A Cycle of Boom and Bust:
[Part 3 of a Pilot Paper, conference on the bank bubble,
The American Institute for Economic Research, 1994. These notes were
not published as such, but were melded by Editor Clifford Cobb into
Money, Credit, and Crisis, of our 2009 book, After the
Crash. Reprinted from GroundSwell, November-December 2012]
Although written in 1994, after the Thrift Debacle (S&L
collapse) of 1991, they could as well have been written, with a few
different details, after 2008. Our leaders, political and
intellectual, had learned nothing from 1991.Â The notes could be
written again today, in 2012, since our leaders of left
and right are still chanting the same old tired slogans I
remember from the playgrounds of 7th Grade when Alf Landon ran against
FDR. Hope springs eternal, so here are the notes. Someday, somewhere,
new leaders will seek new insights and solutions. Tennyson wrote with
hope, Our echoes roll from soul to soul, and grow forever and
forever. That has yet to happen, but remember, the last to
escape from Pandoras Box was Hope.
These notes are most useful if studied in conjunction with The
Canal Boom, a chapter in Homer Hoyt, 100 Years of Land
Values in Chicago, Chicago: University of Chicago Press, 1933.
Herewith a summary of major events, major principles at work, and
- What happened in Chicago happened elsewhere in the nation, and
the N. Atlantic economy.
The world moved more or less in sync. Even then, much of the
world was linked by capital flows; Chicago was a part, a
particularly volatile part, of one stupendous world drama.
- What happened in this cycle happened both earlier and later:
this was only one of many.
Chicago grew in fits and starts, not steadily.
- The amplitude of cycles was greater on the economic/geographic
fringes than at the core.
This refers to cycles in population, land values, and economic
a. Chicago was at the macro fringe of settlement
based on New York States Erie Canal, opened in 1825.
Besides that canal, there was new freedom of competition in
shipping, barging and steamboating on rivers and the Great
Lakes: in 1824 the U.S. Supreme Court outlawed shipping
monopolies (Gibbons v. Ogden). Chicago held what we now realize
is a key macro-geographic site, a continental crossroads and a
breaking point. Its importance was not yet clear to all
contemporaries, however, so it was marginal for its times.
b. Amplitudes were higher, percentagewise, 6-10 miles from
central Chicago than at the city center.
- New building in Chicago depended on the flow of capital
imported from the east; the U.S. depended in part on capital
imported from Europe.Â We were a colonial economy, with
heavy foreign debts and absentee ownership.
- Capital import took the form of consumer goods, i.e. an import
balance. Ships returned east with sand for ballast. What did the
sellers get in exchange? Read on!
- Chicago lived by exporting IOUs. These were secured mostly by
Chicago real estate. Hence, the volume of imports varied as a
function of the level of land prices, and also with their
liquidity. Lord James Bryce, an English visitor, observed that Many
a place has lived upon its boom until it found something more
solid to live on;
- Market agents (buyers and sellers) knew that cities are highly
interdependent and synergistic. In a period of rapid growth,
optimistic buyers acted as though complementary buildings and
public facilities were already in place, or soon would be. Lord
Bryce was struck by it: Men seem to live in the future
they see the country not merely as it is, but as it will be,
Owners of central land and old buildings did not oppose, but
supported new building, and street extensions bringing more land
into the ambit of the central market. Under boom conditions they
are more sensitive to synergy than to competition. They tolerate
logrolling and cross-subsidy, anything to expand the market. They
know they are threatened by rival cities, and they race for the
Number One position. A growing city should be happy, said Bryce, But
there is often a malignant influence at work to destroy happiness
in the shape of a neighbouring city, which is making progress as
swift or swifter, and threatens to eclipse its competitors.
Some famous rivalries are Phila. v. New York; Chicago v. St.
Louis; Seattle v. Tacoma; Charleston v. Savannah; Mobile v. New
Orleans; and San Francisco v. Los Angeles.
