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  1. The Development of a National Financial System: 1863-1914

  1. National Bank Acts -- 1863, 1864, 1865

    1. Aim was to "nationalize" the State Banks and "forcefeed" them federal securites
    2. State Banks were to be recharted by the Federal Government
    3. Stiff Reserve Requirements
    4. Required 1/3 of Reserve be Invested in U.S. Bonds
    5. U.S. Notes Issued to Banks at 90% of face value of Bonds
    6. Notes Made Legal Tender
    7. 10% Tax on State Bank Notes to Drive Them from Circulation
    8. National Bank Acts extended Free Banking to Entire Country

  2. By 1900 There were about 9000 State Banks and 3731 National Banks

  3. Why So Many State Banks? Barriers to Entry Into National Banking

    1. High Capital Requirements
    2. Prohibition Against Mortgage Loans by National Banks
    3. Ceiling on Total U.S. Note Issue Prevented Many State Banks From Switching when it would have been profitable.

  4. Advantages of Non-National Banks

    1. Low Capital Requirements
    2. Could Make Mortgage Loans
    3. Lax Local Regulation

  5. Development of Demand Deposits

    1. Someone Hit upon the idea of making loans via individual Bills of Exchange -- Checks!
    2. Instead of receiving a stack of Bank Notes in exchange for an IOU plus collateral, the borrower is given a checkbook!
    3. A check is a Bill of Exchange -- Whey you write a check you are issuing an order (you are the principal) to your agent (the bank) to pay a third party.
    4. Provided Business and individuals accepted the checks, they are money!

  6. The Currency: Politics vs. Economics, Silver & Gold Prices

    1. Deflation: Prices fell from 1867 to 1896
    2. Deflation caused great Political-Economic strain. Debtors, especially farmers, demanded that steps be taken to inflate the money supply mainly through the coining of silver.
    3. In the 1840s and 1850s Gold was plentiful and Silver relatively scarce
    4. The "Crime of 73" -- Silver was demonetized by an act of Congress just as the Western mines came on line
    5. Bland-Allison Act of 1878. Passed with the support of a coalition of farmers and mining interests. Obligated the Treasury to purchase $2m to $4m of silver bullion per month and coin it into dollars. Treasury always purchased the minimum amount and the price of silver kept falling.
    6. Sherman Silver Purchase Act of 1890 -- Passed as the result of a deal to get the McKinley Tarrif Bill passed. Obligated the Treasury to purchase 4.5m ounces of silver per month (essentially the entire output of the silver mines). The silver bullion was paid for with U.S. Notes. The Notes were redeemable in either gold or silver coin. Because the price of silver was falling relative to gold, the arbitrage opportunity was too good to pass up: Sell silver to get the notes; cash the notes for gold; use gold to buy silver; etc.
    7. Sherman Silver Purchase Act repealled in 1893. The Depression and the outflow of gold came very close to bankrupting the U.S. Government.
    8. Beginning in 1896 the development of the cyanide leaching process and discoveries of gold in the Yukon, South Africa, and Australia produced a sharp increase in the world-wide supply of gold.
  1. Railroads and Economic Growth after the Civil War

  1. U.S. Long on Resources and Short on Population -- Result, capital intensive development

  2. The Creation of the modern economy during the 1840s to the 1890s was due to cheap energy in the form of coal, mass transportation in the form of the railroads, and mass communication in the form of the telegraph.

  3. Growth of the RRs

    1. First railroads were built 1831-32
    2. By 1840 railroad mileage and canal mileage were about equal -- 3000 miles
    3. Between 1850 and 1860 22,500 miles of railroad were built and by 1860 there were about 30,000 miles of railroad. By 1854 Chicago was the leading rail center in the U.S. and by 1860 the major trunk lines -- the New York Central, the Pennsylvania, the Erie, and the B&O all had lines into Chicago. By 1860 a railroad passenger could travel from St. Louis to Boston in 48 hours or from New York City to Charleston, S.C. in 62 hours.

  4. Railroads quickly became the dominate form of transportation because:

    1. Greater Speed -- First form of transportation that was faster than a galloping horse on land.
    2. Open year around -- all weather transportation. Resulted in businesses being open year around!
    3. Less transshipment
    4. Concentrated responsibility

  5. Railroads were the first big businesses.

    1. The trunkline railroads were spread out over a vast territory -- shops, terminals, stations, warehouses, office buildings, bridges, roadbeds, telegraph lines -- all had to be administered and maintained.
    2. The flow of coin was unprecedented. Each day a river of coin was collected from passengers and had to be handled in an efficient and orderly way so it ended up in the Railroad's bank account and not in the pockets of the employees.
    3. The coordination was complex. Each day stations on the line loaded and unloaded a wide variety of cargo. This had to managed and carefully tracked. Cargos could go from any point on the line to any other point on the line.
    4. These complexities required that complex organizational structures be developed to solve the problems. These complex organizational structures evolved into the modern line and staff form of business organization that most big businesses use to this day.

