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The Speculation Economy: How Finance Triumphed over Industry

The Speculation Economy: How Finance Triumphed over Industry

by Lawrence E Mitchell

American businesses today are obsessed with the price of their stock, and no wonder. The consequences of even a modest decrease can be so dire that some executives would rather damage their corporation's long-term health than allow quarterly returns to fall below projections. But how did this situation come about? When did the stock market become the driver of the


American businesses today are obsessed with the price of their stock, and no wonder. The consequences of even a modest decrease can be so dire that some executives would rather damage their corporation's long-term health than allow quarterly returns to fall below projections. But how did this situation come about? When did the stock market become the driver of the American economy? Lawrence E. Mitchell identifies the moment in American history when finance triumphed over industry. He shows how the birth of the giant modern corporation spurred the rise of the stock market and how, by the dawn of the 1920s, the stock market left behind its business origins to become the very reason for the creation of business itself.

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Berrett-Koehler Publishers, Inc.
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BK Currents Series
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6.52(w) x 9.38(h) x 1.35(d)

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Berrett-Koehler Publishers, Inc.

Copyright © 2008 Lawrence E. Mitchell
All right reserved.

ISBN: 978-1-57675-400-9

Chapter One


The creation of the giant modern American corporation was not a slowly evolving process. Individual proprietorships, partnerships and corporations gradually grew in size and number throughout the Industrial Revolution of the nineteenth century. But what we have come to know as the modern American corporation, the giant, publicly held corporation, appeared in a flash. America collectively turned around one day and was staring at the balance sheet of U.S. Steel.


The large corporation was already in late adolescence by the time of the great Chicago World's Columbian Exposition of 1893, that wonderfully quirky celebration of technological achievement and cultural progress that raised the curtain on a devastating four-year depression. The fruits of industrialization on display there had grown from saplings planted many decades before, produced by the large businesses dotting the landscape from Boston to Baltimore, from Pittsburgh to St. Louis and beyond. They had arrived by means of one of the greatest engines of the American economy, the railroads, whose tracks sprawled across the continent, north and south, east and west. The industrialization that had begun at the turn of the nineteenth century had been kicked into high gear by the insatiable material demands of the Civil War and gave birth to factories from which flowed steel, farm machinery, packaged meat, beer, wheat flour and sewing machines; mines that brought forth copper enough to wire the country for newly generated electricity; oil refineries that lighted homes from California to Europe; great dry goods empires and the Sears Roebuck catalogue. Left to themselves, these remarkable businesses might well have grown, financed with debt and their own retained earnings, created new products and services and supplied America's wants and needs for evermore. But the large corporations of the nineteenth century were soon to become the raw materials of a new kind of business, a business created for finance rather than for production.

The businesses of the industrializing nineteenth century were, more often than not, organized as partnerships or closely held corporations. The stock of these enterprises was owned by the founders and their families or a small group of friends and business associates. Standard Oil was owned by Rockefeller and the refiners and suppliers he bought out. Carnegie Steel was a series of partnerships. Only the railroads and a very small handful of industrials issued stock that traded on the markets in any volume. The machinery of finance was in its infancy. When industrial corporations needed money, they dipped into their earnings, went to the bank, or sold bonds.

The giant modern corporation was a phenomenon distinct from the forms and processes of industrialization. Its reasons for being were different from those of the nineteenth-century corporation. Earlier enterprises in the age of industrialization were built to take advantage of improvements in shipping, or new production technologies, or new ways of marketing or packaging. The giant modern corporation was created for a new purpose, to sell stock, stock that would make its promoters and financiers rich.

It took only seven years. In the space of that explosive period, from 1897 to 1903, the giant modern American corporation was created by the fusion of tens, and sometimes hundreds, of existing businesses. The new corporations that emerged from this merger wave transformed the very nature of American business.

The inspirations that first drove businessmen to abandon competition to combine the plants that became the great corporations were business problems. Destructive competition threatened the success, and often the existence, of some of the new industries. Efficiencies of size and efficiencies of management prompted the combination of others. Cooperation was the solution. The great nineteenth-century trusts were the result. Before very long, these business motivations were combined with a different goal. That goal was to manufacture stock.

Corporations created for this purpose transformed the structure of American corporate capitalism. They dumped huge amounts of new stock on the market, dispersing ownership from small numbers of men who managed their businesses to hundreds, and then thousands, and then hundreds of thousands of men and women who invested their savings in small blocks of bonds and stock. Although it would take a while to realize their promise, they forever changed the nature of the American economy by distributing the ownership of corporate wealth across the growing middle class. They also transformed American law and politics, leading the federal government to blossom from a small and undistinguished institution of limited domestic powers to a sovereign state that found, in the regulation of business, a central reason for being.

The creation of the giant modern corporation gave birth to a new class in American society, the capitalists. There existed men who were called capitalists well before the 1890s, men who provided the funds to finance new enterprise. Their wealth came from the profits of land or from trade, and sometimes from the industrial plants they created. The businesses they financed were run, for the most part, by industrialists for industrialists. There were of course the rogue plungers and speculators in corporate stocks and bonds who found their wealth by gambling with the business lives of railroads. But men like these were a sideshow. The business of business was business.