[Later, in depressions, the reverse attitude sets in: everything
competitive is opposed, and local leaders support policies to lock
up land, keep it off the market. The nation has long shown a
manic-depressive collective personality.]
The prime example of a key public facility is the Illinois and
Michigan Canal, designed to link Lake Michigan and the Great Lakes
and St. Lawrence system and Erie Canal with the Illinois River and
the entire Mississippi System. It would exploit the connection to
New York opened by The Erie Canal, opened in 1825. A Federal land
grant was given in the 1820s to help finance this I&M Canal.
Just talking about building The Canal sold lots. From 1830 on,
buyers acted as though this would soon be a fait accompli. Chicago
building and speculation boomed in anticipation. In the event,
however, The Canal was not even begun until 1836, and not usable
The social psychology of land booms is revealed in the language
used by eye-witness reporters: mania, epidemic, fever,
madness, contagion, rage, etc. Â Mob psychology is not
comprehended in formal mathematical models, especially those that
include words like rational among their axioms.Â
Land is peculiarly subject to herd psychology because its value is
based entirely on expectations of the distant future, remote from
the realities of today.Â Land is irreproduceable, so its
value is unchecked by the ability to produce new supplies at a
known, finite cost. There is a steep gradient of land values out
from the center, due to internal transportation costs. This limits
the area of land that can effectively be urbanized around the
center, in spite of the vast prairies stretching endlessly to the
- This all occurred in a time of peace, profound peace. The
nearest thing to a war was the Black Hawk War of 1832,
whereby local militia, with little Federal expense, drove the Sauk
and Fox Indians from northern Illinois. The U.S. in these years
defended its very long border with few troops and minimal taxes,
and was even preparing to distribute a surplus to the states. The
surplus came from booming sales of Federal lands.
The absence of heavy taxes, Federal debts and foreign threats,
and the peace dividend of a boundless public domain
waiting to be exploited, contributed to the optimism that became a
mania of speculation.
- Asking prices for land lagged demand for land.
a. On the upswing, buyers got bargains with a free
joyride up the price elevator.Â Until 1834, legitimate
buyer-users were the majority.Â They gained both from
building, and the rise of land prices.Â After 1834,
speculation took over completely. b. On the downswing, sellers
held out for much more than buyers would pay, turnover dropped
nearly to zero. Here is where a page of history is worth a
volume of theory. In theory, buyers and sellers have the
same information and expectations. In history, sellers hold out
when demand falls, and sales virtually stop. Hoyt documents this
through five full cycles, 1833-1933, and you can see it in
southern California today.
- The amplitude of land price swings was truly extreme: a 60-fold
The amplitude of all cycles related to land (prices, sales,
subdivision, building permits) far exceeded, by orders of
magnitude, the amplitude of swings in other economic data
(production, commodity prices, income, etc.). Ordinary life must
go on, even in the blackest depression. Speculation is what stops.
- Building lagged behind population growth.
a. In 1834 there were ten persons per d.u.
b. In 1840 there were many empty buildings. Buildings could not
be unbuilt, or otherwise liquidated, when people had
- Land values drew in capital:
a. From outside buyers, some of whom moved to town.
b. From lenders, who took it as collateral.
Loans to the State, or its Canal Co., taking their lands
as collateral. This occurred in 1835 especially. The State had a
vast land grant, as the Railroads did later. In 1835, the State
Legislature pledged the lands for a loan.
Loans to private land buyers.
c. From payees who held bank notes issued by Chicago banks, and
held elsewhere. High land values induced builders to build
higher, and more intensively, to match the land value. They
built with borrowed money, secured in part by land value.
- Banks monetize rise in Chicago and other Illinois land values.
a. Land seller creates bank to finance his own sales.
