The Dawn of Innovation (26 page)

America's primary imports, on the other hand, were heavily tilted to manufactures, altogether about 63 percent of all imports during the period. Some of those comprised luxury goods, like gowns, mirrors, fine china, and the like, but a very large share was the high quality steel, engines, rails,
tools, and other capital goods needed to power America's leap into the industrial age. America had chronic trade deficits, but except during financial disruptions, they were typically small. The accumulated deficit during the whole 1820–1860 period was about $175 million, or a little over $4 million a year, but it still had to be financed.
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The United States was not a capital-rich country, and its annual trade deficits had to be covered by shipping gold, by increasing exports, or from inflows of foreign investment. Mega-projects, like canals or railroads, were normally financed by state bond issues, which were sold through American and English banking houses. (The last of the federal debt was discharged in 1835, so there was no Treasury bond market.) A sample of American state bond yields in London and New York from the first half of the 1830s shows spread differentials only in the few hundredths of a percent, suggesting tight integration of the two countries' capital markets.

The splendid success of the Erie Canal, which had been financed with New York bonds, created an eager British market for American canal and railroad bonds. To the British upper classes sitting on inherited low-yielding British consols, American bonds were attractive investment-grade, high-yield paper, so about half of all American canal and railroad-related bonds were held in Great Britain. A spate of canal and railroad building from 1836 to 1842 drew at least $60 million from abroad and was a substantial factor in the American recovery from the 1837 recession.

The ease of bond sales created something of a canal and railroad bubble. A substantial number of newer state bonds, from Indiana, Michigan, Illinois, Arkansas, and Florida, defaulted. They had been mostly issued in the later stages of the market cycle, and most were eventually repudiated. Eastern state bonds continued to perform well, with the exception of Pennsylvania's. That state's businessmen, alarmed by the withering competition from the Erie Canal, had pressured the government to finance
hundreds of miles of canals just on the eve of the railroad age. While almost all American bonds took a reputational hit, differential spreads in London suggest that foreign investors were well able to discriminate between sound offerings and junk.
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Entrepreneurial capital mostly came from personal or family savings, as it still does today. Business startup costs were certainly lower than today, and a skilled craftsman could often make most of his tools and equipment himself. Local merchants also provided capital for likely entrepreneurs, while more expensive startups, like a substantial forge, might get the support of an informal consortium of leading men of an area. The Holley family and their partners financed most of their businesses from their own resources but joined with other leading merchants and business men to found a local bank.

The commercial banking industry of the day was mostly about trade, in accord with the prevailing “real bills” doctrine, which held that bankers should lend only against goods moving in trade to bridge the cash-flow gap between a sale and the receipt of payment. As raw materials production shifted to the West, trade finance was a major development bottleneck. Local banks naturally sprang up to meet the challenge, but often with indifferent results. In theory, farmers could contract with coastal merchants' agents for the sale of their crop at a future date and receive a “bill of exchange,” equivalent to a check, payable in the future when the crops were delivered. A local bank would discount the bill—that is, buy it from the farmer for cash at a discount from face value to cover collection costs—and collect on the bill from the merchant house when the crops were shipped.

In reality, the combination of the distances, the extended performance periods, and the limited liquidity of local banks made the process highly prone to breakdown. Since illiquid local banks would of necessity quickly rediscount their bills, and often pay penalty discounts themselves, all of those costs were deducted from the initial payment to the farmer. Much of the time, the farmer's discounted proceeds did not cover his real costs, trapping him in a continuing debt spiral. The system's instability was
greatly aggravated by the refusal of foreign traders to accept American bills, so import payments had to be made in scarce coin. Hard-money Republicans increased the funding pressure by insisting on accelerating the payment of the public debt. The debt was payable in specie, and much of it was held abroad, so debt retirement drained away gold reserves.

For a relatively brief period, however, through much of the 1820s, when Nicholas Biddle was at the helm of the Second Bank of the United States,
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the country's internal monetary system functioned as well as any in the world. Biddle was a dilettante, a Philadelphia nouveau-aristocrat, a dabbler in painting and poetry, and the compiler of the popular edition of the Lewis and Clark journals. He was also very intelligent and arguably the first to understand both the regulatory and the monetary roles of a central banker.
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First and foremost, Biddle was a careful manager of his own bank's positions, and he maintained a strong relation with Barings, so within a year or so after his ascendance, the notes of the Bank of the United States (BUS) were accepted almost everywhere near par. More important, the high reputation of the Bank's notes gave Biddle de facto regulatory leverage over local banks. Since the BUS applied strict and consistent standards before accepting local bank note issuances, the merchant community quickly learned to accept only notes approved by the BUS. At a stroke, BUS notes and approved local notes became a national mercantile currency. And since Biddle was willing to provide BUS notes to well-managed local banks, interior liquidity was greatly increased, the steep interior discounting rates shrank dramatically, the pace of commerce quickened, and interior incomes rose. A related benefit was an easing of the specie shortage. Once the discount demanded by foreign acceptors of BUS notes fell below the cost of shipping specie, they stopped demanding payment in coin.

