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Borrowed Time: Two Centuries of Booms, Busts, and Bailouts at Citi

Author(s):Freeman, James
McKinley, Vern
Reviewer(s):Hogan, Thomas L.

Published by EH.Net (December 2018)

James Freeman and Vern McKinley, Borrowed Time: Two Centuries of Booms, Busts, and Bailouts at Citi. New York: Harper Business, 2018. xiv + 365 pp. $35 (hardcover),
ISBN: 978-0-06-266987-2.

Reviewed for EH.Net by Thomas L. Hogan, Baker Institute for Public Policy, Rice University.

 
Freeman and McKinley’s Borrowed Time provides a history of Citibank and its central role in the evolution of the banking system in the United States. Since its founding in 1812, Citi (originally City Bank of New York) has been among the largest commercial banks in the country. As such, it has been inexorably entwined with developments in the banking system as well as the major cycles, crashes, and crises faced by the U.S. economy.

Two major themes stand out in the book. First, Citi’s risk profile was highly dependent on the personalities of its managers and oscillated over time between the extremes of risk-avoidance and risk-loving. Presidents Moses Taylor (1856-1882) and James Stillman (1891-1909), for example, pursued “ready money” policies of high reserve and capital ratios, while others such as Frank Vanderlip (1909-1919), Charles Mitchell (1921-1933), Walter Wriston (1967-1984), and Charles Prince (2003-2007) steered the bank through periods of massive expansion and greater risk appetite. Freeman and McKinley construct the narrative of Citi’s history around biographical sketches of these men and how their backgrounds guided the bank’s path.

Second, and perhaps more important, were Citi’s persistent ties to the government. Several of its early directors were former politicians. Vanderlip, who would become Citi’s president, was hired directly from the Department of the Treasury, as was recent executive and board member Robert Rubin. Jack Lew left Citi in 2008 to join the Obama administration, eventually becoming Secretary of the Treasury, while John Dugan, former Comptroller of the Currency, became the chairman of Citi’s board of directors in 2017. Through direct and indirect political influence, Citi helped craft the Federal Reserve Act and influence other important legislation.

While Citi did participate in, and often led, bank risk trends in the United States, it did not, according to Freeman and McKinley, play a causal role in the Great Depression or in the 2008 financial crisis. Depression-era politicians blamed Citi affiliate National City Company for encouraging stock market speculation and excessive leverage. While National City’s lending may have fueled the growing market, the Fed was the source of monetary contraction that crashed the stock market and ultimately the banking system (pp. 149-154). Similarly, Citi in the early 2000s was a proponent and facilitator of collateralized debt obligations (CDOs) that “triggered billions of dollars in losses” (p. 267), but losses were even greater on its own “bread-and-butter commercial banking activities” (p. 269), including subprime and consumer loans. The book attributes the broader housing crisis to a combination of economic factors including federal housing policy, the government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, and unduly low interest rates from the Fed.

While not a cause of the crises, Citi has repeatedly, according to the authors, been instrumental in pushing for government bailouts of U.S. banks. Citi “accepted one of the biggest bailouts of the Great Depression” (p. 166), and it played a part it organizing loans to Mexico and other Latin American governments to which Citi was a creditor. Freeman and McKinley argue that in the recent crisis many of the government’s assistance programs were aimed to protect Citi, which was deemed by some regulators as “systemically important” and vital to the function of the banking system. As Federal Deposit Insurance Corporation (FDIC) chair Shelia Bair later wrote, “I frequently wonder whether, if Citi had not been in trouble, we would have had those massive bailout programs” (quoted on p. 288).

Freeman and McKinley use Citi to illustrate a variety of economic concepts such as the problems created by restrictions on branch banking, regulatory capture, and the political economy of the Fed, as well as the causes of the Great Depression and 2008 financial crisis. While these explanations are readable and concise, I worry that casual readers will fail to appreciate the sophistication of such arguments due to the brevity of their descriptions. Given that the book is published by a business press, such summaries may be ideal for its intended audience, but I found the economic reasoning to be elegantly stated and would have liked to have seen it fleshed out in greater detail for the benefit of readers not familiar with such concepts.

Similarly, while many of the anecdotes are entertaining, I would have preferred greater historical detail. In addition, some statements in the book deserve a higher degree of critical examination. For example, the authors accept Jamie Dimon’s assertion that JP Morgan Chase had a “fortress balance sheet” (p. 263). That claim, however, seems more rhetoric than reality considering that the company’s market value fell by more than 70% during the financial crisis. The authors repeatedly state that few large banks today have equity ratios of 10% or more. In fact, because banks with more than $250 million in total assets are subject to additional regulations, most of the largest U.S. banks have capital ratios above 10%. As of the end of 2017, for example, the average capital ratio of the top 10 largest banks was 10.9% (measured as a percentage of total assets, not the currently popular method of risk-weighted assets). These limitations, however, do not detract from the book’s main theses or its readability.

I found Borrowed Time to be an interesting and entertaining read. The authors do an excellent job of blending history and economics with the personalized story of one of America’s oldest and most important financial institutions.

 
Thomas L. Hogan is a fellow in Rice University’s Baker Institute for Public Policy. His research has been published in academic journals such as Economic Inquiry, the Journal of Regulatory Economics, and the Journal of Money, Credit and Banking.

Copyright (c) 2018 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 (December 2018). All EH.Net reviews are archived at http://www.eh.net/BookReview.

Subject(s):Business History
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

Wall Streeters: The Creators and Corruptors of American Finance

Author(s):Morris, Edward
Reviewer(s):Thies, Clifford F.

Published by EH.Net (January 2016)

Edward Morris, Wall Streeters: The Creators and Corruptors of American Finance. New York: Columbia University Press, 2015. xv + 344 pp. $30 (cloth), ISBN: 978-231-17054-3.

Reviewed for EH.Net by Clifford F. Thies, School of Business, Shenandoah University.

Edward Morris is a professor of finance and a former dean of the school of business of Lindenwood University in St. Charles, Missouri, and was an investment banker with Stifel, Nicolaus & Co. His book, Wall Streeters, is adapted from his course History of Modern Finance, taught through the prism of short biographies spanning the period from the late nineteenth century to the present.

Fourteen mini-biographies are compiled, beginning with J.P. Morgan. Three examine politicians instrumental in the organization of the Federal Reserve and the Securities and Exchange Commission. Two concern investment bankers who expanded the market in corporate stock following World War II. Three examine academics that contributed to our understanding of finance. Three other chapters look at recent investment bankers notable for financial innovations. The final two look at recent investment bankers who assembled financial conglomerates. The chapters are arranged in rough chronological order, with themes appropriate to each major period, and which together span the professions concerned with investment banking.

The chapters are cribbed from a relatively short list of reference materials, most of which are popular biographies and histories. The strength of the book is its survey of somewhat more than a hundred years of finance through a series of biographies. For many readers, this is more engaging than a history devoid of human quality. The author exhibits an ability to tell an informative and satisfying story within the parameters the work requires. The writing is fluid when focused on particular times and places, but jumpy at points. Short introductions of the sections help with the transitions.

Morris reveals his perspective in the introduction to the section comprising chapters 2 to 4 (p. 13). There are two perspectives, he says, the minimalists, who argue that bankers “will naturally act in a responsible manner;” and, the “realists,” who “hold no illusions,” and recognize that bankers will “look after their short-term best interests with scant attention to the long-term benefits for the public.” This is a straw man argument. In keeping with this perspective, none of the three regulators is presented badly, while only two of the nine people in the for-profit sector are presented well. Of the three in the not-for-profit sector, one is presented badly –  the one who strayed over to the dark side.

A number of deficiencies in scholarship detract from the book. For a few examples: No connection is recognized between the attempt to “to tamp down stock market speculation” by the Fed limiting margin borrowing (p. 70), and the “panic selling” that followed in 1929 (p. 56). The cause of the Panic of 1907 is given as the failure of a savings bank in Montana (p. 23), with no mention of the impact of the San Francisco earthquake of 1906 on the financial condition of insurance companies and banks. The author says the Fed was formed to be a lender of last resort, unaware that banks, operating through clearing houses, acted as lenders of last resort prior to the organization of the Fed. He presents John Kenneth Galbraith’s argument for the cause of Great Depression, and does not deal with the deep-rooted problems of the inter-war gold standard. And, of course, the author identifies the villainy responsible for the Panic of 2008 not as the public policies that promoted homeownership, but as the development of mortgage-backed securities.

Morris starts the fourth part of his book, “Wall Street has a penchant for taking good ideas to excess” (p. 201). The insinuation is that Wall Streeters know, beforehand, the point of diminishing returns to good ideas, and act foolishly even from the standpoint of rational self-interest. But, in industries characterized by change, the balancing of risk and return is often discovered by failure. This learning process is not exclusive to the for-profit sector, as is illustrated by the different reactions of the Fed to the Crash of 1929 and to the Panic of 2008. A balanced mix of biographical sketches might better equip students of finance to be deal with change more effectively; indeed, to be better agents of change upon leaving school.

Clifford F. Thies is the Eldon R. Lindsey Chair of Free Enterprise and Professor of Economics and Finance at Shenandoah University. He has recently written on the Crash of 2008 (Cato Journal) and debt repudiation by Mississippi (The Independent Review). cthies@su.edu.

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 (January 2016). All EH.Net reviews are archived at http://eh.net/book-reviews/

Subject(s):Business History
Financial Markets, Financial Institutions, and Monetary History
Government, Law and Regulation, Public Finance
History of Economic Thought; Methodology
Geographic Area(s):North America
Time Period(s):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

The Economic History of Norway

Ola Honningdal Grytten, Norwegian School of Economics and Business Administration

Overview

Norway, with its population of 4.6 million on the northern flank of Europe, is today one of the most wealthy nations in the world, both measured as GDP per capita and in capital stock. On the United Nation Human Development Index, Norway has been among the three top countries for several years, and in some years the very top nation. Huge stocks of natural resources combined with a skilled labor force and the adoption of new technology made Norway a prosperous country during the nineteenth and twentieth century.

Table 1 shows rates of growth in the Norwegian economy from 1830 to the present using inflation-adjusted gross domestic product (GDP). This article splits the economic history of Norway into two major phases — before and after the nation gained its independence in 1814.

Table 1
Phases of Growth in the Real Gross Domestic Product of Norway, 1830-2003

(annual growth rates as percentages)

Year GDP GDP per capita
1830-1843 1.91 0.86
1843-1875 2.68 1.59
1875-1914 2.02 1.21
1914-1945 2.28 1.55
1945-1973 4.73 3.81
1973-2003 3.28 2.79
1830-2003 2.83 2.00

Source: Grytten (2004b)

Before Independence

The Norwegian economy was traditionally based on local farming communities combined with other types of industry, basically fishing, hunting, wood and timber along with a domestic and international-trading merchant fleet. Due to topography and climatic conditions the communities in the North and the West were more dependent on fish and foreign trade than the communities in the south and east, which relied mainly on agriculture. Agricultural output, fish catches and wars were decisive for the waves in the economy previous to independence. This is reflected in Figure 1, which reports a consumer price index for Norway from 1516 to present.

The peaks in this figure mark the sixteenth-century Price Revolution (1530s to 1590s), the Thirty Years War (1618-1648), the Great Nordic War (1700-1721), the Napoleonic Wars (1800-1815), the only period of hyperinflation in Norway — World War I (1914-1918) — and the stagflation period, i.e. high rates of inflation combined with a slowdown in production, in the 1970s and early 1980s.

Figure 1
Consumer Price Index for Norway, 1516-2003 (1850 = 100).

Figure 1
Source: Grytten (2004a)

During the last decades of the eighteenth century the Norwegian economy bloomed along with a first era of liberalism. Foreign trade of fish and timber had already been important for the Norwegian economy for centuries, and now the merchant fleet was growing rapidly. Bergen, located at the west coast, was the major city, with a Hanseatic office and one of the Nordic countries’ largest ports for domestic and foreign trade.

When Norway gained its independence from Denmark in 1814, after a tight union covering 417 years, it was a typical egalitarian country with a high degree of self-supply from agriculture, fisheries and hunting. According to the population censuses from 1801 and 1815 more than ninety percent of the population of 0.9 million lived in rural areas, mostly on small farms.

After Independence (1814)

Figure 2 shows annual development in GDP by expenditure (in fixed 2000 prices) from 1830 to 2003. The series, with few exceptions, reveal steady growth rates with few huge fluctuations. However, economic growth as a more or less continuous process started in the 1840s. We can also conclude that the growth process slowed down during the last three decades of the nineteenth century. The years 1914-1945 were more volatile than any other period in question, while there was an impressive and steady rate of growth until the mid 1970s and from then on slower growth.

Figure 2
Gross Domestic Product for Norway by Expenditure Category
(in 2000 Norwegian Kroner)

Figure 2
Source: Grytten (2004b)

Stagnation and Institution Building, 1814-1843

The newborn state lacked its own institutions, industrial entrepreneurs and domestic capital. However, due to its huge stocks of natural resources and its geographical closeness to the sea and to the United Kingdom, the new state, linked to Sweden in a loose royal union, seized its opportunities after some decades. By 1870 it had become a relatively wealthy nation. Measured in GDP per capita Norway was well over the European average, in the middle of the West European countries, and in fact, well above Sweden.

During the first decades after its independence from Denmark, the new state struggled with the international recession after the Napoleonic wars, deflationary monetary policy, and protectionism from the UK.

The Central Bank of Norway was founded in 1816, and a national currency, the spesidaler pegged to silver was introduced. The daler depreciated heavily during the first troubled years of recession in the 1820s.

The Great Boom, 1843-1875

After the Norwegian spesidaler gained its par value to silver in 1842, Norway saw a period of significant economic growth up to the mid 1870s. This impressive growth was mirrored in only a few other countries. The growth process was very much initiated by high productivity growth in agriculture and the success of the foreign sector. The adoption of new structures and technology along with substitution from arable to lifestock production made labor productivity in agriculture increase by about 150 percent between 1835 and 1910. The exports of timber, fish and in particular maritime services achieved high growth rates. In fact, Norway became a major power in shipping services during this period, accounting for about seven percent of the world merchant fleet in 1875. Norwegian sailing vessels freighted international goods all over the world at low prices.

The success of the Norwegian foreign sector can be explained by a number of factors. Liberalization of world trade and high international demand secured a market for Norwegian goods and services. In addition, Norway had vast stocks of fish and timber along with maritime skills. According to recent calculations, GDP per capita had an annual growth rate of 1.6 percent 1843 to 1876, well above the European average. At the same time the Norwegian annual rate of growth for exports was 4.8 percent. The first modern large-scale manufacturing industry in Norway saw daylight in the 1840s, when textile plants and mechanized industry were established. A second wave of industrialization took place in the 1860s and 1870s. Following the rapid productivity growth in agriculture, food processing and dairy production industries showed high growth in this period.

During this great boom, capital was imported mainly from Britain, but also from Sweden, Denmark and Germany, the four most important Norwegian trading partners at the time. In 1536 the King of Denmark and Norway chose the Lutheran faith as the state religion. In consequence of the Reformation, reading became compulsory; consequently Norway acquired a generally skilled and independent labor force. The constitution from 1814 also cleared the way for liberalism and democracy. The puritan revivals during the nineteenth century created a business environment, which raised entrepreneurship, domestic capital and a productive labor force. In the western and southern parts of the country these puritan movements are still strong, both in daily life and within business.

Relative Stagnation with Industrialization, 1875-1914

Norway’s economy was hit hard during the “depression” from mid 1870s to the early 1890s. GDP stagnated, particular during the 1880s, and prices fell until 1896. This stagnation is mirrored in the large-scale emigration from Norway to North America in the 1880s. At its peak in 1882 as many as 28,804 persons, 1.5 percent of the population, left the country. All in all, 250,000 emigrated in the period 1879-1893, equal to 60 percent of the birth surplus. Only Ireland had higher emigration rates than Norway between 1836 and 1930, when 860,000 Norwegians left the country.

The long slow down can largely been explained by Norway’s dependence on the international economy and in particular the United Kingdom, which experienced slower economic growth than the other major economies of the time. As a result of the international slowdown, Norwegian exports contracted in several years, but expanded in others. A second reason for the slowdown in Norway was the introduction of the international gold standard. Norway adopted gold in January 1874, and due to the trade deficit, lack of gold and lack of capital, the country experienced a huge contraction in gold reserves and in the money stock. The deflationary effect strangled the economy. Going onto the gold standard caused the appreciation of the Norwegian currency, the krone, as gold became relatively more expensive compared to silver. A third explanation of Norway’s economic problems in the 1880s is the transformation from sailing to steam vessels. Norway had by 1875 the fourth biggest merchant fleet in the world. However, due to lack of capital and technological skills, the transformation from sail to steam was slow. Norwegian ship owners found a niche in cheap second-hand sailing vessels. However, their market was diminishing, and finally, when the Norwegian steam fleet passed the size of the sailing fleet in 1907, Norway was no longer a major maritime power.

A short boom occurred from the early 1890s to 1899. Then, a crash in the Norwegian building industry led to a major financial crash and stagnation in GDP per capita from 1900 to 1905. Thus from the middle of the 1870s until 1905 Norway performed relatively bad. Measured in GDP per capita, Norway, like Britain, experienced a significant stagnation relative to most western economies.

After 1905, when Norway gained full independence from Sweden, a heavy wave of industrialization took place. In the 1890s the fish preserving and cellulose and paper industries started to grow rapidly. From 1905, when Norsk Hydro was established, manufacturing industry connected to hydroelectrical power took off. It is argued, quite convincingly, that if there was an industrial breakthrough in Norway, it must have taken place during the years 1905-1920. However, the primary sector, with its labor-intensive agriculture and increasingly more capital-intensive fisheries, was still the biggest sector.

