THE AMERICAN CAPITAL MARKET, 1846-1914: A STUDY OF THE EFFECTS OF PUBLIC POLICY ON ECONOMIC DEVELOPMENT*

Abstract

THE AMERICAN ECONOMY'S rapid industrialization during an extended period of falling prices in the late nineteenth century provides the backdrop for the problems explored in this study. Recent quantitative research has shown that a major feature of that historical experience was the economy's high and rising rate of capital formation. The period was also noted for great increases in the scale of operations of individual enterprises, often termed by later students the emergence of big business. The main questions about the period concern the role capital-market development played in these trends and whether that role was one of passive response to the requirements of, for example, more capital-intensive technologies, or whether exogenous, perhaps fortuitous, forces shaped the capital markets into active promoters of the trends. Analytically, the primary phenomena to be explained are the growing concentrations of funds in financial centers and the increased effectiveness with which these fund concentrations were allocated to industrial uses. The analysis undertaken leads to the conclusion that financial policies of the federal government played the chief role in fashioning the capital market into an engine of economic growth. The relevant policies, however, were formulated in response to exogenous factors-the financial requirements of the Civil War and the War's residue in the form of a greatly enlarged federal debt-rather than with a view toward promoting rapid economic growth. As is well-known amongst financial historians, a major reason for Congressional establishment of the National Banking System during the Civil War was the desire to provide a system of banks which would, by their very existence, provide a market for government bonds. The legislators also hoped that all commercial banks would join the new system, and with this in mind they enacted in 1866 a prohibitive tax on non-national-bank note issues. This retarded the growth of state-banking systems, but did not promote a unified banking development under federal law because high minimum-capital requirements and prohibition of real-estate loans served at the same time as long-term barriers to bank entry into the National System. The net result of these barriers to entry into both the non-national and national systems was to allow the development of monopolistic banking, especially in markets where the provisions of the federal banking laws were most restrictive of entry, namely, in small towns and the rural areas of the South and West. In city banking markets, where entry barriers were less operative, evidences of greater competition would be expected. Data on bank gross and net rates of return on assets, loan/asset ratios, and profit rates on equity were found to be consistent with the existence of differential degrees of monopoly. A variation of the theory of monopolistic price discrimination applies to banks in the late nineteenth century. Since banks paid interest on interbank deposits (bankers' balances), monopolistically-situated country banks always had the choice of placing funds in local loans or on deposit in the cities. The price-discrimination model explains why banks in the countryside, where interest rates were high, sent funds in