Histories    |     Facts    |     Archives    |     About Us    |     Contact Us

Of Revolution, Glory, and Uncertainty

A History of the U.S. Economy

The fledgling thirteen colonies established their independence on ingenuity, the frontier, and support from France and her allies. The United States and her national debt were born, and both have expanded seemingly without limits. However, in the years leading up to America’s sestercentennial, serious questions about the unsustainability of America’s economic practices have developed. Once the world’s leading economic superpower, in the twentieth century America assumed the role of financial capital of the world. As America’s trade deficit continues to increase, much of America’s massive debt is now controlled by China, and a transfer of power seems to be in progress. But even amidst recession, the model of the American Dream is still clinging to life. Whether America and her dream can emerge unscathed in the coming years remains to be seen. It is a complex economic question, and one that cannot be untangled from the global economy.

The Economy of Colonial America (Pre-1776)

Colonial America was a predominately agricultural economy. Even as the economy expanded over the decades of the eighteenth century, the colonies only inched toward industrialization by the year of the Declaration of Independence, in 1776. The economy of the thirteen original colonies was actually relatively stable, in stark contrast to the twentieth and twenty-first centuries. Dynamic economic expansion occurred with population growth from births and immigration, but colonial Americans had naturally become increasingly self-sufficient (Perkins 1988).

agriculture
The economy of the sparsely populated early American colonies was largely agricultural

The initial hardships of European settlers to the New World are well documented, but soon northern prosperity from the fur industry and fishing boosted the local economy (Conte 2001). And as population growth, foreign trade, and general economic expansion allowed the colonies to sustain themselves, Americans such as Benjamin Franklin “foresaw pressure building to shift the balance of political and economic power within the British empire across the Atlantic to the colonies (Perkins 1988).

Whether the world expected it or not, that shift of power is precisely what happened. By 1776, the standard of living of free white American society was already high, with abundant food and land supporting a comparatively high median income (Perkins 1988). Officially sanctioned as a sovereign nation with the Treaty of Paris in 1783, the global economy of the United States of America is born.

The Constitution and Pre-Civil War Economy (1787 – 1850s)

From the writing of the United States Constitution in 1787, America’s economy saw tremendous growth. The Constitution provided a kind of “economic charter,” laying out regulation of both commerce and money by Congress. Most importantly, it opened the market of the United States territory. Open borders allowed for an internal free flow of goods and ideas (Conte 2001). One exception was an unpopular tax on whiskey enacted in 1791 to help pay the national debt established and expanded as a consequence of the Revolutionary War. From 1788, “the U.S. experienced productivity growth of about 2% per year.” Thanks to a strong institutional core adopted from the British, America quickly caught up economically to her former ruler (Bernstein 2004).

The young republic elected its first president in 1789. While goods were abundant, industry was scarce. But American entrepreneurship was given free reign with the departure of British investments. Regional economic character developed with shipyards in New England, crops and furs in the middle colonies, and the plantation economy of the Old South, from Maryland to the Carolina (Conte 2001). That same year, American manufacturing got a boost from the arrival of Samuel Slater, a textile apprentice of a British mill who took his skills (and a carefully memorized “blueprint” of the proprietary equipment) to the United States. In essence, one man caught America up on British textile manufacturing after a year laboriously reconstructing the design from memory. It was precisely the boost the first president, George Washington, desired, having taken oath into office in a humble brown American homespun suit, a deliberate and symbolic choice (Gordon 2001).

Washington wanted to encourage fledgling American industry in an era when ninety percent of her citizens were employed in agriculture, most of whom made everything they needed to live on their own farms (America.gov). The first cotton mill began production in 1790, but the industry was slow to take hold as the labor-intensive processing aspect of cotton kept costs high (Gordon 2001). In addition, there existed an intense debate over what kind of economy America should be. America’s third president, Thomas Jefferson, was a major proponent of the agrarian society. With great support from leaders of the American South, Jefferson and his Democratic-Republicans espoused minimal government with a strong agricultural core.

On the other side of the debate was America’s first Secretary of the Treasury, Alexander Hamilton. Hamilton and his Federalist Party were proponents of a stronger central government in order to encourage manufacturing and commerce as the core of the new American economy. Hamilton further advocated for a national bank to back a strong currency and push policy that would generate capital to support young American industry (America.gov)

railroad
Railroads both dominated and powered the American economy for nearly a century

Supporters of Jefferson economics in the American South, meanwhile, had been looking for the next big thing on the heels of the collapse of indigo exports and increased competition from other tobacco producing territories. Eli Whitney’s simple yet ingenious cotton ginning machine of 1793 elevated the New American South to virtual empire with cotton—and slavery—as the foundation of a new southern economy (Gordon 2001).

