How did the concept of strict constructionism affect the development of banking and transportation during the antebellum years? Solution TRANSPORTATION Two canals were built in the 1790s: the Santee in South Carolina and the Middlesex in Massachusetts. More, the most successful of which was the Erie, which connected between New York City and the upper Midwest, were built later. Canals\' great advantage was that one work animal could move as much freight as 50 could on land. They were, however, very expensive to build and possible to build in only a few places. Their highfixed costs made them economic only where the volume of traffic would be high. Fixed costs are costs which do not vary with the level of output or (in this case) service. The higher is the level of output or service, the lower are fixed costs per unit of output or service. Other costs are called variable costs. Technologically, building canals were a challenge. Most of the money invested in canals was provided by state and local governments, mostly with funds acquired via taxation Low cost transportation, of course, boosted economic activity, and this is how spending this money was justified Atack and Passel estimate that they drove the cost of transportation down from 20 cents per ton mile in 1810s to 2 to 3 cents per ton mile in the 1820s. The last canals built were failures.Another major improvement in transportation was the development of the steamboat, which made it possible to cheaply transport freight and people upstream and speed downstream trips. Prior to their development the muscle power of humans or animals was required to drag boats upriver. Robert Fulton demonstrated the first successful steamboat in 1807. In 1815, the feasibility of using them to transport freight up the Mississippi was demonstrated. The removal of snags in rivers and reductions in steamboats\' draft made more areas reachable. Night travel eventually became possible. Larger steamboats reaped economies of scale. Boiler explosions and a short useful life were problems. Competition became fierce, driving down price. The first railroads faced not only technological problems, but hostility from those associated with competing forms of transportation. Also, some feared traveling over 20 miles per hour would kill a person. Some didn\'t want these noisy, smoky things around. Decatur, Georgia, for example, turned down the opportunity to have a rail line the State of Georgia was building from the Tennessee River terminate there. As a result, it ended a few miles away, where a new town called Terminus came into being. Today this town is the City of Atlanta. More fortunate than Atlanta transportation wise was Chicago, a mid-continent, Great Lakes port that became a major rail center. Railroads could travel uphill. They could reach inland areas not near rivers. They could be built at a fraction of the cost of a canal. Their speed exceeded that of a wagon, and they could transport a ton at a far lower cost th.

1. How did the concept of strict constructionism affect the development of banking and
transportation during the antebellum years?
Solution
TRANSPORTATION
Two canals were built in the 1790s: the Santee in South Carolina and the Middlesex in
Massachusetts. More, the most successful of which was the Erie, which connected between New
York City and the upper Midwest, were built later. Canals' great advantage was that one work
animal could move as much freight as 50 could on land. They were, however, very expensive to
build and possible to build in only a few places. Their highfixed costs made them economic only
where the volume of traffic would be high. Fixed costs are costs which do not vary with the level
of output or (in this case) service. The higher is the level of output or service, the lower are fixed
costs per unit of output or service. Other costs are called variable costs. Technologically,
building canals were a challenge. Most of the money invested in canals was provided by state
and local governments, mostly with funds acquired via taxation Low cost transportation, of
course, boosted economic activity, and this is how spending this money was justified Atack and
Passel estimate that they drove the cost of transportation down from 20 cents per ton mile in
1810s to 2 to 3 cents per ton mile in the 1820s. The last canals built were failures.Another major
improvement in transportation was the development of the steamboat, which made it possible to
cheaply transport freight and people upstream and speed downstream trips. Prior to their
development the muscle power of humans or animals was required to drag boats upriver. Robert
Fulton demonstrated the first successful steamboat in 1807. In 1815, the feasibility of using them
to transport freight up the Mississippi was demonstrated. The removal of snags in rivers and
reductions in steamboats' draft made more areas reachable. Night travel eventually became
possible. Larger steamboats reaped economies of scale. Boiler explosions and a short useful life
were problems. Competition became fierce, driving down price.
