 1860, and slightly more so in many.

Lamoreaux (1993) offers a different explanation for the modest size of the region’s banks. New England’s banks, she argues, were not impersonal financial intermediaries. Rather, they acted as the financial arms of extended kinship trading networks. Throughout the antebellum era banks catered to insiders: directors, officers, shareholders, or business partners and kin of directors, officers, shareholders and business partners. Such preferences toward insiders represented the perpetuation of the eighteenth-century custom of pooling capital to finance family enterprises. In the nineteenth century the practice continued under corporate auspices. The corporate form, in fact, facilitated raising capital in greater amounts than the family unit could raise on its own. But because the banks kept their loans within a relatively small circle of business connections, it was not until the late nineteenth century that bank size increased.2

Once the kinship orientation of the region’s banks was established it perpetuated itself. When outsiders could not obtain loans from existing insider organizations, they formed their own insider bank. In doing so the promoters assured themselves of a steady supply of credit and created engines of economic mobility for kinship networks formerly closed off from many sources of credit. State legislatures accommodated the practice through their liberal chartering policies. By 1860, Rhode Island had 91 banks, Maine had 68, New Hampshire 51, Vermont 44, Connecticut 74 and Massachusetts 178.

The Suffolk System

One of the most commented on characteristic of New England’s banking system was its unique regional banknote redemption and clearing mechanism. Established by the Suffolk Bank of Boston in the early 1820s, the system became known as the Suffolk System. With so many banks in New England, each issuing it own form of currency, it was sometimes difficult for merchants, farmers, artisans, and even other bankers, to discriminate between real and bogus banknotes, or to discriminate between good and bad bankers. Moreover, the rural-urban terms of trade pulled most banknotes toward the region’s port cities. Because country merchants and farmers were typically indebted to city merchants, country banknotes tended to flow toward the cities, Boston more so than any other. By the second decade of the nineteenth century, country banknotes became a constant irritant for city bankers. City bankers believed that country issues displaced Boston banknotes in local transactions. More irritating though was the constant demand by the city banks’ customers to accept country banknotes on deposit, which placed the burden of interbank clearing on the city banks.3

In 1803 the city banks embarked on a first attempt to deal with country banknotes. They joined together, bought up a large quantity of country banknotes, and returned them to the country banks for redemption into specie. This effort to reduce country banknote circulation encountered so many obstacles that it was quickly abandoned. Several other schemes were hatched in the next two decades, but none proved any more successful than the 1803 plan.

The Suffolk Bank was chartered in 1818 and within a year embarked on a novel scheme to deal with the influx of country banknotes. The Suffolk sponsored a consortium of Boston bank in which each member appointed the Suffolk as its lone agent in the collection and redemption of country banknotes. In addition, each city bank contributed to a fund used to purchase and redeem country banknotes. When the Suffolk collected a large quantity of a country bank’s notes, it presented them for immediate redemption with an ultimatum: Join in a regular and organized redemption system or be subject to further unannounced redemption calls.4 Country banks objected to the Suffolk’s proposal, because it required them to keep noninterest-earning assets on deposit with the Suffolk in amounts equal to their average weekly redemptions at the city banks. Most country banks initially refused to join the redemption network, but after the Suffolk made good on a few redemption threats, the system achieved near universal membership.

Early interpretations of the Suffolk system, like those of Redlich (1949) and Hammond (1957), portray the Suffolk as a proto-central bank, which acted as a restraining influence that exercised some control over the region’s banking system and money supply. Recent studies are less quick to pronounce the Suffolk a successful experiment in early central banking. Mullineaux (1987) argues that the Suffolk’s redemption system was actually self-defeating. Instead of making country banknotes less desirable in Boston, the fact that they became readily redeemable there made them perfect substitutes for banknotes issued by Boston’s prestigious banks. This policy made country banknotes more desirable, which made it more, not less, difficult for Boston’s banks to keep their own notes in circulation.

Fenstermaker and Filer (1986) also contest the long-held view that the Suffolk exercised control over the region’s money supply (banknotes and deposits). Indeed, the Suffolk’s system was self-defeating in this regard as well. By increasing confidence in the value of a randomly encountered banknote, people were willing to hold increases in banknotes issues. In an interesting twist on the traditional interpretation, a possible outcome of the Suffolk system is that New England may have grown increasingly financial backward as a direct result of the region’s unique clearing system. Because banknotes were viewed as relatively safe and easily redeemed, the next big financial innovation — deposit banking — in New England lagged far behind other regions. With such wide acceptance of banknotes, there was no reason for banks to encourage the use of deposits and little reason for consumers to switch over.

Summary: New England Banks

New England’s banking system can be summarized as follows: Small unit banks predominated; many banks catered to small groups of capitalists bound by personal and familial ties; banking was becoming increasingly interconnected with other lines of business, such as insurance, shipping and manufacturing; the state took little direct interest in the daily operations of the banks and its supervisory role amounted to little more than a demand that every bank submit an unaudited balance sheet at year’s end; and that the Suffolk developed an interbank clearing system that facilitated the use of banknotes throughout the region, but had little effective control over the region’s money supply.

Banking in the Middle Atlantic Region

Pennsylvania

After 1810 or so, many bank charters were granted in New England, but not because of the presumption that the bank would promote the commonweal. Charters were granted for the personal gain of the promoter and the shareholders and in proportion to the personal, political and economic influence of the bank’s founders. No New England state took a significant financial stake in its banks. In both respects, New England differed markedly from states in other regions. From the beginning of state-chartered commercial banking in Pennsylvania, the state took a direct interest in the operations and profits of its banks. The Bank of North America was the obvious case: chartered to provide support to the colonial belligerents and the fledgling nation. Because the bank was popularly perceived to be dominated by Philadelphia’s Federalist merchants, who rarely loaned to outsiders, support for the bank waned.5 After a pitched political battle in which the Bank of North America’s charter was revoked and reinstated, the legislature chartered the Bank of Pennsylvania in 1793. As its name implies, this bank became the financial arm of the state. Pennsylvania subscribed $1 million of the bank’s capital, giving it the right to appoint six of thirteen directors and a $500,000 line of credit. The bank benefited by becoming the state’s fiscal agent, which guaranteed a constant inflow of deposits from regular treasury operations as well as western land sales.

By 1803 the demand for loans outstripped the existing banks’ supply and a plan for a new bank, the Philadelphia Bank, was hatched and its promoters petitioned the legislature for a charter. The existing banks lobbied against the charter, and nearly sank the new bank’s chances until it established a precedent that lasted throughout the antebellum era. Its promoters bribed the legislature with a payment of $135,000 in return for the charter, handed over one-sixth of its shares, and opened a line of credit for the state.

Between 1803 and 1814, the only other bank chartered in Pennsylvania was the Farmers and Mechanics Bank of Philadelphia, which established a second substantive precedent that persisted throughout the era. Existing banks followed a strict real-bills lending policy, restricting lending to merchants at very short terms of 30 to 90 days.6 Their adherence to a real-bills philosophy left a growing community of artisans, manufacturers and farmers on the outside looking in. The Farmers and Mechanics Bank was chartered to serve excluded groups. At least seven of its thirteen directors had to be farmers, artisans or manufacturers and the bank was required to lend the equivalent of 10 percent of its capital to farmers on mortgage for at least one year. In later years, banks were established to provide services to even more narrowly defined groups. Within a decade or two, most substantial port cities had banks with names like Merchants Bank, Planters Bank, Farmers Bank, and Mechanics Bank. By 1860 it was common to find banks with names like Leather Manufacturers Bank, Grocers Bank, Drovers Bank, and Importers Bank. Indeed, the Emigrant Savings Bank in New York City served Irish immigrants almost exclusively. In the other instances, it is not known how much of a bank’s lending was directed toward the occupational group included in its name. The adoption of such names may have been marketing ploys as much as mission statements. Only further research will reveal the answer.

New York

State-chartered banking in New York arrived less auspiciously than it had in Philadelphia or Boston. The Bank of New York opened in 1784, but operated without a charter and in open violation of state law until 1791 when the legislature finally sanctioned it. The city’s second bank obtained its charter surreptitiously. Alexander Hamilton was one of the driving forces behind the Bank of New York, and his long-time nemesis, Aaron Burr, was determined to establish a competing bank. Unable to get a charter from a Federalist legislature, Burr and his colleagues petitioned to incorporate a company to supply fresh water to the inhabitants of Manhattan Island. Burr tucked a clause into the charter of the Manhattan Company (the predecessor to today’s Chase Manhattan Bank) granting the water company the right to employ any excess capital in financial transactions. Once chartered, the company’s directors announced that $500,000 of its capital would be invested in banking.7 Thereafter, banking grew more quickly in New York than in Philadelphia, so that by 1812 New York had seven banks compared to the three operating in Philadelphia.

Deposit Insurance

Despite its inauspicious banking beginnings, New York introduced two innovations that influenced American banking down to the present. The Safety Fund system, introduced in 1829, was the nation’s first experiment in bank liability insurance (similar to that provided by the Federal Deposit Insurance Corporation today). The 1829 act authorized the appointment of bank regulators charged with regular inspections of member banks. An equally novel aspect was that it established an insurance fund insuring holders of banknotes and deposits against loss from bank failure. Ultimately, the insurance fund was insufficient to protect all bank creditors from loss during the panic of 1837 when eleven failures in rapid succession all but bankrupted the insurance fund, which delayed noteholder and depositor recoveries for months, even years. Even though the Safety Fund failed to provide its promised protections, it was an important episode in the subsequent evolution of American banking. Several Midwestern states instituted deposit insurance in the early twentieth century, and the federal government adopted it after the banking panics in the 1930s resulted in the failure of thousands of banks in which millions of depositors lost money.

