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8 MIN READ - As part of his ongoing series on banking regulation the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff writes in unavoidably wonkish detail about one of the worst and most complicated financial crises in American history: The Panic of 1837.
|Caricature of hard times in 1837|
Once the Second Bank of the United States (SBUS) lost its monopoly privileges in 1836 it began to operate as just another private bank, now renamed the United States Bank of Pennsylvania (USBP).
That same year Andrew Jackson enacted the Specie Circular, an executive order mandating that all purchases of western public lands be paid in gold or silver coin—no paper notes—in an attempt to rein in a speculative boom in land investments.
Combined with a massive inflow of silver coinage from Mexico and simultaneous Bank of England malfeasance, the Panic of 1837 struck two months after Jackson left office, followed by the smaller Panic of 1839.
I. THE PANIC ITSELF
The Panic of 1837 was one of the worst economic crises in American history. Of America’s over 800 private state-chartered banks, nearly 400 failed, many of them having only opened in the previous year. Total assets held by banks fell by over 40%. After the smaller Panic of 1839 the price level fell by over 40%, a steeper decline than that of the famous 1929-33 Great Contraction.
The resulting depression, while long, was not as severe as the panic. Real GDP barely fell albeit in part due to America’s rapidly growing population. Real GDP per-capita fell by a few points.
Unemployment plagued mostly the urban areas and full employment was not achieved until 1844, five years after the 1839 panic and interestingly still two years faster than the post-2008 “Obama recovery.”
But in terms of determining proximate causes, the Economics Correspondent considers the Panic of 1837 among the most complicated and difficult to ascertain of any financial crisis in U.S. history, hence a long explanation.
Mainstream economic historians place the blame squarely on Andrew Jackson’s shoulders for shuttering the SBUS and signing the 1836 Specie Circular.
A great deal of the Jackson blame has been revived only in the last few years ever since Donald Trump stated Andrew Jackson is his favorite president, sending academics and journalists scouring to produce as much Jackson-denigrating material as possible in a rush to smear Trump by extension.
However blaming Jackson ignores other, larger proximate causes such as the destabilizing effect of unit banking laws, a massive inflow of silver coinage from Mexico, and the effects of Bank of England mismanagement.
The mainstream historian fable goes as follows: The Second Bank of the United States competently managed the nation’s money supply and regulated state banks, restraining their tendency to overissue loans and banknotes. When Andrew Jackson killed the SBUS’s recharter, state banks went on a wild cheap-money ride, overissuing notes and deposits far beyond any credible ratio to their tangible gold and silver deposits.
Furthermore, many historians say, Jackson’s order of the Specie Circular required federal government land sales to be paid for in metallic coinage, precipitating a major withdrawal of gold/silver reserves which forced the banking system to sharply contract credit and produce a banking panic and depression.
Supporting the mainstream thesis is data confirming the U.S money supply did indeed rise sharply: by 12% in 1836, the year that the SBUS ceased operations as a central bank.
II. MEXICO AND ENGLAND
But data from former MIT Economics Chair Peter Temin, a Keynesian and hardly sympathetic to free banking, completely contradicts the “undisciplined state banks” thesis.
Temin’s book “The Jacksonian Economy,” written over a half-century ago and still a classic today, provides incontestable evidence that the expansion of the money supply was spurred by neither irresponsible banks nor the absence of some mythical restraining central bank.
Temin’s research confirms that the money supply did rise by 12% the year before the 1837 panic. But the data reveals that the money supply had already increased another 64% in the three years prior to the central bank’s closure (17.9% annualized).
U.S. MONEY SUPPLY:
1832 - $150 million
1833 - $168 million
1834 - $172 million
1835 - $246 million
1836 - $276 million (SBUS loses central bank status)
Source: Van Fenstermaker and U.S. Treasury
Contrary to what writers at the New York Times and Washington Post might say, the SBUS was either doing a lousy job of “restraining” state banks for those three years, or some other factor was responsible for the monetary inflation.
Indeed, Temin records that it wasn’t just bank paper that expanded. U.S. gold and silver coinage reserves rose by an incredible 129% in the same four years prior to 1836.
U.S. GOLD/SILVER SPECIE:
1832 - $31 million
1833 - $41 million
1834 - $51 million
1835 - $65 million
1836 - $71 million
With so much base metal deposited into the system, reserve ratios at the nation’s banks actually *increased* in the years leading up to the panic, the opposite of what happens when banks irresponsibly produce too much paper money.
So where did the vast imports of silver and gold come from?
Mostly from prodigious silver mines in Mexico and gold from England, both slightly offset by silver outflows to China for its growing opium purchases.
The largest driving force was Mexico’s General Santa Anna, who in 1833 had just assumed the first of what would be many of his career presidencies.