Matters had changed by 1903. Still there remained industrialists of the classic mold, but John D. Rockefeller was growing wealthier in retirement as an investor and Andrew Carnegie had sold his empire into the combination created by the very embodiment of the new breed, J. Pierpont Morgan. The nineteenth-century industrialist was passé. As Carnegie put it, "he and his partners knew little about the manufacture of stocks and bonds. They were only conversant with the manufacture of steel." J.P. Morgan and his men knew little about steel, but they were masters of the manufacture of stocks and bonds.

The world of American business belonged to this new breed of capitalist. J.P. Morgan, John R. Dos Passos, the Moore brothers and Charles Flint became the symbols of modern American capitalism. These were the men who released billions in securities by rearranging the companies created by the captains of industry. When John "Bet a Million" Gates decided to create American Steel & Wire, he did not do it by building blast furnaces and rolling mills. He did it by buying almost thirty different plants, from Everett, Washington to Worcester, Massachusetts, using stock as his currency and taking stock as his profit. The giant modern corporation was created for the sake of finance.

The giant modern corporation did more than transform business into finance. It also displaced classical ideas about American individualism. Collective in its very nature, it complicated American social thought born in notions of fervent independence, of rugged individualism. It spread across the landscape cooperative enterprises that organized a new kind of social spirit even as it threatened to subjugate the individual. While it roiled the social order, it nevertheless seemed to pave a road back to older ways of thinking. In its creation of a new kind of property, corporate stock, it put forth a substitute for the traditional ownership of land and small enterprise, the iconic yeoman farmer, the traditional opportunity of the frontier. The stock market was the new frontier and Americans were eager to explore it. The giant modern corporation made Wall Street our wilderness and corporate stock our grubstake.


The Industrial Revolution was a different phenomenon from the consolidations that created the giant modern corporation. American industrialism started from a base of relatively small owner-operators before the Civil War. A few important American business corporations can be traced as far back as the beginning of the nineteenth century. These were mostly local companies, locally owned and locally managed, even if their raw materials came from the cotton plantations of Mississippi, even if their products were widely sold and even if their stock was sometimes traded on the Boston Stock Exchange. Business use of the corporate form really blossomed in the 1840s and 1850s with the expansion of railroads, with their special needs for large amounts of permanent capital and the protection of limited liability. The stock of many railroads traded on exchanges, but more often than not it was controlled by a small group of insiders. As the railroads grew, they came to be financed largely with debt. When railroad stock traded in any great volume, it almost always meant that different factions were clawing for control or speculators were toying with the stock.

The factory system itself appears to have been firmly established by the 1840s and 1850s. Significant growth took place between the end of the Civil War and 1890, with perhaps the greatest increase in the number of factories from 1879 to 1889. The class of wage earners grew from just over 2 million in 1869 to 4.25 million in 1889.

While industrialization created new jobs, especially from around 1880 on, the creation of the giant modern corporation did relatively little for workers. Almost 53 percent of the gainfully employed population worked in agriculture in 1870, and only 19 percent in manufacturing, 39.5 percent when transportation, mining, construction and trade are included. The number of employees engaged in manufacturing, mining, construction transportation and trade had grown to exceed those employed in agriculture by 1890. But this increasing dominance of manufacturing and related industries was already in place by the time of the merger wave. Manufacturing jobs increased at a fairly steady rate during the last two decades of the century, by 33.4 percent between 1880 and 1890 and 34.2 percent between 1890 and 1900. During the decade following the merger wave, manufacturing jobs continued to increase, but at a rate of 30 percent, a slower rate of increase than occurred during the preceding two decades. The merger wave's role in job creation was insignificant.

The merger wave did not create many new manufacturing jobs. It did not even create new factories. The jobs and the factories were already there. The giant modern corporation was an aggregation of existing factories, already fully staffed. The financial imperative that created the giant modern corporation created stock, not jobs. Only in finance and real estate, insignificant employers before 1900, were substantial numbers of jobs created by the merger wave.

The giant modern corporation combined existing jobs and factories under a single corporate umbrella. But it had an enormous financial impact. Although difficult to determine with precision, its magnitude seems to be beyond dispute. According to one contemporaneous study by Luther Conant, Jr., the total capitalization of American industrial combinations of plants with capital greater than $1 million was $216 million in 1887. It had grown over twenty times to more than $4.4 billion by 1900. Slightly over $1 billion of this had been added before the crash of 1893. Relatively little occurred during the following depression, but from 1896 to 1900 almost $4 billion of capitalization by combination was added to American industry. Hans Thorelli's later study, based on slightly different criteria, showed $262 million in combination capitalization in 1893 rising to an aggregate of almost $3.9 billion in 1900, with another $2.3 billion added by 1903. Neither study included railroads, the dominant industry, or public utilities. Thorelli excluded the portion of corporate capitalization represented by bonds, but Conant showed that bonds were a relatively small percentage of combination capitalization.