“Free Banking”

Although the Safety Fund was nearly bankrupted in the late 1830s, it continued to insure a number of banks up to the mid 1860s when it was finally closed. No new banks joined the Safety Fund system after 1838 with the introduction of free banking — New York’s second significant banking innovation. Free banking represented a compromise between those most concerned with the underlying safety and stability of the currency and those most concerned with competition and freeing the country’s entrepreneurs from unduly harsh and anticompetitive restraints. Under free banking, a prospective banker could start a bank anywhere he saw fit, provided he met a few regulatory requirements. Each free bank’s capital was invested in state or federal bonds that were turned over to the state’s treasurer. If a bank failed to redeem even a single note into specie, the treasurer initiated bankruptcy proceedings and banknote holders were reimbursed from the sale of the bonds.

Actually Michigan preempted New York’s claim to be the first free-banking state, but Michigan’s 1837 law was modeled closely after a bill then under debate in New York’s legislature. Ultimately, New York’s influence was profound in this as well, because free banking became one of the century’s most widely copied financial innovations. By 1860 eighteen states adopted free banking laws closely resembling New York’s law. Three other states introduced watered-down variants. Eventually, the post-Civil War system of national banking adopted many of the substantive provisions of New York’s 1838 act.

Both the Safety Fund system and free banking were attempts to protect society from losses resulting from bank failures and to entice people to hold financial assets. Banks and bank-supplied currency were novel developments in the hinterlands in the early nineteenth century and many rural inhabitants were skeptical about the value of small pieces of paper. They were more familiar with gold and silver. Getting them to exchange one for the other was a slow process, and one that relied heavily on trust. But trust was built slowly and destroyed quickly. The failure of a single bank could, in a week, destroy the confidence in a system built up over a decade. New York’s experiments were designed to mitigate, if not eliminate, the negative consequences of bank failures. New York’s Safety Fund, then, differed in the details but not in intent, from New England’s Suffolk system. Bankers and legislators in each region grappled with the difficult issue of protecting a fragile but vital sector of the economy. Each region responded to the problem differently. The South and West settled on yet another solution.

Banking in the South and West

One distinguishing characteristic of southern and western banks was their extensive branch networks. Pennsylvania provided for branch banking in the early nineteenth century and two banks jointly opened about ten branches. In both instances, however, the branches became a net liability. The Philadelphia Bank opened four branches in 1809 and by 1811 was forced to pass on its semi-annual dividends because losses at the branches offset profits at the Philadelphia office. At bottom, branch losses resulted from a combination of ineffective central office oversight and unrealistic expectations about the scale and scope of hinterland lending. Philadelphia’s bank directors instructed branch managers to invest in high-grade commercial paper or real bills. Rural banks found a limited number of such lending opportunities and quickly turned to mortgage-based lending. Many of these loans fell into arrears and were ultimately written when land sales faltered.

Branch Banking

Unlike Pennsylvania, where branch banking failed, branch banks throughout the South and West thrived. The Bank of Virginia, founded in 1804, was the first state-chartered branch bank and up to the Civil War branch banks served the state’s financial needs. Several small, independent banks were chartered in the 1850s, but they never threatened the dominance of Virginia’s “Big Six” banks. Virginia’s branch banks, unlike Pennsylvania’s, were profitable. In 1821, for example, the net return to capital at the Farmers Bank of Virginia’s home office in Richmond was 5.4 percent. Returns at its branches ranged from a low of 3 percent at Norfolk (which was consistently the low-profit branch) to 9 percent in Winchester. In 1835, the last year the bank reported separate branch statistics, net returns to capital at the Farmers Bank’s branches ranged from 2.9 and 11.7 percent, with an average of 7.9 percent.

The low profits at the Norfolk branch represent a net subsidy from the state’s banking sector to the political system, which was not immune to the same kind of infrastructure boosterism that erupted in New York, Pennsylvania, Maryland and elsewhere. In the immediate post-Revolutionary era, the value of exports shipped from Virginia’s ports (Norfolk and Alexandria) slightly exceeded the value shipped from Baltimore. In the 1790s the numbers turned sharply in Baltimore’s favor and Virginia entered the internal-improvements craze and the battle for western shipments. Banks represented the first phase of the state’s internal improvements plan in that many believed that Baltimore’s new-found advantage resulted from easier credit supplied by the city’s banks. If Norfolk, with one of the best natural harbors on the North American Atlantic coast, was to compete with other port cities, it needed banks and the state required three of the state’s Big Six branch banks to operate branches there. Despite its natural advantages, Norfolk never became an important entrepot and it probably had more bank capital than it required. This pattern was repeated elsewhere. Other states required their branch banks to serve markets such as Memphis, Louisville, Natchez and Mobile that might, with the proper infrastructure grow into important ports.

State Involvement and Intervention in Banking

The second distinguishing characteristic of southern and western banking was sweeping state involvement and intervention. Virginia, for example, interjected the state into the banking system by taking significant stakes in its first chartered banks (providing an implicit subsidy) and by requiring them, once they established themselves, to subsidize the state’s continuing internal improvements programs of the 1820s and 1830s. Indiana followed such a strategy. So, too, did Kentucky, Louisiana, Mississippi, Illinois, Kentucky, Tennessee and Georgia in different degrees. South Carolina followed a wholly different strategy. On one hand, it chartered several banks in which it took no financial interest. On the other, it chartered the Bank of the State of South Carolina, a bank wholly owned by the state and designed to lend to planters and farmers who complained constantly that the state’s existing banks served only the urban mercantile community. The state-owned bank eventually divided its lending between merchants, farmers and artisans and dominated South Carolina’s financial sector.

The 1820s and 1830s witnessed a deluge of new banks in the South and West, with a corresponding increase in state involvement. No state matched Louisiana’s breadth of involvement in the 1830s when it chartered three distinct types of banks: commercial banks that served merchants and manufacturers; improvement banks that financed various internal improvements projects; and property banks that extended long-term mortgage credit to planters and other property holders. Louisiana’s improvement banks included the New Orleans Canal and Banking Company that built a canal connecting Lake Ponchartrain to the Mississippi River. The Exchange and Banking Company and the New Orleans Improvement and Banking Company were required to build and operate hotels. The New Orleans Gas Light and Banking Company constructed and operated gas streetlights in New Orleans and five other cities. Finally, the Carrollton Railroad and Banking Company and the Atchafalaya Railroad and Banking Company were rail construction companies whose bank subsidiaries subsidized railroad construction.

“Commonwealth Ideal” and Inflationary Banking

Louisiana’s 1830s banking exuberance reflected what some historians label the “commonwealth ideal” of banking; that is, the promotion of the general welfare through the promotion of banks. Legislatures in the South and West, however, never demonstrated a greater commitment to the commonwealth ideal than during the tough times of the early 1820s. With the collapse of the post-war land boom in 1819, a political coalition of debt-strapped landowners lobbied legislatures throughout the region for relief and its focus was banking. Relief advocates lobbied for inflationary banking that would reduce the real burden of debts taken on during prior flush times.

Several western states responded to these calls and chartered state-subsidized and state-managed banks designed to reinflate their embattled economies. Chartered in 1821, the Bank of the Commonwealth of Kentucky loaned on mortgages at longer than customary periods and all Kentucky landowners were eligible for $1,000 loans. The loans allowed landowners to discharge their existing debts without being forced to liquidate their property at ruinously low prices. Although the bank’s notes were not redeemable into specie, they were given currency in two ways. First, they were accepted at the state treasury in tax payments. Second, the state passed a law that forced creditors to accept the notes in payment of existing debts or agree to delay collection for two years.

The commonwealth ideal was not unique to Kentucky. During the depression of the 1820s, Tennessee chartered the State Bank of Tennessee, Illinois chartered the State Bank of Illinois and Louisiana chartered the Louisiana State Bank. Although they took slightly different forms, they all had the same intent; namely, to relieve distressed and embarrassed farmers, planters and land owners. What all these banks shared in common was the notion that the state should promote the general welfare and economic growth. In this instance, and again during the depression of the 1840s, state-owned banks were organized to minimize the transfer of property when economic conditions demanded wholesale liquidation. Such liquidation would have been inefficient and imposed unnecessary hardship on a large fraction of the population. To the extent that hastily chartered relief banks forestalled inefficient liquidation, they served their purpose. Although most of these banks eventually became insolvent, requiring taxpayer bailouts, we cannot label them unsuccessful. They reinflated economies and allowed for an orderly disposal of property. Determining if the net benefits were positive or negative requires more research, but for the moment we are forced to accept the possibility that the region’s state-owned banks of the 1820s and 1840s advanced the commonweal.

Conclusion: Banks and Economic Growth

Despite notable differences in the specific form and structure of each region’s banking system, they were all aimed squarely at a common goal; namely, realizing that region’s economic potential. Banks helped achieve the goal in two ways. First, banks monetized economies, which reduced the costs of transacting and helped smooth consumption and production across time. It was no longer necessary for every farm family to inventory their entire harvest. They could sell most of it, and expend the proceeds on consumption goods as the need arose until the next harvest brought a new cash infusion. Crop and livestock inventories are prone to substantial losses and an increased use of money reduced them significantly. Second, banks provided credit, which unleashed entrepreneurial spirits and talents. A complete appreciation of early American banking recognizes the banks’ contribution to antebellum America’s economic growth.