  6. The Nature of Railroad Competition

    1. High Fixed Costs -- at least 2/3 of total costs
    2. These fixed costs created inexorable pressure to attract traffic.
    3. Railroads set prices in relation to cost rather than demand
    4. This inexorably led to the setting of rates that discriminated against persons, places, and types of traffic.

      1. Value Based Pricing -- Freight rates for bulk products such as lumber, coal, and ore were less than freight rates for finished goods.
      2. Assymetric Traffic -- If more freight was moved from city A to city B than vice versa, freight rates from B to A were less than from A to B to avoid empty cars.
      3. Volume -- Discounts were given for carload lots.
      4. Complexity -- The Oyster example.

  7. The Perversity of Railroad Rate Competition

    1. By 1873 most major lines had excess capacity. Consequently, prices on competitive through traffic fell way below non-competitive (usually local) traffic. The result was severe rate wars between competing railroads.
    2. Railroads with high bonded debt would cut rates to generate cash to pay the interest on the debt. The stronger roads would match and the weaker roads would go into bankruptcy.
    3. Problem -- The Courts Rarely Liquidated a Railroad! Result, the weak railroad under bankruptcy protection from its creditors could cut rates again!

  8. The response of the railroads to this perverse competitive situation was to try to control competition through various mechanisms of fixing rates. The most common was the formation of freight pools. Later in the 1890s a wave of consolidation took place that solved much of the problem (temporarily).

  9. Rebates and Drawbacks

    1. Because of the competitive nature of the railroad business, large shippers early on insisted, and got, price breaks (a rebate) from the railroads.
    2. Rebates were pervasive and a source of complaint both from shippers -- who always thought that their competitors got better rates than they did -- and the railroads -- who did not like being "blackmailed".
    3. The most perverse from of a rebate was a drawback. A drawback was, in effect, a tax on a competitor. For example, Company A pays $1.00 a pound to ship a certain item and its smaller competitor pays $1.50 a pound to ship the identical item. If Company A is powerful enough, it can demand a drawback of, say, $.50 from Company B! That is, the railroad collects the $1.50 from Company B and gives $.50 to Company A and keeps the remaining $1.00 for itself.
    4. The rebate system favored cities with multiple railroad lines. This had the effect of promoting industrial consolidation in major cities because the railroad rates were cheaper. For example, it is no accident that Standard Oil's base of operations, Cleveland, Ohio, gave it an early advantage over Pittsburgh. Cleveland had two railroads, Pittsburgh had one.

  10. Railroads and Agriculture

    1. The expansion of the railroads into the Midwest lead to the expansion of market based agriculture. Production climbed rapidly from 1850 to 1870 and the U.S. was exporting large quantities of grain to Europe by the early 1870s.
    2. The steady price deflation during the 1869 - 1896 period resulted in farmers getting less for their crops (in nominal dollars). Consequently, especially when times were bad, the farmers agitated for inflation and tended to blame part of their problems on railroad freight rates.
    3. The railroads were popular villains (a view that still persists in many quarters). But was it true that the railroads were "gouging" the farmers? Were their complaints justified?

      1. No. Careful scholarship by economic historians during the 1960s and 1970s could find no evidence of "unfairness". Robert Higgs looked at the ratio of prices received by farmers for the grains as a percentage of a railroad freight index that he computed. He found no increase.
      2. Jeffrey Williamson looked at the spot price differentials between New York City and Iowa/Wisconsin grain markets. These differentials are an excellent objective measure of railroad freight rates. These rates, as a percentage of the price the farmer received for various grains, fell steadily through the 1870-1900 period. In other words, it got cheaper to ship grain.

    4. Why did the farmers complain so much if there is so little evidence for their grievances?

      1. Farming is an inherently risky business. Yields, prices, and incomes can fluctuate wildly from year to year.
      2. The beginning of their complaints and political activity coincided with the widespread switch from self-sufficiency to commercialization in agriculture.
      3. Farmers in the Midwestern plains were drawn into a system of crop specialization and borrowing from lenders to finance commercial agriculture. This was a relatively new lifestyle for them. The stresses and strains of this new lifestyle was a recipe for political-economic problems.
      4. Robert McGuire in his paper "Economic Causes of Late-19th Century Agrarian Unrest" hit upon the idea of correlating the incidence of protest activity by farmers with the variability of measures of price, yield, and income of 4 major crops -- wheat, corn, oats, and hay. He computed Spearman rank-order correlations across states and found that those states most active in the protest movements usually had the highest variability of prices, yields, and incomes. The correlations where between .73 and .81.

  11. Railroads and Industrialization

    1. In 1874 about 150 tons of iron was used per mile of railroad (rails and rolling stock).
    2. The American iron industry was backward and inadequate. Most railroad rails were imported from England.
    3. Andrew Carnegie changed the industry when he applied the system of railroad cost accounting to the iron and steel business. Carnegie had learned and had helped perfect the system when he worked for the Pennsylvania Railroad from 1852-1865.
    4. Carnegie's innovations resulted in the mass production of cheap high quality Bessemer steel railroad rails by the late 1870s.
    5. By 1890 over 80% of rails were steel and railroad productivity greatly increased due to the availability of cheap steel not only for rails, but also for rolling stock.

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