Investing for Middle America

Chapter One

From Frontier to Finance

Even before he knew it, John Elliott Tappan's life was connected to money. In 1873, when he was three years old, living on his family's farm in Wisconsin, momentous events were taking place around him. America plunged into an economic depression, or "Panic" in the word of the times. But this was not just an ordinary downturn of the business cycle. This economic calamity would reshape the social and political landscape of the nation for years to come. Before it was over, railroad workers would go on strike, paralyzing the country's transportation network in America's first nationwide industrial action. Conflicts between two emerging groups, those who owned factories, banks, and stores, and those who worked in them, would raise the specter of class warfare. Unemployment in the nation's rapidly growing cities would turn "respectable" upper-class members of society inward, away from the poor, bedraggled, and increasingly immigrant masses that made up the bulk of the urban population. In the West, farmers would form new organizations with quaint-sounding names like "The Patrons of Husbandry." They rallied against what they saw as a different sort of social danger--not mobs but monopolists, the rich and powerful who owned the means of transportation, communications, and, increasingly, manufacturing.

The source of all this trouble was obscure. Some pinned blame on the nation's railroads, which grew to enormous size in giant systems stretching across the continent. By the late nineteenth century, railroads were employing thousands, and soon tens of thousands, of laborers. They represented hundreds of millions of dollars in invested capital. Railroad corporations were certainly a force to behold, an economic power the likes of which the nation had never seen. Livelihoods of humble farmers were absolutely dependent upon rail transport. Without it, the cost of shipping to market bulky products such as grain, beef, and cotton quickly exceeded the value of the crop. Shipping costs were crucial to western merchants and storekeepers as well. There was also trouble over another group of behemoths--industrial factories, where working men made more and more of the goods the nation consumed.

The direct cause of misery, though, was traced to something else--money. Money has long been an object of intense curiosity, even worship. It has also long been cursed as the root of evil, the corrupter of morals. But how could something so intangible as money have the power to hold hostage the lives and fortunes of men and women? Here was part of money's mystery and allure. It could roil markets or seal a man's economic fate, even as it did no work itself. In Tappan's Middle West, 1873 saw the start of a divisive debate over money--who had it, who controlled it, and how it should be used. This debate would continue long after the depression abated. It would become the key issue of American politics, deciding several presidential campaigns, not finally put to rest until forty years later, with the formation of the Federal Reserve System in 1913. Money, with its occult power, would be more than John Elliott Tappan's business. It would define the contours of his life.

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To untangle the long battle over money that took place in Tappan's world, we have to understand the economy as people in 1873 understood it. Nineteenth-century Americans believed in the labor theory of value, a theory endorsed by both Adam Smith and Karl Marx. In the United States, its most famous exponents included Thomas Jefferson, Alexander Hamilton, and Abraham Lincoln. The theory held that work was the root of all value. Humans gained nothing from raw nature except through their own labor. Only those who worked by the sweat of their brow created and produced the things necessary for human happiness and progress. Only producers counted in this economy.

Central to conflict in the 1870s was intense debate about the interests of producers against the wealth and power of nonproducers. Producers, those who labored and made useful things, included farmers, but also manufacturers, at least small, local ones. Artisans were producers, as were shopkeepers. So were propertyless workers, who labored with their skills and their hands. Who was not a producer? That was hard to say. Americans tended to have a fairly generous definition of labor, including in this category merchants, professionals, inventors, and to some extent bankers. Still, those who did little more than live off land rents or lend money at high interest seemed to fall beyond the pale. In extreme free labor rhetoric, these nonproducers were condemned as "leeches on the business body," who "produce no wealth, but rather consume it."

In the West in particular, eastern bankers and money men were roundly condemned in such fashion. They profited from their control of the vital supplies of credit and money needed for trade, commerce, agriculture, and manufacturing--the "real" production. But even here it was hard to draw the class line. Capital was entitled to some reward, if a minimal one. Local bankers and moneylenders who provided capital seemed to be performing vital and productive functions. So too did merchants who sold on credit the goods farmers needed. They were often given an exemption from the label "parasite," so long as interest rates were low and money was plentiful.

The notion of value in labor and production had roots stretching back to Protestant and ultimately biblical sources that equated hard work with virtue. However, in nineteenth-century America, the notion also had crucial political implications. More than fairness to the worker, or technical economic theory, was at stake here. In a nation fervently committed to the republican form of government, and with wide aspirations toward democratic citizenship, Americans were keenly aware that liberty and equality were easily threatened by despotic concentrations of wealth and power. It was, after all, the concentration and arbitrary use of power by George III that had touched off the American Revolution. Republics were imperiled by aristocrats, who used wealth and position to gain control of government and manipulate it in their own interests. Aristocrats of finance could pose the same danger.

