The relentless revolution: a history of capitalism (30 page)

Because of the very backwardness of Germany, railroad building jump-started the economy by joining hundreds of local markets to a universe of commerce. Railroads gave regional manufacturers a chance to reach the larger, more complex market of a united Germany and its international trading partners. Railroad building stimulated considerable demand for iron products as well. Railroads were the first big business in both countries and, for many years, its only big one. In the United States, railroads were seen as so essential to national unity that the federal government lent its army engineers to lay out the first routes. West Point was in fact the major engineering school in the country at the time. Once railroads were established, maintaining them called for continuous experimentation to improve road beds and rails. Unlike the secrecy surrounding the steam engine, information about railroad construction and operations flowed easily across national borders. Civil engineers shared their findings and visited one another’s countries, sometimes on their own, sometimes sponsored by their governments.
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They wrote reports; they published pamphlets.

The Role of Banks

Even more important in the history of capitalism were the size and permanence of the investment in railroads. A measure of the railroads’ central importance to an economy can be gleaned from the fact that in 1865 the New York Central Railroad alone had assets equal to one-quarter of all American manufacturing wealth. The substantial capital that constructing railroads required changed the operating strategies of their owners because their assets were much greater than the cost of running the roads. The fixity of capital in railroad lines made retrenchment ineffective. Railroad investors had to devise strategies to stimulate uses to spread the fixed costs over more freight and passengers.
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They strove to keep the volume of traffic as high as possible or to recoup capital costs through higher fares. The fixed capital in plants and the adjustments that it entailed represented the new constraints of industrial capitalism. The equation of time with profit became crystal clear; the expensive equipment had to be kept in productive use.

The impact of railroads upon the overall economy went from transportation to production to finance. Through the first half of the century Germany’s fate had been closely tied to the prejudices and preferences of the landed aristocracy, which preferred to invest in mortgage bonds and government annuities rather than commit their considerable funds to industrial ventures. It took new institutions to meet the heavy capital demands of railroad construction. By mid-century investment banks had appeared in Cologne, Berlin, and Leipzig. They concentrated on industrial investment, giving German finance a different cast from that of either France or England.
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Railroads also became integral to the business plans of others—not just manufacturers but farmers as well, all of whom were highly sensitive to rate schedules or any shenanigans that might be used to raise rates. Railroads quickly became a kind of public utility, making them vulnerable to government regulation.

The capital in capitalism needed its own institutions to entice savers to investment in new ventures and enable them to guard against the risk of losing their money, once invested. There was sufficient capital in Europe to finance industrialization if it could be mobilized. This is where banks came in. Banks played a critical role in funneling capital into industry by turning savers into investors. Expanding to mutual companies that accumulated the savings of ordinary people, they performed a great service by luring cash out from the mattress and into the hands of business borrowers, who then paid interest to the savers. Usually everyone benefited except when banks failed, as they sometimes did, taking these small accounts down with them. While rarely initiating ventures, banks acted as catalysts once development began. Of course channeling other people’s money created opportunities for fraud and speculation, an inseparable, if less respectable, twin to enterprise.

Banks floated bonds that allowed governments to cover extraordinary expenses. Insurance companies sold policies to people to guard against future loss from death and accidents like fires and the sinking of a cargo ship plying the waters of the Pacific, Atlantic, or Indian Ocean. Modern statistics gathering came out of these risk management efforts. Industrial workers in England formed friendly societies to collect money to be paid out to their members or their families in the event of mishaps. When they sought information from the government about the frequency of industrial accidents, Parliament intervened, claiming its authority to be the sole institution to gather such information. Statistics got its start here in the early nineteenth century.

The importance of political and religious support of enterprise can’t really be appreciated except in contrast with places where that support didn’t exist. In the Muslim world Koranic injunctions hindered the formation of corporations and the inheritance of partnerships. Deaths could dissolve partnerships and pools of capital without the legal instrument of incorporation.
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Being unable to bequeath a firm’s shares often made it impossible to maintain businesses. Unlike Muslim countries, Europeans developed financial institutions especially for handling investment money.