Crises and Growth, 1914-1945

Officially Norway was neutral during World War I. However, in terms of the economy, the government clearly took the side of the British and their allies. Through several treaties Norway gave privileges to the allied powers, which protected the Norwegian merchant fleet. During the war’s first years, Norwegian ship owners profited from the war, and the economy boomed. From 1917, when Germany declared war against non-friendly vessels, Norway took heavy losses. A recession replaced the boom.

Norway suspended gold redemption in August 1914, and due to inflationary monetary policy during the war and in the first couple of years afterward, demand was very high. When the war came to an end this excess demand was met by a positive shift in supply. Thus, Norway, like other Western countries experienced a significant boom in the economy from the spring of 1919 to the early autumn 1920. The boom was followed by high inflation, trade deficits, currency depreciation and an overheated economy.

The international postwar recession beginning in autumn 1920, hit Norway more severely than most other countries. In 1921 GDP per capita fell by eleven percent, which was only exceeded by the United Kingdom. There are two major reasons for the devastating effect of the post-war recession. In the first place, as a small open economy, Norway was more sensitive to international recessions than most other countries. This was in particular the case because the recession hit the country’s most important trading partners, the United Kingdom and Sweden, so hard. Secondly, the combination of strong and mostly pro-cyclical inflationary monetary policy from 1914 to 1920 and thereafter a hard deflationary policy made the crisis worse (Figure 3).

Figure 3
Money Aggregates for Norway, 1910-1930

Figure 3
Source: Klovland (2004a)

In fact, Norway pursued a long, but non-persistent deflationary monetary policy aimed at restoring the par value of the krone (NOK) up to May 1928. In consequence, another recession hit the economy during the middle of the 1920s. Hence, Norway was one of the worst performers in the western world in the 1920s. This can best be seen in the number of bankruptcies, a huge financial crisis and mass unemployment. Bank losses amounted to seven percent of GDP in 1923. Total unemployment rose from about one percent in 1919 to more than eight percent in 1926 and 1927. In manufacturing it reached more than 18 percent the same years.

Despite a rapid boom and success within the whaling industry and shipping services, the country never saw a convincing recovery before the Great Depression hit Europe in late summer 1930. The worst year for Norway was 1931, when GDP per capita fell by 8.4 percent. This, however, was not only due to the international crisis, but also to a massive and violent labor conflict that year. According to the implicit GDP deflator prices fell more than 63 percent from 1920 to 1933.

All in all, however, the depression of the 1930s was milder and shorter in Norway than in most western countries. This was partly due to the deflationary monetary policy in the 1920s, which forced Norwegian companies to become more efficient in order to survive. However, it was probably more important that Norway left gold as early as September 27th, 1931 only a week after the United Kingdom. Those countries that left gold early, and thereby employed a more inflationary monetary policy, were the best performers in the 1930s. Among them were Norway and its most important trading partners, the United Kingdom and Sweden.

During the recovery period, Norway in particular saw growth in manufacturing output, exports and import substitution. This can to a large extent be explained by currency depreciation. Also, when the international merchant fleet contracted during the drop in international trade, the Norwegian fleet grew rapidly, as Norwegian ship owners were pioneers in the transformation from steam to diesel engines, tramp to line freights and into a new expanding niche: oil tankers.

The primary sector was still the largest in the economy during the interwar years. Both fisheries and agriculture struggled with overproduction problems, however. These were dealt with by introducing market controls and cartels, partly controlled by the industries themselves and partly by the government.

The business cycle reached its bottom in late 1932. Despite relatively rapid recovery and significant growth both in GDP and in employment, unemployment stayed high, and reached 10-11 percent on annual basis from 1931 to 1933 (Figure 4).

Figure 4
Unemployment Rate and Public Relief Work
as a Percent of the Work Force, 1919-1939

Figure 4
Source: Hodne and Grytten (2002)

The standard of living became poorer in the primary sector, among those employed in domestic services and for the underemployed and unemployed and their households. However, due to the strong deflation, which made consumer prices fall by than 50 percent from autumn 1920 to summer 1933, employees in manufacturing, construction and crafts experienced an increase in real wages. Unemployment stayed persistently high due to huge growth in labor supply, as result of immigration restrictions by North American countries from the 1920s onwards.

Denmark and Norway were both victims of a German surprise attack the 9th of April 1940. After two months of fighting, the allied troops surrendered in Norway on June 7th and the Norwegian royal family and government escaped to Britain.

From then until the end of the war there were two Norwegian economies, the domestic German-controlled and the foreign Norwegian- and Allied-controlled economy. The foreign economy was primarily established on the basis of the huge Norwegian merchant fleet, which again was among the biggest in the world accounting for more than seven percent of world total tonnage. Ninety percent of this floating capital escaped the Germans. The ships were united into one state-controlled company, NORTASHIP, which earned money to finance the foreign economy. The domestic economy, however, struggled with a significant fall in production, inflationary pressure and rationing of important goods, which three million Norwegians had to share with 400.000 Germans occupying the country.

Economic Planning and Growth, 1945-1973

After the war the challenge was to reconstruct the economy and re-establish political and economic order. The Labor Party, in office from 1935, grabbed the opportunity to establish a strict social democratic rule, with a growing public sector and widespread centralized economic planning. Norway first declined the U.S. proposition of financial aid after the world. However, due to lack of hard currencies they accepted the Marshall aid program. By receiving 400 million dollars from 1948 to 1952, Norway was one of the biggest per capita recipients.

As part of the reconstruction efforts Norway joined the Bretton Woods system, GATT, the IMF and the World Bank. Norway also chose to become member of NATO and the United Nations. In 1958 the country also joined the European Free Trade Area (EFTA). The same year Norway made the krone convertible to the U.S. dollar, as many other western countries did with their currencies.

The years from 1950 to 1973 are often called the golden era of the Norwegian economy. GDP per capita showed an annual growth rate of 3.3 percent. Foreign trade stepped up even more, unemployment barely existed and the inflation rate was stable. This has often been explained by the large public sector and good economic planning. The Nordic model, with its huge public sector, has been said to be a success in this period. If one takes a closer look into the situation, one will, nevertheless, find that the Norwegian growth rate in the period was lower than that for most western nations. The same is true for Sweden and Denmark. The Nordic model delivered social security and evenly-distributed wealth, but it did not necessarily give very high economic growth.

Figure 5
Public Sector as a Percent of GDP, 1900-1990

Figure 5
Source: Hodne and Grytten (2002)

Petroleum Economy and Neoliberalism, 1973 to the Present

After the Bretton Woods system fell apart (between August 1971 and March 1973) and the oil price shock in autumn 1973, most developed economies went into a period of prolonged recession and slow growth. In 1969 Philips Petroleum discovered petroleum resources at the Ekofisk field, which was defined as part of the Norwegian continental shelf. This enabled Norway to run a countercyclical financial policy during the stagflation period in the 1970s. Thus, economic growth was higher and unemployment lower than for most other western countries. However, since the countercyclical policy focused on branch and company subsidies, Norwegian firms soon learned to adapt to policy makers rather than to the markets. Hence, both productivity and business structure did not have the incentives to keep pace with changes in international markets.

Norway lost significant competitive power, and large-scale deindustrialization took place, despite efforts to save manufacturing industry. Another reason for deindustrialization was the huge growth in the profitable petroleum sector. Persistently high oil prices from the autumn 1973 to the end of 1985 pushed labor costs upward, through spillover effects from high wages in the petroleum sector. High labor costs made the Norwegian foreign sector less competitive. Thus, Norway saw deindustrialization at a more rapid pace than most of her largest trading partners. Due to the petroleum sector, however, Norway experienced high growth rates in all the three last decades of the twentieth century, bringing Norway to the top of the world GDP per capita list at the dawn of the new millennium. Nevertheless, Norway had economic problems both in the eighties and in the nineties.

In 1981 a conservative government replaced Labor, which had been in power for most of the post-war period. Norway had already joined the international wave of credit liberalization, and the new government gave fuel to this policy. However, along with the credit liberalization, the parliament still ran a policy that prevented market forces from setting interest rates. Instead they were set by politicians, in contradiction to the credit liberalization policy. The level of interest rates was an important part of the political game for power, and thus, they were set significantly below the market level. In consequence, a substantial credit boom was created in the early 1980s, and continued to the late spring of 1986. As a result, Norway had monetary expansion and an artificial boom, which created an overheated economy. When oil prices fell dramatically from December 1985 onwards, the trade surplus was suddenly turned to a huge deficit (Figure 6).

Figure 6
North Sea Oil Prices and Norway’s Trade Balance, 1975-2000

Figure 6
Source: Statistics Norway

The conservative-center government was forced to keep a tighter fiscal policy. The new Labor government pursued this from May 1986. Interest rates were persistently high as the government now tried to run a trustworthy fixed-currency policy. In the summer of 1990 the Norwegian krone was officially pegged to the ECU. When the international wave of currency speculation reached Norway during autumn 1992 the central bank finally had to suspend the fixed exchange rate and later devaluate.

In consequence of these years of monetary expansion and thereafter contraction, most western countries experienced financial crises. It was relatively hard in Norway. Prices of dwellings slid, consumers couldn’t pay their bills, and bankruptcies and unemployment reached new heights. The state took over most of the larger commercial banks to avoid a total financial collapse.

After the suspension of the ECU and the following devaluation, Norway had growth until 1998, due to optimism, an international boom and high prices of petroleum. The Asian financial crisis also rattled the Norwegian stock market. At the same time petroleum prices fell rapidly, due to internal problems among the OPEC countries. Hence, the krone depreciated. The fixed exchange rate policy had to be abandoned and the government adopted inflation targeting. Along with changes in monetary policy, the center coalition government was also able to monitor a tighter fiscal policy. At the same time interest rates were high. As result, Norway escaped the overheating process of 1993-1997 without any devastating effects. Today the country has a strong and sound economy.

The petroleum sector is still very important in Norway. In this respect the historical tradition of raw material dependency has had its renaissance. Unlike many other countries rich in raw materials, natural resources have helped make Norway one of the most prosperous economies in the world. Important factors for Norway’s ability to turn resource abundance into economic prosperity are an educated work force, the adoption of advanced technology used in other leading countries, stable and reliable institutions, and democratic rule.

References

Basberg, Bjørn L. Handelsflåten i krig: Nortraship: Konkurrent og alliert. Oslo: Grøndahl and Dreyer, 1992.

Bergh, Tore Hanisch, Even Lange and Helge Pharo. Growth and Development. Oslo: NUPI, 1979.

Brautaset, Camilla. “Norwegian Exports, 1830-1865: In Perspective of Historical National Accounts.” Ph.D. dissertation. Norwegian School of Economics and Business Administration, 2002.

Bruland, Kristine. British Technology and European Industrialization. Cambridge: Cambridge University Press, 1989.

Danielsen, Rolf, Ståle Dyrvik, Tore Grønlie, Knut Helle and Edgar Hovland. Norway: A History from the Vikings to Our Own Times. Oslo: Scandinavian University Press, 1995.

Eitrheim. Øyvind, Jan T. Klovland and Jan F. Qvigstad, editors. Historical Monetary Statistics for Norway, 1819-2003. Oslo: Norges Banks skriftserie/Occasional Papers, no 35, 2004.

Hanisch, Tore Jørgen. “Om virkninger av paripolitikken.” Historisk tidsskrift 58, no. 3 (1979): 223-238.

Hanisch, Tore Jørgen, Espen Søilen and Gunhild Ecklund. Norsk økonomisk politikk i det 20. århundre. Verdivalg i en åpen økonomi. Kristiansand: Høyskoleforlaget, 1999.

Grytten, Ola Honningdal. “A Norwegian Consumer Price Index 1819-1913 in a Scandinavian Perspective.” European Review of Economic History 8, no.1 (2004): 61-79.

Grytten, Ola Honningdal. “A Consumer Price Index for Norway, 1516-2003.” Norges Bank: Occasional Papers, no. 1 (2004a): 47-98.

Grytten. Ola Honningdal. “The Gross Domestic Product for Norway, 1830-2003.” Norges Bank: Occasional Papers, no. 1 (2004b): 241-288.

Hodne, Fritz. An Economic History of Norway, 1815-1970. Tapir: Trondheim, 1975.

Hodne, Fritz. The Norwegian Economy, 1920-1980. London: Croom Helm and St. Martin’s, 1983.

Hodne, Fritz and Ola Honningdal Grytten. Norsk økonomi i det 19. århundre. Bergen: Fagbokforlaget, 2000.

Hodne, Fritz and Ola Honningdal Grytten. Norsk økonomi i det 20. århundre. Bergen: Fagbokforlaget, 2002.

Klovland, Jan Tore. “Monetary Policy and Business Cycles in the Interwar Years: The Scandinavian Experience.” European Review of Economic History 2, no. 2 (1998):

Klovland, Jan Tore. “Monetary Aggregates in Norway, 1819-2003.” Norges Bank: Occasional Papers, no. 1 (2004a): 181-240.

Klovland, Jan Tore. “Historical Exchange Rate Data, 1819-2003”. Norges Bank: Occasional Papers, no. 1 (2004b): 289-328.

Lange, Even, editor. Teknologi i virksomhet. Verkstedsindustri i Norge etter 1840. Oslo: Ad Notam Forlag, 1989.

Nordvik, Helge W. “Finanspolitikken og den offentlige sektors rolle i norsk økonomi i mellomkrigstiden”. Historisk tidsskrift 58, no. 3 (1979): 239-268.

Sejersted, Francis. Demokratisk kapitalisme. Oslo: Universitetsforlaget, 1993.

Søilen. Espen. “Fra frischianisme til keynesianisme? En studie av norsk økonomisk politikk i lys av økonomisk teori, 1945-1980.” Ph.D. dissertation. Bergen: Norwegian School of Economics and Business Administration, 1998.

Citation: Grytten, Ola. “The Economic History of Norway”. EH.Net Encyclopedia, edited by Robert Whaples. March 16, 2008. URL http://eh.net/encyclopedia/the-economic-history-of-norway/

An Economic History of New Zealand in the Nineteenth and Twentieth Centuries

John Singleton, Victoria University of Wellington, New Zealand

Living standards in New Zealand were among the highest in the world between the late nineteenth century and the 1960s. But New Zealand’s economic growth was very sluggish between 1950 and the early 1990s, and most Western European countries, as well as several in East Asia, overtook New Zealand in terms of real per capita income. By the early 2000s, New Zealand’s GDP per capita was in the bottom half of the developed world.

Table 1:
Per capita GDP in New Zealand
compared with the United States and Australia
(in 1990 international dollars)

US Australia New Zealand NZ as
% of US
NZ as % of
Austrialia
1840 1588 1374 400 25 29
1900 4091 4013 4298 105 107
1950 9561 7412 8456 88 114
2000 28129 21540 16010 57 74

Source: Angus Maddison, The World Economy: Historical Statistics. Paris: OECD, 2003, pp. 85-7.

Over the second half of the twentieth century, argue Greasley and Oxley (1999), New Zealand seemed in some respects to have more in common with Latin American countries than with other advanced western nations. As well as a snail-like growth rate, New Zealand followed highly protectionist economic policies between 1938 and the 1980s. (In absolute terms, however, New Zealanders continued to be much better off than their Latin American counterparts.) Maddison (1991) put New Zealand in a middle-income group of countries, including the former Czechoslovakia, Hungary, Portugal, and Spain.

Origins and Development to 1914

When Europeans (mainly Britons) started to arrive in Aotearoa (New Zealand) in the early nineteenth century, they encountered a tribal society. Maori tribes made a living from agriculture, fishing, and hunting. Internal trade was conducted on the basis of gift exchange. Maori did not hold to the Western concept of exclusive property rights in land. The idea that land could be bought and sold was alien to them. Most early European residents were not permanent settlers. They were short-term male visitors involved in extractive activities such as sealing, whaling, and forestry. They traded with Maori for food, sexual services, and other supplies.

Growing contact between Maori and the British was difficult to manage. In 1840 the British Crown and some Maori signed the Treaty of Waitangi. The treaty, though subject to various interpretations, to some extent regularized the relationship between Maori and Europeans (or Pakeha). At roughly the same time, the first wave of settlers arrived from England to set up colonies including Wellington and Christchurch. Settlers were looking for a better life than they could obtain in overcrowded and class-ridden England. They wished to build a rural and largely self-sufficient society.

For some time, only the Crown was permitted to purchase land from Maori. This land was then either resold or leased to settlers. Many Maori felt – and many still feel – that they were forced to give up land, effectively at gunpoint, in return for a pittance. Perhaps they did not always grasp that land, once sold, was lost forever. Conflict over land led to intermittent warfare between Maori and settlers, especially in the 1860s. There was brutality on both sides, but the Europeans on the whole showed more restraint in New Zealand than in North America, Australia, or Southern Africa.

Maori actually required less land in the nineteenth century because their numbers were falling, possibly by half between the late eighteenth and late nineteenth centuries. By the 1860s, Maori were outnumbered by British settlers. The introduction of European diseases, alcohol, and guns contributed to the decline in population. Increased mobility and contact between tribes may also have spread disease. The Maori population did not begin to recover until the twentieth century.

