By James H. Nolt
Capitalism is an economic system dominated by self-expanding wealth. Whereas the principal strategies of expanding wealth under feudalism involved war or marriage, under capitalism wealth expands through productive, commercial, and financial investments that yield profits. Many people would agree with this, but most neglect the flip side that I have emphasized throughout this blog series: capitalism is not only self-expanding, but also self-limiting. Bulls are the agents of expansion, whereas bears draw the boundaries and set the limits. Capitalism necessarily generates both interests simultaneously, but not in any sort of balance or equilibrium.
One way to understand this is to consider a stylized account of the development of capitalism in 19th century America. The details behind my superficial sketch here can be found in the excellent book by banker Bray Hammond, Banks and Politics in America from the Revolution to the Civil War. Consider two stylized sorts of capitalists: Boston merchants and Virginia planters. The Boston merchants own ships and import goods from England while exporting colonial produce there. They also smuggle tea from Asia, violating the monopoly rights of the British East India Company, leading to the famous Boston Tea Party and ultimately the American Revolution.
Merchants need credit to finance their trade, but since they own ships and goods, their credit needs are proportionate to the volume and tempo of trade. Loans are secured against real assets. They will be the more conservative and typically bearish capitalists in this story. Their champion among the “founding fathers” is Alexander Hamilton with his conservative Federalist Party and its chartered banks, such as Hamilton’s own creations, The Bank of New York and the immense Bank of the United States. Their boards are staffed by wealthy merchants. They do not deign to lend to risk-prone “mechanics and farmers,” but only to rich and sober merchants such as themselves and to governments run by their party.
On the other hand, there are the Virginia planters, a.k.a. “farmers,” seemingly quite rich too, but perpetually in debt because of borrowing to buy land and slaves. Their income depends a lot on fickle agricultural prices and the weather. Worse than that, they often seek to expand their wealth through land speculation in the Wild West, buying wilderness land at pennies on the dollar, driving away the native “Indian” inhabitants, and then eventually selling it at a profit to land-hungry pioneers. Land speculation is a risky but potentially lucrative business.
Land speculators, such as Washington and Jackson, have a rather more expansive outlook than merchants. Merchants may travel the world, but their trade is limited by the quantity of goods in circulation. Their business is about the present and the near future. Planters, on the other hand, see a wide open frontier with almost limitless long-run prospects. There is no lack of land to survey and purchase. Furthermore, in order to sell at a profit land they have already bought on speculation, they absolutely need an expanding credit system. Most pioneers are cash poor. There will not be an ever-expanding market for land without an ever-expanding supply of credit. That’s why planters and their cousins, the urban real estate developers, are the bulls in American history.
The planters want banks too, but those run by “aristocratic” Federalist merchants do not serve their interests, so they create their own “democratic” banks serving mechanics (early industrialists) and farmers (land speculators and their customers). Hammond shows in his detailed, state-by-state history how the planters’ party, when in power in a state, created banks to lend to themselves on the security of land and for the development of landed property, creating a credit-fueled land boom. Their party started out as the Democratic-Republican Party, but since the time of Jackson has been called merely the Democratic Party. The merchant bears, on the other hand, formed and financed Hamilton’s Federalist Party. Later some of these merchants, the Boston Associates, morphed into textile capitalists, formed the Whig Party and finally, by the 1850s, convulsed over slavery and merged with the Free Soil and anti-immigrant elements to form the Republican Party.
The two political parties also represented the two sides on the credit question, bears and bulls. It is no wonder that James Madison, an early leader of the Democratic-Republican Party, wrote in Federalist Papers No. 10 that debtors and creditors always stand as polarized, opposing parties in politics. Actually, both Federalist merchants and Democratic-Republican planters included debtors, but the former generally stood for bearish “sound credit” only in the form of self-liquidating commercial bills and long-term refunding of governmental debt using bonds. They were the party of bearish “sound money,” whereas their opponents were for the almost limitless bullish expansion of credit to raise land values. The more credit, the faster the frontier could expand and land values could rise. So rather than debtors and creditors, it is more apt to characterize the two parties in credit-driven capitalism as bulls and bears.
One of the great battles of early American history was about the overweening power of the Bank of the United States. It is often called the first American central bank, but although it was nationally chartered by Congress, it was a private bank run by Philadelphia merchant bankers. It was not in a sense a governmental institution, though Congress did grant it specific monopoly privileges, including as the bank of deposit for Federal government funds. All other private banks were chartered by individual states.
It was by reading Hammond that I first understood how bearish financiers could regulate and restrict their more bullish competitors, not because of any specific legal powers, but only using their private financial power. Bullish state banks are eager to finance a booming real estate market in the interests of the land speculators who chartered them in state assemblies and sat on their boards tended to issue large quantities of notes and bills as loans to their customers, enabling them to buy land, which becomes the security for the loan. Notes are what we call paper money. Bills are short-term credit instruments (for more details on these see my article, “Crises and the Myth of the Money Supply”). As long as the land rises in value, the loan is secured on its value and paid out of the income of the farmer or the resale of the land at a higher price. As long as credit and land prices boom, the system is flawless.
But such “excessive” credit expansion tends to cause prices to inflate, at least land prices, if not others, relatively devaluing paper assets, like bonds, held by Federalist banks and their merchant owners. The bearish financiers among the Federalists/Whigs have both the means and the opportunity to cut short the credit boom. In the normal course of commerce, significant quantities of the notes and bills issued by bullish banks accumulate in the vaults of their bearish East Coast rivals in Philadelphia, New York, and Boston. All these bears needed to do was refuse to discount bills issued by profligate Tennessee banks, or, alternatively, gather a large quantity of their notes and bills and present them all at once for redemption in gold coin. The backwoods banks owned lots of illiquid assets in the form of real estate loans, but had far too little coin on hand. They can face bankruptcy if unable to redeem stacks of paper claims on them brought all at once for redemption. This did happen, as Hammond shows, causing banking panics, crashes, and great resentment against the Bank of the United States, which Jackson eventually destroyed.
The effective limit on a bullish financial bubble is a bear raid on credit and asset values. Every crisis in history shows this pattern. Politics is merely another layer on top of this inherent capitalist conflict.
James H. Nolt is a senior fellow at World Policy Institute and an adjunct associate professor at New York University.
[Photo courtesy of Wikimedia Commons]