Financing his government with debased copper coinage, Santa Anna declared copper compulsory legal tender at par with traditional silver coins (Rockoff, Rutgers).
Through an age-old economic mechanism known as Gresham’s Law—sometimes stated as “bad money drives out good”—Santa Anna’s edict drove the undervalued metal, silver, out of Mexico to the United States where it created a bona fide hard-money inflation.
(the Economics Correspondent will write a more full explanation of Gresham’s Law in a future column)
To a lesser extent, the Bank of England pushed interest rates far too low for several years, sending gold overseas to its primary trading partners which included the United States.
These two international monetary phenomena are not trivial factors. To put their historic scale into perspective, a 129% increase in the United States’ stock of gold and silver specie in four years is probably a record in its history.
The Economics Correspondent has only seen tables for the first half of the 19th century and entire 20th century, and nothing comes close, not even the smaller increase of the California Gold Rush (1848-1856) which took twice as long at eight years.
The Bank of England’s monetary policy of the mid 1830’s can’t be understated either.
The BoE’s insistence of keeping interest rates at rock bottom, even as gold departed the country in droves, was condemned as the worst example of the Bank’s incompetence in its history-to-date by Scottish economist Henry Dunning Macleod who wrote: “Of all the acts of mismanagement in the whole history of the Bank, this is probably the most astonishing.”
In late 1836, when the Bank of England directors finally realized their gold reserves were in danger of being depleted, they rapidly raised interest rates, sparking the English Crisis of 1837 which is considered the trigger point for the American panic in May of 1837.
Another rapid hike of England’s interest rates in 1839, an attempt to quickly reverse another outflow of gold, promptly reversed the flow of metal back out of the U.S. again, worsening another panic that had already begun in March. In 1839 England’s gold position was so desperate that the Bank of England was forced to plead for a humiliating bailout loan from the Bank of France.
And in the United States, what started that second panic in March of 1839?
Nicholas Biddle’s bank, now the private but still outsized United States Bank of Pennsylvania, found itself unable to redeem its notes in specie and suspended payment. Although the USBP survived the 1839 suspension, it ultimately failed and closed its doors in 1841.
Civil suits hounded Biddle the short remainder of his life. He was arrested, indicted for fraud, and forced to pay creditors from his personal estate. The fraud charges were later dropped and Biddle died in 1845 at the age of 58, but his wife’s family was forced to bear the cost of ongoing civil lawsuits related to the USBP’s failure.
III. WHERE TO BLAME?
So how much of the complicated Panic of 1837’s origins can be blamed on government and how much on free market forces?
For once the Second Bank of the United States, which had closed its doors over a year before the panic began, can’t be blamed.
The evidence points to the largest factor by far being the massive inflows of silver from Mexico and, to a smaller extent, gold inflows from Britain.
And were those inflows a free market phenomenon?
Absolutely not. Rather they were the direct result of policies of the governments of Mexico and Great Britain—the former absurdly declaring copper to be legal tender on par with silver and the latter granting a near-monopoly on its privileged central bank to mismanage interest rates and international gold flows through incompetence.
And one more critical factor that can’t be ignored: legal restrictions on interstate branch banking and unit banking laws that persisted throughout the entire 19th century and into most of the 20th, making the entire U.S. banking system weak, fragile, and that much more crisis-prone when disruptive shocks appeared.
The Panic of 1837 would have been much milder, or perhaps not even a systemic crisis at all, had America’s banks been allowed to branch freely across the country.
Scotland, with its large and nationally branched banks, watched as crisis engulfed England in 1837. Yet sitting on its beleaguered neighbor’s northern border and sharing a common currency Scotland felt virtually none of the crisis’ effects.
As economist Robert Bell recorded in 1838 “While England, during the last year, has suffered in almost every branch of her national industry, Scotland has passed paratively uninjured through the late monetary crisis.”
And economic historian William Graham noted in 1911 that “In the heavy losses and banking failures [of 1837] which ensued, Scotland had little share.”
And Canada, allowing its banks unrestricted branching while simultaneously suffering from the Patriots War and Upper Canada Rebellion (both 1837-1838) endured stress on some Ontario banks but avoided a systemic crisis.
And what of Jackson himself? Does he play a role in the Panic of 1837?
Mainstream historians and academics, recently campaigning to attack all things Jacksonian, have laid blame on his Specie Circular since it led to the withdrawal of large balances of specie from the nation’s private state banks.
But Jackson’s Specie Circular only induced Americans to withdraw specie from banks for public land purchases to pay the federal government which in turn redeposited it right back into the private “pet banks."
According to Temin the Specie Circular simply circulated gold and silver, albeit unevenly, within the U.S. banking system, but the Bank of England drove a net loss of gold from the United States.