Equitable wealth distribution countered this danger, by giving every man an equal chance to live the life of a free and independent producer. Free men who owned their own land and property were beholden to no one. They possessed virtue, and virtuous men acted with the public good in mind. Such conditions were considered absolutely essential for democracy. Still, important as equality was, few Americans contemplated radical wealth redistribution or active government intervention to achieve it. There was, in the logic of free labor, no need for activism. Values, of goods or services or even money, in the end reflected, or should reflect, the value of labor put into them. Since labor created value, all those who worked were entitled to the fair and full reward for their efforts. As long as labor received its just reward, as long as no economic parasite siphoned off the value due the laborer, then a fair and equitable distribution of wealth was assured. The Republic might not be a society of exact economic equals, but it should certainly be one of wide property ownership in which each man could support himself and his family without being dependent on another. In a world where labor received the full value of what it created, no one who worked should ever starve or be reduced to a state of charitable dependence.

Implied in this theory was a largely self-regulating market. Labor received its due, unless aristocrats with special connections to the state or monopolists who cornered the market interfered in the distribution of rewards. For this reason, both liberal and conservative Americans generally endorsed a hands-off, laissez-faire policy. Only projects that clearly benefited all classes, such as public works and improvements like roads, canals, bridges, and railroads, or schools, should be actively state supported, and even then in limited fashion, largely by the local rather than the federal government. Far greater danger came when enemies of labor--enemies of the citizen majority, that is--used the state to capture the rewards properly belonging to working men and women.

Even greater than the danger of government corruption, though, was the danger of monetary manipulation. There was no more subtle and nefarious way of siphoning off labor's true reward than by deliberate tampering with the value of currency. The formula for corrupting the Republic by manipulating money worked as follows: The value of labor, determined by work performed, was a constant. But monetary values were infinitely variable. If the quantity (and hence value) of money could somehow be changed, then a clever financial manipulator could line his pockets at the producer's expense. When money changed value, workers' wages and farmers' incomes changed as well, even though the work performed had not changed. Deflation, for example, raised the borrower's burden of debt--and most farmers had to borrow. The moneylender in this case took an unearned increment of value from labor.

Crediting all real value to labor, then, nineteenth-century Americans tended to see changes in money values as unnatural and exploitative. Money had to be tied down, fixed, and tamed so that it stood subordinate to labor. It had to be free from the control of cliques, rings, and insiders. Otherwise, as Andrew Jackson darkly warned in his farewell address, the "money power" would render "property insecure and the wages of labor unsteady or uncertain."

Until 1873, both major parties, Democratic and Republican, agreed that fixing the value of money required an absolute, inviolable standard. Precious metal served as a good standard, and at various times in history gold, silver, or both backed American currency. American farmers, manufacturers, bankers, and workers generally believed that sound money was hard money, as expressed in some metallic standard. Since the supply of metal depended on discoveries of new ore--a rare occurrence--it was impossible to change the value of metal-backed money by arbitrary action.

Although Americans of many persuasions shared this healthy fear of money and gave instinctive support to the "sound" dollar, they did not all share the same self-interest. Increasingly, divergent interests would drive a wedge into the consensus on financial orthodoxy. The first break came during the Civil War, when the Union government was forced to issue paper notes known as Greenbacks to finance the war effort. Most northern Republicans remained hard-money men, however, and they moved quickly to take Greenbacks out of circulation once the fighting ended. Their efforts contracted the money supply, one of the few times in American history that the stock of money actually declined.

In paying off the war debt and taking paper out of circulation, Republicans thought that they were returning the nation to the monetary standards and values existing before the war. But too much had already changed to simply go back to the antebellum status quo. For one thing, northerners had instituted revolutionary changes in economic policy while the South was out of the Union. They supported economic growth through subsidies to railroads and other forms of transportation. They gave land to farmers through the Homestead Act. They founded state-sponsored universities. Most of these measures were uncontroversial, except perhaps to die-hard southern Confederates. Republicans also sought one more thing--to "rationalize" or stabilize the nation's banking industry and monetary system. Banks, the crucial institution of money creation and capital mobilization, became the first battleground in the late-nineteenth-century war over money.