State of Illinois owned Illinois and Michigan lands,
from a Federal grant. It chartered a state bank in 1835 to lend
to buyers thereof. Liberal credit is a potent device for raising
land prices. The Illinois Bank also loaned to the Illinois and
Michigan Canal Co. to begin building the above-referenced canal,
not finished until 1848. As collateral it took lands granted to
said Canal Co. The Illinois Legislature required the State Bank,
as a condition of its charter, to lend to the State by buying
State bonds. These bonds were used for a phantasmagoric,
premature, subeconomic network of canals.Â Canal planning
was driven mainly by the desire of marginal counties to raise
their land values. The modern name for this behavior is rent-seeking.
Abe Lincoln, downstate in Springfield and the Sangamon Valley,
was caught up in it.
b. The State bank, and all banks, also loaned to buyers of
c. Out-of-state (mainly Michigan, Indiana and Wisconsin) banks
also loaned to buyers of Chicago land. These notes for a while
circulated in Chicago, helping raise land and other prices.
d. This new M helped raise land prices, making more land value
to monetize, a positive feedback loop, adding to amplitude of
Monetary expansion holds down interest rates below the level of
an unbiased market. Land value is more sensitive to interest rates
than other values are.
- At the peak, 1836-37, demand dropped but asking prices held.
Result: sales (measured by deeds recorded) fell like a stone. In
1837, sales from the Federal Land Office were 3.6% of those in
1836. Federal asking prices were absolutely fixed, regardless of
- In the crisis, the State plunged inexorably ahead, like a bull
rhino charging with its eyes closed, with its comprehensive
statewide canal network. It also projected a statewide rail grid.
Abe Lincoln was all for it. It issued $10 million in bonds -
a lot of money, then. This crowded out other investment, sucking
capital away and forcing up interest rates. All parts of the State
demanded their shares, to get the same gains as the I&M Canal
was bringing to Chicago. The program was much too great for the
existing resources of Illinois and its lenders.
- There developed an artificial abundance of lands
seeking buyers, owing to overextension of infrastructure and
- The combination of high interest rates with a surplus of land
for sale broke the land market.
- High interest rates resulted from:
a. Huge rise in demand for capital to link, develop,
improve and provision new lands, both extensively and
intensively, both locally, nationally and worldwide. Francois
Quesnay, often called the founder of economics, described
capital as advances, noting that capital consists of
resources paid up front, as we say today, before
there is any return. Quesnay noted that each kind of capital
requires more of the other kinds, to complement it. He listed
avances souveraines (public works, and sometimes military
conquest), avances foncieres (clearing, draining, fencing,
building), avances primitives (equipment, cattle, etc.), and
avances annuelles (current expenses, including public expenses
like police and soldiery). Those who advance one kind of capital
often fail to reckon how much more of their own capital they
must advance to match the first kind, and hardly ever reckon how
much more of others capital must be advanced.
During this canal-boom era, six or more major trunk canals were
being built by Atlantic Coast states to breach the Appalachian
barrier. Hundreds of feeder canals, many of them submarginal and
heavily cross-subsidized, were started at the same time. Seven
or more canals were being built from Lake Erie south to the Ohio
River.Â Drains on world capital were beyond world
b. Capital in the forms of avances souveraines, foncieres, et
primitives did not revolve, but was sunk for decades. Too much
was locked into hard forms like canals and rails and bridges and
tunnels and cuts and fills from which recovery is slow at best
and, as it turned out, often impossible ever. In a bust, even
many avances annuelles are lost. Adam Smith, David Ricardo, John
Stuart Mill, Knut Wicksell, Stanley Jevons, Karl Spiethoff,
perhaps Boehm-Bawerk, and other great economists recognized this
as a cause of depression and unemployment.
c. Too high a share of income was generated by long-term
investments. When funds ran out, these employments could not be
continued, and stopped generating income. There was a loss of
the priming, driving, income-creating power of capital to
sustain real production and income, from which alone real
d. Too little propensity to save from current income. The rise
of land prices was treated like current income by the owners,
and consumed, even though it did not correspond to any
production of consumable goods. Once the values had risen, they
satisfied the owners need for assets without those owners
having to save and create real capital.
