The First Wall Street recounts the fascinating history of Chestnut Street and its forgotten role in the birth of American finance. According to Robert E. Wright, Philadelphia, known for its cultivation of liberty and freedom, blossomed into a financial epicenter during the nation's colonial period. The continent's most prodigious minds and talented financiers flocked to Philly in droves, and by the eve of the Revolution, the Quaker City was the most financially sophisticated region in North America. The First Wall Street reveals how the city played a leading role in the financing of the American Revolution and emerged from that titanic struggle with not just the wealth it forged in the crucible of war, but an invaluable amount of human capital as well.
This capital helped make Philadelphia home to the Bank of the United States, the U.S. Mint, an active securities exchange, and several banks and insurance companies—all clustered in or around Chestnut Street. But as the decades passed, financial institutions were lured to New York, and by the late 1820s only the powerful Second Bank of the United States upheld Philadelphia's financial stature. But when Andrew Jackson vetoed its charter, he sealed the fate of Chestnut Street forever—and of Wall Street too.
Finely nuanced and elegantly written, The First Wall Street will appeal to anyone interested in the history of the United States and the origins of its unrivaled economy.
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The First Wall StreetChestnut Street, Philadelphia, and the Birth of American Finance
By Robert E. Wright
University of Chicago PressCopyright © 2005 University of Chicago
All right reserved.
Chapter OneMoney, Money, Money
Money is the most widely held financial asset. We all use it, most of us every single day of our adult lives. It is a wonderful thing. It seems simple enough, but in fact few of us have a deep understanding of what turns out to be a rather involved subject. In this chapter, I hope to change that. I also hope to show that when it came to money, Philadelphia was an innovator. In the colonial period, it set the standard for quality government paper money. During and after the Revolution, it led the charge to bank money. By the 1790s, it was also home of the U.S. Mint. Though for all intents and purposes a failure until the California gold rush, the Philadelphia Mint coined most of the slim stock of U.S. coins. This chapter, in other words, is truly about money (bills of credit), money (bank liabilities), money (coins). But precisely what is this elusive subject, this money? A few pages should make its essence crystal clear.
Money is literally any "thing" readily accepted in payment for goods, services, or debts. The money supply is simply the sum of all money in an economy at a given time. The set of institutions and markets thatcreates and redeems money is called the monetary system. Money and monetary systems have taken a wide variety of specific forms, most of which can be reduced into one of three types: barter, commodity, and fiat. Of course, those three systems can coexist, but at any given time, one system typically predominates.
Barter is by far the simplest monetary system, likely dating to roving bands of Homo erectus beginning some 2 million years ago. It is simply the exchange of one good or service for another-a hunk of antelope meat for an Acheulean hand ax, a basket of apples for a spear, a necklace of pretty stones for sex. Barter took place during chance encounters, often at the interstices of territories or ranges. Barter within groups was probably quite limited because early bands of hunters and gatherers were likely organized like modern firms. Firm or band members, most of whom were closely related, exchanged goods and services within the group on a nonprice basis. Anthropologists call this behavior "sharing" or "forging ties of mutual reciprocity." It seems extremely unlikely that "sharing" occurred between unrelated bands, so some type of quid pro quo arrangement, or "trading," must have taken place.
Simple trade theory shows that bands that engaged in trading activities would have been better off than those that did not engage in trade, and much better off than those that gave away resources gratis. Trade increases wealth by allowing for specialization of production and hence increased per capita productivity. On a more basic level, it allows people to rid themselves of unneeded items in exchange for more desirable things.
Those "gains from trade," however, were limited because barter is an extremely inefficient method of exchange. The first problem is that each party must desire to acquire the exact good that the other has to offer, including the exact quantity and quality, and at the exact time the other has it to offer. This so-called double coincidence of wants is difficult to overcome within the barter system. Moreover, barter creates an enormous number of "prices," the costs of goods and services in terms of each other. An economy with just ten traded goods and services, for instance, requires forty-five different prices, while an economy with a thousand traded goods and services requires just shy of a half million different prices!
Because of the problems with barter, commodity monies typically arise as population densities increase and as economies produce a greater variety of goods. Despite a superficial similarity to barter, commodity monetary systems are a major advance, arguably much more important to prehistoric economic growth than the invention of the wheel or the harnessing of fire. In a commodity monetary system, one good becomes a unit of account, the means by which all other traded goods and services are priced or valued. The commodity becomes a measure of value, answering the question "What is the price of that?" in the same way that inches or centimeters answer the question "How long is that?" or pounds or kilograms answer the question "How much does that weigh?" The unit of account is an abstraction of reality analogous to human abstractions of distance, mass, time, and so on.