Before the Civil War, there was virtually no federal regulation of banking, and precious little state or local regulation. Under the principles of "free banking," one could simply open a place of deposit, print paper notes, and lend money at interest. Whether these notes actually circulated was another matter, of course. Many traded at a heavy discount, reflecting the shaky reputation of the financial institutions that issued them. But that was the market's problem. Sound institutions would see their notes accepted readily; poor ones would be driven out of business. Serious bankers often sought to enhance their reputation by seeking stare charters, but these charters imposed few obligations.

Wide-open banking fit the American ethos of competition and private experimentation. Though disorderly, an open and competitive banking system at least gave all entrepreneurs a fair chance to get capital. Financial openness and bank competition were highly desirable from the point of view of a striving western farmer or merchant, for example, who wanted money cheap and plentiful to develop land and build businesses. Central control of finance, on the other hand, posed a danger to such interests. Centralization might permit a clique or cabal of moneylenders to control the nation's currency, make money scarce, change monetary values, and deprive labor of its just rewards.

Before the Civil War, such fears had largely discouraged central management of the money supply and encouraged a banking system that was decentralized and wide-open compared to that of other nations. Pleasing to agrarians and to those located outside of major cities, this relatively unrestricted financial system was disturbing to more established business interests and financiers in the East. By the end of the Civil War, the dominant view of the Republican party had shifted firmly toward control and financial regulation. The result was the National Banking Act of 1866. It placed restrictions on bank notes, making it all but impossible for state or private banks to issue paper. Although the number of banks grew in the latter half of the nineteenth century, and checks began to supplement currency, the law still had a constraining effect. It raised reserve requirements in a manner that tended to favor banks located in the East. Banks outside of eastern money centers survived by keeping funds on deposit in city banks, which in turn kept funds in the big banks of New York, Philadelphia, and Boston. The guardians of wealth regarded this system as stable and predictable. Increasingly, however, it would be viewed by westerners and southerners as a form of enforced dependence on the lords of capital in the East. The new financial policies were locking down the wide-open financial system that had operated before the Civil War.

Until 1873, monetary conflicts had remained muted. The new banking act was certainly a change, but one grudgingly accepted. The removal of Greenbacks reduced the supply of money, but paper currency like Greenbacks were controversial anyway. When the Panic of 1873 struck, however, simmering monetary conflict suddenly boiled over. Money grew tight, production closed down, and farmers were forced into bankruptcy as banks called loans. Though the contraction eventually ended and the economy recovered strongly after 1879, for many it was a revelatory experience. They now saw a financial system rigged against the West. Stability and rationalization meant tighter money and higher interest rates. In newly settled territory lacking banks or other financial intermediaries, interest rates could be five times as high as they were in eastern cities. Falling supplies of money and the retirement of some $2 billion of war debt fueled deflation, meaning a decrease in prices. Conditions affected different groups in different ways. Agrarian producers experienced low prices for their products, and hence a fall in income, even as overall national income climbed.

Many consequences of Republican monetary policy were unforeseen. Still, taken together, they suggested a pattern to critics. In the West, interest rates were high, banks scarce, and capital hard to find. In the East, there were plenty of banks, money flowed into industry and railroads, and bondholders watched the value of their bonds rise as prices fell. Speculators who had loaded up on Civil War Greenbacks at discounted prices reaped a windfall when they were retired in gold. Power, it seemed, had flowed into the hands of a small group of financial insiders who set monetary policy in their own interest. In 1873, producers were suddenly not in charge of the economy, as the labor theory of value said they should be. Money itself, a mere tool for the honest producer, slipped through the fingers of the producers of real wealth and into the hands of a small clique of bankers and lenders located in the nation's financial centers, New York City especially.

The bankers of New York, of course, did not see things in quite the same way. Supporters of the new national banking and financial order, they argued that the system worked well, regardless of who was hurt. Panics and downturns, though undesirable, were nothing new, either. These natural economic events merely shook out the inefficient and allowed the more competent to pick up the pieces. Modern historians have largely sided with this view of events.

Still, even if the post-Civil War monetary policies worked, they did so in ways bound to create political conflict. By making large, established banks in the East the crucial economic institutions of capital dispensing, the policies created a pyramid structure that moved money into reserve city banks on the East Coast. New York in particular benefited from this arrangement. It had already become the nation's investment banking center, with its sophisticated communications infrastructure and ties to European investors. By the late nineteenth century, it was becoming the domestic financial balance wheel, drawing in funds from the countryside and redistributing them to a variety of uses. To many Americans, this sort of structure violated notions of local autonomy and went outside the old consensus of a self-regulating monetary system based on some intrinsic, unchanging value. No longer was the system self-regulating and fair. Now it was in the hands of one group located in one section.