John Moody, in his 1904 book, The Truth About the Trusts, calculated that "the aggregate capitalization outstanding in the hands of the public of the 318 important and active Industrial Trusts in this country is at the present time no less than $7,246,342,533," representing the consolidation of almost 5,300 individual plants. Two hundred thirty-six of these trusts had been incorporated after January 1, 1898, and represented more than $6 billion of his estimated capitalization. Adding public utility and railroad combinations, Moody calculated a total capitalization of almost $20.4 billion, comprising 8,664 "original companies." Ralph Nelson, whose numbers set the modern standard of analysis and are based upon a more restricted definition of merger, calculated 2,653 "firm disappearances by merger" with a total capitalization of $6.3 billion between 1898 and 1902. Turn-of-the-century economist Edward Meade pointed out that between 1898 and 1900 alone, 149 large business combinations comprising plants in every industry were formed with an aggregate capitalization of $3.6 billion, including Standard Oil of New Jersey, "the United Fruit Company, the National Biscuit Company, the Diamond Match Company, the American Woolen Company, the International Thread Company, the American Writing-Paper Company, the International Silver Company, The American Bicycle Company, and the American Chicle Company," as well as combinations in whiskey, tobacco, beer, coal, iron, steel and chemicals, among others. And all this was before the creation of the first billion-dollar corporation, U.S. Steel, in 1901. No matter how you look at it, the financial economy created by the merger wave was like a tidal wave crashing over American society.

With all of this new capitalization, the value of stock in the hands of Americans rocketed. Individual (nonagricultural) and nonprofit net acquisitions of corporate stock increased from $105 million in 1897 to a peak of $715 million in 1902, declining to $475 million in 1903, the year of the Rich Man's Panic that effectively called an end to the merger wave. Net acquisitions of corporate and foreign bonds were $58 million in 1897 and $82 million in 1903, with major concentrations ranging from $287 million to $465 million in 1899 and 1902, respectively.

The effect was more than dollars. The merger wave created dramatic increases in the number of shares of stock traded throughout the nation. Seventy-seven million shares were traded on the New York Stock Exchange (NYSE) in 1897, almost all of them issued by railroads. Trading volume reached 176.4 million shares in 1899 and, after a brief decline to 138.3 million in 1900, charged up to 265.6 million in 1901, fluctuating between a low of 161 million and a high of 284.3 million shares during the succeeding decade. At the end of that decade, the number of industrial stocks listed on the New York Stock Exchange passed the railroads for the first time and stock ownership had begun to be widely dispersed among Americans.


The dominance of the stock market over business in American economic life was foreseen by Thorstein Veblen even as the events that would cause it were unfolding. Veblen understood concepts like value and profit in terms of human behavior; what people did, instead of what people made, was the real key to understanding profit. This led him to develop a critical distinction between "industry" and "business." Industry was the physical process of making things. It involved factories, raw materials, workers and end products. The industrial process developed to increase productive efficiency and coordinate among the various intricately related aspects of manufacture. In order best to serve the community, the various industrial processes had to be kept in balance. It was the businessman interacting through business transactions who was to maintain this balance. The business transaction was something different from the process of industry.


Excerpted from THE SPECULATION ECONOMY by LAWRENCE E. MITCHELL Copyright © 2008 by Lawrence E. Mitchell. Excerpted by permission of Berrett-Koehler Publishers, Inc.. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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What People are Saying About This

Charlie Cray
"An impressive work of legal, economic and historical scholarship that will enrich today's debate over corporate accountability and regulatory policy."--(Charlie Cray, director of the Center for Corporate Policy and co-author of The People's Business: Controlling Corporations and Restoring Democracy)
Joel Seligman
"Mitchell highlights two of the most pivotal events in our history of modern finance: the rise of Wall Street and investment banking as a key factor in American capitalism and the federal government's response to the ever more complex role of finance capitalism. Mitchell's writing is graceful, comprehensive, and persuasive that as significant as the story of trusts and the trustbusters has been, the rise of finance capitalism and ultimately its federal coordination through such agencies as the Federal Reserve System and the Securities and Exchange Commission may be even more important."--(Joel Seligman, President, University of Rochester and author, the Transformation of Wall Street)
Stephen M. Bainbridge
"Professor Mitchell's provocative thesis is that the development of the modern American public corporation was not an organic process but rather occurred almost overnight at an identifiable point in time and as a result of identifiable political and economic forces. This important new work helps us understand the forces that continue to shape the dominant form of economic actor of our time."--(Stephen M. Bainbridge, William D. Warren Professor of Law, UCLA School of Law)
Harvey J. Goldschmid
"Lawrence Mitchell's new work is full of fresh insight about the rise of what he calls 'American corporate capitalism.' Anyone interested in the development of our modern financial markets will be richly rewarded by a careful reading."--(Harvey J. Goldschmid, Dwight Professor of Law, Columbia University, former Member, United States Securities and Exchange Commission)

Meet the Author

Mitchell is John Theodore Fey Research Professor of Law at George Washington University.

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