One prodigal living on land sales was the U.S. Government. At
this period it collected less in taxes than it spent, and lived
by selling off the public patrimony for cash, using the proceeds
for current expenses. This aborted capital formation, just as
private prodigality does. (Today the U.S. Government does the
same thing by going into debt, which has the same effect.)
- Why was so much capital locked in?
a. Stretch-out of lines in space.Â Stretch-out
in space was caused by the combined force of leapfrogging over
the better, rentable lands which developed too slowly, combined
with speculative promotional forces trying to force premature or
other subeconomic development of marginal lands. Chicago itself
was a leapfrog, in the continental picture. The Hudson and
Connecticut Valleys were still undeveloped. At the micro level,
the City of Chicago itself sprawled out 6-10 miles, when it
lacked population to fill in a circle of one mile. The same was
true of dozens of growing cities in the U.S. at the same time.
b. Stretch-out of construction times. Overambitious projected
lines, and grand systems, took generations to go on line and
start throwing back cash. Meantime, capitalized interest doubled
and quadrupled the capital sunk in them. By the crash, the State
had put millions into the unfinished Canal and rails. This
capital became torpid: stopped revolving. The effect on the body
economic is much the same as the effect on the human body of
slowing metabolism (the rate of turnover of your protoplasm).
In addition, delay in completing one improvement diverted
demand elsewhere and stimulated competing improvements. The I&M
Canal was just one of dozens of routes projected from the St.
Lawrence system to the Mississippi system. There were six in
Ohio alone, (all completed, too,) south from Lake Erie to the
Ohio River. There was one, craziest of all, projected from the
Maumee River (modern Toledo) s.w. to the Wabash (where Dan
Quayle went to school) through Indiana. Every such project
created new townsites, and an avalanche of new towns was thrown
on the market.
c. Effect of premature high land values on shaping the
character of capital investment. High land values stimulate
land-saving, land-enhancing, land-linking, and rent-leading
investments (as described elsewhere). This may be a rational
economic response, basically, when and if the market is sending
the right signals. Ideally, an optimally high level of land
rents and values serves as a community synchronizer, causing
everyone to build as though others were going to build
complementarily in sync. In the frenzy of a speculative boom it
sent (as it still sends) the wrong signals.
In addition, high land prices motivate land-seizing (rent-seeking)
investments, which are never optimal for society, and always
waste capital. Land-seizing investments will be laid out by
self-seeking individuals (rational economic agents)
with no expectation of ever recovering the capital invested
because the payoff comes as title to land, which never wears
out. Canal promoters were mainly in the business of selling
townsites at stations and terminals along the canals.
d. Misperception of real interest rate. A boom generates
inflationary psychology. Imported consumer goods are costly;
local land values rise even more. Borrowers see the real value
of their debts falling, offsetting some or all of their interest
payments. Such expectations come to be the mark of the shrewd,
knowing, cutting-edge, state-of-the-art inside-dopester, whose
expectations come to be considered more rational
than those of conventional old fogeys. Today, this kind of
thinking is apotheosized in rational expectations,
the Chicago-School economists answer to Divine
Omniscience. Thus inspired, people take on mountains of debt
that they cannot service unless the market keeps rising.
e. The promotional wiles of engineers, contractors, financiers,
empire builders, materials sellers, et al. The same kind of
folks who sold the pyramids, the Tower of Babel, Angkor Vat, the
Mayan-Aztec Temples, the Great Wall of China, the long canals of
Peru, the Roman roads and aqueducts, Irish famine relief through
road-building, the Yukon-San Diego Aqueduct, The Rancho Seco,
Three Mile Island, and Chernobyl Nuclear Generating Stations,
The Washington Public Power Supply System, and other sterile or
abortive monuments are busily at work in all times and places.
These sellers played on the fears and ambitions of public
leaders, who need experts to intimidate the public.