The first railroads faced not only technological problems, but hostility from those associated with
competing forms of transportation. Also, some feared traveling over 20 miles per hour would kill
a person. Some didn't want these noisy, smoky things around. Decatur, Georgia, for example,
turned down the opportunity to have a rail line the State of Georgia was building from the
Tennessee River terminate there. As a result, it ended a few miles away, where a new town
called Terminus came into being. Today this town is the City of Atlanta. More fortunate than
Atlanta transportation wise was Chicago, a mid-continent, Great Lakes port that became a major
rail center. Railroads could travel uphill. They could reach inland areas not near rivers. They

2. could be built at a fraction of the cost of a canal. Their speed exceeded that of a wagon, and they
could transport a ton at a far lower cost than could a wagon. However, it took a quarter of a
century after their introduction for them to come to dominate interregional transportation.
Transportation in this period suffered from three major handicaps: 1) high cost; 2) slow speeds
that kept perishables from moving very far; and 3) irregular service. In addition, overland travel
was damaging to fragile goods. It limited competition, raised prices, and protected the
inefficient. Manufacturers more than fifty miles from Philadelphia, claimed Senator Daniel
Webster, enjoyed natural protection equal to that Philadelphia merchants enjoyed from
manufacturers in Stockholm, Sweden. By this he meant that the cost of transportation from
Philadelphia to areas more than 50 miles away was so high that Philadelphia manufacturers
could not compete with local manufacturers. According to Webster, the cost of only 50 miles of
land transportation equaled the cost of transportation from Stockholm to Philadelphia.The first
and least important improvement in transportation were the turnpikes that began appearing after
the Revolution. Tolls charged for their use was used to grade and maintain them better than other
roads. According to economic historians Jeremy Atack and Peter Passell, report that they may
have cut the cost in terms of labor and capital of moving heavy freight in half. As was true of the
other forms of transportation, most wereprivately financed. Only a few turnpikes were profitable.
(A big problem was that people could avoid passing toll booths.)
Much of the money needed to finance the construction of canals, turnpikes, steamships, and
railroads came from private sources abroad, mainly Great Britain. Transportation and land
booms collapsed whenever foreign money was scarce. Internal improvements during this period
were financed by the states, and when depression hit, many of them repudiated the debt they
incurred to finance them. This alienated Great Britain, whose citizens held much of this debt. In
1839, about $200,000 worth of American securities were in the hands of British citizens.By
1841, $120,000 of these were at risk. (Keep in mine the vastly greater purchasing power of the
dollar then.) The British government asked the federal government to assume these obligations.
It refused. As a result, when the federal government sought foreign loans in 1842, it was
rebuffed.
Employing steam to power ships on the Great Lakes and the Ocean took longer to achieve than
using it to power river boats. "Sail power," say Atack and Passell, [long] held its own against
steam...for a number of reasons. The construction costs of sailing ships were much lower than
steamships, and the ratio of cargo space to total ship tonnage was much higher." A handicap of
using steam for ocean travel was the necessity of carrying a lot of wood or coal to power the
engine. (On a river steamships stopped periodically to pick up fuel.) (The first ship to cross the
Atlantic (partly) via steam power sailed from Savannah.)The most important and well known
advance in transportation in the antebellum period was the development of the railroad. This

3. development led to the introduction of the telegraph. Before the introduction of the telegraph,
because only single track lines were economic, a train could not travel, say North, until a South
bound train arrived. The telegraph made it possible for trains to travel in both directions by
informing one of them to pull off on a siding to allow a train going in the other direction to
pass.A major drawback to antebellum railroads was that different railroads did not use the same
track gage. As a result, when transferring from one line to another, cargo had to be unloaded and
reloaded. Only one antebellum railroad was state owned, Georgia's Western & Atlantic.
However, some cities and states invested in railroad stock.