Gold was discovered in several parts of New Zealand (including Thames and Otago) in the mid-nineteenth century, but the introduction of sheep farming in the 1850s gave a more enduring boost to the economy. Australian and New Zealand wool was in high demand in the textile mills of Yorkshire. Sheep farming necessitated the clearing of native forests and the planting of grasslands, which changed the appearance of large tracts of New Zealand. This work was expensive, and easy access to the London capital market was critical. Economic relations between New Zealand and Britain were strong, and remained so until the 1970s.

Between the mid-1870s and mid-1890s, New Zealand was adversely affected by weak export prices, and in some years there was net emigration. But wool prices recovered in the 1890s, just as new exports – meat and dairy produce – were coming to prominence. Until the advent of refrigeration in the early 1880s, New Zealand did not export meat and dairy produce. After the introduction of refrigeration, however, New Zealand foodstuffs found their way on to the dinner tables of working class families in Britain, but not the tables of the middle and upper classes, as they could afford fresh produce.

In comparative terms, the New Zealand economy was in its heyday in the two decades before 1914. New Zealand (though not its Maori shadow, Aotearoa) was a wealthy, dynamic, and egalitarian society. The total population in 1914 was slightly above one million. Exports consisted almost entirely of land-intensive pastoral commodities. Manufactures loomed large in New Zealand’s imports. High labor costs, and the absence of scale economies in the tiny domestic market, hindered industrialization, though there was some processing of export commodities and imports.

War, Depression and Recovery, 1914-38

World War One disrupted agricultural production in Europe, and created a robust demand for New Zealand’s primary exports. Encouraged by high export prices, New Zealand farmers borrowed and invested heavily between 1914 and 1920. Land exchanged hands at very high prices. Unfortunately, the early twenties brought the start of a prolonged slump in international commodity markets. Many farmers struggled to service and repay their debts.

The global economic downturn, beginning in 1929-30, was transmitted to New Zealand by the collapse in commodity prices on the London market. Farmers bore the brunt of the depression. At the trough, in 1931-32, net farm income was negative. Declining commodity prices increased the already onerous burden of servicing and repaying farm mortgages. Meat freezing works, woolen mills, and dairy factories were caught in the spiral of decline. Farmers had less to spend in the towns. Unemployment rose, and some of the urban jobless drifted back to the family farm. The burden of external debt, the bulk of which was in sterling, rose dramatically relative to export receipts. But a protracted balance of payments crisis was avoided, since the demand for imports fell sharply in response to the drop in incomes. The depression was not as serious in New Zealand as in many industrial countries. Prices were more flexible in the primary sector and in small business than in modern, capital-intensive industry. Nevertheless, the experience of depression profoundly affected New Zealanders’ attitudes towards the international economy for decades to come.

At first, there was no reason to expect that the downturn in 1929-30 was the prelude to the worst slump in history. As tax and customs revenue fell, the government trimmed expenditure in an attempt to balance the budget. Only in 1931 was the severity of the crisis realized. Further cuts were made in public spending. The government intervened in the labor market, securing an order for an all-round reduction in wages. It pressured and then forced the banks to reduce interest rates. The government sought to maintain confidence and restore prosperity by helping farms and other businesses to lower costs. But these policies did not lead to recovery.

Several factors contributed to the recovery that commenced in 1933-34. The New Zealand pound was devalued by 14 percent against sterling in January 1933. As most exports were sold for sterling, which was then converted into New Zealand pounds, the income of farmers was boosted at a stroke of the pen. Devaluation increased the money supply. Once economic actors, including the banks, were convinced that the devaluation was permanent, there was an increase in confidence and in lending. Other developments played their part. World commodity prices stabilized, and then began to pick up. Pastoral output and productivity continued to rise. The 1932 Ottawa Agreements on imperial trade strengthened New Zealand’s position in the British market at the expense of non-empire competitors such as Argentina, and prefigured an increase in the New Zealand tariff on non-empire manufactures. As was the case elsewhere, the recovery in New Zealand was not the product of a coherent economic strategy. When beneficial policies were adopted it was as much by accident as by design.

Once underway, however, New Zealand’s recovery was comparatively rapid and persisted over the second half of the thirties. A Labour government, elected towards the end of 1935, nationalized the central bank (the Reserve Bank of New Zealand). The government instructed the Reserve Bank to create advances in support of its agricultural marketing and state housing schemes. It became easier to obtain borrowed funds.

An Insulated Economy, 1938-1984

A balance of payments crisis in 1938-39 was met by the introduction of administrative restrictions on imports. Labour had not been prepared to deflate or devalue – the former would have increased unemployment, while the latter would have raised working class living costs. Although intended as a temporary expedient, the direct control of imports became a distinctive feature of New Zealand economic policy until the mid-1980s.

The doctrine of “insulationism” was expounded during the 1940s. Full employment was now the main priority. In the light of disappointing interwar experience, there were doubts about the ability of the pastoral sector to provide sufficient work for New Zealand’s growing population. There was a desire to create more industrial jobs, even though there seemed no prospect of achieving scale economies within such a small country. Uncertainty about export receipts, the need to maintain a high level of domestic demand, and the competitive weakness of the manufacturing sector, appeared to justify the retention of quantitative import controls.

After 1945, many Western countries retained controls over current account transactions for several years. When these controls were relaxed and then abolished in the fifties and early sixties, the anomalous nature of New Zealand’s position became more visible. Although successive governments intended to liberalize, in practice they achieved little, except with respect to trade with Australia.

The collapse of the Korean War commodity boom, in the early 1950s, marked an unfortunate turning point in New Zealand’s economic history. International conditions were unpropitious for the pastoral sector in the second half of the twentieth century. Despite the aspirations of GATT, the United States, Western Europe and Japan restricted agricultural imports, especially of temperate foodstuffs, subsidized their own farmers and, in the case of the Americans and the Europeans, dumped their surpluses in third markets. The British market, which remained open until 1973, when the United Kingdom was absorbed into the EEC, was too small to satisfy New Zealand. Moreover, even the British resorted to agricultural subsidies. Compared with the price of industrial goods, the price of agricultural produce tended to weaken over the long term.

Insulation was a boon to manufacturers, and New Zealand developed a highly diversified industrial structure. But competition was ineffectual, and firms were able to pass cost increases on to the consumer. Import barriers induced many British, American, and Australian multinationals to establish plants in New Zealand. The protected industrial economy did have some benefits. It created jobs – there was full employment until the 1970s – and it increased the stock of technical and managerial skills. But consumers and farmers were deprived of access to cheaper – and often better quality – imported goods. Their interests and welfare were neglected. Competing demand from protected industries also raised the costs of farm inputs, including labor power, and thus reduced the competitiveness of New Zealand’s key export sector.

By the early 1960s, policy makers had realized that New Zealand was falling behind in the race for greater prosperity. The British food market was under threat, as the Macmillan government began a lengthy campaign to enter the protectionist EEC. New Zealand began to look for other economic partners, and the most obvious candidate was Australia. In 1901, New Zealand had declined to join the new federation of Australian colonies. Thus it had been excluded from the Australian common market. After lengthy negotiations, a partial New Zealand-Australia Free Trade Agreement (NAFTA) was signed in 1965. Despite initial misgivings, many New Zealand firms found that they could compete in the Australian market, where tariffs against imports from the rest of the world remained quite high. But this had little bearing on their ability to compete with European, Asian, and North American firms. NAFTA was given renewed impetus by the Closer Economic Relations (CER) agreement of 1983.

Between 1973 and 1984, New Zealand governments were overwhelmed by a group of inter-related economic crises, including two serious supply shocks (the oil crises), rising inflation, and increasing unemployment. Robert Muldoon, the National Party (conservative) prime minister between 1975 and 1984, pursued increasingly erratic macroeconomic policies. He tightened government control over the economy in the early eighties. There were dramatic fluctuations in inflation and in economic growth. In desperation, Muldoon imposed a wage and price freeze in 1982-84. He also mounted a program of large-scale investments, including the expansion of a steel works, and the construction of chemical plants and an oil refinery. By means of these investments, he hoped to reduce the import bill and secure a durable improvement in the balance of payments. But the “Think Big” strategy failed – the projects were inadequately costed, and inherently risky. Although Muldoon’s intention had been to stabilize the economy, his policies had the opposite effect.

Economic Reform, 1984-2000

Muldoon’s policies were discredited, and in 1984 the Labour Party came to power. All other economic strategies having failed, Labour resolved to deregulate and restore the market process. (This seemed very odd at the time.) Within a week of the election, virtually all controls over interest rates had been abolished. Financial markets were deregulated, and, in March 1985, the New Zealand dollar was floated. Other changes followed, including the sale of public sector trading organizations, the reduction of tariffs and the elimination of import licensing. However, reform of the labor market was not completed until the early 1990s, by which time National (this time without Muldoon or his policies) was back in office.

Once credit was no longer rationed, there was a large increase in private sector borrowing, and a boom in asset prices. Numerous speculative investment and property companies were set up in the mid-eighties. New Zealand’s banks, which were not used to managing risk in a deregulated environment, scrambled to lend to speculators in an effort not to miss out on big profits. Many of these ventures turned sour, especially after the 1987 share market crash. Banks were forced to reduce their lending, to the detriment of sound as well as unsound borrowers.

Tight monetary policy and financial deregulation led to rising interest rates after 1984. The New Zealand dollar appreciated strongly. Farmers bore the initial brunt of high borrowing costs and a rising real exchange rate. Manufactured imports also became more competitive, and many inefficient firms were forced to close. Unemployment rose in the late eighties and early nineties. The early 1990s were marked by an international recession, which was particularly painful in New Zealand, not least because of the high hopes raised by the post-1984 reforms.

An economic recovery began towards the end of 1991. With a brief interlude in 1998, strong growth persisted for the remainder of the decade. Confidence was gradually restored to the business sector. Unemployment began to recede. After a lengthy time lag, the economic reforms seemed to be paying off for the majority of the population.

Large structural changes took place after 1984. Factors of production switched out of the protected manufacturing sector, and were drawn into services. Tourism boomed as the relative cost of international travel fell. The face of the primary sector also changed, and the wine industry began to penetrate world markets. But not all manufacturers struggled. Some firms adapted to the new environment and became more export-oriented. For instance, a small engineering company, Scott Technology, became a world leader in the provision of equipment for the manufacture of refrigerators and washing machines.

Annual inflation was reduced to low single digits by the early nineties. Price stability was locked in through the 1989 Reserve Bank Act. This legislation gave the central bank operational autonomy, while compelling it to focus on the achievement and maintenance of price stability rather than other macroeconomic objectives. The Reserve Bank of New Zealand was the first central bank in the world to adopt a regime of inflation targeting. The 1994 Fiscal Responsibility Act committed governments to sound finance and the reduction of public debt.

By 2000, New Zealand’s population was approaching four million. Overall, the reforms of the eighties and nineties were responsible for creating a more competitive economy. New Zealand’s economic decline relative to the rest of the OECD was halted, though it was not reversed. In the nineties, New Zealand enjoyed faster economic growth than either Germany or Japan, an outcome that would have been inconceivable a few years earlier. But many New Zealanders were not satisfied. In particular, they were galled that their closest neighbor, Australia, was growing even faster. Australia, however, was an inherently much wealthier country with massive mineral deposits.

Assessment

Several explanations have been offered for New Zealand’s relatively poor economic performance during the twentieth century.

Wool, meat, and dairy produce were the foundations of New Zealand’s prosperity in Victorian and Edwardian times. After 1920, however, international market conditions were generally unfavorable to pastoral exports. New Zealand had the wrong comparative advantage to enjoy rapid growth in the twentieth century.

Attempts to diversify were only partially successful. High labor costs and the small size of the domestic market hindered the efficient production of standardized labor-intensive goods (e.g. garments) and standardized capital-intensive goods (e.g. autos). New Zealand might have specialized in customized and skill-intensive manufactures, but the policy environment was not conducive to the promotion of excellence in niche markets. Between 1938 and the 1980s, Latin American-style trade policies fostered the growth of a ramshackle manufacturing sector. Only in the late eighties did New Zealand decisively reject this regime.

Geographical and geological factors also worked to New Zealand’s disadvantage. Australia drew ahead of New Zealand in the 1960s, following the discovery of large mineral deposits for which there was a big market in Japan. Staple theory suggests that developing countries may industrialize successfully by processing their own primary products, instead of by exporting them in a raw state. Canada had coal and minerals, and became a significant industrial power. But New Zealand’s staples of wool, meat and dairy produce offered limited downstream potential.

Canada also took advantage of its proximity to the U.S. market, and access to U.S. capital and technology. American-style institutions in the labor market, business, education and government became popular in Canada. New Zealand and Australia relied on, arguably inferior, British-style institutions. New Zealand was a long way from the world’s economic powerhouses, and it was difficult for its firms to establish and maintain contact with potential customers and collaborators in Europe, North America, or Asia.

Clearly, New Zealand’s problems were not all of its own making. The elimination of agricultural protectionism in the northern hemisphere would have given a huge boost the New Zealand economy. On the other hand, in the period between the late 1930s and mid-1980s, New Zealand followed inward-looking economic policies that hindered economic efficiency and flexibility.

References

Bassett, Michael. The State in New Zealand, 1840-1984. Auckland: Auckland University Press, 1998.

Belich, James. Making Peoples: A History of the New Zealanders from Polynesian Settlement to the End of the Nineteenth Century, Auckland: Penguin, 1996.

Condliffe, John B. New Zealand in the Making. London: George Allen & Unwin, 1930.

Dalziel, Paul. “New Zealand’s Economic Reforms: An Assessment.” Review of Political Economy 14, no. 2 (2002): 31-46.

Dalziel, Paul and Ralph Lattimore. The New Zealand Macroeconomy: Striving for Sustainable Growth with Equity. Melbourne: Oxford University Press, fifth edition, 2004.

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Gould, John D. The Rake’s Progress: the New Zealand Economy since 1945. Auckland: Hodder and Stoughton, 1982.

Greasley, David and Les Oxley. “A Tale of Two Dominions: Comparing the Macroeconomic Records of Australia and Canada since 1870.” Economic History Review 51, no. 2 (1998): 294-318.

Greasley, David and Les Oxley. “Outside the Club: New Zealand’s Economic Growth, 1870-1993.” International Review of Applied Economics 14, no. 2 (1999): 173-92.

Greasley, David and Les Oxley. “Regime Shift and Fast Recovery on the Periphery: New Zealand in the 1930s.” Economic History Review 55, no. 4 (2002): 697-720.

Hawke, Gary R. The Making of New Zealand: An Economic History. Cambridge: Cambridge University Press, 1985.

Jones, Steve R.H. “Government Policy and Industry Structure in New Zealand, 1900-1970.” Australian Economic History Review 39, no, 3 (1999): 191-212.

Mabbett, Deborah. Trade, Employment and Welfare: A Comparative Study of Trade and Labour Market Policies in Sweden and New Zealand, 1880-1980. Oxford: Clarendon Press, 1995.

Maddison, Angus. Dynamic Forces in Capitalist Development. Oxford: Oxford University Press, 1991.

Maddison, Angus. The World Economy: Historical Statistics. Paris: OECD, 2003.

McKinnon, Malcolm. Treasury: 160 Years of the New Zealand Treasury. Auckland: Auckland University Press in association with the Ministry for Culture and Heritage, 2003.

Schedvin, Boris. “Staples and Regions of the Pax Britannica.” Economic History Review 43, no. 4 (1990): 533-59.

Silverstone, Brian, Alan Bollard, and Ralph Lattimore, editors. A Study of Economic Reform: The Case of New Zealand. Amsterdam: Elsevier, 1996.

Singleton, John. “New Zealand: Devaluation without a Balance of Payments Crisis.” In The World Economy and National Economies in the Interwar Slump, edited by Theo Balderston, 172-90. Basingstoke: Palgrave, 2003.

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Ville, Simon. The Rural Entrepreneurs: A History of the Stock and Station Agent Industry in Australia and New Zealand. Cambridge: Cambridge University Press, 2000.

Citation: Singleton, John. “New Zealand in the Nineteenth and Twentieth Centuries”. EH.Net Encyclopedia, edited by Robert Whaples. February 10, 2008. URL http://eh.net/encyclopedia/an-economic-history-of-new-zealand-in-the-nineteenth-and-twentieth-centuries/

The Depression of 1893

David O. Whitten, Auburn University

The Depression of 1893 was one of the worst in American history with the unemployment rate exceeding ten percent for half a decade. This article describes economic developments in the decades leading up to the depression; the performance of the economy during the 1890s; domestic and international causes of the depression; and political and social responses to the depression.

The Depression of 1893 can be seen as a watershed event in American history. It was accompanied by violent strikes, the climax of the Populist and free silver political crusades, the creation of a new political balance, the continuing transformation of the country’s economy, major changes in national policy, and far-reaching social and intellectual developments. Business contraction shaped the decade that ushered out the nineteenth century.

Unemployment Estimates

One way to measure the severity of the depression is to examine the unemployment rate. Table 1 provides estimates of unemployment, which are derived from data on output — annual unemployment was not directly measured until 1929, so there is no consensus on the precise magnitude of the unemployment rate of the 1890s. Despite the differences in the two series, however, it is obvious that the Depression of 1893 was an important event. The unemployment rate exceeded ten percent for five or six consecutive years. The only other time this occurred in the history of the US economy was during the Great Depression of the 1930s.

Timing and Depth of the Depression

The National Bureau of Economic Research estimates that the economic contraction began in January 1893 and continued until June 1894. The economy then grew until December 1895, but it was then hit by a second recession that lasted until June 1897. Estimates of annual real gross national product (which adjust for this period’s deflation) are fairly crude, but they generally suggest that real GNP fell about 4% from 1892 to 1893 and another 6% from 1893 to 1894. By 1895 the economy had grown past its earlier peak, but GDP fell about 2.5% from 1895 to 1896. During this period population grew at about 2% per year, so real GNP per person didn’t surpass its 1892 level until 1899. Immigration, which had averaged over 500,000 people per year in the 1880s and which would surpass one million people per year in the first decade of the 1900s, averaged only 270,000 from 1894 to 1898.