Bibliographic Essay

Because of the large number of sources used to construct the essay, the essay was more readable and less cluttered by including a brief bibliographic essay. A full bibliography is included at the end.

Good general histories of antebellum banking include Dewey (1910), Fenstermaker (1965), Gouge (1833), Hammond (1957), Knox (1903), Redlich (1949), and Trescott (1963). If only one book is read on antebellum banking, Hammond’s (1957) Pulitzer-Prize winning book remains the best choice.

The literature on New England banking is not particularly large, and the more important historical interpretations of state-wide systems include Chadbourne (1936), Hasse (1946, 1957), Simonton (1971), Spencer (1949), and Stokes (1902). Gras (1937) does an excellent job of placing the history of a single bank within the larger regional and national context. In a recent book and a number of articles Lamoreaux (1994 and sources therein) provides a compelling and eminently readable reinterpretation of the region’s banking structure. Nathan Appleton (1831, 1856) provides a contemporary observer’s interpretation, while Walker (1857) provides an entertaining if perverse and satirical history of a fictional New England bank. Martin (1969) provides details of bank share prices and dividend payments from the establishment of the first banks in Boston through the end of the nineteenth century. Less technical studies of the Suffolk system include Lake (1947), Trivoli (1979) and Whitney (1878); more technical interpretations include Calomiris and Kahn (1996), Mullineaux (1987), and Rolnick, Smith and Weber (1998).

The literature on Middle Atlantic banking is huge, but the better state-level histories include Bryan (1899), Daniels (1976), and Holdsworth (1928). The better studies of individual banks include Adams (1978), Lewis (1882), Nevins (1934), and Wainwright (1953). Chaddock (1910) provides a general history of the Safety Fund system. Golembe (1960) places it in the context of modern deposit insurance, while Bodenhorn (1996) and Calomiris (1989) provide modern analyses. A recent revival of interest in free banking has brought about a veritable explosion in the number of studies on the subject, but the better introductory ones remain Rockoff (1974, 1985), Rolnick and Weber (1982, 1983), and Dwyer (1996).

The literature on southern and western banking is large and of highly variable quality, but I have found the following to be the most readable and useful general sources: Caldwell (1935), Duke (1895), Esary (1912), Golembe (1978), Huntington (1915), Green (1972), Lesesne (1970), Royalty (1979), Schweikart (1987) and Starnes (1931).

References and Further Reading

Adams, Donald R., Jr. Finance and Enterprise in Early America: A Study of Stephen Girard’s Bank, 1812-1831. Philadelphia: University of Pennsylvania Press, 1978.

Alter, George, Claudia Goldin and Elyce Rotella. “The Savings of Ordinary Americans: The Philadelphia Saving Fund Society in the Mid-Nineteenth-Century.” Journal of Economic History 54, no. 4 (December 1994): 735-67.

Appleton, Nathan. A Defence of Country Banks: Being a Reply to a Pamphlet Entitled ‘An Examination of the Banking System of Massachusetts, in Reference to the Renewal of the Bank Charters.’ Boston: Stimpson & Clapp, 1831.

Appleton, Nathan. Bank Bills or Paper Currency and the Banking System of Massachusetts with Remarks on Present High Prices. Boston: Little, Brown and Company, 1856.

Berry, Thomas Senior. Revised Annual Estimates of American Gross National Product: Preliminary Estimates of Four Major Components of Demand, 1789-1889. Richmond: University of Richmond Bostwick Paper No. 3, 1978.

Bodenhorn, Howard. “Zombie Banks and the Demise of New York’s Safety Fund.” Eastern Economic Journal 22, no. 1 (1996): 21-34.

Bodenhorn, Howard. “Private Banking in Antebellum Virginia: Thomas Branch & Sons of Petersburg.” Business History Review 71, no. 4 (1997): 513-42.

Bodenhorn, Howard. A History of Banking in Antebellum America: Financial Markets and Economic Development in an Era of Nation-Building. Cambridge and New York: Cambridge University Press, 2000.

Bodenhorn, Howard. State Banking in Early America: A New Economic History. New York: Oxford University Press, 2002.

Bryan, Alfred C. A History of State Banking in Maryland. Baltimore: Johns Hopkins University Press, 1899.

Caldwell, Stephen A. A Banking History of Louisiana. Baton Rouge: Louisiana State University Press, 1935.

Calomiris, Charles W. “Deposit Insurance: Lessons from the Record.” Federal Reserve Bank of Chicago Economic Perspectives 13 (1989): 10-30.

Calomiris, Charles W., and Charles Kahn. “The Efficiency of Self-Regulated Payments Systems: Learnings from the Suffolk System.” Journal of Money, Credit, and Banking 28, no. 4 (1996): 766-97.

Chadbourne, Walter W. A History of Banking in Maine, 1799-1930. Orono: University of Maine Press, 1936.

Chaddock, Robert E. The Safety Fund Banking System in New York, 1829-1866. Washington, D.C.: Government Printing Office, 1910.

Daniels, Belden L. Pennsylvania: Birthplace of Banking in America. Harrisburg: Pennsylvania Bankers Association, 1976.

Davis, Lance, and Robert E. Gallman. “Capital Formation in the United States during the Nineteenth Century.” In Cambridge Economic History of Europe (Vol. 7, Part 2), edited by Peter Mathias and M.M. Postan, 1-69. Cambridge: Cambridge University Press, 1978.

Davis, Lance, and Robert E. Gallman. “Savings, Investment, and Economic Growth: The United States in the Nineteenth Century.” In Capitalism in Context: Essays on Economic Development and Cultural Change in Honor of R.M. Hartwell, edited by John A. James and Mark Thomas, 202-29. Chicago: University of Chicago Press, 1994.

Dewey, Davis R. State Banking before the Civil War. Washington, D.C.: Government Printing Office, 1910.

Duke, Basil W. History of the Bank of Kentucky, 1792-1895. Louisville: J.P. Morton, 1895.

Dwyer, Gerald P., Jr. “Wildcat Banking, Banking Panics, and Free Banking in the United States.” Federal Reserve Bank of Atlanta Economic Review 81, no. 3 (1996): 1-20.

Engerman, Stanley L., and Robert E. Gallman. “U.S. Economic Growth, 1783-1860.” Research in Economic History 8 (1983): 1-46.

Esary, Logan. State Banking in Indiana, 1814-1873. Indiana University Studies No. 15. Bloomington: Indiana University Press, 1912.

Fenstermaker, J. Van. The Development of American Commercial Banking, 1782-1837. Kent, Ohio: Kent State University, 1965.

Fenstermaker, J. Van, and John E. Filer. “Impact of the First and Second Banks of the United States and the Suffolk System on New England Bank Money, 1791-1837.” Journal of Money, Credit, and Banking 18, no. 1 (1986): 28-40.

Friedman, Milton, and Anna J. Schwartz. “Has the Government Any Role in Money?” Journal of Monetary Economics 17, no. 1 (1986): 37-62.

Gallman, Robert E. “American Economic Growth before the Civil War: The Testimony of the Capital Stock Estimates.” In American Economic Growth and Standards of Living before the Civil War, edited by Robert E. Gallman and John Joseph Wallis, 79-115. Chicago: University of Chicago Press, 1992.

Goldsmith, Raymond. Financial Structure and Development. New Haven: Yale University Press, 1969.

Golembe, Carter H. “The Deposit Insurance Legislation of 1933: An Examination of its Antecedents and Purposes.” Political Science Quarterly 76, no. 2 (1960): 181-200.

Golembe, Carter H. State Banks and the Economic Development of the West. New York: Arno Press, 1978.

Gouge, William M. A Short History of Paper Money and Banking in the United States. Philadelphia: T.W. Ustick, 1833.

Gras, N.S.B. The Massachusetts First National Bank of Boston, 1784-1934. Cambridge, MA: Harvard University Press, 1937.

Green, George D. Finance and Economic Development in the Old South: Louisiana Banking, 1804-1861. Stanford: Stanford University Press, 1972.

Hammond, Bray. Banks and Politics in America from the Revolution to the Civil War. Princeton: Princeton University Press, 1957.

Hasse, William F., Jr. A History of Banking in New Haven, Connecticut. New Haven: privately printed, 1946.

Hasse, William F., Jr. A History of Money and Banking in Connecticut. New Haven: privately printed, 1957.

Holdsworth, John Thom. Financing an Empire: History of Banking in Pennsylvania. Chicago: S.J. Clarke Publishing Company, 1928.

Huntington, Charles Clifford. A History of Banking and Currency in Ohio before the Civil War. Columbus: F. J. Herr Printing Company, 1915.

Knox, John Jay. A History of Banking in the United States. New York: Bradford Rhodes & Company, 1903.

Kuznets, Simon. “Foreword.” In Financial Intermediaries in the American Economy, by Raymond W. Goldsmith. Princeton: Princeton University Press, 1958.

Lake, Wilfred. “The End of the Suffolk System.” Journal of Economic History 7, no. 4 (1947): 183-207.

Lamoreaux, Naomi R. Insider Lending: Banks, Personal Connections, and Economic Development in Industrial New England. Cambridge: Cambridge University Press, 1994.

Lesesne, J. Mauldin. The Bank of the State of South Carolina. Columbia: University of South Carolina Press, 1970.