The transportation revolution that played the most important role in economic development was
the one which opened up the interior of the country; thus making possible the exploitation of its
vast resources. This revolutionmatured after 1850, when the nation's regions began to be
connected by railroads. (Railroads were first introduced in the 1830s.) Some railroad companies
became the nation's first big businesses and its first major issuers of corporate stock. Railroads
were big because of: 1) the wide geographical area they cover; 2) the huge amount of capital
they utilized; and 3) their technological complexity. Solving the problems in building and
operating the railroads required a managerial revolution. Railroad companies split management
from entrepreneurship, creating a new class: professional managers. Railroads required the
delegation of authority and specialized employees, and they introduced middle management.
BANKING
From the start, banking in this country was conducted on the basis of fractional reserves. In the
antebellum period bank reserves consisted of specie (gold and silver). Fractional reserve banking
allows banks to createmoney. They do so by making loans. Example: You deposit $100 in gold
in a bank in exchange for a $100 demand deposit. Now there is $100 less money in circulation in
the form of coins, but there is an equal increase in checkbook money; so the amount of money in
circulation hasn't changed. Your bank only has to keep on hand a fraction of the $100 in
reserves you have provided; say, $10; so it loans the other $90 to someone. Now the amount of
money in circulation has increased by $90.During the antebellum period, the federal government
minted gold and silver coins, and commercial banks provided paper money (banknotes). Banks
issued banknotes in exchange for specie coins (gold and silver) or customers' promissory notes.
The amount of domestically produced gold expanded substantially in the antebellum period. It
first grew significantly when gold was discovered in Georgia. Subsequently, gold output
expanded even more when gold was discovered in California and then in Colorado. Gold was
also obtained through foreign trade.
From 1783 to 1815, the nation's financial system was only a bit more complicated than during
colonial times. Capital was primarily invested in local business ventures. Only a few
corporations existed, and they were in endeavors like canals and banks. The interruption of

4. foreign credit flows during the Revolution forced American merchants to create their own
financial institutions. Banking was the chief political issue at both the state and national level
until the 1840s, when the slavery issue began to heat up.The nation's first commercial bank, the
Bank of North America, was founded in Philadelphia in 1781. It did not take long for
commercial banks to come to dominate the banking business. While today they only issue
checkbook money, in the antebellum period they issued all our currency (banknotes, paper
money). Unlike previous American banks called private banks, the Bank of North America was
incorporated.Private banks, unlike incorporated banks, do not accept deposits or issue banknotes
(paper money). They make loans like commercial banks do, and they may engage in investment
banking and other activities. (Investment banks purchase securities from their issuers for resale.)
The belief behind this theory is that by only lending to finance the production or sale of already
produced goods, the price level could only very briefly rise because additional goods would soon
be on the market to absorb the money created by the making of the loan. After the goods were
sold, the money supply would shrink because the loan would then be repaid. This theory would
not have worked even if all banks had followed it. This is because businesses that wanted, say, to
get the money to build a new store would simply tell its bank that it was borrowing the money
for the inventory of an existing store. If the bank did not make the loan, the business would buy
the inventories anyway with cash on hand. So, if the loan was made, there would be no more
goods on the market than there otherwise would have been, but the money supply would be
greater.A characteristic of American banking which set it apart from banking in the rest of the
world and one that has had a significant impact on the timing and direction of economic
development in this country is that states have often limited the area in which a bank can operate.
As a result, though there might be a lot of banks relative to population, many banks could be near
monopolies.Another distinguishing characteristic of the monetary system was the fact that it was
a bimetallic standard, that is, the federal government minted two types of specie coins: gold and
silver. This produced a problem: periodically one or the other types of coins ceased to circulate.
This was the result of the fact that these metals' relative market prices varied from the ratio of
the price in silver the mint paid for gold to the price in gold it paid for silver. Sometimes people
could profit by taking gold to a government mint and exchanging it for silver; other times the
reverse was true. The government, of course, could only mint what was being brought to it; so
that was what was available to circulate.The mechanics of bank lending in the antebellum period
differed significantly from today's, but the economic effects of their operations was the same.
