Foundations of US Financial Markets - Part 1

If you had put $100 dollars into the S&P 500 in 1980 it would have grown over 4000% inflation adjusted with dividends reinvested, that’s over $4000 dollars from a single hundred-dollar bill. Most young Americans know the market builds wealth over time, what almost none of them know is that the system producing that return was constructed over 200 years through deliberate institutional design, repeated bank runs, and legislative choices. Your brokerage app is the technological evolution of an architecture most people never see.

Alexander Hamilton believed financial markets needed deliberate institutional design to function at all, without structure capital flows toward speculation and volatility rather than productive capability. As Treasury Secretary he established the First Bank, created a national currency, and converted Revolutionary War debt into government bonds. Those bonds needed somewhere to be traded safely. So, in 1792, twenty-four merchants and brokers signed the Buttonwood Agreement under a sycamore tree on Wall Street and established what would become the New York Stock Exchange. American capital markets were born from a deliberate act of institutional design. Hamilton needed investors to trust the new republic, so he facilitated the conditions for them to trade.

For the next century markets grew without a stabilizing force. Speculation, manipulation, boom-bust cycles, and bank runs defined American financial life. The market had an engine but no institutional brakes. The Federal Reserve Act of 1913 attempted to install them, congress created a central bank to serve as lender of last resort, injecting liquidity during panics and preventing the cascading failures that had repeatedly destabilized markets. For the first time American capital markets had an institutional backstop.

But this wasn’t enough, the crash of 1929 exposed a deeper flaw, commercial banks had been using ordinary Americans’ deposits to speculate in equity markets on their own portfolios.  When markets collapsed, deposits collapsed with them. The Glass-Steagall Act of 1933 separated commercial banking from investment banking entirely. Ordinary deposits could no longer be used in equity markets. Economist John Maynard Keynes provided the intellectual framework behind the era that follow, The New Deal era. This brought a school of thinking that enacted policy around the ideas that markets do not self-correct fast enough during downturns and that stable, regulated financial architecture is the condition that makes markets function for ordinary people.

For twenty-five years after World War II that architecture delivered insured deposits, regulated banks, a securities market with disclosure requirements, and a global dollar standard anchored at Bretton Woods which gave American markets unrivaled supremacy and stability. The postwar middle class and overall economy were built in part on a financial system that rewarded productive enterprise, it was not perfect and access was uneven but in a fundamental design it was a system built for a broad economy.

In 1971 that foundation shifted. The dollar’s convertibility to gold ended, the Bretton Woods system collapsed, and the dollar floated in a fiat system. The anchor that was built since the founding of the nation, was pulled up in a single decision. The architecture that had delivered the most prosperous, and financially dominant post-war economy in American financial history was about to be changed. What replaced it reshaped how markets work, and how they reward.

Part 2 – the deregulation era, the modern market, and what it means for the economy today is coming next week.