Great Northern RR Locomotive

James J. Hill And The Liquidation Of Malinvestment

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James J. Hill is unquestionably one of the greatest entrepreneurs in American history.  This past weekend marked the 100th anniversary of his passing.  He is best remembered for the successful construction of the only transcontinental railroad to not go bankrupt.  He didn’t accept government subsidies, and argued eloquently against his competitors who did:

“The government should not furnish capital to these companies, in addition to their enormous land subsidies, to enable them to conduct their business in competition with enterprises that have received no aid from the public treasury.”

His endeavors can claim to be largely responsible for the settling and economic development of the upper midwest United States, and for making Seattle into the commercial metropolis that it is today.  For the best histories of the man and his legacy, these two articles (here and here) are unmatched.

Countless business, entrepreneurial, and economic lessons can be learned from a detailed study of Mr. Hill.  One particular economic lesson stems from his entrance into the business of railroad ownership – that of malinvestment and the liquidation thereof.

Hill purchased his first railroad when the Panic of 1873 made purchase of the St. Paul & Pacific line financially possible.  The line had been in steady decline, and eventually made its way into receivership.  With a group of three partners, Hill purchased the line for what he estimated to be 20% of its actual value.  He tirelessly invested in his purchase, extending the line to other cities and connecting it to branches of other lines.

His efforts brought him great success and enormous wealth.  His fortune swelled to an estimated $63 million.  His efforts also led to levels of prosperity for anyone who did business with, worked for, or lived near his lines that had previously only been dreamed of.

The catalyst that started all of this was Hill’s decision to provide the capital necessary to liquidate the malinvestment that the St. Paul & Pacific had succumbed to.  Although much maligned, the liquidation of bankrupt companies or of toxic assets is a good and necessary function of a healthy economy.

Malinvestment, as described by the Austrian Theory of the Business Cycle, is most commonly associated with monetary inflation by central banks.  This malinvestment is the source of bubbles, the cause of economic crises, and must eventually be liquidated.  Of course, the Federal Reserve wasn’t founded until 1913, and there was no central bank in the US in 1873.  That fact does not repudiate the theory as it relates to Hill’s purchase of the St. Paul & Pacific.

Panics occurred prior to central banks whenever governments or “private” banks (with special government granted privileges) artificially created money and credit out of thin air.  The Panic of 1873 was the result of US government monetary expansion to finance the Civil War.  This “funny money” was shoveled towards expanding the railroad network and the iron and steel industries.  Many companies in those sectors eventually failed with 1873 (like the recent 2008 crisis) becoming the year of reckoning.

Many are quick to demonize those who take advantage of these situations to purchase bankrupt companies at “rock-bottom” prices.  Mitt Romney was attacked for his company’s role in just such purchases.  Granted, there is plenty to dislike about Mitt Romney – he’s a politician for Pete’s sake.  But from an economic standpoint, companies like his and that of James J. Hill more than a century ago, serve the public good by correcting the problems of malinvestment.

Corrections as described in the preceding paragraph will certainly be economically painful for some people.  Liquidation of malinvestment can result in job loss, and in financial ruin for those invested in the bankrupt companies.  However, as shown by the history of Mr. Hill, there is much to be gained through these corrections.

Another important point related to the economic pain stemming from liquidating malinvestment is that any pain felt is fundamentally NOT the fault of the companies who purchase or liquidate the financially troubled firms.  The malinvestment was only made possible in the first place by central banks or by a governmentally privileged banking system.  Demonizing those who work to correct – and who subsequently further economic growth – the problems that come from artificial money creation is entirely unfounded.  These people should instead be looked upon as benefactors to all of society.  The true focus of demonization should be the institution that made the malinvestment possible.  As with so many societal ills, blame lies solely with the government.

While the story of James J. Hill provides us with many important lessons, it is unfortunate to note that his story did not have an entirely happy ending.  Hill’s success in the railroad business came as a result of his vigorous price cutting and through setting special rates for his biggest customers (along with an obsession for efficient construction and direct railroad routes).

Because all other railroad companies were on the receiving end of government subsidies, and because they were thus able to avoid the losses they would have suffered through competition in a free market, they provided poor service at high prices.  The public rightfully complained about this.  Of course, instead of recognizing their failures and getting out of the railroad subsidy business, the government chose to correct their poor policies by passing more laws and regulations.

The Interstate Commerce Act was passed in 1887.  The Hepburn Act was passed in 1906.  These laws forced all railroad companies to charge set rates for all customers, and effectively ended Hill’s price cutting endeavors.  He eventually began shrinking his business operations, switching his focus from expansion to preservation of what he had built.  An untold number of economic growth opportunities were lost forever.

Answers to economic hardships can always be found in the shrinking of government and in the freeing of markets.  Liquidation of malinvestment will be necessary as long as governments make possible artificial monetary inflation.  Once liquidation takes place, the only way to prevent malinvestment from taking hold again is a return to sound money.

James J. Hill worked to liquidate malinvestment.  That his efforts were eventually undermined is a tragedy.  His story should serve as a lesson in economics for us all.

Jared graduated in 2009 from Rensselaer Polytechnic Institute with a Bachelors Degree in Mechanical Engineering. He is currently employed as an energy efficiency consultant in New Jersey, drives for Uber in his spare time, and is an aspiring entrepreneur. He came to the philosophy of liberty through the Ron Paul presidential campaigns, and has evolved into a voluntaryist anarchist through reading LewRockwell.com and listening to the Tom Woods Show.

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