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What Is the Rate of Return on the Louisiana Purchase?

  • Daily July 7 2014 Louisiana Purchase
July 7, 2014

Tags Financial MarketsU.S. HistoryValue and Exchange

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Everyone loves making a buck, including governments. Unfortunately, the reality of many “great deals,” especially in the history books, has today been inflated to mythical proportions.

While most countries throughout history expanded their frontiers through peaceful trade or the spoils of war, the United States purchased much of its land, mostly from foreign governments. Today several of these land purchases are immortalized as great financial coups for the country.

Of the great land purchases, the three most famous are: the purchase of Manhattan from the natives in 1626; the Louisiana Purchase from the French in 1803; and finally the Alaska Purchase from the Russians in 1867. Each of these transactions shares in common the fact that they were voluntarily agreed upon by the parties directly involved, and that the sums involved are paltry by today’s standards. (Historians debate whether the natives that “sold” Manhattan to the Dutchman Pieter Minuit understood the concept of private property in the same sense as European merchants. The surviving documents for the purchase of Manhattan show a completed contract with no ensuing bloodshed or hard feelings on either side.)

The problem with reckoning costs in historical terms is that it compares apples to oranges. A dollar today just doesn’t buy what a dollar bought in 1626, 1803, or even a decade ago.

Figure 1

Adjusting for the effects of inflation throughout American history is a little complicated. Up until 1914 America had been on some form of gold (or silver) standard. There were several bouts of deflation during this time to mute the effects of inflation, which in general was quite tame. Inflation averaged 0.4 percent per year prior to 1914. In 1914, the creation of the Federal Reserve System changed everything dramatically. With the ability to economize on bank reserves and to create fiat money at whim, the inflation rate surged. Since 1914 the inflation rate has averaged about 3.5 percent per year.

Adjusting the original purchase prices for inflation, they still look pretty good. In fact, the price Pieter Minuit paid for all of Manhattan would today buy about a half square meter of condo real estate on the island. Not bad. Likewise, sitting smack-dab in the middle of the Louisiana Purchase, farmland in eastern Nebraska today sells for around $7,000 an acre. The United States government bought roughly 53 million acres in 1803 for the same price as 100,000 acres of Nebraska farmland would cost today. Again, that looks like a shrewd investment.

But wait. When these tracts of land were initially purchased they were undeveloped. It would take some time before the pioneers, capitalists, entrepreneurs, and settlers arrived and started to make improvements to the land. Land in Nebraska or Manhattan is now more valuable because of the infrastructure improvements — highways, canals, utilities, and other services — that were made throughout the centuries. This allowed the land and people to be more productive.

Agriculture, such as dominates the eastern Nebraska landscape, has experienced productivity in leaps and bounds over just the past decades. Wheat yields which averaged less than 1,000 kg/Ha in the 1950s have increased to over 2,500 kg/Ha since the mid-1990s. Advances in mechanization, fertilizers, irrigation, herbicides, and methods of planting have all had the effect of increasing what we can harvest from this land. (In 1900, 38 percent of the US labor force was still employed in agriculture; today the figure is less than 1 percent.)

There was virtually no productivity on Manhattan island at the time it was purchased, and thus of less value. Today, 388 years later, and much work by hundreds of thousands of people, Manhattan has been transformed from a wilderness into a global financial center.

Adjusting the purchase prices for inflation for these three tracts of land is a good start, but it still compares apples with oranges. An acre of rocky, uncleared Nebraska land in 1803 is just not the same as a tilled, fertilized acre of farmland today.

To see if the prices paid centuries ago were reasonable, we need to determine what the same land is worth today; this will allow us to see what the return on the original investment has been. One way is to treat the current level of production in each region as a perpetuity to determine its present value. (We will discount these future cash flows at the long-run rate of nominal GDP growth of 5.5 percent.)

The greater metropolitan area of New York City generated $1.3 trillion in income in 2012, roughly 8 percent of the American total. The present value of a perpetuity paying $1.3 trillion per year (ignoring growth), discounted at 5.5 percent, is just shy of $24 trillion dollars.

The Louisiana Purchase is more complicated, as its boundaries do not correspond to actual states today. If we include states that have at least half of their area within what was the Louisiana Purchase: Montana, Wyoming, Colorado, Oklahoma, Louisiana, Arkansas, Kansas, Missouri, Iowa, Nebraska, South Dakota, North Dakota and Minnesota, we find that their combined output is roughly $1.7 trillion, or 12 percent of total American GDP. The present value of such a perpetuity (again, ignoring growth for simplicity) discounted at 5.5 percent is about $30 trillion.

Finally we get to Alaska. The total output of this state was around $60 billion last year in 2013, or about 3.5 percent of the total GDP of the United States. This perpetuity is worth around $1 trillion.

Figure 2

So how good were these original purchase prices viewed with the benefit of hindsight? We can answer this by comparing the present value of their current output with their original cost.

While historians often give credit for these purchases to the foresight of the governments of Thomas Jefferson and Ulysses S. Grant, in reality they haven’t paid off as well as one might expect. The Louisiana Purchase in particular has only “returned” about 7 percent once we adjust the figures for economic growth since 1803. The purchase of Manhattan hasn’t fared much better, and the figure would even be worse if we were to include only output produced within Manhattan, instead of the greater New York metropolitan area. All three purchases experienced fairly standard rates of return compared to what the general American economy has been able to generate.

By all appearances, instead of being wonder-investments they are just par-for-the-course. In comparison to many investors, like Warren Buffet for example, these returns are downright dismal.

To be fair, there are intangible benefits to each of these purchases not apparent in the objective numbers. Manhattan provided a trading foothold in the new world. The Louisiana Purchase secured the Mississippi River watershed, and with it, removed the ability of Napoleon and the French from halting the westward advance of Americans. Finally, Alaska has suffered from centuries of public ownership of its lands with heavy-handed regulations stopping entrepreneurs from developing its resources and putting them to good use.

This exercise demonstrates the dangers inherent in looking at historical transactions and thinking of them in modern terms. Not only is adjustment for inflation necessary, it may be insufficient as improvements to productivity still create a comparison of apples to oranges. The real value and relevancy comes by adjusting historical amounts by economic growth; only in this way can we grasp how profitable certain ventures have been.

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