Back then borrowers received in exchange for their promissory notes or mortgages banknotes
(paper money). Today a borrower gets a deposit on which checks can be written. Like paper
money, checks are part of the money supply. Checks did not come into wide use until the latter
part of the nineteenth century.

5. Most banknotes circulated at a discount (below face value). That is, although a merchant would,
say, accept a ten dollar gold piece for some merchandise, he would charge more than ten dollars
if offered banknotes. The more doubtful a merchant was of whether a bank would redeem its
notes either because he was familiar with the bank's bad record or knew little about it, the
greater would be the discount. Banknotes from distant banks, ceteris paribus, would carry the
highest discounts due both to lack of knowledge about the bank and the cost of presenting its
notes to it for redemption. Counterfeiting was a significant problem both because nobody could
be familiar with the appearance of the many different banks' notes in circulation and because
making good counterfeits was easy.
By 1790, there were commercial banks in Philadelphia, New York, Boston, and Baltimore. By
1800, there was at least one chartered bank in every state but Vermont, Georgia, North Carolina,
and New Jersey. In the nation's early years, commercial banks accounted for the great majority
of its financial intermediaries. (Insurance companies are an example of another type of financial
intermediary.)The first banks were established to underwrite the trading activities of merchants.
(In the colonial and early national period mercantile activity was almost the only economic
activity going on in America besides agriculture.) The loans these banks made were short term
because that was what merchants needed. However, by the 1840s, the growing demand for long
term finance by transportation companies, manufacturers, and Southern planters led to more and
more banks making long term loans. Difficulties they encountered during the depressed, early
1840s caused some states to forbid banks from making many long term loans.The cornerstone of
nineteenth century banking was what is called either the real bills or commercial loan doctrine.
The theory behind this doctrine was that if a bank only made productive, short-term, self-
liquidating loans that banknotes would expand and contract in step with trade; thus there would
be no inflation or deflation. While this was a widely accepted doctrine, banks often did not
follow it. A short-term, self-liquidating loanis one expected to be quickly repayable via the
proceeds of the sale of what was acquired with the borrowed money. (Loans to finance retail
inventories are an example.)
Many people distrusted banks, believing them to be engines of inflation that profited a few and
harmed everybody else. Hostility to banks was so intense in some states that they banned banks.
Anti-bank sentiment was most common in the West and least common in the Northeast. In some
states banking was either a state monopoly or near state monopoly. Banks were said by their
critics to increase the incidence of usury; diverted funds from agriculture; and drove specie out
of circulation and out of the country.After the 1830s, so many people were sour on banks that 7
states outlawed them. Only private banks that did not issue banknotes operated in these states.
Some commercial banks were established in other states (including Georgia) with the intention
of circulating most of their notes in these 7 states. These banks were called wildcat banks.

6. Supposedly they were called this because they were located in the backwoods where wildcats
roamed. Those who received their notes were not expected to show up asking that they be
redeemed.
Inflation, too, can cause problems. Inflation discourages saving and investment. In the
antebellum period the only time inflation produced serious problems was during the
Revolutionary War.The Bank of the United States was the first federally-chartered bank. It was
chartered in 1791. (There were only two federally-chartered banks in the antebellum period: this
bank and a later bank of the same name.) Both the federal government and private investors
owned this bank's stock. (The government financed its investment in the Bank with a loan from
the Bank!) This bank is today called the First Bank of the United States to distinguish it from a
second bank with this name.The First Bank of the United States tried to control other banks and
was the federal government's fiscal agent, that is, the government deposited its funds in it and it
disbursed them for it. It was the nation's most important bank because it was the largest. Regular
commercial banking was the source of most of its income. (This is not true of our central bank
today, the Federal Reserve System.) The Bank of the United States made itself a force for bank
stability by systematically presenting other banks' notes to them for specie redemption Many
Southerners did not believe that the First Bank of the United States would benefit them.
