Out of Thin Air: How Debt Creation Grew America and Doomed Mexico in the Late 1800s

Aaron McIlhenny
Sep 4, 2018 · 10 min read
Promotional poster for the 1896 play, “The War of Wealth.” Contrary to this poster’s apparent editorial focus, the growth of the investment class was crucial to establishing American economic prosperity after the Civil War (image source: Wikipedia)

Analyses of the evolution of investment banking and debt creation within the Mexican and American political systems reveal that both nations’ economies went through vastly different growing pains in the late nineteenth and early twentieth centuries. Both countries’ struggles and achievements in growing their economies show the importance that debt creation and risk-management plays in the creation of capital, and they throw into relief the differences in political and cultural systems that allowed the American economy to soar while Mexico’s floundered. Both nations created institutions expressly to generate capital for investment in new ventures, and through the effective use of debt creation, an economic infrastructure emerged that allowed for the creation of increased industrial and mercantile activity for both Mexico and the U.S. However, the United States and Mexico differed in terms of the success of their economic ventures.

Sven Beckert’s study The Monied Metropolis describes how through a combination of risk-taking ventures and the consolidation of debt as a means of payment, a rich and highly interconnected bourgeoisie was able to emerge in New York City during the nineteenth century. Because it was maintained through an interlocking web of social and marital ties in addition to more professional ones, this bourgeoisie was able to act as a support network concerning the ways it handled debt, allowing it to be traded and refinanced in ways that more decentralized systems lacked. The knowledge of this ease provided a measure of stability that allowed investors and entrepreneurs to take greater and greater economic risks, contributing to the positive development of the American economy as a whole.

Mexico, however, was constantly plagued in the 1800s by external and internal threats, and this situation, coupled with the massive amount of debt its government owed to foreign creditors, limited Mexican entrepreneurs’ willingness to take risks and invest in new ventures. Mexico’s decentralized government allowed regional landowners to convert their territories into fiefs that operated semi-autonomously from the federal government, giving investors little confidence that laws concerning debt would be enforced. Additionally, Mexico’s lack of a clear banking capitol in the style of New York (Mexico City was still developing in the 1800s), along with the scarcity of investors themselves, offered little opportunity for an investment class to form as it did in the US, further diminishing trust between debt engineers.

The differing situations between the Mexican and American economies stem in part from the cataclysmic wars that remade both countries in the 1800s. The bourgeois population of the northern United States was made up of immigrants and outsiders who sought to differentiate themselves from European systems of thought and commerce, and thus they prized innovation and the generation of new markets and methods of business. Conversely, the colonizers of New Spain and later Mexico were made up primarily of Spanish nobility, and they sought to generate wealth using more traditional, feudal systems of economic development; this meant that they tended to focus more on keeping power consolidated within the elite instead of developing a mercantile class. This focus on power consolidation contributed to Mexico’s later difficulties in raising capital to pay off foreign debt, as its elite suppressed rather than developed the labor potential of its citizens, in turn increasing the threats of both rebellion by disgruntled workers as well as of invasion by the governments of its creditors.

Although the United States and Mexico share a history of wealthy noble classes funding revolutions against European colonial powers in an effort to avoid sending their wealth overseas, the the trajectories each country took post-revolution differed greatly from each other. After its independence from Britain, the United States quickly split along regional lines into a distinct North, whose economy was dominated by mercantilism and industrial commerce, and South, which depended on a more feudal system of landed estates and indentured servitude (as occurred in Mexico). However, the American Civil War provided the United States with a dialectic reason to embrace the northern model, causing its economy to diverge from the agrarian model promoted by the Southern and Mexican elite. In addition to the struggle between freedom and slavery for which it is primarily remembered, the Civil War also represented a conflict between the ideals of an industrialized, proletariat state that valued the free movement of labor and capital and those of a feudal society comprised of a rigid master/servant hierarchy. In simplified terms, the American Civil War demonstrated that Southern model could not hold up against a severe existential challenge because it could not match the North’s ability to raise both soldiers and capital. This in turn caused the US as a whole to get on board with the principles espoused by its Northern industrial class, based in large part on the freedom of any individual to invest in new ventures and the freedom to receive returns on these investments. The North’s victory, and the intense bouts of investment that accompanied it, caused a bourgeoisie made up of the nouveau riche to flourish in Northern cities, creating a strong investment climate that has in many ways defined the American economy ever since. The North’s victory over the South conclusively proved to its populace the superiority of industry and wage labor, a decisive spectacle that did not occur in Mexican history until much later.

