Railroads and capital: money, credit, and the industrialization of shoemaking - Special Invited Issue: Money, Trust, Speculation and Social Justice - Part 2: Trust and Money

American Journal of Economics and Sociology, The, Oct, 1998 by Robert Enoch Buck

II

Capital, Railroads, and Early Industrialization in the United States

With the possible exception of the periods of activity of the first and second Bank of the United States, the money supply and large scale credit resources in the United States were relatively inadequate prior to the Legal Tender Act of 1862 (Hammond, 1957).(1) The suspension of coinage of U.S. dollars in 1806 forced the nation's business to be done via a combination of gold, U.S. coins, foreign coins and bank notes, fiat monies, letters of credit and exchange, and barter and other exchanges in kind. Bank notes constituted the only paper money of the era. Because of the money shortage, banks generally did not loan hard currency to its customers, but issued promissory notes that were discounted up front. These notes then circulated as money, although they were generally accepted at less than their face value depending on the closeness and reputation of the bank (Bruchey, 1990, ch. 6; Gurley & Shaw, 1962; Hammond, 1957; Lebergott, 1984, ch. 11; Ratner et al., 1979, pp. 161-168). In the absence of a federal bank, states supplied credit, which in the northeast, among other places, went principally to railroads and canals. However, the majority of credit within the American economy prior to the Civil War operated beyond governmental, commercial banking and, for the most part, hard money channels. This was the trade credit supplied by storekeepers who let customers have goods on credit and allowed them to pay later with goods in kind, wholesalers who allowed these merchants goods on credit, manufacturers who let goods to wholesalers on credit, and other individuals who placed money with money lenders to extend credit to farmers for the purchase of land and equipment (Lebergott, 1984, pp. 117-122).

Railroads had a number of differential effects on the process of capital formation in the antebellum era. First, because building railroads required very large capital outlays, the use of local capital stores for such purposes precluded allocating assets elsewhere. Second, railroads created wider markets that generated increased aggregate demand, requiring greater capital resources for increasing production and financing credit purchases. Finally, by providing access to previously remote territories, railroads generated major increases in land values, leading to waves of land speculation, thus enhancing real estate's role as a source of capital formation. Indeed, during the building of the transcontinental railroad, such processes accounted for as much as twenty percent of the nation's gross capital formation (Hacker, 1977, pp. 183-185; Nettels, 1962; Stover, 1961, pp. 89-90; Taylor, 1962).

The problem of capital formation in New England towns was affected perversely because money and credit were unequally distributed throughout society. Larger centers of commerce drew gold, specie, and better quality bank notes to them as if they were magnets. This meant that little money entered the villages where industrialization began, and money that did enter exited almost as quickly. It was spent as payment to local merchants who used it to pay for goods from suppliers in major trade centers. This made borrowing in such villages very expensive, with interest rates sometimes reaching twenty-five percent per annum on the best credit (Long, 1820-1836).