They got paid up front, leaving the public to clean up their
messes. The U.S. Army Engineer Corps was in there. They dredged
the Chicago Harbor, using Federal dollars. They were the agent
for implementing Henry Clays American System,
a compromise whereby eastern states got tariff protection, and
western states got Federal aid for internal improvements. Its
been called The Great American System of Public Works for
Private Gain. This was an early way of distributing
Federal surpluses to the states: River and Harbor
Improvements became synonymous with pork-barrel
politics early on. Thus the surpluses were turned into
capital all right, but often it was capital of low productivity
and long, long deferred payoff.
Chicago came off well in this Congressional bargaining. It got
its Federal aid, and then the S. Carolina Nullification Crisis
of 1832 forced the tariff, which was raised in 1828, back down
anyway. Besides, as a potential industrial site, Chicago was
positioned to gain from the tariff, too.
- Artificial abundance of land for sale was caused by:
a. Speculative holdouts pushed prices up high, and
held them there too long.
b. The market responded slowly but massively, adapting capital
to this artificially high land price level.
Macro-infrastucture like The Erie Canal, and Mississippi River
improvements, were justified by tapping and enhancing lands that
were worth it at the higher price level.
Micro-infrastructure like streets in Chicago. Hoyt found that in
1836 there was enough subdivided land in Chicago to house and
support 50,000 people, when the actual population was 4,000.
Intensification of private land is the most intuitively obvious
result of high land prices.
- Capital import inevitably was overpowered by debt service. That
has to happen as debt rises, which it cannot do forever. That
forces a new city back on its basic, long-term export industries
and services. As it and its competitors seek to expand those, the
terms of trade turn against them: more supply means lower prices.
Chicago then was like many third-world nations today, e.g. Mexico
and Nigeria with their oil. As they turn to debt service, human
and other resources previously used to build new capital
(exporting IOUs) must be turned to exporting real goods. If they
are one of many in the same position, that lowers prices of their
exports and puts them on a downward price treadmill.
- At the national level there were only blue skies and smooth
sailing. In 1835 the national debt was totally extinguished, and
surpluses mounted swiftly from soaring land sales and excise
taxes. Pres. Jackson deposited the surpluses in private banks
around the country, giving them reserves on which to expand fast.
They loaned to speculators to buy more Federal lands, raising the
surplus still more.
In 1836 Texas won independence from Mexico, giving spirits a
lift. No powerful nation threatened our rapid westward expansion.
- In Chicago, however, there was a fragile circle of dependence
among several elements. Previously we have looked at positive
feedback loops of the First Kind, simple ones with just two
elements. Here there were many elements, serving to disguise the
elements of positive feedback. The arrows below show the direction
of support: i.e., the element at the tip of the arrow, to the
right, depends on the element at the shank end, to the left.
Closing the loop, the first element on the left depends on the
last element on the right.
GO > Chicagos basic economy > Chi.
speculative land pricesÂ > Illinois banks >
Illinois State bonds > Illinois State building program >
The Illinois and Michigan Canal > Return to GO
Take especial note of the dependence of banks on speculative land
prices. This is the great secret missing from textbook
macroeconomics. It has been obvious to all contemporary reporters,
even as it is today. Yet you look in vain through volumes of
macroeconomic theory for any recognition of it. Classicals,
Keynesians, Monetarists, Post-Keynesians, Lucasians,
econometricians, cliometricians, radicals, conservatives: they
almost all theorize in the clouds as though it never happened, or
could never happen again. It is a fantastic feat of collective
amnesia that should make us very wary of received doctrines and
their expositors. This is one reason why A page of history
is worth a volume of theory. In principle, theory should be
useful; in practise, theory seems to be dominated by those who are
willfully blind and deaf.
Every element depended on every other. It was too much to
understand: the interdependency and vulnerability was shrouded in
complexity, in a naive age. It was too much to keep working for
long: one failing element would bring down the whole system, and
did. What element failed? Read on!
- The weakest element was speculative land pricing. We have cited
over-subdivision, enough to support 50,000 people when there were
at most 4,000. The market was bound to fall in any credit pinch.