Lewis, Lawrence, Jr. A History of the Bank of North America: The First Bank Chartered in the United States. Philadelphia: J.B. Lippincott & Company, 1882.

Lockard, Paul A. Banks, Insider Lending and Industries of the Connecticut River Valley of Massachusetts, 1813-1860. Unpublished Ph.D. thesis, University of Massachusetts, 2000.

Martin, Joseph G. A Century of Finance. New York: Greenwood Press, 1969.

Moulton, H.G. “Commercial Banking and Capital Formation.” Journal of Political Economy 26 (1918): 484-508, 638-63, 705-31, 849-81.

Mullineaux, Donald J. “Competitive Monies and the Suffolk Banking System: A Contractual Perspective.” Southern Economic Journal 53 (1987): 884-98.

Nevins, Allan. History of the Bank of New York and Trust Company, 1784 to 1934. New York: privately printed, 1934.

New York. Bank Commissioners. “Annual Report of the Bank Commissioners.” New York General Assembly Document No. 74. Albany, 1835.

North, Douglass. “Institutional Change in American Economic History.” In American Economic Development in Historical Perspective, edited by Thomas Weiss and Donald Schaefer, 87-98. Stanford: Stanford University Press, 1994.

Rappaport, George David. Stability and Change in Revolutionary Pennsylvania: Banking, Politics, and Social Structure. University Park, PA: The Pennsylvania State University Press, 1996.

Redlich, Fritz. The Molding of American Banking: Men and Ideas. New York: Hafner Publishing Company, 1947.

Rockoff, Hugh. “The Free Banking Era: A Reexamination.” Journal of Money, Credit, and Banking 6, no. 2 (1974): 141-67.

Rockoff, Hugh. “New Evidence on the Free Banking Era in the United States.” American Economic Review 75, no. 4 (1985): 886-89.

Rolnick, Arthur J., and Warren E. Weber. “Free Banking, Wildcat Banking, and Shinplasters.” Federal Reserve Bank of Minneapolis Quarterly Review 6 (1982): 10-19.

Rolnick, Arthur J., and Warren E. Weber. “New Evidence on the Free Banking Era.” American Economic Review 73, no. 5 (1983): 1080-91.

Rolnick, Arthur J., Bruce D. Smith, and Warren E. Weber. “Lessons from a Laissez-Faire Payments System: The Suffolk Banking System (1825-58).” Federal Reserve Bank of Minneapolis Quarterly Review 22, no. 3 (1998): 11-21.

Royalty, Dale. “Banking and the Commonwealth Ideal in Kentucky, 1806-1822.” Register of the Kentucky Historical Society 77 (1979): 91-107.

Schumpeter, Joseph A. The Theory of Economic Development: An Inquiry into Profit, Capital, Credit, Interest, and the Business Cycle. Cambridge, MA: Harvard University Press, 1934.

Schweikart, Larry. Banking in the American South from the Age of Jackson to Reconstruction. Baton Rouge: Louisiana State University Press, 1987.

Simonton, William G. Maine and the Panic of 1837. Unpublished master’s thesis: University of Maine, 1971.

Sokoloff, Kenneth L. “Productivity Growth in Manufacturing during Early Industrialization.” In Long-Term Factors in American Economic Growth, edited by Stanley L. Engerman and Robert E. Gallman. Chicago: University of Chicago Press, 1986.

Sokoloff, Kenneth L. “Invention, Innovation, and Manufacturing Productivity Growth in the Antebellum Northeast.” In American Economic Growth and Standards of Living before the Civil War, edited by Robert E. Gallman and John Joseph Wallis, 345-78. Chicago: University of Chicago Press, 1992.

Spencer, Charles, Jr. The First Bank of Boston, 1784-1949. New York: Newcomen Society, 1949.

Starnes, George T. Sixty Years of Branch Banking in Virginia. New York: Macmillan Company, 1931.

Stokes, Howard Kemble. Chartered Banking in Rhode Island, 1791-1900. Providence: Preston & Rounds Company, 1902.

Sylla, Richard. “Forgotten Men of Money: Private Bankers in Early U.S. History.” Journal of Economic History 36, no. 2 (1976):

Temin, Peter. The Jacksonian Economy. New York: W. W. Norton & Company, 1969.

Trescott, Paul B. Financing American Enterprise: The Story of Commercial Banking. New York: Harper & Row, 1963.

Trivoli, George. The Suffolk Bank: A Study of a Free-Enterprise Clearing System. London: The Adam Smith Institute, 1979.

U.S. Comptroller of the Currency. Annual Report of the Comptroller of the Currency. Washington, D.C.: Government Printing Office, 1931.

Wainwright, Nicholas B. History of the Philadelphia National Bank. Philadelphia: William F. Fell Company, 1953.

Walker, Amasa. History of the Wickaboag Bank. Boston: Crosby, Nichols & Company, 1857.

Wallis, John Joseph. “What Caused the Panic of 1839?” Unpublished working paper, University of Maryland, October 2000.

Weiss, Thomas. “U.S. Labor Force Estimates and Economic Growth, 1800-1860.” In American Economic Growth and Standards of Living before the Civil War, edited by Robert E. Gallman and John Joseph Wallis, 19-75. Chicago: University of Chicago Press, 1992.

Whitney, David R. The Suffolk Bank. Cambridge, MA: Riverside Press, 1878.

Wright, Robert E. “Artisans, Banks, Credit, and the Election of 1800.” The Pennsylvania Magazine of History and Biography 122, no. 3 (July 1998), 211-239.

Wright, Robert E. “Bank Ownership and Lending Patterns in New York and Pennsylvania, 1781-1831.” Business History Review 73, no. 1 (Spring 1999), 40-60.

1 Banknotes were small demonination IOUs printed by banks and circulated as currency. Modern U.S. money are simply banknotes issued by the Federal Reserve Bank, which has a monopoly privilege in the issue of legal tender currency. In antebellum American, when a bank made a loan, the borrower was typically handed banknotes with a face value equal to the dollar value of the loan. The borrower then spent these banknotes in purchasing goods and services, putting them into circulation. Contemporary law held that banks were required to redeem banknotes into gold and silver legal tender on demand. Banks found it profitable to issue notes because they typically held about 30 percent of the total value of banknotes in circulation as reserves. Thus, banks were able to leverage $30 in gold and silver into $100 in loans that returned about 7 percent interest on average.

2 Paul Lockard (2000) challenges Lamoreaux’s interpretation. In a study of 4 banks in the Connecticut River valley, Lockard finds that insiders did not dominate these banks’ resources. As provocative as Lockard’s findings are, he draws conclusions from a small and unrepresentative sample. Two of his four sample banks were savings banks, which were designed as quasi-charitable organizations designed to encourage savings by the working classes and provide small loans. Thus, Lockard’s sample is effectively reduced to two banks. At these two banks, he identifies about 10 percent of loans as insider loans, but readily admits that he cannot always distinguish between insiders and outsiders. For a recent study of how early Americans used savings banks, see Alter, Goldin and Rotella (1994). The literature on savings banks is so large that it cannot be be given its due here.

3 Interbank clearing involves the settling of balances between banks. Modern banks cash checks drawn on other banks and credit the funds to the depositor. The Federal Reserve system provides clearing services between banks. The accepting bank sends the checks to the Federal Reserve, who credits the sending bank’s accounts and sends the checks back to the bank on which they were drawn for reimbursement. In the antebellum era, interbank clearing involved sending banknotes back to issuing banks. Because New England had so many small and scattered banks, the costs of returning banknotes to their issuers were large and sometimes avoided by recirculating notes of distant banks rather than returning them. Regular clearings and redemptions served an important purpose, however, because they kept banks in touch with the current market conditions. A massive redemption of notes was indicative of a declining demand for money and credit. Because the bank’s reserves were drawn down with the redemptions, it was forced to reduce its volume of loans in accord with changing demand conditions.

4 The law held that banknotes were redeemable on demand into gold or silver coin or bullion. If a bank refused to redeem even a single $1 banknote, the banknote holder could have the bank closed and liquidated to recover his or her claim against it.

5 Rappaport (1996) found that the bank’s loans were about equally divided between insiders (shareholders and shareholders’ family and business associates) and outsiders, but nonshareholders received loans about 30 percent smaller than shareholders. The issue remains about whether this bank was an “insider” bank, and depends largely on one’s definition. Any modern bank which made half of its loans to shareholders and their families would be viewed as an “insider” bank. It is less clear where the line can be usefully drawn for antebellum banks.

6 Real-bills lending followed from a nineteenth-century banking philosophy, which held that bank lending should be used to finance the warehousing or wholesaling of already-produced goods. Loans made on these bases were thought to be self-liquidating in that the loan was made against readily sold collateral actually in the hands of a merchant. Under the real-bills doctrine, the banks’ proper functions were to bridge the gap between production and retail sale of goods. A strict adherence to real-bills tenets excluded loans on property (mortgages), loans on goods in process (trade credit), or loans to start-up firms (venture capital). Thus, real-bills lending prescribed a limited role for banks and bank credit. Few banks were strict adherents to the doctrine, but many followed it in large part.