Conceptual confusion arises because sometimes the commodity that underlies the unit of account is also used as a physical medium of exchange. In other words, the commodity upon which the abstract unit of account was formed was literally turned over to the seller to make a purchase. It is important to keep in mind, however, that the unit of account and the medium of exchange are distinct concepts. For example, imagine a monetary system with the commodity money "clams." (Or, to be more precise, clamshells. I could not resist the pun because the word "clams" is slang for dollars.) All the goods and services in that economy would be priced in clams, not in terms of each other. A bow, for instance, might cost 20 clams, each arrow for that bow 2 clams, a bead necklace 10 clams, a handful of rare medicinal herbs 50 clams. A purchaser of those herbs might actually have paid the shaman 50 clams. Or he might have paid 2 bows and a bead necklace ([2 x 20] + 10), or 1 bow and 15 arrows ([1 x 20] + [2 x 15]). Whatever the particulars of the case, two concepts should be clear: First, commodity money systems are much more efficient than barter because the number of prices will equal the number of traded goods and services. Second, the unit of account and the medium of exchange need not be the same physical thing. The breakthrough was the creation of an abstract measure of value, not the physical form of the exchange.
Commodity monetary systems have existed in some human communities for at least the last several thousand years and perhaps much longer than that. As self-equilibrating systems, they need no government aid to form or to continue. In fact, they function better when governments leave them alone. Here is how they work: Suppose that clams are the unit of account or measure of the value of things. Further suppose that the economy produces 10 goods and services, A through J. Suppose, too, that at the initial condition, each unit of each good can be produced on average in 1 hour (total) and hence all cost the same in terms of clams, say, 1 clam. To wit, A = 1 clam, B = 1 clam, C = 1 clam, and so on. Now let us suppose that an individual can on average harvest 5 clams in an hour. Obviously, it will be more lucrative to harvest 5 clams in an hour rather than to spend that hour producing 1 unit of A or B, et cetera. Individuals will quite rationally harvest clams and exchange them for A Ç J. By introducing more clams into the economy, however, the clam price of A ... J will increase. In other words, soon it will take 2 clams to acquire a unit of A Ç J, then 3, then 4, then 5. At that point, individuals in the economy will be indifferent about whether they produce 1 unit of A ... J in their hour, or if they harvest 5 clams and then exchange the clams for 1 unit of A ... J.
Of course, the numbers used above are just for the sake of example. If 100 clams could be harvested in an hour, then the nominal clam price would be higher but equilibrium would still be reached. Conversely, if it became easier to produce A Ç J, so that 5 units could be produced in an hour, then the clam price of A Ç J would drop until people would again be indifferent about producing A Ç J or harvesting clams. In other words, commodity monetary systems are self-equilibrating systems where the supply of money grows or shrinks as market forces indicate.
Interestingly, clamshells were a fairly effective commodity money, as were animal teeth, beads, bronze, cattle and other large domesticated quadrupeds, coconuts, feathers, furs, leather, needles, rice, rum, salt, sundry types of shells, stones, tobacco, wheat, wool, and a huge host of other non-rare commodities. As late as the 1960s, monetary theorists in the United States seriously considered a monetary system based on common bricks. The problem with such monies is not their lack of rarity, which, as we will see is actually a great virtue, but rather their lack of uniformity. One variety of tobacco is better than another, insect-infested wheat can be mixed with good grain, and so forth. Heterogeneity creates incentives for buyers (or debtors) to adulterate their payments. Consider the problem from another angle-diamonds, rubies, and other precious stones are extremely rare but almost never become money because it is not easy to distinguish valuable gems from common or flawed ones.
Gold and silver are the classic commodity monies not because of their rarity but because of their homogeneity. They are, after all, elements. Though susceptible to debasement by mixture with lesser metals, there are fairly easy ways, like water displacement and standardized weights, to distinguish between adulterated blocks of precious metals and blocks of specified purity.
The relative rarity of the precious metals actually decreased their effectiveness as units of value. When the gold standard ruled, there were periods of inflation (higher prices) and deflation (lower prices) due to fluctuating supplies of new gold. When new gold supplies slowed, the monetary supply could not keep up with increased demand, and the market price of gold moved higher. The prices of goods and services, therefore, trended lower because each ounce of gold purchased more goods and services. That, of course, induced more people to seek out gold in expectations of above-market returns. After gold strikes, the money supply expanded rapidly and inflation ensued, as with the clam example above. And as with the clam example, there was a natural limit to the price increases because as the aggregate price level rose-that is, as each ounce of gold purchased fewer goods and services-it became less lucrative to mine gold. Eventually the equilibrium point was reached where the return from producing gold equaled the going risk-adjusted market rate of return. The monetary system was again in balance or equilibrium.
The rarity of precious metals turned out to be the main cause of their downfall. The supply of the precious metals was not, in the words of economists, sufficiently "elastic." Unlike common commodities like clams or bricks, which can be harvested or manufactured virtually at will, the precious metals, particularly gold, were often elusive. There were periods when the entire known stock of gold was in circulation or other use. When commodity prices began to fall, signaling a need for more gold money, new natural deposits had to be discovered before equilibrium could be restored. The process could take years, even decades. In the second half of the nineteenth century, many Americans urged moving from a gold standard to a silver standard on the supposition that the supply of silver was more elastic than that of gold. Silverites, like the Populists, ultimately failed. Gold strikes in the Klondike relieved the pressure on gold supplies until the government decided to do away with commodity money entirely.