Biddle also understood a central bank's role of easing credit at times of temporary market stress. (During this period, the Bank of England reflexively
pulled back credit to protect its own specie at the barest hint of problems, displaying in the words of one authority, “an inexcusable degree of incompetence.”
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) Biddle, by contrast, tuned his collection procedures to the state of the economy. Rather than increase pressure on merchant houses when credit was tight, he would let his notes remain uncollected until conditions eased—effectively expanding the money supply. Similarly, when animal spirits were on the boil, he would reduce his discounting activity and speed up on collections. In 1825, 1827–1828, and 1830–1831, he steered the United States through major credit contractions caused by typically benighted specie-hoarding policies at the Bank of England.
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That happy state of affairs existed for most of the 1820s, a period labeled in elementary history texts as the Era of Good Feelings. It ended when Andrew Jackson, in a triumph of prejudice and ignorance, vetoed a bill reauthorizing the BUS. (It had passed both the House and the Senate by good margins but was two short of the votes required to override a veto.) Jackson was heavily influenced by people like Amos Kendall, his postmaster general, an early telegraph entrepreneur, and a radical advocate of laissez-faire, who believed the BUS to be a near-biblical scourge. Another close banking adviser, William Gouge, a former newspaperman who was knowledgeable in finance, insisted that banking “was the principal cause of social evil in the United States.”
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Gouge and Kendall held their views sincerely, but many of the businessmen in the Jacksonian Kitchen Cabinet were tied to bankers who greatly resented the BUS's restraining hand.
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Biddle didn't help his case by his aristocratic style or his dismissiveness of people less intelligent than he. His reputation was finally destroyed by his hopeless and ultimately vindictive rearguard action against Jackson's veto, which succeeded only in creating a political firestorm and rattling the entire economy. Once the BUS's charter expired in 1836, he rechar-tered
it in Pennsylvania and seems to have deluded himself that he could replicate the position of the old BUS from a state platform. He was quickly overextended and not only destroyed the Bank but hastened the collapse of the state's canal-stretched finances. It was a time when the transatlantic financial system was badly strained by excesses in western land, in canals, in cotton, and much else. If the BUS had survived with Biddle as president, he might have considerably ameliorated the American crisis, but in his new incarnation as an overreaching head of a state bank, he materially contributed to the excesses. It took more than a century before historians discovered his earlier accomplishments.

With the demise of the BUS, state banks once again came into their own. “Free banking” legislation spread, especially in the West. Some, indeed, were sober and well-run institutions, but in many states they were mere engines of chicanery, shipping the same small trove of gold coin from one bank to the next to stay ahead of auditors, and pumping out notes beyond reason. “Wild cat” banking referred to some bankers' hiding “in the woods where the wild cats are” to avoid having to redeem their notes. The key to success, counseled one banker, was to create such gorgeous notes that the rubes would never redeem them: “a real furioso plate, one that will take with all creation—flaming with cupids, locomotives, rural scenery, and Hercules kicking the world over.” While there appears to be no truth in the tales of western farmers hauling wagons full of bank notes on provisioning trips, the shutdown of the BUS ushered in a long period of financial instability. Remarkably, it does not appear to have interfered much with the average rate of growth, although the stomach-churning year-to-year ups and downs must have inflicted great hardship.
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As an industrial boom took hold in the rest of the country, the South slipped into the position of an internal colony. In effect, the South exploited its slaves, while the rest of the country exploited the South. Cotton prices were generally strong from the 1830s until the Civil War, and virtually
all the South's resources were sucked into cotton production. Cotton was very profitable, but the first large slice of cotton profits accrued to Northern finance houses in the form of hefty trading, marketing, shipping, banking, and insurance revenues. The earnings that did flow to the South mostly flowed right back out again, for food from the West and for western and northern manufactures. By the 1840s, the everyday clothes and shoes worn by Southerners were made in Massachusetts, Rhode Island, and New York. The steam engines, farm tools, grain, and packed meats they needed came down the Ohio and Mississippi from Cincinnati, Louisville, and Pittsburgh. The schools the planter elite chose for their children were in New Jersey, New York, and New England.
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By 1860, the West, New England, and the Middle Atlantic states were rapidly evolving into an approximation of a unified commercial and industrial economy. Erie Canal traffic is a good proxy for the integration: after it opened, the traffic was primarily between western New York and the coastal cities, but by 1860 the eastward traffic originated primarily in the West.
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Unlike the South, the West invested its agricultural surpluses in businesses and public infrastructure, like railroads. Much as in Massachusetts a few decades before, the intense commercialization of agriculture was creating larger, mechanized farms, and the agricultural workforce was shifting to higher productivity industrial employment. By mid-century, the United States had the second-largest GDP in the world, and the second-largest per capita GDP. Great Britain was still far ahead, with nearly three times the output as America. But the United States had the fastest growth rate in industrial production by far than any other country, on both an overall and per capita basis, and with a rapidly growing adult population besides.
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Foreign travelers in America were uniformly stunned by the commercialism. Tocqueville wrote, “I know of no country, indeed, where wealth has taken a stronger hold on the affections of men.”
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But the full reality didn't
dawn on him until he was in Ohio, when he wrote, “The entire society is a factory!”
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Harriet Martineau noted that bad roads limited the availability of some goods in the interior, but still, she wrote: “When a few other neighbors besides frogs, gather round the settler, some one opens a grocery store. [On the Niagara peninsula] . . . there is a store on the borders of the forest. I saw there glass and bacon; staylaces, prints, drugs, rugs, and crockery; bombazeens and tin cans; books, boots, and moist sugar, &c. &c.”
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Trollope found the source of American industriousness in “the unceasing goad which necessity applies to industry.” During her stay in Cincinnati, she reported, “I neither saw a beggar, nor a man of sufficient fortune to permit his ceasing his effort to increase it.”
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She was ambivalent, at best, about the constant drive for advancement. A young, energetic, illiterate farmer she knew made a favorable impression. He and his family had “plenty of beef-steaks and onions” three times a day. Besides tending his farm, he cleared forests, split rails and built fences, built a new house, rented half of it, contracted to build a bridge, and opened a store. Trollope had “no doubt that every sun that sets sees him a richer man than when it rose.” The farmer hoped his son would become a lawyer, and she supposed he would, and would “sit in congress” besides, and “the idea that his origin is a disadvantage, will never occur to the imagination of the most exalted of his fellow-citizens.”
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