“We are under the bank bubble, as England was under the South Sea bubble, France under the Mississippi bubble.”
-Thomas Jefferson letter to Charles Yancey, 1816
“The Bank was saved, and the people were ruined.”
-American economist William Gouge (1833) on the Panic of 1819
|Second Bank of the United States banknote|
6 MIN READ - On Tuesday the Economics Correspondent posted Part 1 of "The Second Bank of the United States" (War of 1812 origins). If you find today's column on the Bank's role in the Panic of 1819 interesting you can find the previous article at:
III. CORRUPTION, INFLATION, BOOM AND BUST AT THE SECOND BANK
Congress’ strategy for chartering the Second Bank of the United States (SBUS) in 1816 was to use its prestigious banknotes to buy up excess private banknotes which had been overissued in the wartime environment of irredeemable paper money.
The SBUS would then gradually demand specie redemption (gold or silver coin) from the state banks who would steadily retire their notes, and the country could avoid a rapid contraction of the money supply.
At least that was the plan.
The SBUS did buy up state banknotes, but it never forced the issue of redemption, perhaps out of cowardice.
Or perhaps due to corruption.
For the SBUS turned out to be riddled with fraud and corruption itself, particularly in its two largest branches: Philadelphia and Baltimore.
Of the SBUS’s peak twenty-five nationwide branches, the Philadelphia and Baltimore offices issued a full three-fifths of the entire institution's loans.
Particularly guilty were Baltimore branch president and merchant James A. Buchanan (no relation to future President James Buchanan who voted against the SBUS’s recharter) and branch cashier William McCulloch.
McCulloch had a habit of making large, confidential loans to Buchanan and his merchant friends for their own purposes “without any authority and without the knowledge of the board of that office, or of the parent bank.” (William Graham Sumner, 1896)
In all $3 million of such secret loans were issued, over half of which was spent for personal reasons and most of which went unpaid, ultimately collapsing the Baltimore office when the ruse was later discovered.
But together the SBUS’s hoard of government securities, refusal to call in state banknotes, and fraud and corruption posed an insignificant risk to the U.S. economy when compared to its greatest blunder of all: inflation.
From the late Professor Murray Rothbard, for 57 years the only economist to have written a book exclusively on the Panic of 1819:
“From its inception, the Second Bank launched a spectacular inflation of money and credit… …At the peak of its initial expansion, in July 1818, the Bank of the United States’s specie totaled $2.36 million, and its aggregate notes and deposits totaled $21.8 million. Thus in a scant year and a half of operation, the Second Bank of the United States had added a net of $19.2 million to the nation’s money supply… …The huge expansion of money and credit impelled a full-scale inflationary boom throughout the country.”
Citing J. Van Festermaker’s estimates (1965), the “total money supply in the nation rose from $67.3 million in 1816 to $94.7 million in 1818, a rise of 40.7 percent in two years.”
Rothbard also provides a sketch of how enormous the resulting price and speculative booms became:
“The index of export staples in Charleston rose from 105 to 160 [from 1815 to 1818]; the prices of Louisiana staples rose from 178 to 224 in the same period… exports rose from $81 million in 1815 to a peak of $116 million in 1818. Prices rose greatly in real estate, land, farm improvement, and slaves, much of it fueled by the use of bank credit for speculation. There was a boom in turnpike construction, furthered by vast federal expenditures on turnpikes.”
Frontier land values also surged in remote western states like Tennessee, Kentucky, Ohio, Indiana, and Alabama.
Stock prices soared too. Trading activity on the outside curbs of Wall Street ballooned so much that traders were forced to open the nation’s first indoor stock exchange, the NYSE, in March of 1817.
And all the new cheap SBUS money floating around…
“…impelled a further inflationary expansion of state banks on top of the spectacular enlargement of the central bank. Thus the number of incorporated state banks rose from 232 in 1816 to 338 in 1818 (+45.7%). Kentucky alone chartered 40 new banks in the 1817-1818 legislative session.” (Rothbard)
But the cheap-money speculative mania was not lost on everyone.