Therefore, it got its charter because it had a great deal of support in the North. Rural interests on
the frontier that needed easy credit, farm debtors, and some businesses desiring easy credit were
other classes of people often opposed to the First Bank. This opposition arose from the fact that
because the First Bank would refuse to accept the banknotes of banks that would not redeem
their notes in specie, it made it difficult for many banks to expand their lending. The First Bank
lost its federal charter, but it continued to operate under a state (Pennsylvania) charter.
During the antebellum period, state regulation of banking gradually increased. States set ceilings
on the ratio of the banknotes (paper money) a bank issued to its specie reserves and on the ratio
of its deposits and banknotes to the capital invested by its owners. (This capital was supposed to
be provided in the form of specie.) Banks that issued banknotes had to be incorporated. (There
was no federal regulation.) Although the requirement that banks redeem their banknotes in specie
on demand, this was frequently not enforced during money panics (liquidity crisis due to the
public net withdrawing gold from banks).Some states, including New York, established deposit
insurance funds that in the long run were not very successful. In the late 1830s, as the nation fell
into a depression, a few states tried to take politics out of the obtaining of a bank charter by
passing free banking laws: meet certain requirements, and a state official had to issue you a
charter. (New York and Georgia were the first to pass a free banking law, and many free banks
were established in the former.) Previously, someone wanting a bank charter only choice was to
get a state legislature to provide it, and this might require paying the state a subsidy, making it a

7. loan, or bribing legislators.Assuming a monetary system is well run, trade carried out by the use
of money is far more efficient than trade conducted by barter. If the price level is not to decline,
the money supply must rise as trade increases because the possible increase in the velocity of
money is limited. The Equation of Exchange explains this: the money supply times the velocity
of money equals the average price per transaction times the number of transactions. Producers
suffer when the price level declines because inputs are bought at a higher price level than outputs
are sold at. Creditors, however, gain, as the dollars they receive from debtors have a greater
purchasing power than those they loaned. However, bad debt losses rise as a result of producers'
profits declining or turning negative.
Some banks, like the Suffolk Bank in New England, took it upon themselves to try and restrain
other banks' issuance of banknotes in the same way as the Banks of the United States did:
demanding they redeem their banknotes in gold. (If the ratio of a bank's notes constantly rose
relative to its stock of gold, it would eventually be forced out of business because it could not
meet redemption demands; thus taking away some of a bank's holdings of gold would reduce the
amount of banknotes it could safely issue.) Preventing inflation wasn't the Suffolk's bank's
only motive. This also increased its profits because banks created banknotes in making loans,
and the fewer loans other banks made, the more the Suffolk could make. The Suffolk's system's
success meant that New England banknotes circulated at par throughout New England. This was
the only region that was successful in controlling the quantity of its banknotes.
The British attack on Washington led to all the banks in Washington and Baltimore being closed.
Those in Philadelphia and New York closed shortly thereafter. Only New England banks were
able to maintain specie convertibility. Under these circumstances, some who had opposed the
First Bank of the United States changed their minds. Also, people who loaned the U.S. money to
finance the War were very much interested in another Bank of the United States being
established because they thought it would protect their interests.Most Congressmen from the
South and the West supported chartering a second Bank of the United States, but, because they
had many large commercial banks, many Northerners did not. However, a second Bank was
established that operated much like its predecessor. State-chartered banks were promised that
there would not be a sudden resumption of specie redemption--the objective of those favoring the
creation of this bank--as a result of the chartering of this bank.What we today call the Second
Bank of the United States dealt only in bills of exchange, gold and silver, and the sale of goods
pledged as security that were obtained as a result of loan defaults. It issued banknotes and dealt
in foreign exchange (foreign currencies). A bill of exchange is an unconditional order in writing
drawn on one party by another party commanding payment to the second or a third party. The
firm it is drawn upon has bought on credit from the firm which draws it. Usually bills of
exchange arise in foreign trade. They are negotiable; so the party drawing one can get cash

8. before it comes due by selling it. It will sell at a discount, that is, less than its value at maturity.