Table 1
Estimates of Unemployment during the 1890s

Year Lebergott Romer
1890 4.0% 4.0%
1891 5.4 4.8
1892 3.0 3.7
1893 11.7 8.1
1894 18.4 12.3
1895 13.7 11.1
1896 14.5 12.0
1897 14.5 12.4
1898 12.4 11.6
1899 6.5 8,7
1900 5.0 5.0

Source: Romer, 1984

The depression struck an economy that was more like the economy of 1993 than that of 1793. By 1890, the US economy generated one of the highest levels of output per person in the world — below that in Britain, but higher than the rest of Europe. Agriculture no longer dominated the economy, producing only about 19 percent of GNP, well below the 30 percent produced in manufacturing and mining. Agriculture’s share of the labor force, which had been about 74% in 1800, and 60% in 1860, had fallen to roughly 40% in 1890. As Table 2 shows, only the South remained a predominantly agricultural region. Throughout the country few families were self-sufficient, most relied on selling their output or labor in the market — unlike those living in the country one hundred years earlier.

Table 2
Agriculture’s Share of the Labor Force by Region, 1890

Northeast 15%
Middle Atlantic 17%
Midwest 43%
South Atlantic 63%
South Central 67%
West 29%

Economic Trends Preceding the 1890s

Between 1870 and 1890 the number of farms in the United States rose by nearly 80 percent, to 4.5 million, and increased by another 25 percent by the end of the century. Farm property value grew by 75 percent, to $16.5 billion, and by 1900 had increased by another 25 percent. The advancing checkerboard of tilled fields in the nation’s heartland represented a vast indebtedness. Nationwide about 29% of farmers were encumbered by mortgages. One contemporary observer estimated 2.3 million farm mortgages nationwide in 1890 worth over $2.2 billion. But farmers in the plains were much more likely to be in debt. Kansas croplands were mortgaged to 45 percent of their true value, those in South Dakota to 46 percent, in Minnesota to 44, in Montana 41, and in Colorado 34 percent. Debt covered a comparable proportion of all farmlands in those states. Under favorable conditions the millions of dollars of annual charges on farm mortgages could be borne, but a declining economy brought foreclosures and tax sales.

Railroads opened new areas to agriculture, linking these to rapidly changing national and international markets. Mechanization, the development of improved crops, and the introduction of new techniques increased productivity and fueled a rapid expansion of farming operations. The output of staples skyrocketed. Yields of wheat, corn, and cotton doubled between 1870 and 1890 though the nation’s population rose by only two-thirds. Grain and fiber flooded the domestic market. Moreover, competition in world markets was fierce: Egypt and India emerged as rival sources of cotton; other areas poured out a growing stream of cereals. Farmers in the United States read the disappointing results in falling prices. Over 1870-73, corn and wheat averaged $0.463 and $1.174 per bushel and cotton $0.152 per pound; twenty years later they brought but $0.412 and $0.707 a bushel and $0.078 a pound. In 1889 corn fell to ten cents in Kansas, about half the estimated cost of production. Some farmers in need of cash to meet debts tried to increase income by increasing output of crops whose overproduction had already demoralized prices and cut farm receipts.

Railroad construction was an important spur to economic growth. Expansion peaked between 1879 and 1883, when eight thousand miles a year, on average, were built including the Southern Pacific, Northern Pacific and Santa Fe. An even higher peak was reached in the late 1880s, and the roads provided important markets for lumber, coal, iron, steel, and rolling stock.

The post-Civil War generation saw an enormous growth of manufacturing. Industrial output rose by some 296 percent, reaching in 1890 a value of almost $9.4 billion. In that year the nation’s 350,000 industrial firms employed nearly 4,750,000 workers. Iron and steel paced the progress of manufacturing. Farm and forest continued to provide raw materials for such established enterprises as cotton textiles, food, and lumber production. Heralding the machine age, however, was the growing importance of extractives — raw materials for a lengthening list of consumer goods and for producing and fueling locomotives, railroad cars, industrial machinery and equipment, farm implements, and electrical equipment for commerce and industry. The swift expansion and diversification of manufacturing allowed a growing independence from European imports and was reflected in the prominence of new goods among US exports. Already the value of American manufactures was more than half the value of European manufactures and twice that of Britain.

Onset and Causes of the Depression

The depression, which was signaled by a financial panic in 1893, has been blamed on the deflation dating back to the Civil War, the gold standard and monetary policy, underconsumption (the economy was producing goods and services at a higher rate than society was consuming and the resulting inventory accumulation led firms to reduce employment and cut back production), a general economic unsoundness (a reference less to tangible economic difficulties and more to a feeling that the economy was not running properly), and government extravagance .

Economic indicators signaling an 1893 business recession in the United States were largely obscured. The economy had improved during the previous year. Business failures had declined, and the average liabilities of failed firms had fallen by 40 percent. The country’s position in international commerce was improved. During the late nineteenth century, the United States had a negative net balance of payments. Passenger and cargo fares paid to foreign ships that carried most American overseas commerce, insurance charges, tourists’ expenditures abroad, and returns to foreign investors ordinarily more than offset the effect of a positive merchandise balance. In 1892, however, improved agricultural exports had reduced the previous year’s net negative balance from $89 million to $20 million. Moreover, output of non-agricultural consumer goods had risen by more than 5 percent, and business firms were believed to have an ample backlog of unfilled orders as 1893 opened. The number checks cleared between banks in the nation at large and outside New York, factory employment, wholesale prices, and railroad freight ton mileage advanced through the early months of the new year.

Yet several monthly series of indicators showed that business was falling off. Building construction had peaked in April 1892, later moving irregularly downward, probably in reaction to over building. The decline continued until the turn of the century, when construction volume finally turned up again. Weakness in building was transmitted to the rest of the economy, dampening general activity through restricted investment opportunities and curtailed demand for construction materials. Meanwhile, a similar uneven downward drift in business activity after spring 1892 was evident from a composite index of cotton takings (cotton turned into yarn, cloth, etc.) and raw silk consumption, rubber imports, tin and tin plate imports, pig iron manufactures, bituminous and anthracite coal production, crude oil output, railroad freight ton mileage, and foreign trade volume. Pig iron production had crested in February, followed by stock prices and business incorporations six months later.

The economy exhibited other weaknesses as the March 1893 date for Grover Cleveland’s inauguration to the presidency drew near. One of the most serious was in agriculture. Storm, drought, and overproduction during the preceding half-dozen years had reversed the remarkable agricultural prosperity and expansion of the early 1880s in the wheat, corn, and cotton belts. Wheat prices tumbled twenty cents per bushel in 1892. Corn held steady, but at a low figure and on a fall of one-eighth in output. Twice as great a decline in production dealt a severe blow to the hopes of cotton growers: the season’s short crop canceled gains anticipated from a recovery of one cent in prices to 8.3 cents per pound, close to the average level of recent years. Midwestern and Southern farming regions seethed with discontent as growers watched staple prices fall by as much as two-thirds after 1870 and all farm prices by two-fifths; meanwhile, the general wholesale index fell by one-fourth. The situation was grave for many. Farmers’ terms of trade had worsened, and dollar debts willingly incurred in good times to permit agricultural expansion were becoming unbearable burdens. Debt payments and low prices restricted agrarian purchasing power and demand for goods and services. Significantly, both output and consumption of farm equipment began to fall as early as 1891, marking a decline in agricultural investment. Moreover, foreclosure of farm mortgages reduced the ability of mortgage companies, banks, and other lenders to convert their earning assets into cash because the willingness of investors to buy mortgage paper was reduced by the declining expectation that they would yield a positive return.

Slowing investment in railroads was an additional deflationary influence. Railroad expansion had long been a potent engine of economic growth, ranging from 15 to 20 percent of total national investment in the 1870s and 1880s. Construction was a rough index of railroad investment. The amount of new track laid yearly peaked at 12,984 miles in 1887, after which it fell off steeply. Capital outlays rose through 1891 to provide needed additions to plant and equipment, but the rate of growth could not be sustained. Unsatisfactory earnings and a low return for investors indicated the system was over built and overcapitalized, and reports of mismanagement were common. In 1892, only 44 percent of rail shares outstanding returned dividends, although twice that proportion of bonds paid interest. In the meantime, the completion of trunk lines dried up local capital sources. Political antagonism toward railroads, spurred by the roads’ immense size and power and by real and imagined discrimination against small shippers, made the industry less attractive to investors. Declining growth reduced investment opportunity even as rail securities became less appealing. Capital outlays fell in 1892 despite easy credit during much of the year. The markets for ancillary industries, like iron and steel, felt the impact of falling railroad investment as well; at times in the 1880s rails had accounted for 90 percent of the country’s rolled steel output. In an industry whose expansion had long played a vital role in creating new markets for suppliers, lagging capital expenditures loomed large in the onset of depression.

European Influences

European depression was a further source of weakness as 1893 began. Recession struck France in 1889, and business slackened in Germany and England the following year. Contemporaries dated the English downturn from a financial panic in November. Monetary stringency was a base cause of economic hard times. Because specie — gold and silver — was regarded as the only real money, and paper money was available in multiples of the specie supply, when people viewed the future with doubt they stockpiled specie and rejected paper. The availability of specie was limited, so the longer hard times prevailed the more difficult it was for anyone to secure hard money. In addition to monetary stringency, the collapse of extensive speculations in Australian, South African, and Argentine properties; and a sharp break in securities prices marked the advent of severe contraction. The great banking house of Baring and Brothers, caught with excessive holdings of Argentine securities in a falling market, shocked the financial world by suspending business on November 20, 1890. Within a year of the crisis, commercial stagnation had settled over most of Europe. The contraction was severe and long-lived. In England many indices fell to 80 percent of capacity; wholesale prices overall declined nearly 6 percent in two years and had declined 15 percent by 1894. An index of the prices of principal industrial products declined by almost as much. In Germany, contraction lasted three times as long as the average for the period 1879-1902. Not until mid-1895 did Europe begin to revive. Full prosperity returned a year or more later.

Panic in the United Kingdom and falling trade in Europe brought serious repercussions in the United States. The immediate result was near panic in New York City, the nation’s financial center, as British investors sold their American stocks to obtain funds. Uneasiness spread through the country, fostered by falling stock prices, monetary stringency, and an increase in business failures. Liabilities of failed firms during the last quarter of 1890 were $90 million — twice those in the preceding quarter. Only the normal year’s end grain exports, destined largely for England, averted a gold outflow.

Circumstances moderated during the early months of 1891, although gold flowed to Europe, and business failures remained high. Credit eased, if slowly: in response to pleas for relief, the federal treasury began the premature redemption of government bonds to put additional money into circulation, and the end of the harvest trade reduced demand for credit. Commerce quickened in the spring. Perhaps anticipation of brisk trade during the harvest season stimulated the revival of investment and business; in any event, the harvest of 1891 buoyed the economy. A bumper American wheat crop coincided with poor yields in Europe increase exports and the inflow of specie: US exports in fiscal 1892 were $150 million greater than in the preceding year, a full 1 percent of gross national product. The improved market for American crops was primarily responsible for a brief cycle of prosperity in the United States that Europe did not share. Business thrived until signs of recession began to appear in late 1892 and early 1893.

The business revival of 1891-92 only delayed an inevitable reckoning. While domestic factors led in precipitating a major downturn in the United States, the European contraction operated as a powerful depressant. Commercial stagnation in Europe decisively affected the flow of foreign investment funds to the United States. Although foreign investment in this country and American investment abroad rose overall during the 1890s, changing business conditions forced American funds going abroad and foreign funds flowing into the United States to reverse as Americans sold off foreign holdings and foreigners sold off their holdings of American assets. Initially, contraction abroad forced European investors to sell substantial holdings of American securities, then the rate of new foreign investment fell off. The repatriation of American securities prompted gold exports, deflating the money stock and depressing prices. A reduced inflow of foreign capital slowed expansion and may have exacerbated the declining growth of the railroads; undoubtedly, it dampened aggregate demand.

As foreign investors sold their holdings of American stocks for hard money, specie left the United States. Funds secured through foreign investment in domestic enterprise were important in helping the country meet its usual balance of payments deficit. Fewer funds invested during the 1890s was one of the factors that, with a continued negative balance of payments, forced the United States to export gold almost continuously from 1892 to 1896. The impact of depression abroad on the flow of capital to this country can be inferred from the history of new capital issues in Britain, the source of perhaps 75 percent of overseas investment in the United States. British issues varied as shown in Table 3.

Table 3
British New Capital Issues, 1890-1898 (millions of pounds, sterling)

1890 142.6
1891 104.6
1892 81.1
1893 49.1
1894 91.8
1895 104.7
1896 152.8
1897 157.3
1898 150.2

Source: Hoffmann, p. 193

Simultaneously, the share of new British investment sent abroad fell from one-fourth in 1891 to one-fifth two years later. Over that same period, British net capital flows abroad declined by about 60 percent; not until 1896 and 1897 did they resume earlier levels.

Thus, the recession that began in 1893 had deep roots. The slowdown in railroad expansion, decline in building construction, and foreign depression had reduced investment opportunities, and, following the brief upturn effected by the bumper wheat crop of 1891, agricultural prices fell as did exports and commerce in general. By the end of 1893, business failures numbering 15,242 averaging $22,751 in liabilities, had been reported. Plagued by successive contractions of credit, many essentially sound firms failed which would have survived under ordinary circumstances. Liabilities totaled a staggering $357 million. This was the crisis of 1893.

Response to the Depression

The financial crises of 1893 accelerated the recession that was evident early in the year into a major contraction that spread throughout the economy. Investment, commerce, prices, employment, and wages remained depressed for several years. Changing circumstances and expectations, and a persistent federal deficit, subjected the treasury gold reserve to intense pressure and generated sharp counterflows of gold. The treasury was driven four times between 1894 and 1896 to resort to bond issues totaling $260 million to obtain specie to augment the reserve. Meanwhile, restricted investment, income, and profits spelled low consumption, widespread suffering, and occasionally explosive labor and political struggles. An extensive but incomplete revival occurred in 1895. The Democratic nomination of William Jennings Bryan for the presidency on a free silver platform the following year amid an upsurge of silverite support contributed to a second downturn peculiar to the United States. Europe, just beginning to emerge from depression, was unaffected. Only in mid-1897 did recovery begin in this country; full prosperity returned gradually over the ensuing year and more.

The economy that emerged from the depression differed profoundly from that of 1893. Consolidation and the influence of investment bankers were more advanced. The nation’s international trade position was more advantageous: huge merchandise exports assured a positive net balance of payments despite large tourist expenditures abroad, foreign investments in the United States, and a continued reliance on foreign shipping to carry most of America’s overseas commerce. Moreover, new industries were rapidly moving to ascendancy, and manufactures were coming to replace farm produce as the staple products and exports of the country. The era revealed the outlines of an emerging industrial-urban economic order that portended great changes for the United States.

Hard times intensified social sensitivity to a wide range of problems accompanying industrialization, by making them more severe. Those whom depression struck hardest as well as much of the general public and major Protestant churches, shored up their civic consciousness about currency and banking reform, regulation of business in the public interest, and labor relations. Although nineteenth century liberalism and the tradition of administrative nihilism that it favored remained viable, public opinion began to slowly swing toward governmental activism and interventionism associated with modern, industrial societies, erecting in the process the intellectual foundation for the reform impulse that was to be called Progressivism in twentieth century America. Most important of all, these opposed tendencies in thought set the boundaries within which Americans for the next century debated the most vital questions of their shared experience. The depression was a reminder of business slumps, commonweal above avarice, and principle above principal.

Government responses to depression during the 1890s exhibited elements of complexity, confusion, and contradiction. Yet they also showed a pattern that confirmed the transitional character of the era and clarified the role of the business crisis in the emergence of modern America. Hard times, intimately related to developments issuing in an industrial economy characterized by increasingly vast business units and concentrations of financial and productive power, were a major influence on society, thought, politics, and thus, unavoidably, government. Awareness of, and proposals of means for adapting to, deep-rooted changes attending industrialization, urbanization, and other dimensions of the current transformation of the United States long antedated the economic contraction of the nineties.

Selected Bibliography

*I would like to thank Douglas Steeples, retired dean of the College of Liberal Arts and professor of history, emeritus, Mercer University. Much of this article has been taken from Democracy in Desperation: The Depression of 1893 by Douglas Steeples and David O. Whitten, which was declared an Exceptional Academic Title by Choice. Democracy in Desperation includes the most recent and extensive bibliography for the depression of 1893.

Clanton, Gene. Populism: The Humane Preference in America, 1890-1900. Boston: Twayne, 1991.

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

Goodwyn, Lawrence. Democratic Promise: The Populist Movement in America. New York: Oxford University Press, 1976.

Grant, H. Roger. Self Help in the 1890s Depression. Ames: Iowa State University Press, 1983.

Higgs, Robert. The Transformation of the American Economy, 1865-1914. New York: Wiley, 1971.

Himmelberg, Robert F. The Rise of Big Business and the Beginnings of Antitrust and Railroad Regulation, 1870-1900. New York: Garland, 1994.

Hoffmann, Charles. The Depression of the Nineties: An Economic History. Westport, CT: Greenwood Publishing, 1970.

Jones, Stanley L. The Presidential Election of 1896. Madison: University of Wisconsin Press, 1964.