7 Robert E. Wright (1998) offers a different interpretation, but notes that Burr pushed the bill through at the end of a busy legislative session so that many legislators voted on the bill without having read it thoroughly

Citation: Bodenhorn, Howard. “Antebellum Banking in the United States”. EH.Net Encyclopedia, edited by Robert Whaples. March 26, 2008. URL http://eh.net/encyclopedia/antebellum-banking-in-the-united-states/

The Economic History of Australia from 1788: An Introduction

Bernard Attard, University of Leicester

Introduction

The economic benefits of establishing a British colony in Australia in 1788 were not immediately obvious. The Government’s motives have been debated but the settlement’s early character and prospects were dominated by its original function as a jail. Colonization nevertheless began a radical change in the pattern of human activity and resource use in that part of the world, and by the 1890s a highly successful settler economy had been established on the basis of a favorable climate in large parts of the southeast (including Tasmania ) and the southwest corner; the suitability of land for European pastoralism and agriculture; an abundance of mineral wealth; and the ease with which these resources were appropriated from the indigenous population. This article will focus on the creation of a colonial economy from 1788 and its structural change during the twentieth century. To simplify, it will divide Australian economic history into four periods, two of which overlap. These are defined by the foundation of the ‘bridgehead economy’ before 1820; the growth of a colonial economy between 1820 and 1930; the rise of manufacturing and the protectionist state between 1891 and 1973; and the experience of liberalization and structural change since 1973. The article will conclude by suggesting briefly some of the similarities between Australia and other comparable settler economies, as well as the ways in which it has differed from them.

The Bridgehead Economy, 1788-1820

The description ‘bridgehead economy’ was used by one of Australia’s foremost economic historians, N. G. Butlin to refer to the earliest decades of British occupation when the colony was essentially a penal institution. The main settlements were at Port Jackson (modern Sydney, 1788) in New South Wales and Hobart (1804) in what was then Van Diemen’s Land (modern Tasmania). The colony barely survived its first years and was largely neglected for much of the following quarter-century while the British government was preoccupied by the war with France. An important beginning was nevertheless made in the creation of a private economy to support the penal regime. Above all, agriculture was established on the basis of land grants to senior officials and emancipated convicts, and limited freedoms were allowed to convicts to supply a range of goods and services. Although economic life depended heavily on the government Commissariat as a supplier of goods, money and foreign exchange, individual rights in property and labor were recognized, and private markets for both started to function. In 1808, the recall of the New South Wales Corps, whose officers had benefited most from access to land and imported goods (thus hopelessly entangling public and private interests), coupled with the appointment of a new governor, Lachlan Macquarie, in the following year, brought about a greater separation of the private economy from the activities and interests of the colonial government. With a significant increase in the numbers transported after 1810, New South Wales’ future became more secure. As laborers, craftsmen, clerks and tradesmen, many convicts possessed the skills required in the new settlements. As their terms expired, they also added permanently to the free population. Over time, this would inevitably change the colony’s character.

Natural Resources and the Colonial Economy, 1820-1930

Pastoral and Rural Expansion

For Butlin, the developments around 1810 were a turning point in the creation of a ‘colonial’ economy. Many historians have preferred to view those during the 1820s as more significant. From that decade, economic growth was based increasingly upon the production of fine wool and other rural commodities for markets in Britain and the industrializing economies of northwestern Europe. This growth was interrupted by two major depressions during the 1840s and 1890s and stimulated in complex ways by the rich gold discoveries in Victoria in 1851, but the underlying dynamics were essentially unchanged. At different times, the extraction of natural resources, whether maritime before the 1840s or later gold and other minerals, was also important. Agriculture, local manufacturing and construction industries expanded to meet the immediate needs of growing populations, which concentrated increasingly in the main urban centers. The colonial economy’s structure, growth of population and significance of urbanization are illustrated in tables 1 and 2. The opportunities for large profits in pastoralism and mining attracted considerable amounts of British capital, while expansion generally was supported by enormous government outlays for transport, communication and urban infrastructures, which also depended heavily on British finance. As the economy expanded, large-scale immigration became necessary to satisfy the growing demand for workers, especially after the end of convict transportation to the eastern mainland in 1840. The costs of immigration were subsidized by colonial governments, with settlers coming predominantly from the United Kingdom and bringing skills that contributed enormously to the economy’s growth. All this provided the foundation for the establishment of free colonial societies. In turn, the institutions associated with these — including the rule of law, secure property rights, and stable and democratic political systems — created conditions that, on balance, fostered growth. In addition to New South Wales, four other British colonies were established on the mainland: Western Australia (1829), South Australia (1836), Victoria (1851) and Queensland (1859). Van Diemen’s Land (Tasmania after 1856) became a separate colony in 1825. From the 1850s, these colonies acquired responsible government. In 1901, they federated, creating the Commonwealth of Australia.

Table 1
The Colonial Economy: Percentage Shares of GDP, 1891 Prices, 1861-1911

Pastoral Other rural Mining Manuf. Building Services Rent
1861 9.3 13.0 17.5 14.2 8.4 28.8 8.6
1891 16.1 12.4 6.7 16.6 8.5 29.2 10.3
1911 14.8 16.7 9.0 17.1 5.3 28.7 8.3

Source: Haig (2001), Table A1. Totals do not sum to 100 because of rounding.

Table 2
Colonial Populations (thousands), 1851-1911

Australia Colonies Cities
NSW Victoria Sydney Melbourne
1851 257 100 46 54 29
1861 669 198 328 96 125
1891 1,704 608 598 400 473
1911 2,313 858 656 648 593

Source: McCarty (1974), p. 21; Vamplew (1987), POP 26-34.

The process of colonial growth began with two related developments. First, in 1820, Macquarie responded to land pressure in the districts immediately surrounding Sydney by relaxing restrictions on settlement. Soon the outward movement of herdsmen seeking new pastures became uncontrollable. From the 1820s, the British authorities also encouraged private enterprise by the wholesale assignment of convicts to private employers and easy access to land. In 1831, the principles of systematic colonization popularized by Edward Gibbon Wakefield (1796-1862) were put into practice in New South Wales with the substitution of land sales for grants in order to finance immigration. This, however, did not affect the continued outward movement of pastoralists who simply occupied land where could find it beyond the official limits of settlement. By 1840, they had claimed a vast swathe of territory two hundred miles in depth running from Moreton Bay in the north (the site of modern Brisbane) through the Port Phillip District (the future colony of Victoria, whose capital Melbourne was marked out in 1837) to Adelaide in South Australia. The absence of any legal title meant that these intruders became known as ‘squatters’ and the terms of their tenure were not finally settled until 1846 after a prolonged political struggle with the Governor of New South Wales, Sir George Gipps.

The impact of the original penal settlements on the indigenous population had been enormous. The consequences of squatting after 1820 were equally devastating as the land and natural resources upon which indigenous hunter-gathering activities and environmental management depended were appropriated on a massive scale. Aboriginal populations collapsed in the face of disease, violence and forced removal until they survived only on the margins of the new pastoral economy, on government reserves, or in the arid parts of the continent least touched by white settlement. The process would be repeated again in northern Australia during the second half of the century.

For the colonists this could happen because Australia was considered terra nullius, vacant land freely available for occupation and exploitation. The encouragement of private enterprise, the reception of Wakefieldian ideas, and the wholesale spread of white settlement were all part of a profound transformation in official and private perceptions of Australia’s prospects and economic value as a British colony. Millennia of fire-stick management to assist hunter-gathering had created inland grasslands in the southeast that were ideally suited to the production of fine wool. Both the physical environment and the official incentives just described raised expectations of considerable profits to be made in pastoral enterprise and attracted a growing stream of British capital in the form of organizations like the Australian Agricultural Company (1824); new corporate settlements in Western Australia (1829) and South Australia (1836); and, from the 1830s, British banks and mortgage companies formed to operate in the colonies. By the 1830s, wool had overtaken whale oil as the colony’s most important export, and by 1850 New South Wales had displaced Germany as the main overseas supplier to British industry (see table 3). Allowing for the colonial economy’s growing complexity, the cycle of growth based upon land settlement, exports and British capital would be repeated twice. The first pastoral boom ended in a depression which was at its worst during 1842-43. Although output continued to grow during the 1840s, the best land had been occupied in the absence of substantial investment in fencing and water supplies. Without further geographical expansion, opportunities for high profits were reduced and the flow of British capital dried up, contributing to a wider downturn caused by drought and mercantile failure.

Table 3
Imports of Wool into Britain (thousands of bales), 1830-50

German Australian
1830 74.5 8.0
1840 63.3 41.0
1850 30.5 137.2

Source: Sinclair (1976), p. 46

When pastoral growth revived during the 1860s, borrowed funds were used to fence properties and secure access to water. This in turn allowed a further extension of pastoral production into the more environmentally fragile semi-arid interior districts of New South Wales, particularly during the 1880s. As the mobs of sheep moved further inland, colonial governments increased the scale of their railway construction programs, some competing to capture the freight to ports. Technical innovation and government sponsorship of land settlement brought greater diversity to the rural economy (see table 4). Exports of South Australian wheat started in the 1870s. The development of drought resistant grain varieties from the turn of the century led to an enormous expansion of sown acreage in both the southeast and southwest. From the 1880s, sugar production increased in Queensland, although mainly for the domestic market. From the 1890s, refrigeration made it possible to export meat, dairy products and fruit.