The first half of the nineteenth century saw a frontier opened by significant developments in transportation. Government-built waterways such as the Erie Canal opened up new areas to westward settlers, while improvements in water transportation, most notably the steamboat allowed better movement the Mississippi River and her tributaries. After the 1840s—considered the Golden Age of the steamboat—a new mode of transportation, the railroad, picked up the reigns of the American economy, and took it to places and heights it had never before seen (Gordon 2001). The east was finally and forever linked to the west with the completion of the Transcontinental Railroad in 1869. The railroads became the driving economic force of America in the second half of the nineteenth century, backed by governmental land grants and multi-national investments. (America.gov). By then, however, the United States economy had been hit by two major forces: the California Gold Rush and the Civil War.

The Economics of War

The 1848 discovery of gold in California not only drew hundreds of thousands of people out West; it also shifted the balance of economic attention of the United States. By the onset of the Civil War in 1861, gold not only backed American currency, but because of its role in Northern industry, it was indirectly a primary funder of the Northern war effort. Before long, however, both the North and the South resorted to paper currency. Inflation was rampant on both sides but particularly in the South, which lacked the institutional and bureaucratic power of the North, who had both “an established Treasury and a revenue-gathering system” (Gordon 2001). For example, in 1861 the United States saw the establishment of its first federal income tax and the earliest predecessor to the modern Internal Revenue Service (IRS) by the following year. The Civil War also caused a serious spike to the national debt, growing to eighty times its pre-Civil War size (Gordon 2001).

Leading up to the war, the opposing political parties were divided by the question of slavery. The answer to that question, ultimately decided by Union victory, would determine the very appearance of the economy of the United States. Elected in 1860, Abraham Lincoln and his Republican party had Northern industrial interests to preserve, which led to the establishment of a new tariff on foreign goods in 1861. And, because of the war, industry in the North further flourished. The industrial economy of the North would persevere.

Reconstruction through the Roaring Twenties (1865 – 1929)

Following the war, the South lay in economic shambles, and the slave-supported “aristocracy” was dissolved as plantations were divided up. Tenant-style farming or sharecropping became the predominant form of southern agriculture, particularly among the recently freed slaves. Indeed, those freed by the Emancipation Proclamation of 1863 were hit hardest by the chaos of the southern economy, and the wildest ambitions of Reconstruction to improve conditions withered into a divisive era of segregation (America.gov).

Civil War
The momentum of U.S. economic growth was disrupted by the Civil War, especially in the South

By the Civil War, already a third of the national economy was powered by manufacturing, most of which was in the North. Following the war, the American economy was driven by innovation and invention that spurred tremendous growth of the industrial infrastructure. In short, rapid development—and much of it a result of advances in mass production. Individual business enterprise became the backbone of the United States economy (Conte 2001) It was a “Gilded Age” in America, built by entrepreneurs in manufacturing and commerce, which outpaced the economic contribution of agriculture by the 1880s (America.gov).

The era was not without its economic recessions. Depressions (or Panics) of 1873 and 1893 were actually caused in large part by unrestrained development and financial over-speculation, as is true of even the most recent recessions. The Panics devastated small businesses and spiked unemployment rates.

In the economic history of the United States, the early twentieth century remains critical for major advancements in technology. The steam- and water-powered economy received a jolt by the spread of modern electricity, and the advent of the automobile. Entering late into World War I, the United States was primed to shift its industry and vast amounts of raw materials to wartime production. America mobilized not only millions of soldiers, but an economy to support their needs abroad. As during the Civil War, the question of financing the military became a focus of the federal government (Rockoff 2008).

The 1917 War Revenue Act raised taxes while the government sold bonds to the general public and the newly founded Federal Reserve. At the time, America was clinging to a gold standard to back its currency, so avoiding simply printing additional money was meant to help preserve the standard, while preventing inflation. However, the war altered the American economy in many ways. Taxes were lowered after the war, but remained higher than before it. The Federal Reserve assumed a more dominant role as New York became the financial center of the world. The federal government, in short, showed it could be a dominant force in the American economy. Economic prosperity during the “Roaring” 1920s was driven by post-war consumerism. When the decade came to a crashing halt, a dominant role is what the United States government would be obligated to play (Rockoff 2008).