Kindleberger, Charles Poor. Manias, Panics, and Crashes: A History of Financial Crises. Revised Edition. New York: Basic Books, 1989.

Kolko, Gabriel. Railroads and Regulation, 1877-1916. Princeton: Princeton University Press, 1965.

Lamoreaux, Naomi R. The Great Merger Movement in American Business, 1895-1904. New York: Cambridge University Press, 1985.

Rees, Albert. Real Wages in Manufacturing, 1890-1914. Princeton, NJ: Princeton University Press, 1961.

Ritter, Gretchen. Goldbugs and Greenbacks: The Antimonopoly Tradition and the Politics of Finance in America. New York: Cambridge University Press, 1997.

Romer, Christina. “Spurious Volatility in Historical Unemployment Data.” Journal of Political Economy 94, no. 1. (1986): 1-37.

Schwantes, Carlos A. Coxey’s Army: An American Odyssey. Lincoln: University of Nebraska Press, 1985.

Steeples, Douglas, and David Whitten. Democracy in Desperation: The Depression of 1893. Westport, CT: Greenwood Press, 1998.

Timberlake, Richard. “Panic of 1893.” In Business Cycles and Depressions: An Encyclopedia, edited by David Glasner. New York: Garland, 1997.

White, Gerald Taylor. Years of Transition: The United States and the Problems of Recovery after 1893. University, AL: University of Alabama Press, 1982.

Citation: Whitten, David. “Depression of 1893″. EH.Net Encyclopedia, edited by Robert Whaples. August 14, 2001. URL http://eh.net/encyclopedia/the-depression-of-1893/

The First Bank of the United States

David Cowen

Birth of the Bank

In February 1791, the First Bank of the United States (1791-1811) received a unique national charter for twenty years. Alexander Hamilton’s brainchild, a semi-public national bank, was a crucial component in the building of the early U.S. economy. The Bank prospered for twenty years and performed traditional banking functions in exemplary fashion. With a main office in Philadelphia and eight branches nationwide to serve its customers, the Bank’s influence stretched along the entire Atlantic seaboard from Boston to Charleston and Savannah and westward along the Gulf Coast to New Orleans.

Hamilton’s Broad Economic Plan

When the Treasury Department was created by an Act of Congress in September 1789, President George Washington rewarded Hamilton with the post of Secretary. Hamilton quickly became the nation’s leading economic figure. When Congress asked Hamilton to submit an economic plan for the country, he was well prepared. The Secretary delivered several monumental state papers that forged the financial system for the nation: The Report on Public Credit (January 9, 1790), The Report on the Bank (December 13, 1790), The Establishment of a Mint (January, 1791), and The Report on Manufactures (December 5, 1791). Hamilton’s reports outlined the strategies that were part of a comprehensive Federalist economic and financial program. They included a sinking fund to extinguish the national debt and an excise tax to be collected on all distilled liquors.

A key component of Hamilton’s economic plan for the country was the national Bank, an institution that would safeguard all pecuniary transactions. The Bank would not only stimulate the economy but also enhance the shaky credit of the government. The English financial system, particularly the Bank of England, provided an important model for Hamilton.

The Bank’s Funding and Privileges

The Report on the Bank explained that the national Bank would be chartered for twenty years, during which time the Congress would agree not to establish another national bank. The seed capital would be $10 million: $8 million from private sources, and $2 million from the government. The Bank would have the right to issue notes or currency up to $10 million. The government would also pledge that the notes of the Bank would be unique in that they were valid for payments to the United States. In short, the notes would be suitable for payment of taxes, a feature that would provide the Bank with a strong advantage over its competitors.

The national Bank would confer many benefits on the government including a ready source of loans, a principal depository for federal monies that were transferable from city to city without charge, and a clearing agent for payments on the national debt. The government, as the largest stockholder, would share in the profits, but have no direct participation in the management.

Debate over Establishment of the Bank

The Bank bill was introduced into Congress on December 13, 1790, passed the Senate on January 20, 1791, the House on February 8, 1791, and therefore was forwarded to President Washington for his signature. It was unclear whether Washington would sign the bill into law. Powerful forces led by James Madison, Thomas Jefferson and the Attorney General, Edmund Randolph, argued to Washington that the Constitution had not granted the government the power to incorporate a Bank and therefore he should not sign the bill.

Washington Accepts Hamilton’s View on Implied Powers

Washington showed Hamilton the opposition’s argument and asked him to prepare a document explaining why he should sign the bill. The pressure was therefore on Hamilton to produce a flawless retort. His reply to Washington has been christened as the benchmark of a broad interpretation of the Constitution. Hamilton turned the tables on his opposition. If Thomas Jefferson, James Madison and Edmund Randolph argued that the power to incorporate was not available unless explicitly prescribed by the Constitution, then Alexander Hamilton retorted that a power was not unavailable unless so stated in the Constitution. Washington accepted Hamilton’s logic and signed the bill on February 25, 1791 to create the national Bank.

Most important, however, was not the political infighting, but rather that Hamilton’s view holding that implied governmental powers were a viable part of the Constitution had carried the day. Hamilton had accomplished his aim: his detractors defeated; his economic approach adopted. In the ensuing years the Bank of the United States occupied center stage of the American financial system.

Life of the Bank

Initial Stock Offering

On July 4, 1791, in the largest initial stock offering the country had ever witnessed, investors displayed confidence in the new funding system by scooping up $8 million in Bank of United States stock with unprecedented alacrity. Many notable members of the Congress were purchasers. Prices of receipts for the right to buy stock (i.e. not the stock itself), know as scripts, were driven from an initial offering price of $25 to the unsustainable height of over $300, and then tumbled to $150 within days, causing alarm in the markets. Secretary Hamilton calmed the storm much as a modern central banker would have by using public money to directly purchase government securities. However, the script bubble led many to blame the Bank for such rabid speculations.

Bank Branches

In the fall of 1791 the new stockholders met in Philadelphia to choose board members and decide on rules and regulations. While the Bank would be headquartered in Philadelphia, the stockholders clamored for and received branches, with four opening in Baltimore, Boston, Charleston, and New York in 1792, and eventually four more in Norfolk (1800), Washington (1802), Savannah (1802) and New Orleans (1805). The branches were of great concern to the existing state banks, which viewed the national Bank as a competitive threat.

The Bank’s First President and Cashiers

Thomas Willing accepted the title of president of the Bank and remained in that position until 1807. Willing possessed strong credentials as he had been president of the Bank of North America, Mayor of Philadelphia, the Secretary to the Congress of delegates at Albany, and a Judge of the Supreme court of Pennsylvania. As the day-to- day manager, the role of bank cashier was also important. At the head office in Philadelphia, John Kean was appointed the cashier; however, the most noteworthy was George Simpson, who held the post from 1795-1811.

The Bank’s Roles in the Economy

On December 12, 1791, the Bank opened for business in Philadelphia. The customers were merchants, politicians, manufacturers, landowners, and most importantly, the government of the United States. The Banks notes circulated countrywide and therefore infused a safe medium of paper money into the economy for business transactions. The sheer volume of deposits, loans, transfers and payments conducted by the Bank throughout the country made it far and away the single largest enterprise in the fledgling nation. Profits, however, were moderate during the operation of the Bank because its directors opted for stability over risk taking.

The Bank and the “Panic of 1792″

The Bank had an enormous impact on the economy within two months of opening its doors for business by flooding the market with its discounts (loans) and banknotes and then sharply reversing course and calling in many of the loans. Although the added liquidity initially helped push a rising securities market higher, the subsequent drain caused the very first U.S. securities market crash by forcing speculators to sell their stocks. The largest speculator caught in the financial crisis was William Duer. When he went insolvent in March 1792, the markets were temporarily paralyzed. This so-called “Panic of 1792″ was short lived as again Secretary Hamilton (as in the previous year during the script bubble) injected funds by buying securities directly and on behalf of the sinking fund. Yet incidents like the Panic of 1792 and the script bubble would be remembered for many years by opponents of the Bank who were still in steadfast opposition to the Hamilton inspired institution.

The Bank’s Business with the National Government

The rest of Bank years were never as tumultuous as the events surrounding the Panic of 1792. Rather during its twenty-year lifespan the Bank performed many mundane pecuniary functions for its customers. The largest customer, the government, had many notable interactions with the Bank. One of the highlights of the relationship was the Bank’s efficient managing of the government’s fiscal affairs with respect to the Louisiana Purchase in 1803. In its earlier days, the Bank had lent heavily to its largest customer. By the end of 1795 the Bank had lent the government over $6 million, or 60% of its capital. At this point Willing and the other directors became alarmed and demanded the Government repay part of its loan. Since Government credit was still weak, the Treasury resorted to selling shares of its Bank stock. The sales began in 1796 and ended in 1802. With the proceeds from the sales of stock, the government repaid the Bank.

Central Banking Functions of the Bank

The Bank performed certain functions that today are associated with central banking. First, the Bank attempted to regulate state banks by curtailing those that had overissued their bank notes. Second, the Bank, in coordination with the Treasury department, discussed economic conditions and attempted to promote the safety of the entire credit system. Third, while the Philadelphia board gave each branch autonomy respecting lending to individuals, the Bank tried to coordinate aggregate policy changes, whether a loosening or tightening of lending credit, across the entire network of branches.

Death of the Bank

The anti-Bank forces had remained steadfast in their opposition to the Bank since its inception in 1791. By the time of the renewal debate in Congress, the Federalists were no longer in control. The Democrats now held the majority and were ready to act against the Federalist conceived institution. The opponents of the Bank included Henry Clay, William Branch Giles and Vice-President George Clinton. The Federalists supported renewal and were joined by two notable Democrats who crossed party lines, Treasury Secretary Albert Gallatin, who believed in the usefulness of the institution, and then President Madison, who had switched camps with respect to the Bank issue because he believed the matter had been settled by precedent.

Complaints about the Bank

The opponents charged that because three-fourths of the ownership of the stock was held by foreigners, that the Bank was under their direct influence. The charge was false, as foreigners were prohibited from electing directors. The opposition also charged that the Bank was concealing profits, operating in a mysterious fashion, unconstitutional, and simply a tool for loaning money to the Government.

Rechartering Suffers a Narrow Defeat in Congress

Although the charter did not expire until March 4, 1811, the renewal process commenced in the House on March 28, 1808 and in the Senate on April 20, 1808. The matter developed slowly and was referred to Secretary Gallatin for an opinion. On March 3, 1809 Gallatin communicated his beliefs to the House that the Bank charter should be renewed. The matter returned to the House on January 29, 1810 for Committee debate. On February 19th, the committee recommended in favor of renewing the charter and sent the bill to the floor of the House. Floor debate opened on April 13th, and the bill was stopped dead in its tracks. Stockholders resubmitted the bill on December 10th, and despite an intense three-month debate, the bill was killed. The vote in each section of the Congress was incredibly close. The bill was defeated in the House by a 65 to 64 margin on January 24, 1811, and in the Senate was deadlocked at 17 on February 20th before Vice-President Clinton, an enemy of both Madison and Gallatin, broke the tie with a negative vote. The Bank of the United States closed its doors on March 3, 1811.

The Bank and the Debate over Central Government Power

The reason the Bank lost its charter had precious little to do with banking. When charter renewal debate transpired in 1811 banking on the whole was flourishing. The Bank was born, lived, and eventually died a victim of politics. The Bank has been remembered not for what occurred during its operation — stimulating business, infusing safe paper money into the economy, supporting the credit of the country and national government, and with the Treasury department regulating the financial arena — but rather for what occurred during the stormy debates at its birth and death. The death of the Bank was another chapter in an ongoing debate between the early leaders of the country who were split between those who preferred a weak central government on the one hand and those who desired a strong central government on the other.

The chartering of a national economic institution, a Bank of the United States, marks the take-off of the Federalist financial revolution that began several years earlier with the signing of the Constitution. The political die of the United States was cast with that document, and by 1792 the economic base of Federalism was in place, first with the Federal funding of national and state war debts, and second, with a sound national Bank in place to give coherence to the developing U.S. financial system.

Further Reading:

Bowling, Kenneth R. “The Bank Bill, the Capital City and President Washington.” Capital Studies 1, no. 1 (1972).

Cowen, David J. “The First Bank of the United States and the Securities Market Crash of 1792.” Journal of Economic History 60, no. 4 (2000).

Cowen, David J. _The Origins and Economic Impact of the First Bank of the United States, 1791-1797_. New York: Garland Publishing, 2000.

Dewey, Davis Rich and John Thom Holdsworth. The First and Second Banks of the United States. Washington, D.C.: Government Printing Office, 1910.

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

Klubes, Benjamin. “The First Federal Congress and the First National Bank: A Case Study in Constitutional History.” Journal of the Early American Republic10 (1990).

McDonald, Forrest. “The Constitution and Hamiltonian Capitalism.” In How Capitalistic is the Constitution? Edited by Robert A. Goldwin and William A. Schambra. New York: American Enterprise Institute for Public Policy Research, 1982.

Perkins, Edwin. American Public Finance and Financial Services 1700-1815 Columbus: Ohio State University Press, 1994.

Redlich, Fritz. The Molding of American Banking. New York: Johnson Reprint Corporation, 1968.

St. Clair Clarke, M. and D. A. Hall. Legislative and Documentary History of the Bank of United States. Washington, D.C.: Gales and Seaton, 1832. Reprint. New York: Augustus M. Kelley Publishers, 1967.

Sylla, Richard. “U.S. Securities Markets and the Banking System, 1790-1840.” Federal Reserve Bank of St. Louis Review 80, no. 3 (1998).

Syrett, Harold, editor. The Papers of Alexander Hamilton. New York: Columbia University Press, 1961-87.

Wettereau, James O. “Branches of the First Bank of the United States.” Journal of Economic History 2 (1942).

Wettereau, James O. “New Light on the First Bank of the United States.” Pennsylvania Magazine of History and Biography 61 (1937).

Wettereau, James O. Statistical Records of the First Bank of the United States. New York: Garland Publishing, 1985.

Wettereau, James O. “The Oldest Bank Building in the United States.” Transactions of the American Philosophical Society 43, part 1, 1953.

Wright, Robert. Origins of Commercial Banking in America, 1750-1800. Lanham, MD: Rowman & Littlefield, 2001.

Wright, Robert. The Wealth of Nations Rediscovered: Integration and Expansion of the U.S. Financial Sector, 1780-1850. New York: Cambridge University Press, 2002.

Wright, Robert. “Thomas Willing (1731-1821): Philadelphia Financier and Forgotten Founding Father.” Pennsylvania History, Fall, 1996.

Citation: Cowen, David. “First Bank of the United States”. EH.Net Encyclopedia, edited by Robert Whaples. March 16, 2008. URL http://eh.net/encyclopedia/the-first-bank-of-the-united-states/

US Banking History, Civil War to World War II

Richard S. Grossman, Wesleyan University

The National Banking Era Begins, 1863

The National Banking Acts of 1863 and 1864

The National Banking era was ushered in by the passage of the National Currency (later renamed the National Banking) Acts of 1863 and 1864. The Acts marked a decisive change in the monetary system, confirmed a quarter-century-old trend in bank chartering arrangements, and also played a role in financing the Civil War.

Provision of a Uniform National Currency

As its original title suggests, one of the main objectives of the legislation was to provide a uniform national currency. Prior to the establishment of the national banking system, the national currency supply consisted of a confusing patchwork of bank notes issued under a variety of rules by banks chartered under different state laws. Notes of sound banks circulated side-by-side with notes of banks in financial trouble, as well as those of banks that had failed (not to mention forgeries). In fact, bank notes frequently traded at a discount, so that a one-dollar note of a smaller, less well-known bank (or, for that matter, of a bank at some distance) would likely have been valued at less than one dollar by someone receiving it in a transaction. The confusion was such as to lead to the publication of magazines that specialized in printing pictures, descriptions, and prices of various bank notes, along with information on whether or not the issuing bank was still in existence.

Under the legislation, newly created national banks were empowered to issue national bank notes backed by a deposit of US Treasury securities with their chartering agency, the Department of the Treasury’s Comptroller of the Currency. The legislation also placed a tax on notes issued by state banks, effectively driving them out of circulation. Bank notes were of uniform design and, in fact, were printed by the government. The amount of bank notes a national bank was allowed to issue depended upon the bank’s capital (which was also regulated by the act) and the amount of bonds it deposited with the Comptroller. The relationship between bank capital, bonds held, and note issue was changed by laws in 1874, 1882, and 1900 (Cagan 1963, James 1976, and Krooss 1969).

Federal Chartering of Banks

A second element of the Act was the introduction bank charters issued by the federal government. From the earliest days of the Republic, banking had been considered primarily the province of state governments.[1] Originally, individuals who wished to obtain banking charters had to approach the state legislature, which then decided if the applicant was of sufficient moral standing to warrant a charter and if the region in question needed an additional bank. These decisions may well have been influenced by bribes and political pressure, both by the prospective banker and by established bankers who may have hoped to block the entry of new competitors.

An important shift in state banking practice had begun with the introduction of free banking laws in the 1830s. Beginning with laws passed in Michigan (1837) and New York (1838), free banking laws changed the way banks obtained charters. Rather than apply to the state legislature and receive a decision on a case-by-case basis, individuals could obtain a charter by filling out some paperwork and depositing a prescribed amount of specified bonds with the state authorities. By 1860, over one half of the states had enacted some type of free banking law (Rockoff 1975). By regularizing and removing legislative discretion from chartering decisions, the National Banking Acts spread free banking on a national level.