Table 4
Australian Exports (percentages of total value of exports), 1881-1928/29

Wool Minerals Wheat,flour Butter Meat Fruit
1881-90 54.1 27.2 5.3 0.1 1.2 0.2
1891-1900 43.5 33.1 2.9 2.4 4.1 0.3
1901-13 34.3 35.4 9.7 4.1 5.1 0.5
1920/21-1928/29 42.9 8.8 20.5 5.6 4.6 2.2

Source: Sinclair (1976), p. 166

Gold and Its Consequences

Alongside rural growth and diversification, the remarkable gold discoveries in central Victoria in 1851 brought increased complexity to the process of economic development. The news sparked an immediate surge of gold seekers into the colony, which was soon reinforced by a flood of overseas migrants. Until the 1870s, gold displaced wool as Australia’s most valuable export. Rural industries either expanded output (wheat in South Australia) or, in the case of pastoralists, switched production to meat and tallow, to supply a much larger domestic market. Minerals had been extracted since earliest settlement and, while yields on the Victorian gold fields soon declined, rich mineral deposits continued to be found. During the 1880s alone these included silver, lead and zinc at Broken Hill in New South Wales; copper at Mount Lyell in Tasmania; and gold at Charters Towers and Mount Morgan in Queensland. From 1893, what eventually became the richest goldfields in Australia were discovered at Coolgardie in Western Australia. The mining industry’s overall contribution to output and exports is illustrated in tables 1 and 4.

In Victoria, the deposits of easily extracted alluvial gold were soon exhausted and mining was taken over by companies that could command the financial and organizational resources needed to work the deep lodes. But the enormous permanent addition to the colonial population caused by the gold rush had profound effects throughout eastern Australia, dramatically accelerating the growth of the local market and workforce, and deeply disturbing the social balance that had emerged during the decade before. Between 1851 and 1861, the Australian population more than doubled. In Victoria it increased sevenfold; Melbourne outgrew Sydney, Chicago and San Francisco (see table 2). Significantly enlarged populations required social infrastructure, political representation, employment and land; and the new colonial legislatures were compelled to respond. The way this was played out varied between colonies but the common outcomes were the introduction of manhood suffrage, access to land through ‘free selection’ of small holdings, and, in the Victorian case, the introduction of a protectionist tariff in 1865. The particular age structure of the migrants of the 1850s also had long-term effects on the building cycle, notably in Victoria. The demand for housing accelerated during the 1880s, as the children of the gold generation matured and established their own households. With pastoral expansion and public investment also nearing their peaks, the colony experienced a speculative boom which added to the imbalances already being caused by falling export prices and rising overseas debt. The boom ended with the wholesale collapse of building companies, mortgage banks and other financial institutions during 1891-92 and the stoppage of much of the banking system during 1893.

The depression of the 1890s was worst in Victoria. Its impact on employment was softened by the Western Australian gold discoveries, which drew population away, but the colonial economy had grown to such an extent since the 1850s that the stimulus provided by the earlier gold finds could not be repeated. Severe drought in eastern Australia from the mid-1890s until 1903 caused the pastoral industry to contract. Yet, as we have seen, technological innovation also created opportunities for other rural producers, who were now heavily supported by government with little direct involvement by foreign investors. The final phase of rural expansion, with its associated public investment in rural (and increasingly urban) infrastructure continued until the end of the 1920s. Yields declined, however, as farmers moved onto the most marginal land. The terms of trade also deteriorated with the oversupply of several commodities in world markets after the First World War. As a result, the burden of servicing foreign debt rose once again. Australia’s position as a capital importer and exporter of natural resources meant that the Great Depression arrived early. From late 1929, the closure of overseas capital markets and collapse of export prices forced the Federal Government to take drastic measures to protect the balance of payments. The falls in investment and income transmitted the contraction to the rest of the economy. By 1932, average monthly unemployment amongst trade union members was over 22 percent. Although natural resource industries continued to have enduring importance as earners of foreign exchange, the Depression finally ended the long period in which land settlement and technical innovation had together provided a secure foundation for economic growth.

Manufacturing and the Protected Economy, 1891-1973

The ‘Australian Settlement’

There is a considerable chronological overlap between the previous section, which surveyed the growth of a colonial economy during the nineteenth century based on the exploitation of natural resources, and this one because it is a convenient way of approaching the two most important developments in Australian economic history between Federation and the 1970s: the enormous increase in government regulation after 1901 and, closely linked to this, the expansion of domestic manufacturing, which from the Second World War became the most dynamic part of the Australian economy.

The creation of the Commonwealth of Australia on 1 January 1901 broadened the opportunities for public intervention in private markets. The new Federal Government was given clearly-defined but limited powers over obviously ‘national’ matters like customs duties. The rest, including many affecting economic development and social welfare, remained with the states. The most immediate economic consequence was the abolition of inter-colonial tariffs and the establishment of a single Australian market. But the Commonwealth also soon set about transferring to the national level several institutions that different the colonies had experimented with during the 1890s. These included arrangements for the compulsory arbitration of industrial disputes by government tribunals, which also had the power to fix wages, and a discriminatory ‘white Australia’ immigration policy designed to exclude non-Europeans from the labor market. Both were partly responses to organized labor’s electoral success during the 1890s. Urban business and professional interests had always been represented in colonial legislatures; during the 1910s, rural producers also formed their own political parties. Subsequently, state and federal governments were typically formed by the either Australian Labor Party or coalitions of urban conservatives and the Country Party. The constituencies they each represented were thus able to influence the regulatory structure to protect themselves against the full impact of market outcomes, whether in the form of import competition, volatile commodity prices or uncertain employment conditions. The institutional arrangements they created have been described as the ‘Australian settlement’ because they balanced competing producer interests and arguably provided a stable framework for economic development until the 1970s, despite the inevitable costs.

The Growth of Manufacturing

An important part of the ‘Australian settlement’ was the imposition of a uniform federal tariff and its eventual elaboration into a system of ‘protection all round’. The original intended beneficiaries were manufacturers and their employees; indeed, when the first protectionist tariff was introduced in 1907, its operation was linked to the requirement that employers pay their workers ‘fair and reasonable wages’. Manufacturing’s actual contribution to economic growth before Federation has been controversial. The population influx of the 1850s widened opportunities for import-substitution but the best evidence suggests that manufacturing grew slowly as the industrial workforce increased (see table 1). Production was small-scale and confined largely to the processing of rural products and raw materials; assembly and repair-work; or the manufacture of goods for immediate consumption (e.g. soap and candle-making, brewing and distilling). Clothing and textile output was limited to a few lines. For all manufacturing, growth was restrained by the market’s small size and the limited opportunities for technical change it afforded.

After Federation, production was stimulated by several factors: rural expansion, the increasing use of agricultural machinery and refrigeration equipment, and the growing propensity of farm incomes to be spent locally. The removal of inter-colonial tariffs may also have helped. The statistical evidence indicates that between 1901 and the outbreak of the First World War manufacturing grew faster than the economy as a whole, while output per worker increased. But manufacturers also aspired mainly to supply the domestic market and expended increasing energy on retaining privileged access. Tariffs rose considerably between the two world wars. Some sectors became more capital intensive, particularly with the establishment of a local steel industry, the beginnings of automobile manufacture, and the greater use of electricity. But, except during the first half of the 1920s, there was little increase in labor productivity and the inter-war expansion of textile manufacturing reflected the heavy bias towards import substitution. Not until the Second World War and after did manufacturing growth accelerate and extend to those sectors most characteristic of an advance industrial economy (table 5). Amongst these were automobiles, chemicals, electrical and electronic equipment, and iron-and-steel. Growth was sustained during 1950s by similar factors to those operating in other countries during the ‘long boom’, including a growing stream of American direct investment, access to new and better technology, and stable conditions of full employment.

Table 5
Manufacturing and the Australian Economy, 1913-1949

1938-39 prices
Manufacturing share of GDP % Manufacturing annual rate of growth % GDP, annual rate of growth %
1913/14 21.9
1928/29 23.6 2.6 2.1
1948/49 29.8 3.4 2.2

Calculated from Haig (2001), Table A2. Rates of change are average annual changes since the previous year in the first column.

Manufacturing peaked in the mid-1960s at about 28 percent of national output (measured in 1968-69 prices) but natural resource industries remained the most important suppliers of exports. Since the 1920s, over-supply in world markets and the need to compensate farmers for manufacturing protection, had meant that virtually all rural industries, with the exception of wool, had been drawn into a complicated system of subsidies, price controls and market interventions at both federal and state levels. The post-war boom in the world economy increased demand for commodities, benefiting rural producers but also creating new opportunities for Australian miners. Most important of all, the first surge of breakneck growth in East Asia opened a vast new market for iron ore, coal and other mining products. Britain’s significance as a trading partner had declined markedly since the 1950s. By the end of the 1960s, Japan overtook it as Australia’s largest customer, while the United States was now the main provider of imports.

The mining bonanza contributed to the boom conditions experienced generally after 1950. The Federal Government played its part by using the full range of macroeconomic policies that were also increasingly familiar in similar western countries to secure stability and full employment. It encouraged high immigration, relaxing the entry criteria to allow in large numbers of southern Europeans, who added directly to the workforce, but also brought knowledge and experience. With state governments, the Commonwealth increased expenditure on education significantly, effectively entering the field for the first time after 1945. Access to secondary education was widened with the abandonment of fees in government schools and federal finance secured an enormous expansion of university places, especially after 1960. Some weaknesses remained. Enrolment rates after primary school were below those in many industrial countries and funding for technical education was poor. Despite this, the Australian population’s rising levels of education and skill continued to be important additional sources of growth. Finally, although government advisers expressed misgivings, industry policy remained determinedly interventionist. While state governments competed to attract manufacturing investment with tax and other incentives, by the 1960s protection had reached its highest level, with Australia playing virtually no part in the General Agreement on Tariffs and Trade (GATT), despite being an original signatory. The effects of rising tariffs since 1900 were evident in the considerable decline in Australia’s openness to trade (Table 6). Yet, as the post-war boom approached its end, the country still relied upon commodity exports and foreign investment to purchase the manufactures it was unable to produce itself. The impossibility of sustaining growth in this way was already becoming clear, even though the full implications would only be felt during the decades to come.