Only after the coercive powers of the state are well developed does a fiat monetary system have a chance to succeed. In such a system, the government establishes a unit of account literally by fiat or decree. To help make the decree stick, the government often creates a medium of exchange, composed of paper bills and/or metal tokens, that it proclaims to be "legal tender for all debts, public and private." The great strength of such a scheme is that the supply of fiat monies, like today's Federal Reserve notes, is in theory perfectly elastic. In other words, the supply of money can be increased or decreased as needed. That flexibility, however, turns out to be a great weakness. Fiat systems are not self-equilibrating. They are similar to the command economies of communist nations. Unless the commander, like Federal Reserve chairman Alan Greenspan, is an able or lucky one, the results can be disastrous. Often the central monetary authority, the government agency responsible for determining the supply of money, creates too much. That, in turn, causes inflation, as during the 1770s-and 1970s. Sometimes, as in the case of the United States in the early stages of the Great Depression, the central monetary authority creates too little money, leading to deflation and greatly reduced per capita economic output. Over long stretches, fiat monetary systems almost invariably create inflation. The aggregate price level of the United States, for instance, has increased tenfold since it abandoned gold in favor of Federal Reserve money.
After the first few years of initial settlement, colonial Pennsylvanians, like colonists in the rest of British North America, resorted to barter only infrequently. Barter was extremely inefficient, and the colonists knew it. "Bartering one species of property for another," they realized, "would be endless labour." "For some years after the settling of this colony," a Pennsylvanian wrote in 1768, "we had but little specie, and trade was carried on chiefly by truck or barter." "Under such inconveniences," the aged man correctly noted, "it was found impossible for a colony to flourish, or the inhabitants make any considerable progress in their improvements." The legal monetization of country produce, like wheat and beef, helped but was not as efficient as the use of coins, which finally began to circulate after about 1700.
When in the late 1710s and early 1720s "the balance of trade carried out the gold and silver as fast as it was brought in" to the province, domestic trade again temporarily had to be "carried on by the extremely inconvenient method of barter." In response to that crisis, Pennsylvania issued a fiat medium of exchange called "bills of credit." The bills, made of paper, were essentially non-interest-bearing government promissory notes (IOUs). The government redeemed the bills when citizens presented them to government officials to pay taxes or to repay sums borrowed from the government's General Loan Office, or GLO. (When an IOU is returned to its maker or issuer, it is effectively repaid because it is nonsensical to owe something to oneself.) Sometimes the Pennsylvania government issued the bills to government suppliers and called them in via taxes. At other times the government, through the GLO, lent the bills to citizens on the security of land or other assets. In that case, the bills were redeemed when presented by the borrowers to make loan repayments. Between their issuance and redemption, bills of credit passed hand to hand as cash, canceling debts and making purchases. Between 1723 and 1775, Pennsylvania emitted a grand total of just over £1 million bills of credit. Never, however, did the total volume of bills outstanding exceed £500,000.
It is essential to understand that those bills never became Pennsylvania's unit of account. They served only as one of many media of exchange. In other words, the bills represented value but did not define it. Many modern Americans will have difficulty understanding this point because they are so accustomed to having the unit of account and the medium of exchange coincide. A moment's reflection will reveal that even today, the unit of account and the medium of exchange are conceptually distinct aspects of money. Suppose, for example, that you decide to sell your used car for $10,000. When you draw up the contract, you do not specifically state that the buyer may take possession of the vehicle when he delivers a hundred $100 bills or anything of the sort. In fact, you would probably find it odd if the buyer tendered cash at all. You might want a money order or cashier's check instead of the buyer's personal check, or to maintain possession of the vehicle until the check cleared, but, except perhaps to avoid taxation, you would not expect a cash payment. In other words, when you think "$10,000," you have an abstraction in your mind, a measure of what you can buy with that $10,000, not a particular thing in mind. Indeed, if the buyer of your automobile happened to have $10,000 worth of goods and services that you wanted, say a thousand shares of a particular $10 stock that you wanted to own or a thoroughbred racehorse worth $10,000 that you wanted to race, you would be just as happy to take either of them as the money. Importantly, you would not be engaging in "barter" because you would have valued each item according to its current dollar price.
Excerpted from The First Wall Street by Robert E. Wright Copyright © 2005 by University of Chicago. Excerpted by permission.
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Table of ContentsAcknowledgments
1. Of Financial Markets and Marketplaces
2. Colonial Precedents
3. Revolutionary Developments
4. Money, Money, Money
5. Hamilton’s Vision
6. Hazardous Voyages
7. Building Nest Eggs and Homes
8. Transportation Elation
9. Philadelphia’s Finest
10. Wall Street Ascendant
11. Legacy of Growth