Great Depression through World War II (1929 – 1945)

The two most influential economic events of the twentieth century in America are the Great Depression and World War II. While the precise causes of the Great Depression are both numerous and challenging to pinpoint, the economic effects were disastrous. At its peak, unemployment was nearly 25 percent of the workforce as hundreds of banks failed (about 40 percent) and hundreds of millions of deposits were lost (Ferguson 2008). In summary, after “increasingly stock speculation, the stock market crash of 1929 wiped out millions of investors and crippled confidence among business executives and consumers” (America.gov).

great depression
Unemployment during the Great Depression reached nearly 25 percent

Under the watch of President Franklin Delano Roosevelt, America launched a vast economic stimulus program called the “New Deal.” The program was designed to rebuild the confidence lost during the Depression and put people back to work through government-sponsored works projects. The new Federal Deposit Insurance Corporation (FDIC) lured people back to banks while the Public Works Administration provided vast tracts of inexpensive housing. The Federal Housing Administration provided government underwriting for mortgages, rebuilding the mortgage market in the United States. It was 1938, the year the Federal National Mortgage Association, or Fannie Mae, was born (Ferguson 2008). In short, the New Deal vastly expanded the role of the federal government in the American economy.

A close relationship between the private sector of the economy and the American government was developed as a result of the Great Depression. That relationship would continue into World War II, when the nation’s industrial sector was mobilized and coordinated by the government to contribute products directly to the war effort (Conte 2001). The gross national product (GNP) of the United States increased over 50 percent between 1941 and 1945 and unemployment hit its lowest point ever at 1.2 percent. America, meanwhile, was becoming increasingly urban as populations shifted to cities and agriculture became more mechanized and absorbed by big business as a result of wartime technology (Tassava 2008).

Into the Modern Era (1950s – Present)

While portions of Asia and Europe lay in literal ruins, the United States continued to grow after the war, both in population and economically. The postwar “baby boom” was one of many results of the American military returning home. Most significantly, consumer spending and numbers of consumers increased substantially. The American “middle class” became dominant (Conte 2001). Suburbs exploded with the passing of the Federal-Aid Highway Act of 1956. By now the United States was the richest nation in the world. As a result, America was developing an extensive infrastructure to match its wealth. The completion of the Interstate Highway System “remains the largest public works project in the history of the world” (Gordon 2001). Finally, the strong interrelationship between the government and the ever-expanding industrial sector (the “military-industrial complex”) helped establish the United States as the economic superpower of the world going into the Cold War—a dominance that would be cemented with the collapse of the Soviet Union (Tassava 2008).

Interstate Highway
The immense transportation network of the Interstate Highway System spurred vast economic growth

The middle of the twentieth century saw a brief expansion of labor unions and then labor policy. Most important to American workers were expanded labor rights regulated by the federal government, as well as the Civil Rights movement of the 1960s. President Lyndon Johnson’s “Great Society” further expanded and guaranteed access to opportunity by minorities in America while Congress helped support new federal spending in the form of programs such as Medicare and Food Stamps (Conte 2001). Economic trouble largely resulting from the Vietnam War and high domestic spending plagued the economy in the 1970s as the government grappled with inflation and shockwaves from global crises that drove oil prices and consumer discontent high.

As president from 1977 to 1981, Jimmy Carter was hit hard by such discontent as the trade deficit increased dramatically, inflation hit its highest point since World War I, and unemployment had climbed to 9 percent. With the country in another recession, President Ronald Reagan was subsequently elected on promises of smaller government as well as lower taxes and increased deregulation. But Reagan did not also decrease public spending. The result of increased expenditures (particular in the military and defense) but decreased taxes was significant increases in both the budget deficit and the national debt as the U.S. government was forced to borrow heavily from other countries (America.gov).

A recession of the early 1990s lingering from the stock market crash of 1987 was drawn out by high oil prices stemming from the Persian Gulf War, but consumer confidence and spending helped keep the economy afloat. The economy of the 1990s was driven by the rise of technology and the Internet, whose companies made startling gains on the stock market. Personal and business technology alike broadened and streamlined access to the global marketplace. Economic optimism was based upon high-tech “dot.com” industries who built their success from low interest rates and enthusiastic investors during an era of low unemployment and low inflation (American.gov).