Table 6
Trade (Exports Plus Imports)
as a Share of GDP, Current Prices, %

1900/1 44.9
1928/29 36.9
1938/38 32.7
1964/65 33.3
1972/73 29.5

Calculated from Vamplew (1987), ANA 119-129.

Liberalization and Structural Change, 1973-2005

From the beginning of the 1970s, instability in the world economy and weakness at home ended Australia’s experience of the post-war boom. During the following decades, manufacturing’s share in output (table 7) and employment fell, while the long-term relative decline of commodity prices meant that natural resources could no longer be relied on to cover the cost of imports, let alone the long-standing deficits in payments for services, migrant remittances and interest on foreign debt. Until the early 1990s, Australia also suffered from persistent inflation and rising unemployment (which remained permanently higher, see chart 1). As a consequence, per capita incomes fluctuated during the 1970s, and the economy contracted in absolute terms during 1982-83 and 1990-91.

Even before the 1970s, new sources of growth and rising living standards had been needed, but the opportunities for economic change were restricted by the elaborate regulatory structure that had evolved since Federation. During that decade itself, policy and outlook were essentially defensive and backward looking, despite calls for reform and some willingness to alter the tariff. Governments sought to protect employment in established industries, while dependence on mineral exports actually increased as a result of the commodity booms at the decade’s beginning and end. By the 1980s, however, it was clear that the country’s existing institutions were failing and fundamental reform was required.

Table 7
The Australian Economy, 1974-2004

A. Percentage shares of value-added, constant prices

1974 1984 1994 2002
Agriculture 4.4 4.3 3.0 2.7
Manufacturing 18.1 15.2 13.3 11.8
Other industry, inc. mining 14.2 14.0 14.6 14.4
Services 63.4 66.4 69.1 71.1

B. Per capita GDP, annual average rate of growth %, constant prices

1973-84 1.2
1984-94 1.7
1994-2004 2.5

Calculated from World Bank, World Development Indicators (Sept. 2005).

Figure 1
Unemployment, 1971-2005, percent

Unemployment, 1971-2005, percent

Source: Reserve Bank of Australia (1988); Reserve Bank of Australia, G07Hist.xls. Survey data at August. The method of data collection changed in 1978.

The catalyst was the resumption of the relative fall of commodity prices since the Second World War which meant that the cost of purchasing manufactured goods inexorably rose for primary producers. The decline had been temporarily reversed by the oil shocks of the 1970s but, from the 1980/81 financial year until the decade’s end, the value of Australia’s merchandise imports exceeded that of merchandise exports in every year but two. The overall deficit on current account measured as a proportion of GDP also moved became permanently higher, averaging around 4.7 percent. During the 1930s, deflation had been followed by the further closing of the Australian economy. There was no longer much scope for this. Manufacturing had stagnated since the 1960s, suffering especially from the inflation of wage and other costs during the 1970s. It was particularly badly affected by the recession of 1982-83, when unemployment rose to almost ten percent, its highest level since the Great Depression. In 1983, a new federal Labor Government led by Bob Hawke sought to engineer a recovery through an ‘Accord’ with the trade union movement which aimed at creating employment by holding down real wages. But under Hawke and his Treasurer, Paul Keating — who warned colorfully that otherwise the country risked becoming a ‘banana republic’ — Labor also started to introduce broader reforms to increase the efficiency of Australian firms by improving their access to foreign finance and exposing them to greater competition. Costs would fall and exports of more profitable manufactures increase, reducing the economy’s dependence on commodities. During the 1980s and 1990s, the reforms deepened and widened, extending to state governments and continuing with the election of a conservative Liberal-National Party government under John Howard in 1996, as each act of deregulation invited further measures to consolidate them and increase their effectiveness. Key reforms included the floating of the Australian dollar and the deregulation of the financial system; the progressive removal of protection of most manufacturing and agriculture; the dismantling of the centralized system of wage-fixing; taxation reform; and the promotion of greater competition and better resource use through privatization and the restructuring of publicly-owned corporations, the elimination of government monopolies, and the deregulation of sectors like transport and telecommunications. In contrast with the 1930s, the prospects of further domestic reform were improved by an increasingly favorable international climate. Australia contributed by joining other nations in the Cairns Group to negotiate reductions of agricultural protection during the Uruguay round of GATT negotiations and by promoting regional liberalization through the Asia Pacific Economic Cooperation (APEC) forum.

Table 8
Exports and Openness, 1983-2004

Shares of total exports, % Shares of GDP: exports + imports, %
Goods Services
Rural Resource Manuf. Other
1983 30 34 9 3 24 26
1989 23 37 11 5 24 27
1999 20 34 17 4 24 37
2004 18 33 19 6 23 39

Calculated from: Reserve Bank of Australia, G10Hist.xls and H03Hist.xls; World Bank, World Development Indicators (Sept. 2005). Chain volume measures, except shares of GDP, 1983, which are at current prices.

The extent to which institutional reform had successfully brought about long-term structural change was still not clear at the end of the century. Recovery from the 1982-83 recession was based upon a strong revival of employment. By contrast, the uninterrupted growth experienced since 1992 arose from increases in the combined productivity of workers and capital. If this persisted, it was a historic change in the sources of growth from reliance on the accumulation of capital and the increase of the workforce to improvements in the efficiency of both. From the 1990s, the Australian economy also became more open (table 8). Manufactured goods increased their share of exports, while rural products continued to decline. Yet, although growth was more broadly-based, rapid and sustained (table 7), the country continued to experience large trade and current account deficits, which were augmented by the considerable increase of foreign debt after financial deregulation during the 1980s. Unemployment also failed to return to its pre-1974 level of around 2 percent, although much of the permanent rise occurred during the mid to late 1970s. In 2005, it remained 5 percent (Figure 1). Institutional reform clearly contributed to these changes in economic structure and performance but they were also influenced by other factors, including falling transport costs, the communications and information revolutions, the greater openness of the international economy, and the remarkable burst of economic growth during the century’s final decades in southeast and east Asia, above all China. Reform was also complemented by policies to provide the skills needed in a technologically-sophisticated, increasingly service-oriented economy. Retention rates in the last years of secondary education doubled during the 1980s, followed by a sharp increase of enrolments in technical colleges and universities. By 2002, total expenditure on education as a proportion of national income had caught up with the average of member countries of the OECD (Table 9). Shortages were nevertheless beginning to be experienced in the engineering and other skilled trades, raising questions about some priorities and the diminishing relative financial contribution of government to tertiary education.

Table 9
Tertiary Enrolments and Education Expenditure, 2002

Tertiary enrolments, gross percent Education expenditure as a proportion of GDP, percent
Australia 63.22 6.0
OECD 61.68 5.8
United States 70.67 7.2

Source: World Bank, World Development Indicators (Sept. 2005); OECD (2005). Gross enrolments are total enrolments, regardless of age, as a proportion of the population in the relevant official age group. OECD enrolments are for fifteen high-income members only.

Summing Up: The Australian Economy in a Wider Context

Virtually since the beginning of European occupation, the Australian economy had provided the original British colonizers, generations of migrants, and the descendants of both with a remarkably high standard of living. Towards the end of the nineteenth century, this was by all measures the highest in the world (see table 10). After 1900, national income per member of the population slipped behind that of several countries, but continued to compare favorably with most. In 2004, Australia was ranked behind only Norway and Sweden in the United Nation’s Human Development Index. Economic historians have differed over the sources of growth that made this possible. Butlin emphasized the significance of local factors like the unusually high rate of urbanization and the expansion of domestic manufacturing. In important respects, however, Australia was subject to the same forces as other European settler societies in New Zealand and Latin America, and its development bore striking similarities to theirs. From the 1820s, its economy grew as one frontier of an expanding western capitalism. With its close institutional ties to, and complementarities with, the most dynamic parts of the world economy, it drew capital and migrants from them, supplied them with commodities, and shared the benefits of their growth. Like other settler societies, it sought population growth as an end in itself and, from the turn of the nineteenth century, aspired to the creation of a national manufacturing base. Finally, when openness to the world economy appeared to threaten growth and living standards, governments intervened to regulate and protect with broader social objectives in mind. But there were also striking contrasts with other settler economies, notably those in Latin America like Argentina, with which it has been frequently compared. In particular, Australia responded to successive challenges to growth by finding new opportunities for wealth creation with a minimum of political disturbance, social conflict or economic instability, while sharing a rising national income as widely as possible.

Table 10
Per capita GDP in Australia, United States and Argentina
(1990 international dollars)

Australia United States Argentina
1870 3,641 2,457 1,311
1890 4,433 3,396 2,152
1950 7,493 9,561 4,987
1998 20,390 27,331 9,219

Sources: Australia: GDP, Haig (2001) as converted in Maddison (2003); all other data Maddison (1995) and (2001)

From the mid-twentieth century, Australia’s experience also resembled that of many advanced western countries. This included the post-war willingness to use macroeconomic policy to maintain growth and full employment; and, after the 1970s, the abandonment of much government intervention in private markets while at the same time retaining strong social services and seeking to improve education and training. Australia also experienced a similar relative decline of manufacturing, permanent rise of unemployment, and transition to a more service-based economy typical of high income countries. By the beginning of the new millennium, services accounted for over 70 percent of national income (table 7). Australia remained vulnerable as an exporter of commodities and importer of capital but its endowment of natural resources and the skills of its population were also creating opportunities. The country was again favorably positioned to take advantage of growth in the most dynamic parts of the world economy, particularly China. With the final abandonment of the White Australia policy during the 1970s, it had also started to integrate more closely with its region. This was further evidence of the capacity to change that allowed Australians to face the future with confidence.