Lacking a similar cataclysmic event to persuade it otherwise, the influence of the New Spanish nobility continued to permeate Mexican economic development even as it tried to mimic the institutions of its northern neighbor. At the onset of the 1850s, Mexican economy still consisted primarily of landed estates under econmienda-inspired systems. The Spanish government encouraged its middle- and upper-class citizens to embrace econmienda as a system of labor, broadcasting this feudal, agrarian model as an economic system that will enrich prospective emigrants. Under econmienda, any Spanish citizen of certain means could be granted a parcel of land in New Spain, gaining also the right to use the labor of those already living within this parcel (i.e., indigenous Mexicans, indentured servants, slaves, and peasants imported from Spain) as they saw fit. This system resulted in a continually simmering countryside, as Mexican workers were cut out of the economic rewards that the nobility enjoyed. Coupled with political instability in continental Spain, organized resistance by disgruntled labor eventually resulted in a series of conflicts throughout the 1800s and early 1900s, which affected several decades of Mexican economic development. As Tenenbaum writes, “[Y]ears of pitched battles and guerilla skirmishes destroyed property, scared capitalists into exile, and left many of the richest mines flooded, neglected, and useless, and the viceregal government heavily in debt to the elites” (Tenenbaum 168). These issues and others hindered Mexican attempts to create centralized banking institutions and effective investment infrastructure since its instability discouraged investors and other actors essential to the development of a diversified economy. As such, Mexico was unable to develop a bourgeois social class willing to take risks on economic ventures, since it was unable to find both the security and innovation that characterized the New York elite.

Much of America’s success in creating a strong commercial capitol in New York City relied on the close-knit nature of the bourgeois community. Beckert describes the New York bourgeois as a society in which most of its members knew each other — or, at least, knew of each other. This web of relationships contributed to a greater ease in moneylending, as banks and investors were able to judge the risk of new ventures based on personal knowledge of those to whom they were lending. Beckert writes, “In a world based on trust and personal contacts, ‘character’ proved critical” in determining credit ratings, since “in a society that knew of no formal system of ranking and mutual obligation, it was no great surprise that the first systematic efforts at reporting the creditworthiness of individuals focused, to a large degree, on character” (Beckert 41). It was a Catch-22 for moneylenders: the American economy was still too young to have developed standardized ways of calculating risk, but the richness of its resources and labor potential made it even riskier for investors to withhold their money and miss out on their piece of the economic pie. Investors were able to — and, in many ways, were compelled to — make value judgments of individuals based on the positions they occupied within society, as the lack of a formal investment banking infrastructure hindered more official ways of assessing risk.

Thus, despite somewhat nebulous risk-assessment strategies, America’s economy expanded rapidly during the late 1800s, and New York society expanded with it. Innovation and entrepreneurship proliferated as investors were able to lend increasing amounts of capital with greater and greater confidence, and exponentially expanding business ventures generated evermore successful returns. As investment banks proliferated, and as New York’s commercial enterprises expanded, an growing safety net appeared regarding how debt was handled. A borrower that defaulted on a loan would not automatically ruin creditors, as creditors possessed a diverse share of assets to draw from to protect against bankruptcy, as well as an increasingly diverse pool of compatriots who could take the debt off their hands. Even the Great Panic of 1873, while an important learning moment for a market still unfamiliar with the tools it needed to survive, did not doom the American investment sector; instead, it forced, finally, investors to formalize their risk-assessment infrastructure without sacrificing the expediency that defined the American business climate. While Beckert details how this practice heightened economic disparity and raised class tensions within America to one of their most severe points in the nation’s history (Beckert 235–236), it also greatly sped American economic development and established America’s place as an economic heavyweight on an international stage.