The Federal Reserve closely monitored America’s economic pace, so despite President Bill Clinton’s insistence on smaller government, it still played an active role in the American’s economy (Conte 2001). But it is also because of the Reserve selling billions in bonds to the Chinese that China has gradually assumed role of banker to America. That, in addition to America’s virtual dependence upon cheaply manufactured Chinese goods to sustain America’s consumer-driven economy, had managed to keep inflation, interest rates, and corporate wage costs in America artificially low (Ferguson 2008). Low, even as the economy was taxed by terrorism, dual military fronts in Afghanistan and Iraq, and natural disaster.

Understanding the Recession: Stock Markets, Subprime Lending, and Bursting Bubbles

In all, there have been over thirty cycles of expansions and recessions of the U.S. Economy just since 1854, according to the National Bureau of Economic Research. When markets are surging, “bubbles” form out of wild speculation and overvaluation that are based largely upon euphoria and greed. Electronic “herds” of investors are populated with optimistic, or “bull” buyers (Ferguson 2008). In 2000, the dot.com economic boom came to an end as interest rates rose and investments in technology slowed (America.gov). When an economic bubble bursts, the herd became fearful. A pessimistic “bear” market is a seller’s stock market in decline. Some of these economic forces were the same key factors that caused the “subprime” mortgage bubble that burst in late 2007. However, it was dubious and unregulated lending practices (with encouragement from the U.S. government) that caused this shutter in the economy—with aftershocks felt around the world (Ferguson 2008).

foreclosures
Subprime lending and rising interest rates forced many Americans to default on their mortgage payments and lose their homes

President George W. Bush and the U.S. Department of Housing and Urban Development urged lenders and the governmental mortgage enterprises like Fannie Mae to support subprime mortgage lending to extend the American “dream” of homeownership to low-income groups, but most notably to minority home owners. The model of lending may have worked if interest rates stayed low, but because the loans were mostly adjustable-rate mortgages (ARMs) with “teaser” introductory rates, when rates inevitably did rise, borrowers could no longer afford their mortgages and began to default. Since the success of the loans was also dependent upon a good job market and rising real estate, defaults on loans and house foreclosures signaled just the opposite. House and real estate prices in fact fell dramatically, and “asset-backed securities,” like those bundled with the subprime mortgages, collapsed in value (Ferguson 2008). Mortgage-backed securitization had attempted to manage the risk of subprime lending by dividing and bundling the loans into units of investments that were sold in the form of “exotic securities” and bonds to eager—and unfortunate—investors around the world (America.gov).

Americans have tried to be cautiously optimistic, embracing the message of “Hope” in the presidential campaign of Barack Obama. Like many presidents who took over in the midst of recession, President Obama faces the task of virtually “remaking America,” and to do so with a sharply partisan Congress. Direct effects of smaller government and deregulation under previous administrations, but most recently with the energy and environmental policies of President Bush and Vice President Dick Cheney, were seen in the Gulf of Mexico when as much as 180 million gallons of oil gushed from a self-regulated rig’s blownout wellhead. The question, then, seems virtually the same as that which faced a younger America: how big should the government be? The answer is overwhelmed by the sheer number of complexities that complicate the task facing President Obama and Americans today—the task of remaking another new American economy.

-- Posted September 8, 2010

References

Bernstein, William J. 2004. The Birth of Plenty: How the Prosperity of the Modern World was Created. New York: McGraw-Hill.

Conte, Christopher. 2001. An Outline of the U.S. Economy. Washington D.C.: U.S. Dept. of State, International Information Programs.

Gordon, John Steele. 2001. The Business of America. New York: Walker & Company.

Outline of the U.S. Economy. America.gov. September, 2009. Accessed: July 26, 2010.

Perkins, J. Edwin. 1988. The Economy of Colonial America. New York: Columbia University Press.

Rockoff, Hugh. “U.S. Economy in World War I.” EH.Net Encyclopedia. Robert Whaples, ed. February 10, 2008. Accessed: August 12, 2010.

Tassava, Christopher. “The American Economy during World War II.” EH.Net Encyclopedia. Robert Whaples, ed. February 10, 2008. Accessed: August 12, 2010.

US Business Cycle Expansions and Contractions.” Nber.org. Accessed: August 20, 2010.