Financing the Civil War

A third important element of the National Banking Acts was that they helped the Union government pay for the war. Adopted in the midst of the Civil War, the requirement for banks to deposit US bonds with the Comptroller maintained the demand for Union securities and helped finance the war effort.[2]

Development and Competition with State Banks

The National Banking system grew rapidly at first (Table 1). Much of the increase came at the expense of the state-chartered banking systems, which contracted over the same period, largely because they were no longer able to issue notes. The expansion of the new system did not lead to the extinction of the old: the growth of deposit-taking, combined with less stringent capital requirements, convinced many state bankers that they could do without either the ability to issue banknotes or a federal charter, and led to a resurgence of state banking in the 1880s and 1890s. Under the original acts, the minimum capital requirement for national banks was $50,000 for banks in towns with a population of 6000 or less, $100,000 for banks in cities with a population ranging from 6000 to 50,000, and $200,000 for banks in cities with populations exceeding 50,000. By contrast, the minimum capital requirement for a state bank was often as low as $10,000. The difference in capital requirements may have been an important difference in the resurgence of state banking: in 1877 only about one-fifth of state banks had a capital of less than $50,000; by 1899 the proportion was over three-fifths. Recognizing this competition, the Gold Standard Act of 1900 reduced the minimum capital necessary for national banks. It is questionable whether regulatory competition (both between states and between states and the federal government) kept regulators on their toes or encouraged a “race to the bottom,” that is, lower and looser standards.

Table 1: Numbers and Assets of National and State Banks, 1863-1913

Number of Banks Assets of Banks ($millions)
National Banks State Banks National Banks State Banks
1863 66 1466 16.8 1185.4
1864 467 1089 252.2 725.9
1865 1294 349 1126.5 165.8
1866 1634 297 1476.3 154.8
1867 1636 272 1494.5 151.9
1868 1640 247 1572.1 154.6
1869 1619 259 1564.1 156.0
1870 1612 325 1565.7 201.5
1871 1723 452 1703.4 259.6
1872 1853 566 1770.8 264.5
1873 1968 277 1851.2 178.9
1874 1983 368 1851.8 237.4
1875 2076 586 1913.2 395.2
1876 2091 671 1825.7 405.9
1877 2078 631 1774.3 506.9
1878 2056 510 1770.4 388.8
1879 2048 648 2019.8 427.6
1880 2076 650 2035.4 481.8
1881 2115 683 2325.8 575.5
1882 2239 704 2344.3 633.8
1883 2417 788 2364.8 724.5
1884 2625 852 2282.5 760.9
1885 2689 1015 2421.8 802.0
1886 2809 891 2474.5 807.0
1887 3014 1471 2636.2 1003.0
1888 3120 1523 2731.4 1055.0
1889 3239 1791 2937.9 1237.3
1890 3484 2250 3061.7 1374.6
1891 3652 2743 3113.4 1442.0
1892 3759 3359 3493.7 1640.0
1893 3807 3807 3213.2 1857.0
1894 3770 3810 3422.0 1782.0
1895 3715 4016 3470.5 1954.0
1896 3689 3968 3353.7 1962.0
1897 3610 4108 3563.4 1981.0
1898 3582 4211 3977.6 2298.0
1899 3583 4451 4708.8 2707.0
1900 3732 4659 4944.1 3090.0
1901 4165 5317 5675.9 3776.0
1902 4535 5814 6008.7 4292.0
1903 4939 6493 6286.9 4790.0
1904 5331 7508 6655.9 5244.0
1905 5668 8477 7327.8 6056.0
1906 6053 9604 7784.2 6636.0
1907 6429 10761 8476.5 7190.0
1908 6824 12062 8714.0 6898.0
1909 6926 12398 9471.7 7407.0
1910 7145 13257 9896.6 7911.0
1911 7277 14115 10383 8412.0
1912 7372 14791 10861.7 9005.0
1913 7473 15526 11036.9 9267.0

Source: U.S. Department of the Treasury. Annual Report of the Comptroller of the Currency (1931), pp. 3, 5. State bank columns include data on state-chartered commercial banks and loan and trust companies.

Capital Requirements and Interest Rates

The relatively high minimum capital requirement for national banks may have contributed to regional interest rate differentials in the post-Civil War era. The period from the Civil War through World War I saw a substantial decline in interregional interest rate differentials. According to Lance Davis (1965), the decline in difference between regional interest rates can be explained by the development and spread of the commercial paper market, which increased the interregional mobility of funds. Richard Sylla (1969) argues that the high minimum capital requirements established by the National Banking Acts represented barriers to entry and therefore led to local monopolies by note-issuing national banks. These local monopolies in capital-short regions led to the persistence of interest rate spreads.[3] (See also James 1976b.)

Bank Failures

Financial crises were a common occurrence in the National Banking era. O.M.W. Sprague (1910) classified the main financial crises during the era as occurring in 1873, 1884, 1890, 1893, and 1907, with those of 1873, 1893, and 1907 being regarded as full-fledged crises and those of 1884 and 1890 as less severe.

Contemporary observers complained of both the persistence and ill effects of bank failures under the new system.[4] The number and assets of failed national and non-national banks during the National Banking era is shown in Table 2. Suspensions — temporary closures of banks unable to meet demand for their liabilities — were even higher during this period.

Table 2: Bank Failures, 1865-1913

Number of Failed Banks Assets of Failed Banks ($millions)
National Banks Other Banks National Banks Other banks
1865 1 5 0.1 0.2
1866 2 5 1.8 1.2
1867 7 3 4.9 0.2
1868 3 7 0.5 0.2
1869 2 6 0.7 0.1
1870 0 1 0.0 0.0
1871 0 7 0.0 2.3
1872 6 10 5.2 2.1
1873 11 33 8.8 4.6
1874 3 40 0.6 4.1
1875 5 14 3.2 9.2
1876 9 37 2.2 7.3
1877 10 63 7.3 13.1
1878 14 70 6.9 26.0
1879 8 20 2.6 5.1
1880 3 10 1.0 1.6
1881 0 9 0.0 0.6
1882 3 19 6.0 2.8
1883 2 27 0.9 2.8
1884 11 54 7.9 12.9
1885 4 32 4.7 3.0
1886 8 13 1.6 1.3
1887 8 19 6.9 2.9
1888 8 17 6.9 2.8
1889 8 15 0.8 1.3
1890 9 30 2.0 10.7
1891 25 44 9.0 7.2
1892 17 27 15.1 2.7
1893 65 261 27.6 54.8
1894 21 71 7.4 8.0
1895 36 115 12.1 11.3
1896 27 78 12.0 10.2
1897 38 122 29.1 17.9
1898 7 53 4.6 4.5
1899 12 26 2.3 7.8
1900 6 32 11.6 7.7
1901 11 56 8.1 6.4
1902 2 43 0.5 7.3
1903 12 26 6.8 2.2
1904 20 102 7.7 24.3
1905 22 57 13.7 7.0
1906 8 37 2.2 6.6
1907 7 34 5.4 13.0
1908 24 132 30.8 177.1
1909 9 60 3.4 15.8
1910 6 28 2.6 14.5
1911 3 56 1.1 14.0
1912 8 55 5.0 7.8
1913 6 40 7.6 6.2

Source: U.S. Department of the Treasury. Annual Report of the Comptroller of the Currency (1931), pp. 6, 8.

The largest number of failures occurred in the years following the financial crisis of 1893. The number and assets of national and non-national bank failures remained high for four years following the crisis, a period which coincided with the free silver agitation of the mid-1890s, before returning to pre-1893 levels. Other crises were also accompanied by an increase in the number and assets of bank failures. The earliest peak during the national banking era accompanied the onset of the crisis of 1873. Failures subsequently fell, but rose again in the trough of the depression that followed the 1873 crisis. The panic of 1884 saw a slight increase in failures, while the financial stringency of 1890 was followed by a more substantial increase. Failures peaked again following several minor panics around the turn of the century and again at the time of the crisis of 1907.

Among the alleged causes of crises during the national banking era were that the money supply was not sufficiently elastic to allow for seasonal and other stresses on the money market and the fact that reserves were pyramided. That is, under the National Banking Acts, a portion of banks’ required reserves could be held in national banks in larger cities (“reserve city banks”). Reserve city banks could, in turn, hold a portion of their required reserves in “central reserve city banks,” national banks in New York, Chicago, and St. Louis. In practice, this led to the build-up of reserve balances in New York City. Increased demands for funds in the interior of the country during the autumn harvest season led to substantial outflows of funds from New York, which contributed to tight money market conditions and, sometimes, to panics (Miron 1986).[5]

Attempted Remedies for Banking Crises

Causes of Bank Failures

Bank failures occur when banks are unable to meet the demands of their creditors (in earlier times these were note holders; later on, they were more often depositors). Banks typically do not hold 100 percent of their liabilities in reserves, instead holding some fraction of demandable liabilities in reserves: as long as the flows of funds into and out of the bank are more or less in balance, the bank is in little danger of failing. A withdrawal of deposits that exceeds the bank’s reserves, however, can lead to the banks’ temporary suspension (inability to pay) or, if protracted, failure. The surge in withdrawals can have a variety of causes including depositor concern about the bank’s solvency (ability to pay depositors), as well as worries about other banks’ solvency that lead to a general distrust of all banks.[6]

Clearinghouses

Bankers and policy makers attempted a number of different responses to banking panics during the National Banking era. One method of dealing with panics was for the bankers of a city to pool their resources, through the local bankers’ clearinghouse and to jointly guarantee the payment of every member banks’ liabilities (see Gorton (1985a, b)).

Deposit Insurance

Another method of coping with panics was deposit insurance. Eight states (Oklahoma, Kansas, Nebraska, Texas, Mississippi, South Dakota, North Dakota, and Washington) adopted deposit insurance systems between 1908 and 1917 (six other states had adopted some form of deposit insurance in the nineteenth century: New York, Vermont, Indiana, Michigan, Ohio, and Iowa). These systems were not particularly successful, in part because they lacked diversification: because these systems operated statewide, when a panic fell full force on a state, deposit insurance system did not have adequate resources to handle each and every failure. When the agricultural depression of the 1920s hit, a number of these systems failed (Federal Deposit Insurance Corporation 1988).

Double Liability

Another measure adopted to curtail bank risk-taking, and through risk-taking, bank failures, was double liability (Grossman 2001). Under double liability, shareholders who had invested in banks that failed were liable to lose not only the money they had invested, but could be called on by a bank’s receiver to contribute an additional amount equal to the par value of the shares (hence the term “double liability,” although clearly the loss to the shareholder need not have been double if the par and market values of shares were different). Other states instituted triple liability, where the receiver could call on twice the par value of shares owned. Still others had unlimited liability, while others had single, or regular limited, liability.[7] It was argued that banks with double liability would be more risk averse, since shareholders would be liable for a greater payment if the firm went bankrupt.

By 1870, multiple (i.e., double, triple, and unlimited) liability was already the rule for state banks in eighteen states, principally in the Midwest, New England, and Middle Atlantic regions, as well as for national banks. By 1900, multiple liability was the law for state banks in thirty-two states. By this time, the main pockets of single liability were in the south and west. By 1930, only four states had single liability.

Double liability appears to have been successful (Grossman 2001), at least during less-than-turbulent times. During the 1890-1930 period, state banks in states where banks were subject to double (or triple, or unlimited) liability typically undertook less risk than their counterparts in single (limited) liability states in normal years. However, in years in which bank failures were quite high, banks in multiple liability states appeared to take more risk than their limited liability counterparts. This may have resulted from the fact that legislators in more crisis-prone states were more likely to have already adopted double liability. Whatever its advantages or disadvantages, the Great Depression spelled the end of double liability: by 1941, virtually every state had repealed double liability for state-chartered banks.

The Crisis of 1907 and Founding of the Federal Reserve

The crisis of 1907, which had been brought under control by a coalition of trust companies and other chartered banks and clearing-house members led by J.P. Morgan, led to a reconsideration of the monetary system of the United States. Congress set up the National Monetary Commission (1908-12), which undertook a massive study of the history of banking and monetary arrangements in the United States and in other economically advanced countries.[8]

The eventual result of this investigation was the Federal Reserve Act (1913), which established the Federal Reserve System as the central bank of the US. Unlike other countries that had one central bank (e.g., Bank of England, Bank of France), the Federal Reserve Act provided for a system of between eight and twelve reserve banks (twelve were eventually established under the act, although during debate over the act, some had called for as many as one reserve bank per state). This provision, like the rejection of the first two attempts at a central bank, resulted, in part, from American’s antipathy towards centralized monetary authority. The Federal Reserve was established to manage the monetary affairs of the country, to hold the reserves of banks and to regulate the money supply. At the time of its founding each of the reserve banks had a high degree of independence. As a result of the crises surrounding the Great Depression, Congress passed the Banking Act of 1935, which, among other things, centralized Federal Reserve power (including the power to engage in open market operations) in a Washington-based Board of Governors (and Federal Open Market Committee), relegating the heads of the individual reserve banks to a more consultative role in the operation of monetary policy.

The Goal of an “Elastic Currency”

The stated goals of the Federal Reserve Act were: ” . . . to furnish an elastic currency, to furnish the means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.” Furnishing an “elastic currency” was important goal of the act, since none of the components of the money supply (gold and silver certificates, national bank notes) were able to expand or contract particularly rapidly. The inelasticity of the money supply, along with the seasonal fluctuations in money demand had led to a number of the panics of the National Banking era. These panic-inducing seasonal fluctuations resulted from the large flows of money out of New York and other money centers to the interior of the country to pay for the newly harvested crops. If monetary conditions were already tight before the drain of funds to the nation’s interior, the autumnal movement of funds could — and did –precipitate panics.[9]

Growth of the Bankers’ Acceptance Market

The act also fostered the growth of the bankers’ acceptance market. Bankers’ acceptances were essentially short-dated IOUs, issued by banks on behalf of clients that were importing (or otherwise purchasing) goods. These acceptances were sent to the seller who could hold on to them until they matured, and receive the face value of the acceptance, or could discount them, that is, receive the face value minus interest charges. By allowing the Federal Reserve to rediscount commercial paper, the act facilitated the growth of this short-term money market (Warburg 1930, Broz 1997, and Federal Reserve Bank of New York 1998). In the 1920s, the various Federal Reserve banks began making large-scale purchases of US Treasury obligations, marking the beginnings of Federal Reserve open market operations.[10]

The Federal Reserve and State Banking

The establishment of the Federal Reserve did not end the competition between the state and national banking systems. While national banks were required to be members of the new Federal Reserve System, state banks could also become members of the system on equal terms. Further, the Federal Reserve Act, bolstered by the Act of June 21, 1917, ensured that state banks could become member banks without losing any competitive advantages they might hold over national banks. Depending upon the state, state banking law sometimes gave state banks advantages in the areas of branching,[11] trust operations,[12] interlocking managements, loan and investment powers,[13] safe deposit operations, and the arrangement of mergers.[14] Where state banking laws were especially liberal, banks had an incentive to give up their national bank charter and seek admission to the Federal Reserve System as a state member bank.

McFadden Act

The McFadden Act (1927) addressed some of the competitive inequalities between state and national banks. It gave national banks charters of indeterminate length, allowing them to compete with state banks for trust business. It expanded the range of permissible investments, including real estate investment and allowed investment in the stock of safe deposit companies. The Act greatly restricted the ability of member banks — whether state or nationally chartered — from opening or maintaining out-of-town branches.

The Great Depression: Panic and Reform

The Great Depression was the longest, most severe economic downturn in the history of the United States.[15] The banking panics of 1930, 1931, and 1933 were the most severe banking disruption ever to hit the United States, with more than one quarter of all banks closing. Data on the number of bank suspensions during this period is presented in Table 3.

Table 3: Bank Suspensions, 1921-33

Number of Bank Suspensions
All Banks National Banks
1921 505 52
1922 367 49
1923 646 90
1924 775 122
1925 618 118
1926 976 123
1927 669 91
1928 499 57
1929 659 64
1930 1352 161
1931 2294 409
1932 1456 276
1933 5190 1475

Source: Bremer (1935).

Note: 1933 figures include 4507 non-licensed banks (1400 non-licensed national banks). Non-licensed banks consist of banks operating on a restricted basis or not in operation, but not in liquidation or receivership.

The first banking panic erupted in October 1930. According to Friedman and Schwartz (1963, pp. 308-309), it began with failures in Missouri, Indiana, Illinois, Iowa, Arkansas, and North Carolina and quickly spread to other areas of the country. Friedman and Schwartz report that 256 banks with $180 million of deposits failed in November 1930, while 352 banks with over $370 million of deposits failed in the following month (the largest of which was the Bank of United States which failed on December 11 with over $200 million of deposits). The second banking panic began in March of 1931 and continued into the summer.[16] The third and final panic began at the end of 1932 and persisted into March of 1933. During the early months of 1933, a number of states declared banking holidays, allowing banks to close their doors and therefore freeing them from the requirement to redeem deposits. By the time President Franklin Delano Roosevelt was inaugurated on March 4, 1933, state-declared banking holidays were widespread. The following day, the president declared a national banking holiday.

Beginning on March 13, the Secretary of the Treasury began granting licenses to banks to reopen for business.

Federal Deposit Insurance

The crises led to the implementation of several major reforms in banking. Among the most important of these was the introduction of federal deposit insurance under the Banking (Glass-Steagall) Act of 1933. Originally an explicitly temporary program, the Act established the Federal Deposit Insurance Corporation (the FDIC was made permanent by the Banking Act of 1935); insurance became effective January 1, 1934. Member banks of the Federal Reserve (which included all national banks) were required to join FDIC. Within six months, 14,000 out of 15,348 commercial banks, representing 97 percent of bank deposits had subscribed to federal deposit insurance (Friedman and Schwartz, 1963, 436-437).[17] Coverage under the initial act was limited to a maximum of $2500 of deposits for each depositor. Table 4 documents the increase in the limit from the act’s inception until 1980, when it reached its current $100,000 level.