Recall the extreme sensitivity of speculative land prices to
interest rates. Current cash flow was overcapitalized,
in the common expression, meaning the price/earnings ratio of land
was extremely high, and correspondingly dependent on easy credit.
- Much publicity went to Pres. Jacksons Specie
Circular of May, 1836. After that, the Federal Land Office
would not accept bank notes for public lands, except from banks
that settled their balances in specie, and except from bona fide
settlers. Apparently there were only few of those: in 1837, sales
from the Federal Land Office dropped to 3.6% of those in 1836.
The Land Office had been selling mainly to speculators, financed
by wildcat banks that printed their own notes. Jackson
demanded specie, a term of the times for gold and
silver. He was either tired or apprehensive of getting burned by wildcat
banks. He did continue to accept bank notes from banks that
settled in specie.
Too much has been blamed on this episode, because of its dramatic
and political nature. If anything, it should have upheld the
market for lands previously sold, and may have had that intent. It
meant Federal lands were held off the market. It did undercut many
wildcat banks, thus helping create a shortage of cash in frontier
areas. We will see, however, world banking was about to collapse
anyway. We will also see from the Illinois case, banks depended
heavily on the collateral value of lands already sold, more than
the prospect of lending on lands not yet sold.
- In January 1837 Pres. Jackson began distributing the surplus to
State governments, as authorized by Congress six months earlier.
This staved off crisis for a few months, causing the cycle to have
a double peak.
- In May 1837, N.Y. banks suspended specie payments.Â New
York had its own problems, of a similar kind. New York City,
despite its advanced age, had never previously developed anywhere
near its potential, partly due to the aristocratic landholding
system that aborted development of its Hudson Valley, plus the New
England orientation of settlers who developed the upstate Mohawk
This was New Yorks first great boom, and it went as wild as
Chicago, and fell as hard. Perhaps it went wilder: it had the
misfortune of a good credit rating. For a few years before 1837,
90% of the cost of government in New York City was spending on new
streets, financed by local improvement bonds. After 1837, its
speculative land values melted away like snow in the April sun.
Buffalo, at the west end of the Erie Canal, also had a wild ride.
New York banks were also under pressure from England. When we
were discovering canals, they were discovering railroads, with
similar results. Chicagos crisis, like most crises, was a
small scene of a vast worldwide drama.
Suspensions swept the south and west. At the end of May, Illinois
banks suspended specie payments. A general liquidity crisis
followed. People scrambled to convert real goods into cash.
Converting normal provisions into cash is an everyday occurrence:
loans on such collateral are self-liquidating. On the
other hand, converting huge volumes of real estate into cash is
extraordinary, and cannot be done. There arent buyers. What
resulted was total collapse of sales. Demand dropped but asking
prices held. Result: sales (measured by deeds recorded) fell like
a stone. Cf. southern California, 1989-93.
- Subdividing land came to a complete halt, 1837-43.
- Asking prices for land held until mid-1839. Then, finally, they
dropped by 75% overall, and 90% on the most speculative fringes.
1842 was the nadir, when most construction everywhere came to a
- The Illinois State Bank foreclosed on lands but could not sell
them.Â It failed, 1842. Many marginal wildcat banks failed
- Indiana and several southern states declared bankruptcy,
repudiating their state bonds, ruining their credit for years to
come. (This severely weakened the Confederate States in the Civil
- The tide of migration ebbed back east (even as it is today from
California). Chicagos population fell; houses lay vacant.
- Revival began around 1844, leading to another peak and crash in
1857, following nearly the same patterns.
When will they ever learn? could have been written much
earlier, and probably will play again. Make sure you, at least, learn
now. In 1987-90 I had students study this material, and asked on the
final if they saw any danger of its happening again now. Almost
everyone answered It cant happen here. Thus, most
people get caught up in the mass delusion. Be you, rather, the rare
one who learns from history! In time!