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Citation: Attard, Bernard. “The Economic History of Australia from 1788: An Introduction”. EH.Net Encyclopedia, edited by Robert Whaples. March 16, 2008. URL
http://eh.net/encyclopedia/the-economic-history-of-australia-from-1788-an-introduction/

Railroaded: The Transcontinentals and the Making of Modern America

Author(s):White, Richard
Reviewer(s):Brown, John Howard

Published by EH.Net (June 2012)

Richard White, Railroaded: The Transcontinentals and the Making of Modern America. New York: Norton, 2011. xxxix + 621 pp. $35 (hardcover), ISBN: 978-0-393-06126-0.

Reviewed for EH.Net by John Howard Brown, School of Economic Development, Georgia Southern University.

Richard White?s Railroaded is a professional tour de force. This book provides an overview of the development of railroads in United States west of the Missouri River. The timeframe covered is the last third of the nineteenth century. The volume invites reflection on how the nineteenth century experience is related to the travails of our twenty-first century market economy.?

White?s thesis has several distinct themes. The first, and most prominent, theme is that there was no economic rationale for building even one railroad between the great valleys of the west coast and the Missouri basin.? (Or course, the federal government might well have entertained political, and what are now called national security, considerations in the decision to create a transcontinental railroad system.)? In the era of transcontinental railroad building between roughly 1865 and 1895, local populations in this vast region were too small to generate much in the way of paying freight. At the same time, California?s central valley and the Willamette in Oregon were adequately served by steamships and purely local railroads.

This led to the original sin in the creation of these roads. Government land grants were employed as subsidies for construction. Even more important, the U.S. government?s credit was employed to guarantee the creditworthiness of the enterprises. To put this into contemporary economic jargon, an opportunity for rent-seeking was created. The power of human cupidity in service of this opportunity for rent extraction is well documented.

This book lays to rest the fantasy that markets in the late nineteenth-century United States were any sort of libertarian idyll.? As White documents, the great transcontinental railroads recognized the need for ?friends? in government. This rather peculiar friendship was acquired, if not by out-and-out bribery, by substantial material considerations.? Both sides of the transaction were unembarrassed by the naked solicitation and dispensing of such ?tokens? of friendship.

The second major theme of the book is of endemic corruption and insider enrichment. White demonstrates that those in control of these vast honeypots viewed them more as a means to build personal fortunes than railroads. Self-dealing, by setting up a construction company to soak up the largest share of the wealth made available, was routine.?

In addition to the U.S. government, a more or less willing victim, the biggest losers in these frauds were foreign investors in American railroads. It hardly needs emphasizing that foreign (and domestic) investors have suffered a similar fate during the recent sub-prime mortgage initiated debacle.

White?s third theme is the economic, and related environmental, effects of the transcontinental railroad systems. The fourth chapter, ?Spatial Politics,? is a brilliant exposition of the transformation of the economic geography wrought by the coming of railroads. In simplest terms, rail transportation integrated localities out of reach of tidewater into the world economy by making it feasible to ship relatively low valued goods over great distances.

However, in a later chapter, ironically titled, ?Creative Destruction,? White compellingly demonstrates that this integration was not an unmixed blessing.? In fact, from the point of view of the integrity of ecosystems and the natural environment, he labels it an unmitigated disaster.? The transcontinental railroads? thirst for freight drove several successive economic booms with devastating effects on both the native flora and fauna and distant investors.

The first of these involved the trade in buffalo hides.? Cheap transportation provided by the southern transcontinentals was the catalyst for the industrial-scale slaughter of the great southern buffalo herd. The extermination of these beasts was accomplished in a matter of a few years, and the speculators moved on to find the next big thing.

As it happens the next boom is etched into the romantic imagination of American history, the long distance cattle drive, and subsequently, free range ranching.? The original drives were intended not only to move cattle efficiently to market, but also to eliminate parasites that were potentially devastating to other cattle breeds. The rail towns west of the Missouri were appealing precisely because there were few cattle to be infected by the parasites carried by Texas longhorn cattle. This boom was short-lived because longhorns were not very satisfactory beef cattle.

The lure of the vast, unfenced grasslands of the Great Plains soon created industrial-scale ranching. These enterprises were fueled by foreign capital and ?perhaps irrational exuberance.?? The promoters thought natural increase and free grazing would result in vast herds which might be sold with only the expense of gathering them and delivering them to the rails. White takes great pains to note the accounting tricks employed by the cattle companies were as egregious as Enron?s a century and a quarter later. This boom also collapsed quickly when it turned out that Corn Belt farmers could raise higher quality cattle more cheaply than free ranging cattle.? In addition to the excessive mortality of free range cattle, these cattle damaged the fragile riverine ecologies of these semiarid regions.

After the collapse of the cattle boom, the railroads attempted to promote dry farming exploiting the claim that, ?rain follows the plow.? Thus the final boom which White charts was wheat-growing in what later became North Dakota, and throughout the semiarid Great Plains generally.? This industry, too, had its day. This occurred largely, according to White, because freight rates fell even more rapidly than wheat prices. A combination of technical advance and the transcontinental roads? hunger for traffic was sufficient to secure this result.? In addition, the weather was unusually wet on the high plains in the 1880s.? When more normal conditions subsequently returned, farmers abandoned the plains in great numbers.?

What connects these episodes?? All of the booms involved the appropriation of resources that either had not been exploited previously or, as in the case of grazing, were available as a usufruct right. The chapter title where these events are related references Joseph Schumpeter?s (1942), Capitalism, Socialism, and Democracy.? In one sense, this is unfair, since Schumpeter saw ?creative destruction? as the force within the capitalist market system which limited the scope and force of monopoly. Thus for him, creative destruction worked at the level of the individual firm, undermining any transitory monopoly a firm might acquire.? A firm with an established monopoly in a product category inevitably faced challenges from innovators offering improved versions of a product. These innovators threatened the erstwhile monopolist with displacement from its dominant role in the market.

Schumpeter?s optimism about capitalist outcomes was grounded in the notion that competition for monopoly rents must always redound to the benefit of the consumer and society as a whole.? However, he never addressed resources which were outside of the existing scope of the market economy.

Heilbroner (1985) posited that a capitalist economy expands, at least in part, by creating market commodities where none existed before.? Seen in this light, the transcontinental railroads facilitated this commodification process in the high plains and intermountain West. The attendant booms were fueled by an exuberance that, at least in retrospect, appears to have been irrational.?

What lessons do these historical episodes have a century and a quarter later?? Both the Internet boom of the 1990s and the subprime episode of early in this century have roots in the same process of commodity creation. In both, novel forms of property were being created and a ?land rush? atmosphere prevailed. In parallel with the nineteenth century events, the bubbles were driven by irrational exuberance, and the chief victims were not the ?boomers.? Instead, the investors drawn by the promise of easy returns in a transformed economy were the victims.

This suggests that Schumpeter?s framework ought to be extended by recognizing both an intensive and extensive margin in an economy for those struggling for economic rents.? The intensive margin was what Schumpeter analyzed.? Competition within an existing framework of markets functions as the source of creative destruction.? An example of this process was Apple?s introduction of the iPod.? There were already devices offering playback of digital audio files, however, the iPod overwhelmed them because of its superior design.

The extensive margin exists where entirely novel varieties of property rights are being created.? Irrational exuberance plays its part here, because there is no frame of reference for evaluating the claims of insiders. Apple?s creation of the Apple II is an example rent-seeking on the extensive margin. Microcomputers represented an entirely new class of product.? The resulting ?land rush? in the early 1980s was as chaotic as the booms described by White, before it was prematurely ended by IBM?s introduction of its Personal Computer (PC).? Competition in this market then proceeded along what I have characterized as the intensive margin with IBM ultimately exiting, the victim of creative destruction.

White?s history thus demonstrates the essential continuity of American-style capitalism from the latter half of the nineteenth century to the early twenty-first.? Irrational exuberance is not a new phenomenon, rather it seems inherent where technical or legal change creates new opportunities for acquiring property rights.?? Financial shenanigans and ?creative? bookkeeping are likewise not novelties enabled by some uniquely modern depravity.? Finally, a noteworthy role for government in business, and business in government, was not an invention of Franklin Roosevelt and the New Deal.? None of this will surprise economic historians.? However, White?s prose is lively and his presentation highly engaging.? A non-specialist will find this book to be rewarding reading.

References:

Heilbroner, Robert L. (1985), The Nature and Logic of Capitalism, New York: W.W. Norton & Company.

Schumpeter, Joseph (1942), Capitalism, Socialism, and Democracy, New York: Harper and Brothers.

John Howard Brown is an Associate Professor in the Finance and Economics Department at Georgia Southern University.? He recently served as guest editor and author in a special issue of the Review of Industrial Organization memorializing the centennial of the Standard Oil antitrust decision.

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Subject(s):Agriculture, Natural Resources, and Extractive Industries
Business History
Transport and Distribution, Energy, and Other Services
Geographic Area(s):North America
Time Period(s):19th Century