A bank bill of exchange is one drawn by an exporter on the importer's bank, which has given its
permission for this to be done. By turning over to someone you owe a bill of exchange you own,
you can pay off a creditor. Thus, Southerners who exported cotton to Europe would pay off
Northerners from whom they had purchased manufactured goods.
After the First Bank of the United States lost its national charter, the number of state-chartered
banks rose rapidly. By 1816, there were 246 banks. The U.S. Treasury did not attempt to restrain
these banks' note issuance, and the number of banknotes in circulation tripled from 1811 to
1816. Demand deposits (checking accounts) also rose. Between 1830 and 1837 the number of
state-chartered banks doubled, and their note issue nearly tripled. The business boom these banks
financed drove cotton prices from 9 cents to 18 cents per pound.President Thomas Jefferson was
unsuccessful in keeping us from going to war (with either England or France) through the
passage of the Embargo Act (1807), as we went to war with England anyway. This Act banned
trade with England and France, who were at war. As a result, our foreign trade collapsed and the
Act was repealed in 1809. The negative impact of the loss of foreign trade was concentrated in
New England and port cities. The impact on manufacturing and the subsequent War of 1812 was
favorable. Financing the War of 1812 was difficult. There was no income tax back then because
the levying of taxes directly on individuals was then unconstitutional; so the government had to
resort to issuing fiat money. (Fiat money is money because the government says it is; not
because it is redeemable in specie.)During the War of 1812, the federal government was so
financially strapped that the State Department could not even afford to pay its stationary bill. It
was only the willingness of Secretary of State James Madison to pledge his personal fortune as
security that enabled General Andrew Jackson to obtain the funds he needed to move his troops
to New Orleans, where we experienced our greatest victory on land during the War of 1812.
(Unfortunately, unknown to General Jackson, our diplomats in Europe had already signed a
peace treaty.)
Many historians believe that in the 1800s banks aggravated and accentuated the ups and downs
of the business cycle by offering credit (loans) liberally during the upswing of the cycle, when
their specie reserves were high, and drastically reducing the amount of credit during the
downswing. Changes in the level of banks' reserves in the antebellum period were closely
correlated to fluctuations in exports and imports. Ceteris paribus, banks' specie reserves would
rise when exports (mostly agricultural commodities--primarily cotton) and/or their prices rose
and decline when the reverse took place. Rising imports and/or their prices, ceteris paribus,
would diminish banks' reserves and vice versa.Some have blamed the Second Bank of the
United States for not preventing inflation in 1817 and 1818. Then, they complain, it caused a
contraction from 1818 to 1820 by refusing to accept the notes of state banks that would not

9. redeem them and reducing its lending. Only a Supreme Court decision prevented some states
from shutting down the Second Bank's offices in their states.
The Second Bank of the United States was denounced as an anti-democratic monopoly. President
Andrew Jackson was suspicious of banks and believed the Second Bank was unconstitutional
and that it was too closely associated with a monied oligarchy and foreigners; so he vetoed its
rechartering. It continued to operate under a state charter until it failed in 1841 during the
depression which began in 1837. After its demise, Jackson began putting the federal
government's funds in some state-chartered banks, six of which were closely associated with
some of his advisers. As a result, they were referred to as his pet banks.After 1840, New York
City became the nation's reserve city. That is, banks elsewhere deposited their surplus gold
there. These banks could than offer note redemption in New York, which was the nation's major
port and the source of many commercial transactions. New York banks used much of this gold to
make call loans. These are loans that are due whenever the lending bank decided to demand they
be repaid. Call loans were usually made to people buying stocks. Because stocks are such a risky
investment, banks would not lend for their purchase except on this basis.States and cities
sometimes during the antebellum period issued fiat money that called skin plasters. It was called
this because the money wasn't worth much because enough of it was issued to cause it to
depreciate rapidly. People were often induced to accept this money because the issuing
government would accept it in payment of taxes.