Table 4: FDIC Insurance Limit

1934 (January) $2500
1934 (July) $5000
1950 $10,000
1966 $15,000
1969 $20,000
1974 $40,000
1980 $100,000
Source: http://www.fdic.gov/

Additional Provisions of the Glass-Steagall Act

An important goal of the New Deal reforms was to enhance the stability of the banking system. Because the involvement of commercial banks in securities underwriting was seen as having contributed to banking instability, the Glass-Steagall Act of 1933 forced the separation of commercial and investment banking.[18] Additionally, the Acts (1933 for member banks, 1935 for other insured banks) established Regulation Q, which forbade banks from paying interest on demand deposits (i.e., checking accounts) and established limits on interest rates paid to time deposits. It was argued that paying interest on demand deposits introduced unhealthy competition.

Recent Responses to New Deal Banking Laws

In a sense, contemporary debates on banking policy stem largely from the reforms of the post-Depression era. Although several of the reforms introduced in the wake of the 1931-33 crisis have survived into the twenty-first century, almost all of them have been subject to intense scrutiny in the last two decades. For example, several court decisions, along with the Financial Services Modernization Act (Gramm-Leach-Bliley) of 1999, have blurred the previously strict separation between different financial service industries (particularly, although not limited to commercial and investment banking).

FSLIC

The Savings and Loan crisis of the 1980s, resulting from a combination of deposit insurance-induced moral hazard and deregulation, led to the dismantling of the Depression-era Federal Savings and Loan Insurance Corporation (FSLIC) and the transfer of Savings and Loan insurance to the Federal Deposit Insurance Corporation.

Further Reading

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

Bordo, Michael D., Claudia Goldin, and Eugene N. White, editors. The Defining Moment: The Great Depression and the American Economy in the Twentieth Century. Chicago: University of Chicago Press, 1998.

Bremer, C. D. American Bank Failures. New York: Columbia University Press, 1935.

Broz, J. Lawrence. The International Origins of the Federal Reserve System. Ithaca: Cornell University Press, 1997.

Cagan, Phillip. “The First Fifty Years of the National Banking System: An Historical Appraisal.” In Banking and Monetary Studies, edited by Deane Carson, 15-42. Homewood: Richard D. Irwin, 1963.

Cagan, Phillip. The Determinants and Effects of Changes in the Stock of Money. New York: National Bureau of Economic Research, 1065.

Calomiris, Charles W. and Gorton, Gary. “The Origins of Banking Panics: Models, Facts, and Bank Regulation.” In Financial Markets and Financial Crises, edited by Glenn R. Hubbard, 109-73. Chicago: University of Chicago Press, 1991.

Davis, Lance. “The Investment Market, 1870-1914: The Evolution of a National Market.” Journal of Economic History 25 (1965): 355-399.

Dewald, William G. “ The National Monetary Commission: A Look Back.”

Journal of Money, Credit and Banking 4 (1972): 930-956.

Eichengreen, Barry. “Mortgage Interest Rates in the Populist Era.” American Economic Review 74 (1984): 995-1015.

Eichengreen, Barry. Golden Fetters: The Gold Standard and the Great Depression, 1919-1939, Oxford: Oxford University Press, 1992.

Federal Deposit Insurance Corporation. “A Brief History of Deposit Insurance in the United States.” Washington: FDIC, 1998. http://www.fdic.gov/bank/historical/brief/brhist.pdf

Federal Reserve. The Federal Reserve: Purposes and Functions. Washington: Federal Reserve Board, 1994. http://www.federalreserve.gov/pf/pdf/frspurp.pdf

Federal Reserve Bank of New York. U.S. Monetary Policy and Financial Markets.

New York, 1998. http://www.ny.frb.org/pihome/addpub/monpol/chapter2.pdf

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

Goodhart, C.A.E. The New York Money Market and the Finance of Trade, 1900-1913. Cambridge: Harvard University Press, 1969.

Gorton, Gary. “Bank Suspensions of Convertibility.” Journal of Monetary Economics 15 (1985a): 177-193.

Gorton, Gary. “Clearing Houses and the Origin of Central Banking in the United States.” Journal of Economic History 45 (1985b): 277-283.

Grossman, Richard S. “Deposit Insurance, Regulation, Moral Hazard in the Thrift Industry: Evidence from the 1930s.” American Economic Review 82 (1992): 800-821.

Grossman, Richard S. “The Macroeconomic Consequences of Bank Failures under the National Banking System.” Explorations in Economic History 30 (1993): 294-320.

Grossman, Richard S. “The Shoe That Didn’t Drop: Explaining Banking Stability during the Great Depression.” Journal of Economic History 54, no. 3 (1994): 654-82.

Grossman, Richard S. “Double Liability and Bank Risk-Taking.” Journal of Money, Credit, and Banking 33 (2001): 143-159.

James, John A. “The Conundrum of the Low Issue of National Bank Notes.” Journal of Political Economy 84 (1976a): 359-67.

James, John A. “The Development of the National Money Market, 1893-1911.” Journal of Economic History 36 (1976b): 878-97.

Kent, Raymond P. “Dual Banking between the Two Wars.” In Banking and Monetary Studies, edited by Deane Carson, 43-63. Homewood: Richard D. Irwin, 1963.

Kindleberger, Charles P. Manias, Panics, and Crashes: A History of Financial Crises. New York: Basic Books, 1978.

Krooss, Herman E., editor. Documentary History of Banking and Currency in the United States. New York: Chelsea House Publishers, 1969.

Minsky, Hyman P. Can ‘It” Happen Again? Essays on Instability and Finance. Armonk, NY: M.E. Sharpe, 1982.

Miron , Jeffrey A. “Financial Panics, the Seasonality of the Nominal Interest Rate, and the Founding of the Fed.” American Economic Review 76 (1986): 125-38.

Mishkin, Frederic S. “Asymmetric Information and Financial Crises: A Historical Perspective.” In Financial Markets and Financial Crises, edited by R. Glenn Hubbard, 69-108. Chicago: University of Chicago Press, 1991.

Rockoff, Hugh. The Free Banking Era: A Reexamination. New York: Arno Press, 1975.

Rockoff, Hugh. “Banking and Finance, 1789-1914.” In The Cambridge Economic History of the United States. Volume 2. The Long Nineteenth Century, edited by Stanley L Engerman and Robert E. Gallman, 643-84. New York: Cambridge University Press, 2000.

Sprague, O. M. W. History of Crises under the National Banking System. Washington, DC: Government Printing Office, 1910.

Sylla, Richard. “Federal Policy, Banking Market Structure, and Capital Mobilization in the United States, 1863-1913.” Journal of Economic History 29 (1969): 657-686.

Temin, Peter. Did Monetary Forces Cause the Great Depression? New York: Norton, 1976.

Temin, Peter. Lessons from the Great Depression. Cambridge: MIT Press, 1989.

Warburg,. Paul M. The Federal Reserve System: Its Origin and Growth: Reflections and Recollections, 2 volumes. New York: Macmillan, 1930.

White, Eugene N. The Regulation and Reform of American Banking, 1900-1929. Princeton: Princeton University Press, 1983.

White, Eugene N. “Before the Glass-Steagall Act: An Analysis of the Investment Banking Activities of National Banks.” Explorations in Economic History 23 (1986) 33-55.

White, Eugene N. “Banking and Finance in the Twentieth Century.” In The Cambridge Economic History of the United States. Volume 3. The Twentieth Century, edited by Stanley L.Engerman and Robert E. Gallman, 743-802. New York: Cambridge University Press, 2000.

Wicker, Elmus. The Banking Panics of the Great Depression. New York: Cambridge University Press, 1996.

Wicker, Elmus. Banking Panics of the Gilded Age. New York: Cambridge University Press, 2000.


[1] The two exceptions were the First and Second Banks of the United States. The First Bank, which was chartered by Congress at the urging of Alexander Hamilton, in 1791, was granted a 20-year charter, which Congress allowed to expire in 1811. The Second Bank was chartered just five years after the expiration of the first, but Andrew Jackson vetoed the charter renewal in 1832 and the bank ceased to operate with a national charter when its 20-year charter expired in 1836. The US remained without a central bank until the founding of the Federal Reserve in 1914. Even then, the Fed was not founded as one central bank, but as a collection of twelve regional reserve banks. American suspicion of concentrated financial power has not been limited to central banking: in contrast to the rest of the industrialized world, twentieth century US banking was characterized by large numbers of comparatively small, unbranched banks.

[2] The relationship between the enactment of the National Bank Acts and the Civil War was perhaps even deeper. Hugh Rockoff suggested the following to me: “There were western states where the banking system was in trouble because the note issue was based on southern bonds, and people in those states were looking to the national government to do something. There were also conservative politicians who were afraid that they wouldn’t be able to get rid of the greenback (a perfectly uniform [government issued wartime] currency) if there wasn’t a private alternative that also promised uniformity…. It has even been claimed that by setting up a national system, banks in the South were undermined — as a war measure.”

[3] Eichengreen (1984) argues that regional mortgage interest rate differentials resulted from differences in risk.

[4] There is some debate over the direction of causality between banking crises and economic downturns. According to monetarists Friedman and Schwartz (1963) and Cagan (1965), the monetary contraction associated with bank failures magnifies real economic downturns. Bernanke (1983) argues that bank failures raise the cost of credit intermediation and therefore have an effect on the real economy through non-monetary channels. An alternative view, articulated by Sprague (1910), Fisher (1933), Temin (1976), Minsky (1982), and Kindleberger (1978), maintains that bank failures and monetary contraction are primarily a consequence, rather than a cause, of sluggishness in the real economy which originates in non-monetary sources. See Grossman (1993) for a summary of this literature.

[5] See Calomiris and Gorton (1991) for an alternative view.

[6] See Mishkin (1991) on asymmetric information and financial crises.

[7] Still other states had “voluntary liability,” whereby each bank could choose single or double liability.

[8] See Dewald (1972) on the National Monetary Commission.

[9] Miron (1986) demonstrates the decline in the seasonality of interest rates following the founding of the Fed.

[10] Other Fed activities included check clearing.

[11] According to Kent (1963, pp. 48), starting in 1922 the Comptroller allowed national banks to open “offices” to receive deposits, cash checks, and receive applications for loans in head office cities of states that allowed state-chartered banks to establish branches.

[12] Prior to 1922, national bank charters had lives of only 20 years. This severely limited their ability to compete with state banks in the trust business. (Kent 1963, p. 49)

[13] National banks were subject to more severe limitations on lending than most state banks. These restrictions included a limit on the amount that could be loaned to one borrower as well as limitations on real estate lending. (Kent 1963, pp. 50-51)

[14] Although the Bank Consolidation Act of 1918 provided for the merger of two or more national banks, it made no provision for the merger of a state and national bank. Kent (1963, p. 51).

[15] References touching on banking and financial aspects of the Great Depression in the United States include Friedman and Schwartz (1963), Temin (1976, 1989), Kindleberger (1978), Bernanke (1983), Eichangreen (1992), and Bordo, Goldin, and White (1998).

[16] During this period, the failures of the Credit-Anstalt, Austria’s largest bank, and the Darmstädter und Nationalbank (Danat Bank), a large German bank, inaugurated the beginning of financial crisis in Europe. The European financial crisis led to Britain’s suspension of the gold standard in September 1931. See Grossman (1994) on the European banking crisis of 1931. The best source on the gold standard in the interwar years is Eichengreen (1992).

[17] Interestingly, federal deposit insurance was made optional for savings and loan institutions at about the same time. The majority of S&L’s did not elect to adopt deposit insurance until after 1950. See Grossman (1992).

[18] See, however, White (1986) for

Citation: Grossman, Richard. “US Banking History, Civil War to World War II”. EH.Net Encyclopedia, edited by Robert Whaples. March 16, 2008. URL
http://eh.net/encyclopedia/us-banking-history-civil-war-to-world-war-ii/

Economic History of Tractors in the United States

William J. White, Research Triangle Institute

The farm tractor is one of the most important and easily recognizable technological components of modern agriculture in the United States. Its development in the first half of the twentieth century fundamentally changed the nature of farm work, significantly altered the structure of rural America, and freed up millions of workers to be absorbed into the rapidly growing manufacturing and service sectors of the country. The tractor represents an important application of the internal combustion engine, rivaling the automobile and the truck in its economic impact.

A tractor is basically a machine that provides machine power for performing agricultural tasks. Tractors can be used to pull a variety of farm implements for plowing, planting, cultivating, fertilizing, and harvesting crops, and can also be used for hauling materials and personal transportation. In the provision of motive power, tractors were a replacement for human effort and that of draft animals, both of which are still used extensively in other parts of the world.

Technical Description

The heart of a farm tractor is a powerful internal combustion engine that drives the wheels to provide forward motion. Direct ignition (diesel) and spark-driven engines are both found on tractors, just as with cars and light trucks. Power from the engine can be transmitted to the implement being used through a power take-off (PTO) shaft or belt pulley. The engine also provides energy for the electrical system, including the ignition system and lights, and for the most recent models, air conditioner, stereo system, and other creature comforts.

The drawing below, taken from an undated John Deere operating manual, shows a typical general-purpose tractor from the period around 1940. The machine is little more than an engine on wheels, with a seat for the operator and a hitch for pulling implements centered in the rear. Later models would feature an enclosed cab to keep the operator out of the weather, but this model features only simple controls and the metal seat. The drawing shows a wheel-tractor, which comprised more than 95% of machines sold for farm use. Tracked units, also called crawler tractors, were common in California, and of course, dominated construction and other non-farm uses for tractors.

Background and Technological History

Farmers in 1900, whether engaged in growing wheat, corn, or cotton, raising livestock, producing dairy products, or combining a variety of these or other products, had only two sources of power aside from their own strength: steam engines and draft animals. Steam boilers provided motive power for threshing small grains, and a very small number of farmers were using recently-developed steam traction engines for plowing and other arduous tasks. Draft animals provided most of the power on all types of farms, however. As of 1910, there were more than 24 million horses and mules on American farms, about three or four animals for the average farm. In addition to supplying farm power, the horses were also relied upon for transportation, of both goods and people.

Horses and mules pulled an impressive variety of farm implements at the turn of the century, including plows, disks, harrows, planters, cultivators, mowers, and reapers. Several important farm tasks were typically done by hand at this time, including picking of corn and cotton. The greatest amount of power was needed for plowing, often forcing farmers to keep one or two extra horses above the number needed for the remainder of the year. As an example, power requirements during plowing have been estimated at 60% of the annual total needs for growing wheat at that time. A new source of power, then, would be valuable to the farmer if it could replace the horsepower requirements of plowing, as long as the cost was less than that of maintaining one to two extra horses. It would be even more valuable if it could economically replace all of the functions currently performed by draft animals, and further if it could facilitate automation of the cotton and corn picking operations.

As early as the 1870s, engineers had succeeded in producing steam traction engines, referred to today as steam tractors. These monsters, weighing in excess of 30,000 pounds (excluding water), could move under their own power, and had impressive horsepower capacity. Unfortunately, their size, mechanical complexity, and constant danger of explosion made these traction engines unusable for most farms in North America. In all but the driest soils, steam traction engines tended to become mired in the mud and refuse to move. Because of these handicaps, the use of steam tractors increased slowly in the United States during the last two decades of the nineteenth century. Annual production of less than 2000 units per year in the 1890s had increased to around 4000 in the ten years after 1900. Nonetheless, the rate of growth of steam horsepower was far smaller than the growth in animal horsepower. For the reasons mentioned above, adoption of steam power was clearly not a candidate to replace the horse.

The First Gasoline Tractors

With the commercialization of the internal combustion engine, a more practical alternative emerged. Farmers bought large numbers of stationary gasoline engines in the first decade of the twentieth century, and quickly became familiar with their operation. A wide variety of household chores were simplified by the use of stationary engines, including pumping water, washing clothes, and churning butter. Companies began developing gasoline-powered traction engines during the same period; the first commercial machines were sold in 1902, and quickly became known as ‘tractors’.

The first tractors shared similar traits to the steam traction engines. Weighing between 20,000 and 30,000 pounds, with huge steel wheels or tracks, these models were large and expensive. Fairly quickly, the large manufacturers, including Hart-Parr, International Harvester, Case, and Rumely had reduced the size and cost. By the time Ford introduced its Fordson model, the first successful small tractor, average weights were down to 2000-6000 pounds, and prices were under $1000. These tractors proved to be excellent at plowing, and were quite capable of driving mowers and reapers. The large steel wheels, low clearance, and substantial weight made them unsuitable for cultivating growing crops like corn and cotton, however.

Technological Improvements

Henry Ford, who had tinkered with steam and gasoline tractors prior to achieving his success with automobile production, introduced a small, inexpensive model which he called the Fordson during the World War I. This model sold well for several years, aided considerably by a war-caused shortage of horses. After a post-war crash in farm prices drastically reduced sales in 1920-21, Ford initiated a price war in 1922 by cutting the price of its Fordson from $625 to $395. Alone of the large competitors, International Harvester matched Ford’s price, and sales boomed for those two firms throughout the rest of the 1920s. Ford’s production of tractors were always a sidelight to his main business of manufacturing automobiles, however, and when the Fordson production lines were needed for the critical Model-A launch in 1928, Ford decided to leave the tractor business.