German banks began as private institutions, becoming joint-stock companies later. As so-called universal banks they offered a range of financial services from extending short-term credit to taking deposits, discounting bills, selling insurance, and handling mortgages while underwriting and trading in securities.
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Britain industrialized at the leisurely pace of a pathbreaker. Most of its financing came from personal savings and the shrewd reinvestment of profits. Both England and France had central banks, but the German regional banks proved to be just what was needed for them.

Napoleon had created the Bank of France in 1800. Established by merchant bankers outside the inner circle of financial officers, the Bank of France had a monopoly on issuing notes and refused until the 1860s to establish branches outside Paris.
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After banking restrictions were lifted in 1848, financiers formed the Crédit Mobilier, but it didn’t really help French industry much because French investors preferred to send their money overseas for more exotic investments than those near home.

Between 1871 and 1911, the British annual rate of savings was 12 to 15 percent; Germany had an even more impressive rate of 15 to 20 percent. Savings were important because they created a pool of capital that enabled businesses, in Thornstein Veblen’s words, to expedite their “quest of profits,” a wry observation that well captures the restlessness built into capitalism.
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Those enjoying that momentum didn’t appreciate efforts to slow it down that often put industrialists and bankers, especially in France and Germany, at odds. Nobody, it is said, loves his banker. Certainly many a business resented its bankers’ insistence upon rationalizing procedures in accounting, borrowing, and personnel policies.
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Americans started two stock exchanges in Philadelphia and New York in the 1790s, two decades after British brokers had formally established “the Stock Exchange” to replace their informal gatherings in coffeehouses and on the streets. Although dealing primarily in government issues, the stock exchanges in London, Antwerp, Amsterdam, Paris, Lyon, and Marseille became cosmopolitan oases where men of many different nationalities, from Armenians and Jews to Swedes and Frenchmen, conducted business cheek by jowl. Thomas Paine wrote that commerce “cordializes men,” introducing a neologism that never caught on. Voltaire caught the spirit of the exchange when he wrote that “there the Jew, the Mohammedan, and the Christian transact together as though they all profess the same religion, and give the name of infidel to none but bankrupts.”
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Railroads did usher in a more complex stock exchange in the United States when Wall Street began trading railroad stocks and bonds. Not until the end of the nineteenth century did trading in corporate stock become the main activity in stock exchanges around the world. Mindful of the rowdiness of brokers, governments kept a close eye out to ensure order.

In the 1850s the world economy got a phenomenal boost when James Marshall discovered gold at the site of a sawmill he was building in 1848. Nine days later the United States signed the treaty that ended the Mexican-American War and gave the nation California. The volatility of a gold find in an area not yet outfitted with the clothes of government produced a unique situation. Fortune hunters sped to California from the west coast of South America, Hawaii, Australia, Tahiti, and China. Those coming by water took one-third the time of Americans coming from the East Coast. Within 4 years California had attracted a quarter of a million immigrants from twenty-five countries. Most actual miners were Chinese. Both Great Britain and France dumped convicts into the boiling cauldron of San Francisco. At the same time, indigenous men and women died in great numbers at the hands of the lawless and racist newcomers.
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More gold was dug up in the 1850s than all places put together in the previous 150 years. Lubricated by an influx of gold that increased the world’s currency sixfold, world trade almost tripled. Gold surpassed silver as the standard currency. More countries adopted the gold standard as finds in Australia, Alaska, and South Africa bulked up the gold supply.