Thomas Jefferson, himself a student of economic history who was aware of past central bank-induced bubbles in France (1719), England (1721, 1772, 1783) and the United States (1791, 1797) warned in a letter to his friend Colonel Charles Yancey that:
“The American mind is now in that state of fever which the world has so often seen in the history of other nations. We are under the bank bubble, as England was under the South Sea bubble, France under the Mississippi bubble.”
IV. CONTRACTION, PANIC, AND DEPRESSION
By 1818 the Second Bank realized it was in deep trouble.
Late 1818 and early 1819 brought the final maturity dates for America to repay its Louisiana Purchase debt. Not only was the U.S. Treasury scheduled to repay over $4 million, but the terms of the original 1803 agreement obliged payment in gold or silver coin only—no paper notes.
As the SBUS was the federal government’s banker, the Treasury was poised to withdraw a massive $4 million in specie within months, but the Second Bank had only $2.36 million of specie backing $21.8 million of paper liabilities in July of 1818.
The SBUS was in real danger of bankruptcy.
Thus the Bank resorted to the only course of action available: It stopped lending and aggressively called in loans from all corners of the country. In a desperate attempt to raise coinage to save itself, the Second Bank launched a massive contraction of money and credit just as spectacular as the expansion it had just inflated.
According to Rothbard: “Contraction of money and credit by the Second Bank of the United States was almost unbelievable, total notes and deposits falling from $21.9 million in June 1818 to $11.5 million only a year later (-47.2%).”
Starved of new money to fuel speculative mania asset bubbles in land and business ventures quickly popped, setting off widespread bankruptcies and bank failures. The latter, whose notes and deposits became worthless, led to further contraction of the money supply.
Rothbard: “We get the following estimated total money supply [of the United States]: in 1818, $103.5 million; in 1819, $74.2 million, a contraction in one year of 28.3 percent.”
To put the deflation in perspective, the Great Depression is largely blamed on a 30% contraction of the nation’s money supply over three-and-a-half years. The 1819 contraction was squeezed into one year.
America quickly fell into a full-fledged national depression.
The number of bank failures lends credence to the name “Panic of 1819.” From 1819 to 1822, over 20% of America’s incorporated banks failed, falling from 341 to 267.
Former President Thomas Jefferson wrote to former President John Adams in late 1819 that “The paper bubble is then burst. This is what you and I, and every reasoning man, seduced by no obliquity of mind, or interest, have long foreseen.”
And there was more bloodletting. From Rothbard:
“The index of export staples fell from 158 in November 1818 to 77 in June 1819, an annualized drop of 87.9%... …imports fell from $122 million in 1818 to $87 million the year later (-29%)… …Bankruptcies abounded, and one observer estimated that $100 million of mercantile debts to Europe were liquidated by bankruptcy during the crisis.”
Lastly, falling wages and widespread unemployment plagued the country. The estimated wage for agricultural workers rose from 60 cents a day in 1811 to $1.50 in 1818, but one year later it fell to 53 cents.
Nationwide unemployment estimates are difficult to calculate for 1819 when the government didn’t keep official statistics. However, manufacturing in cities was hard hit and one telling statistic from Philadelphia reveals of the 9,700 employed in branches of manufacturing in 1815, only 2,100 remained by the fall of 1819.
By 1821 the economy bottomed out. With the process of debt liquidation and monetary contraction cleared, the economy began a recovery.
However, the Second Bank had done itself no favors ingratiating itself to the public which largely blamed it for the economic pain and suffering inflicted upon the country.
Americans of the early 19th century appear to have been far more educated in matters of economics than their 21st century successors.
To end with a summation from Rothbard:
“In the dramatic summing up of hard-money economist and historian William Gouge, by its precipitous and dramatic contraction ‘the Bank was saved, and the people were ruined.’”