The competition with Ford drove International Harvester to make significant improvements in its tractors. The first innovation to appear was the power take-off, offered after 1922. This device, a metal shaft turned by the rotation of the tractor motor, allowed implements to be driven directly by the tractor engine, as opposed to obtaining power from a wheel rolling along the ground. The power take-off quickly became a standard feature on all tractors, and implement makers began the process of re-designing their equipment to take advantage of this innovation.

An even more important improvement by International Harvester was the introduction of a general-purpose tractor, the Farmall, in 1925. This model, with high ground clearance, small front wheels, and minimal weight, was designed for cultivating, as well as for plowing and cutting. It was tested in Texas in 1923, and was released for broad scale distribution in 1925. Competitors, such as Deere, Massey-Harris, and Case rushed to develop a general-purpose tractor (a ‘GP’) of their own, and by the mid-1930s, GPs had replaced the standard Fordson-type tractor. In addition, these same firms began the process of modifying their implements for these tractors, and the wholesale replacement of the horse began in earnest.

A Dominant Design Emerges

Three other improvements were critical in completing the technology base for the tractor. Deere released a power lift for its models beginning in 1927. This device allowed the implement to be raised before every turn by pulling a lever. Prior to this, the farmer had to lift the implement by hand at each turn, which was a time-consuming and enervating task. As with the power takeoff, the power lift was rapidly adopted by other tractor makers. Rubber tires first became available for tractors in 1932, and by 1938 had largely replaced steel wheels. The low-pressure tires not only did less damage to fields, but also allowed a higher forward speed, due to reduced friction. Finally, the development of diesel engines in the mid-1930s gave farmers access to a lower-cost fuel for their machines. Many tractors from that time forward had a small gasoline tank for cold starts, and a large diesel tank for the majority of the operation.

International Harvester pioneered a ‘one plow’ tractor at about this time, and began selling it in 1934. This tractor was smaller and less expensive than the original Farmall, but had the same general-purpose capabilities. Its introduction offered operators on small farms the chance to replace their one horse or mule with a tractor, and was responsible for the beginnings of the tractor’s diffusion in the South. These small tractors often featured adjustable front wheels and high ground clearance, which made them considerably more flexible than the larger models. Within a few more years, manufacturers were offering their larger models in ‘high-clearance’ versions as well.

A final innovation was responsible for bringing Ford back into the tractor business in 1937. In that year, the firm agreed to enter into a joint venture with Irish inventor Harry Ferguson. Ferguson had worked for almost 20 years to perfect a ‘three-point hitch,’ a device that produced superior plowing by continuously leveling the implement as it traveled over uneven terrain. The Ford-Ferguson tractors quickly amassed a significant market share (14% by 1940), and the hitch design was rapidly imitated.

By about 1938, the technology of tractor development had achieved what is known as a ‘dominant design.’ The Farmall-type general-purpose tractors, both large and small, would change little, except for increasing in size and horsepower, over the next 30 years. Beginning in the mid-1930s, and despite the ongoing depression in the United States, tractor sales increased rapidly. Figure 1 shows the number of tractors on farms from 1910 through 1960. By the latter date, the process of technological diffusion was essentially complete. With the exception of the deep South, the increase in percent of farms with tractors from year to year had stopped.

Development of Related Equipment

The general-purpose tractor proved to be an excellent replacement for the horse in plowing, soil preparation, planting, and cultivating tasks for a wide variety of field crops. In addition, the tractor was fully capable of providing power for mowing hay and for harvesting of wheat and other small grains. In the latter application, it facilitated the practice known as ‘combining,’ the simultaneous reaping and threshing of wheat. Horse-drawn combines had been available since the 1880s, and had found limited acceptance on the larger farms of the arid West. However, a large team of horses was required to drag the heavy, complex machine through the fields. The tractors of the 1930s and 1940s had no trouble pulling a re-designed combine, and they began a process of rapid adoption in the Midwest. Eventually, a self-propelled combine was produced, with the tractor engine and cab subsumed into the combine apparatus.

The general-purpose tractor was not capable of bringing mechanization to the corn and cotton harvest until separate, but related innovations produced a corn picker in the 1920s and a mechanical cotton picker after the Second World War. Prior to the development and adoption of the corn picker, corn was often cut with a binder, followed by manual shelling. One of the more important uses of stationary gas engines early in the twentieth century was for the shelling of corn. The picker combined the operations of cutting and shelling, and also distributed the stalks back onto the field, eliminating an additional step.

Mechanical cotton pickers fundamentally altered not only the harvesting of cotton, but the very nature of cotton growing in the United States. The mechanical picker, even after extensive development, produced higher crop losses than hand picking in the hot, humid areas where most cotton was grown — Mississippi, Alabama, and east Texas. In the dry areas of west Texas, however, the picker was very efficient, both in terms of labor effort and crop yields. The mechanical cotton picker thus precipitated a relocation of cotton production westward, resulting in large-scale migration out of the deep South in the years after World War II.

As with the combine, self-propelled corn and cotton pickers were soon developed, combining the power train and cab of the tractor within the implement’s apparatus. For this reason, pickers and combines are often considered as separate machines, and their development and diffusion are not included in discussions of the impact of the tractor. It should be pointed out, however, that none of these devices could have been powered efficiently by horses or steam; the gasoline-powered tractor was necessary for their development. As such, I will include combines and mechanical pickers in assessing the impact of the tractor on inputs to agriculture.

Recent Developments

The recent history of tractor development is less dramatic than the first 50 years. The peak year of tractor production was 1951, during which 564,000 units were made. From that time, the approaching saturation of the market produced a steady fall in production and sales. As one might expect, manufacturers responded by developing ever-larger tractors to supply farms that were growing in size. Interestingly enough, this pursuit of size left the small end of the market open to foreign competition, and, as in the case of the U.S. automobile industry, imports grew to dominate the small-tractor market.

Creature comforts have been improved markedly since the 1950s as well. Enclosed cabs soon had heating and air conditioning, and are now likely to be supplied with a television and stereo-CD. As a result, modern tractors are quite comfortable in comparison with the machines of 40 years ago, let alone versus the monsters of the early tractor era.

Production and Corporate History

From a slow start in the 1920s and 1930s, tractor production grew through the late Depression years, as farmers increasingly parted with their horses and mules. Figure 2 shows the annual output of farm tractors from 1909 to 1970, including the peak years of the early 1950s. It is likely that this peak would have been reached much sooner, had it not been for the disruption of the Second World War. Not only were raw materials such as steel, copper, and rubber severely limited due to wartime production needs, but the government actually limited the total number of machines that could be built each year, and allocated only the raw materials needed for that production. Many of the tractor factories were converted over to production of tanks, airplanes, vehicles, and other military goods.

Despite the presence of corporate giants such as International Harvester and Ford in the early development of the farm tractor, there were hundreds of firms that began producing or selling machines in the first two decades of the twentieth century. As is the case with many emerging industries, inventors, entrepreneurs, and promoters were attracted to this important and rapidly-growing field. The agricultural depressions of 1920-21 and 1930-32 drove many of these firms into mergers or out of business, and by the early 1930s seven companies dominated the industry. These firms, along with Ford, would make almost all of the wheel-tractors sold in the United States from 1930 through 1955.

The dominance of the seven firms is shown in Table 1, which presents market share data by decade for the key years of tractor industry growth. As discussed above, Ford dominated the market in the 1920s, then left the business to create production capacity for the Model A; upon returning to tractors in the 1940s, Ford once again became an important presence. International Harvester was the largest consistent seller, as well as being the technological leader, while Deere would grow into the most significant challenger. By 1963, Deere overtook International Harvester in a declining market, and remains the largest presence in agricultural equipment today.

Table 1. Market Share of Leading Wheel Tractor Manufacturers by Decade
1910s 1920s 1930s 1940s 1950-55 Overall

Deere

4.0% 6.4% 21.7% 17.0% 14.5% 14.5%
International Harvester 21.4% 28.6% 44.3% 32.7% 30.6% 32.5%
Ford 20.1% 44.2% 0.0% 7.9% 19.3% 16.7%
Massey-Ferguson 2.9% 1.9% 2.9% 14.7% 10.8% 9.1%
Case 7.2% 3.6% 7.4% 7.6% 5.1% 6.2%
Allis Chalmers 6.2% 3.5% 12.6% 9.7% 10.3% 9.1%
Oliver 2.1% 2.2% 5.0% 4.8% 5.4% 4.4%
Minneapolis Moline 8.0% 0.7% 2.9% 3.2% 3.6% 3.1%
All Others 28.0% 9.0% 3.2% 2.5% 0.2% 4.4%
Source: White (2000)
Note: Totals include production of predecessor companies

Social and Economic Significance

The farm tractor had made a major impact on the social and economic fabric of the United States. By increasing the productivity of agricultural labor, mechanization freed up millions of farm operators, unpaid family workers, and farm hands. After the Second World War, many of these people relocated to the growing cities across the country and provided technically-skilled, hard-working labor to the manufacturing and service industries. Millions of others remained in rural areas, working off-farm either part-time or full-time in a variety of professions.

The landscape of the country has changed as a result. Farms have grown larger as one proprietor can manage to cultivate the land that several families would have worked in 1900. Small market towns, especially in the Plains states, have almost ceased to exist as the customer base for local businesses has dwindled. Land formerly devoted to raising and feeding horses has been converted to alternate uses or reverted to grassland or forest. Several generations of agricultural families have experienced the sadness of giving up the farm and the rural way of life.

On balance, however, the tractor has had a markedly positive economic impact. Horses and mules, while providing farm power, ate up more than twenty percent of the food they helped farmers grow! By replacing them with machines that consumed much less expensive quantities of fuel, oil, and hydraulic fluid, farmers were able to reduce their costs and pass these social savings along to food buyers. More importantly, the millions of farm workers freed up by the technology were able to contribute their labor elsewhere in the economy, creating large economic benefits. According to a recent estimate by the author, the U.S. would have been almost ten percent poorer in 1955 in the absence of the farm tractor. Along with the revolution in yields generated by the advances in biological and chemical research, the farm tractor has helped agriculture make a significant contribution to economic growth in the United States.

References for Further Study

Ankli, Robert E. “Horses vs. Tractors on the Corn Belt” Agricultural History 54 (1980): 134-148.

Berardi, Gigi M., and Charles C. Geisler, editors. Social Consequences and Challenges of New Agricultural Technology. Boulder, CO: Westview Press, 1984.

Broehl, Wayne G., Jr. John Deere’s Company. New York: Doubleday, 1984.

Clarke, Sally H. Regulation and the Revolution in United States Farm Productivity. Cambridge: Cambridge University Press, 1994.

Danbom, David B. Born in the Country: A History of Rural America. Baltimore: Johns Hopkins University Press, 1995.

Gray, R. B. The Agricultural Tractor: 1855 – 1950. St. Joseph, Michigan: American Society of Agricultural Engineers, 1954 (revised, 1975).

Griliches, Zvi. “The Demand for a Durable Input: Farm Tractors in the United States, 1921-57.” In The Demand for Durable Goods, edited by Arnold C. Harberger. Chicago: University of Chicago Press, 1960.

Hayami, Yujiro, and Vernon W. Ruttan. Agricultural Development: An International Perspective. Baltimore: Johns Hopkins Press, 1971.

Jasny, Naum. Research Methods on Farm Use of Tractors. New York: Columbia University Press, 1938.

Jones, Fred R. Farm Gas Engines and Tractors, fourth edition. New York: McGraw-Hill, 1966.

McCormick, Cyrus. The Century of the Reaper. Boston: Houghton Mifflin, 1931.

Rogin, Leo. The Introduction of Farm Machinery in Its Relation to the Productivity of Labor in the Agriculture of the United States during the Nineteenth Century. University of California Publications in Economics: Volume 9. Berkeley: University of California Press, 1931.

Sargen, Nicholas Peter. “Tractorizationin the United States and Its Relevance for the Developing Countries. New York: Garland Publishing, 1979.

Schultz, Theodore W. “Reflections on Agricultural Production, Output, and Supply.” Journal of Farm Economics 38 (1956): 748-62.

Whatley, Warren C. “Institutional Change and Mechanization in the Cotton South.” Ph.D. dissertation, Stanford University, 1983.

White, William J. “An Unsung Hero: The Farm Tractor’s Contribution to Twentieth-century United States Economic Growth.” Ph.D. dissertation, Ohio State University, 2000.

Wik, Reynold M. Steam Power on the American Farm. Philadelphia: University of Pennsylvania Press, 1953.

Wik, Reynold M. Benjamin Holt & Caterpillar: Tracks & Combines. St. Joseph, Michigan: American Society of Agricultural Engineers, 1984.

Williams, Robert C. Fordson, Farmall, and Poppin’ Johnny. Urbana, Illinois: University of Illinois Press, 1987.

Citation: White, William. “Economic History of Tractors in the United States”. EH.Net Encyclopedia, edited by Robert Whaples. March 26, 2008. URL
http://eh.net/encyclopedia/economic-history-of-tractors-in-the-united-states/

The South Sea Bubble: An Economic History of Its Origins and Consequences

Author(s):Paul, Helen J.
Reviewer(s):Murphy, Anne L.

Published by EH.Net (February 2011)

Helen J. Paul, The South Sea Bubble: An Economic History of Its Origins and Consequences. London: Routledge, 2011. xx + 155 pp. $145 (hardcover), ISBN: 978-0-415-46973-9.

Reviewed for EH.Net by Anne L. Murphy, Department of History, University of Hertfordshire.

As Helen Paul argues in the introduction to this book, the South Sea Bubble has become a byword for human folly. Despite the passing of nearly three hundred years, it is still cited by journalists seeking examples to prove the ubiquity of irrationality and fraud in financial markets. Popular histories of the Bubble too, present a world momentarily driven mad by the possibilities and disappointments of speculation. Perhaps in reaction to this characterization, when economists and economic historians consider the Bubble, they often view it a test case for the efficiency, or otherwise, of early modern financial markets. The consequence has been that the real history of the South Sea Company and the scheme of 1720 has disappeared behind disagreements about the nature of bubbles, how they blow up, why they burst and whether they can ever be judged as rational.

Paul, a fellow in economics at the University of Southampton, offers an explanation for the Bubble that does not rely upon the assumption that everyone in 1720 had lost their wits. In doing so she also attempts to rescue the history of the South Sea Company from its distracting association with the Bubble. A wide variety of sources, rather than just stock ledgers and price data, are employed to place the Bubble in broader economic and social contexts and, in particular, to help the reader understand the purpose and strengths of the South Sea Company, both before 1720 and until its dissolution in 1854. All this is done in a style which, although employing economic theory and making use of quantitative methods, remains accessible and appealing to an audience of economists and non-economists alike.

Following an introduction which explains both the historiographical and theoretical backgrounds to the Bubble debate, Paul goes on to provide a thematic account of the rise of the financial market in London, the development of the South Sea Company and the contexts and consequences of the Bubble.

The early chapters provide a history of the stock market in early modern England, discuss the development of the national debt and explain the reasons for the establishment of the South Sea Company. Paul emphasizes that the Company, the scheme of 1720 and the blowing up and bursting of the Bubble were just one part of the broader development of the British financial system. She also explains the origins of the mistrust of finance and financiers and makes the particularly useful and oft-forgotten point that most financial innovation during this period was deeply criticized. The South Sea Company, in other words, was not alone in attracting the disapproval of contemporaries.

Chapter 6 is key to Paul?s argument. It explains the reasons why investors might have chosen to commit their funds to the South Sea Company. And this is indeed an important point. The Company was not established solely for the fraudulent management of government debt, nor was its only focus on conning the na?ve investor. The South Sea Company did engage in trade, both slaving and later, whaling. Paul makes the point that, given this knowledge, those who invested in the Company might have had sound reasons for doing so. Moreover, in addition to its trading activities, the South Sea Company?s connections with the management of the national debt ensured a guaranteed and lucrative income. The Bank of England had already grown rich and secure from just such connections with the state. It might also be argued that there were some fine business minds among the Company?s management. Even John Blunt, although undoubtedly duplicitous, was precociously talented in managing matters financial.

Chapter 7 explains the complexities of contemporary financial analyses of the South Sea scheme and casts doubt on the notion that Archibald Hutcheson was the lone voice of sanity speaking out against the iniquities of the project to convert the national debt to Company shares.

Chapters 8 and 9 examine the aftermath of the Bubble. The former details the reaction to the crash and the creation of the popular myths that have tended to dominate our understanding of the events of 1720. It also notes the anti-Semitic nature of much of the post-Bubble rhetoric, a factor that has largely been ignored by later commentators. Chapter 9 shows that there was little evidence of widespread economic depression in the wake of the collapse of the South Sea scheme.?
?
In the conclusion Paul notes that, while the Bubble has been studied by both those who claim that Georgian society was, for a moment, gambling mad and those who claim that financial markets are always inherently rational, ultimately both views are too simplistic. The value of this book to scholars is that it effectively straddles the divide between those two points of view and complicates much of the accepted wisdom on the South Sea Company. In doing so, it offers a much needed reconsideration of the causes and consequences of the Bubble.

Anne Murphy is a lecturer in early modern history at the University of Hertfordshire. Her publications include articles in History, Business History, and the Economic History Review and a monograph published by Cambridge University Press entitled The Origins of English Financial Markets: Investment and Speculation before the South Sea Bubble.? a.l.murphy@herts.ac.uk

Copyright (c) 2011 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 2011). All EH.Net reviews are archived at http://www.eh.net/BookReview.

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):Europe
Time Period(s):18th Century