17. The combination of high interest rates with a surplus of land for sale broke the land market.
18. 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. Drains on world capital were beyond world resources.
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. [24]
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 savings come.
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.)
19. Why was so much capital locked in?
a. Stretch-out of lines in space. 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.
e. Misperception of real interest rate.
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