The telltale sign of this power shift was known as the "Crime of '73." As young John Tappan was celebrating his third birthday, deep in the recesses of Congress a new bill was under debate that would remove silver from the nation's money supply. This seemingly innocuous little bill, which became the Coinage Act of 1873, touched off the great silver controversy that defined the politics of money until the end of the century. The act simply discontinued the coinage of silver dollars. It seemed of little consequence. Few people had even seen silver dollars. In 1836 they had disappeared from circulation. In a classic demonstration of Gresham's law ("bad money drives out good"), silver had been driven from the marketplace. Before 1873, gold was the "bad" money. It was relatively less valuable than silver, pushed down in price by new gold discoveries in the middle nineteenth century, including the famous California Gold Rush. As gold went down in value, silver went up, and relatively lower valued gold coins replaced silver ones. But by 1873, the metals had reversed position. New discoveries of silver ore pushed down silver, making it cheaper than gold. Now, by Gresham's law, gold coins were threatened with elimination.

One might ask, What difference did it make, since U.S. law accepted both silver and gold as backing for money? If silver drove out gold, silver would simply become the new standard. The difference is that by the 1870s, gold had taken on a new, urgent meaning. It was not merely one of several possible standards for money. It was the international medium of exchange. The United States was in fact one of the few bimetallic nations left in the "civilized" world, accepting either gold or silver as lawful money. Most of the world's business, international trade in particular, was conducted in gold. If silver drove gold out of circulation, the United States would be out of kilter with the rest of the commercial world, particularly Europe. Fear in the international financial community over the stability of the gold dollar had already affected America's fiscal health and economic position. With the 1873 law, Republicans moved the United States toward the gold standard, a mechanism for adjusting the balance of payments between nations by expressing different national currencies in the common standard of gold. It was the last piece of the new monetary policy instituted after the Civil War. It would also become the most controversial.

Under the new gold standard, with silver now gone, the amount and value of money in the nation were directly related to the amount of gold in the nation's vaults. Gold, however, was an international medium that followed trade and commerce across borders. The amount of gold in the United States was determined by the nation's balance of payments, or, in other words, by international economic forces far beyond the control or even understanding of most farmers, workers, and small-business people. When American imports exceeded exports (and they usually did at this time), gold flowed out to pay for the deficit. These international economic forces, Republicans argued, meant that gold should have pride of place as the standard of monetary value within the United States. Internationalism also meant, however, that the supply of money in the United States was closely linked to events taking place far from home. Unlike the mid nineteenth century, moreover, there were no big new discoveries of ore to boost the money supply, until the Yukon strike at the end of the century. Decline or slow growth of the money supply, brought on by shifts in America's international position, meant falling prices and periodic depressions, like the one that gripped the nation in 1873.

"Gold" Republicans had freighted seemingly arcane and technical matters of monetary policy with a heavy cultural burden. Without a gold standard, they argued, the United States would lose its international standing, which they wanted to enhance. Without gold, values would be subject to the arbitrary depredations of backwoods bankers and ignorant farmers, who wanted to inflate the currency. Eastern creditors believed that calls for more money and a looser banking structure were mere inflationary ploys by western debtors who wanted to pay off their obligations in currency of lesser value. Such perceived efforts to shirk obligations were denounced in strident moralistic tones.

Opponents of the gold standard were no less self-righteous. They too believed in fundamental values, that money was a "God-given thing," and that metallic currency was "the only real and most perfect medium of exchange," because it had "intrinsic value." A few westerners, called Greenbackers after the Civil War currency, had departed from this tradition by supporting paper money. Most farmers and merchants throughout the West, however, held strong to their belief in bullion, just not gold alone. They sought to protect the nation from the "arbitrary and capricious" changes in value that Gold Republicans were enacting through their experiments in financial reform and internationalism. Westerners believed that prices were being forced down unfairly by bankers more interested in the international economy than in the economic health of the United States. It was not the financial establishment that was suffering from the new monetary policy. Bringing silver back into the game was seen as a corrective move that would restore prices and monetary values to their true and natural levels.

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Excerpted from Investing for Middle America by Kenneth Lipartito and Carol Heher Peters. Copyright © 2001 by Kenneth Lipartito and Carol Heher Peters. Excerpted by permission. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.