Internal divisions and external threats diminished Mexico’s ability to form a bourgeoisie and investment climate similar to that of New York; instead, the Mexican government engaged in a vicious cycle where it would (1) take out loans from foreign creditors, (2) attempt to use these loans to finance internationally competitive industry despite its underdeveloped and war-torn infrastructure, (3) fail to grow these industries because its bad infrastructure raised costs and its markets were flooded with cheap foreign-made products, (4) increase taxes on its industries as well as impose tariffs on foreign goods, making Mexican-produced products even more expensive to its consumers, and then (5) ultimately default on these loans, causing either another creditor to assume its debt at a higher rate, thus restarting the cycle, or for creditors to simply invade Mexico, further disrupting its economy.

Analyses of Mexico’s investment climate in the late nineteenth and early twentieth centuries take on more dire tones than those of investment in New York: Robert A. Potash discusses how Mexico’s central bank faced pushback both internally and externally during its attempt to make the Mexican government the sole benefactor from the Mexican economy (Potash 49–50), and creditors viewed Mexico’s attempted centralization as a threat to their private (or sovereign, in the case of its foreign lenders) practices. Additionally, Barbara A. Tenenbaum describes how agiotistas, or Mexican moneylenders, “virtually became the government and kept providing funds and services during its darkest hours, even though it had already become apparent that many loans would never be repaid” (Tenenbaum 172). In Potash’s view, the Mexican economy faltered because of its overzealous central government, and in Tenenbaum’s, the federal government lacked the ability to operate independently of those to whom it owed money in the first place.

However, both studies make clear that Mexican moneylenders were not able to successfully coexist with the Mexican government during the 1800s. This lack of mutual trust hindered the creation of the economic safety net which New York creditors enjoyed, since agiotistas constantly had to guard their capital against both the Mexican government (operating through taxation) and foreign creditors (who threatened lending freezes, interest hikes, and asset seizure [i.e., invasion]). These threats reduced agiotistas’ ability to fund the bold projects that the Mexican economy needed to compete internationally. Since the Mexican investors faced existential threats unknown to the New York elite (especially after the American Civil War), much of the use of their funds had to be channeled to their survival, rather than to the comparatively less dire issue of economic proliferation. Even when Mexico established a central bank in the 1850s, the venture was faced with constant setbacks, as private opponents and foreign creditors repeatedly accused it of overstepping its power even as it became increasingly underfunded as time went on (Potash 50–51). Mexico eventually solved this program through an aggressive use of trade protection and economic deregulation (described in another post), but this only occurred after a series of invasions (most notably by France and the United States) as well as a devastating revolution in the 1910s.

The American and Mexican examples support the idea that for economic proliferation to exist, there has to be a closely-knit community of investment bankers whose effective management of debt causes them to become less risk-averse as their economies grow. These communities have to arise from ideal conditions, with an economic climate receptive to the commercial and industrial ventures they seek to promote, in order to be effective. However, the implications of this practice include the necessity for there to be some capital already circulating within an economy for an effective investment banking sector to take flight. America was able to generate a stable investment sector in part through its relative stability and the already-established industries upon which it sought to capitalize. Mexico, on the other hand, never had time to develop its industrial infrastructure, so its attempts to establish an investment sector were faced with corruption and infighting. These competing versions of success argue that ultimately, investing is a human business as any other. Were it not for the personal ties enjoyed by American investors, they could not have built a strong investment climate with such an otherwise-undeveloped banking infrastructure, as demonstrated by the lack of trust endemic to the Mexican economy throughout the 1800s.

Works Cited

Beckert, Sven. The Monied Metropolis: New York City and the Consolidation of the American Bourgeoisie, 1850–1896. 1993. Cambridge: Cambridge University Press.

Potash, Robert A. Mexican Government and Industrial Development in the Early Republic: The Banco De Avio. 1983. Amherst: University of Massachusetts Press.

Tenenbaum, Barbara A. The Politics of Penury: Debts and Taxes in Mexico, 1821–1856. 1986. Albuquerque: University of New Mexico Press.

Aaron McIlhenny

Written by

SF Native living in Brooklyn, NY

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