The Invention that Built (and almost destroyed) America

On this day in economic and financial history...

Eli Whitney received a patent for his cotton gin on March 14, 1794. For the first time, American plantation owners would be able to harvest large amounts of cotton profitably. This invention -- which was copied an astounding number of times before Whitney gained any measure of patent compensation -- is perhaps more responsible for America as we know it than any other invention in the nation's history.

Historian Gene Dattel, writing in The New York Times some material from his book Cotton and Race in the Making of America, paints a stark picture of profound change:

In 1787, there was virtually no cotton grown in America. Two things, however, quickly changed that. Eli Whitney's cotton gin allowed cotton production to go from a process limited by manual labor to an industrial machine, allowing a person to "clean" 50 pounds, rather than one pound, of cotton a day. And of course, the cotton gin didn't remove manual labor from the process; it just shifted it. In fact, this labor-saving device extended slavery by creating a labor shortage in the cotton fields.

The mass production of cotton was accompanied by a dramatic 90% drop in the price of a cotton textile garment. This in turn led to a consumer revolution whose raw material was slave-produced cotton -- 80% of which was produced in the South. As a result, American cotton production exploded from almost nothing in 1787 to over 4.5 million bales, at 500 pounds a bale, by 1860. On the eve of the war, cotton comprised almost 60% of America's exports.

Slavery expanded accordingly. The number of slaves increased from 700,000 in 1787 to over 4 million on the eve of the American Civil War; approximately 70 percent were involved in some way with cotton production. Indeed, so closely tied were cotton and slavery that the price of a slave directly correlated to the price of cotton (except during years of excessive speculation).


Economists Samuel Williamson of the University of Illinois and Louis Cain of Loyola attempted in 2011 to quantify the value of slavery to the South in modern monetary terms:

The average slave price in 1850 was roughly equal to the average price of a house, so the purchase of even one slave would have given the purchaser some status. Comparisons based on economic status are measured by the relative ratio of GDP per capita. Consequently $400 [the average price of a slave] in those days corresponds to nearly $175,000 in economic status today. ... Total slave wealth was immense. ... While it varies with the price of slaves over the period [1805 to 1860], it is never less that seven trillion 2011 dollars and, at the time of Emancipation, was close to ten trillion 2011 dollars.

By comparison, the American Petroleum Institute estimated in 2007 that the oil and gas industry's total annual impact on the U.S. economy was between $10 trillion and $11 trillion. Considering the far greater population and the more global nature of the oil and gas industry, it is truly staggering that it barely exceeds the aggregate value of the slave economy in antebellum America.

Whitney, the man who had almost single-handedly perpetuated this economic system, saw little benefit from his transformative invention. His gin business was bankrupt three years after he earned the patent, as high fees for use and a relatively straightforward mechanical design pushed many tinkerers to simply copy Whitney, rather than obtain licenses. Whitney spent much of the rest of his life as a gunsmith for the federal government.

A prewar collapse of epic proportions
The Dow Jones Industrial Average suffered an 8.3% decline -- the second-worst of the pre-Depression era -- on March 14, 1907. The Chicago Daily Tribune reported:

Stocks closed in a panic on the exchange today and the last 15 minutes of the session left all Wall Street in a "brain storm" it will not forget for many a day. Not since the wild Northern Pacific swirl of 1901 has there been such a scene. Brokers were driven to the point of frenzy by the avalanche of selling orders, while the street teemed with excitement. Prices dropped from 10 to 20 points and the battering of values still was going on as the day's business finished.

Chief among the causes cited for the panic was a rumor that the U.S. Attorney General was preparing to indict railroad tycoon E. H. Harriman on antitrust charges. At the time, Harriman controlled a number of major railroad and transport companies, including both the former Dow component Pacific Mail Steamship and Wells Fargo , which had maintained both express delivery services and banking operations under the same corporate umbrella (why do you think their logo is a stagecoach?) until just two years prior to this crash. Union Pacific , one of Harriman's largest holdings, was one of the hardest-hit stocks on the market, posting a drop of roughly 15%. The railroad had lost a third of its value from the start of 1907 to March 14's close.

Harriman was asked his opinion after the close, but the executive passive-aggressively demurred to questions as to what had happened. "I would hate to tell you to whom I think you ought to go for the explanation of all this." When pressed, Harriman flatly denied rumors that he had been behind the sales of Union Pacific and Southern Pacific, another of his large railroad concerns.

The day's crash occurred halfway into a two-year bear market that would wipe out nearly half of the Dow's value. During this time, a combination of President Theodore Roosevelt's trust-busting efforts and a string of shocks to the financial markets ultimately led to the Panic of 1907, a series of devastating bank failures that were directly responsible for the creation of the Federal Reserve. Harriman lost a great deal of his wealth during this period, but after the crash ended, he recovered to a net worth of approximately $100 million. His good fortune was short-lived, as Harriman died only two years later. Union Pacific, which controlled Southern Pacific at the time of Harriman's death, was forced to divest itself of Southern in 1913. The two railroads came together again in 1996, and they remain together to this day.

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The article The Invention that Built (and almost destroyed) America originally appeared on Fool.com.

Fool contributor Alex Planes holds no financial position in any company mentioned here. Add him on Google+ or follow him on Twitter @TMFBiggles for more insight into markets, history, and technology. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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