Every country has its own financial history. In America, the Bank of the United States, the country’s only central bank, fell victim in 1836 to Andrew Jackson’s determination to strangle “the monster bank.” It could never be said that a central bank was necessary to economic development since the United States saw phenomenal growth without one. The vibrancy of the economy sustained this rickety monetary structure. Only the exigencies of paying for the American Civil War got Congress to support a network of federally chartered banks that could issue notes in 1863. The provision that the banks had to deposit their cash reserves in New York City consolidated that city as the country’s financial center. Prior to the war, banks—hundreds of them—had supplied the nation’s currency by issuing notes, giving counterfeiters a field day. The North issued greenbacks that depreciated almost as fast as had the continental notes that paid for the American Revolution. By war’s end the greenbacks and war borrowing amounted to half the annual gross national product! Taxes had paid for only a fifth of the crushingly expensive war. The war’s burden continued when widows’ pensions became the largest expenditure in the national budget.
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From Thomas Jefferson at the beginning of the century to William Jennings Bryan at the end, many American leaders have articulated their fellow citizens’ unease with the invisible part of the economy: the money that circulated, the savings that went into banks, the borrowed capital that financed enterprises. The greenbacks actually proved a blessing to those who wanted to stabilize the currency and have a federal bank. When the government offered to redeem them for gold in 1879, few took up the offer. The old American faith in credit extension and soft money reasserted itself. Any correction of the fiscal mess would bring hardship, and the majority of entrepreneurs wanted to avoid pain. Currency expansion was the promoters’ slogan whether by adding silver to the country’s legal specie or by issuing more bank notes. Quite reasonably most investors were counting on the country’s sunny economic prospects. Mark Twain captured the spirit of the early 1870s in the character of Colonel Beriah Sellers. Moving from small-town America to New York City, Sellers bragged to friends that he had arrived in the city penniless and now owed half a million dollars. Like many actual Americans, Sellers expected his creditors to keep him afloat.
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Like most wars, the American Civil War accelerated the pace of change. For decades cotton exports had dominated the American economy, orienting northern agriculture and industry toward southern consumption. The Union army’s demand for uniforms, tents, rifles, wagons, and foodstuffs soon took the place of cotton. This new market acted like a catalyst in the industrialization of the economy. After the war the party of Lincoln became the party of nascent industrialists. Economic opportunity burgeoned in the West as well. A 1913 law put in place the Federal Reserve Banks, which consolidated federal power over the currency.
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These diverse experiences suggest that while mobilizing capital was important, how it was done was less so.

A narrative account of a subject like capitalism tends to focus on the key developments that advanced progress or unblocked obstacles halting forward motion. It needs to be stressed that much happened in capitalism’s history that did neither. Falling from view are the millions of dollars, pounds, francs, and marks along with untold man-and woman-hours that went down the ratholes of ill-conceived projects. Their presence reminded investors that innovation was never risk-free, but success was frequent and conspicuous enough to keep the flow of investments coming. What capitalism needed above all was capital, not just the nest eggs of inventors and their friends and family but freshets of cash from those who didn’t want to produce anything except a return on their money.

The Benefits of Incorporation

Nothing revolutionized industrial finance more than the legal form of incorporation that gave limited liability to the owners of enterprises. Incorporation had long existed as a means for giving cities or charities a specific and largely autonomous scope of power in perpetuity. We still have incorporated residential areas. Pooling capital through partnerships operated superbly when the right participants came together, and still does. Partners usually wrote contracts that enabled each to break up the enterprise in deference to the vicissitudes of life. This ease of dissolution acted as a significant drawback to the long-term growth of a company.
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As the name suggests, incorporation created an artificial person who paid taxes, could sue to collect debts in the company’s name, or could less happily be sued. The corporation could borrow money and sell shares in the company to members of the public to raise money. This meant that records were open to shareholders’ scrutiny, though access became more restricted as companies grew in size. Management often had controlling shares of stock in the nineteenth century, but incorporation enabled a separation between investors and managers. It also had the advantage of locking in large sums of money. And because they are artificial, corporations could exist forever, removing the threat of inopportune dissolution that partnerships carried with them.