7 MIN READ - The Cautious Optimism Correspondent for Economic Affairs (and Other Egghead Stuff) explains how a heap of government regulations and a botched return to a silver standard induced the Panic and Depression of 1893, arguably the second worst economic downturn in U.S. history — or what Americans dubbed “The Great Depression” for a generation before the arrival of the 1930's.
|Contemporary portrayal of the Panic of 1893|
The Panic of 1893 and resulting depression were so disruptive that Americans called it “The Great Depression” for nearly 40 years. It was only when the 1929 stock market crash morphed into the more famous calamity that the 1930’s disaster inherited that title.
The Panic of 1893’s severity is no coincidence as it was caused by a confluence of regulatory factors that outmatched all financial crises before it: the simultaneous merging of three destabilizing legal regimes that came together to create the mother of all depressions in American history to-date.
First, as we’ve already reviewed in previous chapters, there were the two ever-present problems of state unit banking laws which forbade or severely restricted branch banking, and federal regulations from the Civil War-era National Banking Acts that plagued the industry for a half century until the establishment of the Federal Reserve System in 1914.
These two problems were enough to precipitate plenty of crises on their own (1873, 1880, 1884, 1907) and links to more details on unit banking laws can be found at:
And the National Banking System at:
However during the early 1890’s Congress and President Benjamin Harrison added a third layer of regulatory dysfunction atop the rest: the remonetization of silver at an absurdly overvalued rate.
BIMETALLIC RATIOS AND GRESHAM’S LAW
Countries that attempted to define their currencies simultaneously as weights of both gold and silver had struggled for centuries to avoid the unwanted effects of Gresham’s Law, the disappearance of one metal from circulation when its value vis-à-vis the other metal falls below the fixed ratios defined by governments.
The Coinage Act of 1792 defined the U.S. dollar as approximately 1/20th of an ounce of gold and approximately 15 times the weight in silver—a 15-to-1 ratio which was nearly identical to the going market ratio between the two metals at the time.
Over the next few decades prodigious output from Latin American mines boosted world silver supplies, lowering the metal’s market value against the more scarce gold. With the U.S. 15-to-1 ratio still in effect, any American would have been a fool to pay for goods and services with undervalued gold dollars which began to disappear from circulation—either being hoarded or shipped overseas where they fetched a more honest price.
In 1834 Congress recognized the need to adjust the ratios and the silver dollar was revalued at 16 times the weight of a gold dollar.
Silver continued to fall steadily in world markets until the California Gold Rush expanded world gold supplies, restablizing the ratio around 16-to-1 again.
But in the 1870’s silver took a global nosedive against gold. The industrialized nations of Europe began to adopt the less complicated monometallic gold standard—Britain having been first going de facto gold in 1717 (also the result of Gresham’s Law) enacted de jure in 1821. The German Empire joined in 1873, followed by the Latin Monetary Union of France, Switzerland, Italy, and Belgium, then Scandinavia and the Netherlands in 1875, with the U.S. joining last in 1879.
In less than a decade global demand for silver plummeted due to demonetization and its world market value fell to 32-to-1 against gold. It would have fallen even further had China, India, and several Spanish colonies not remained on a silver standard.
America’s own decision to join the international gold standard was controversial from the start, and under it a mild deflation set in with prices falling about 0.5% a year (1879-1900).
By the 1880’s two major political camps were agitating for a return to inflation: western silver miners and debtors who were largely farmers. The former wanted a greater demand for their product and the latter wanted debts that were easier to pay back with less valuable dollars in the future. Together they rallied around their slogan to return the country to "free silver at 16-to-1.”
POLITICS AND CRISIS
In the 1880’s the Republican Party was generally pro-silver and pro-inflation while the Democratic Party tended to support the gold standard.
(Their roles completely reversed in the 1896 presidential election between pro-silver populist Democrat William Jennings Bryan and pro-gold Republican William McKinley)
True to partisan form, Republican President Benjamin Harrison signed the Sherman Silver Purchase Act in 1890 which mandated the United States government become the largest silver purchaser in the world; buying up roughly the entire output of the U.S. silver mining industry.
To purchase so much silver the federal government—not a central bank—would print new paper money, unceremoniously dubbed “Treasury Notes” that in turn were redeemable upon demand in either silver or gold (more on that mistake in a moment).
The new government paper notes created the inflation that miners and silver-movement farmers had asked for, but that wasn’t all.
It's important to stress that there’s nothing inherently wrong with returning to silver and bimetallism. But what went horribly wrong in 1893 was Congress making the reckless error of granting an absurdly overvalued silver currency to its constituents in exchange for votes.
In 1890 the world market value of silver vis-à-vis gold was still roughly 32-to-1, reflecting low global demand. Given its low value, the resources required to mine new silver cost more than the value of the silver produced, making it a moneylosing enterprise. So Congress threw an additional political bone to silver miners by valuing the silver dollar at the old 1834 ratio of 16-to-1, a 100% premium over its world market price.
So once again, and more than ever, only a fool would ever pay for anything with gold dollars or ever redeem Treasury Notes in silver.
Gresham’s Law quickly took hold and gold rapidly disappeared from U.S. circulation with silver dominating the economy.
But most critical of all was the impact of this overvaluation on foreign investment. America’s economic and industrial upsurge of the 1870’s and 1880’s was financed largely by European capital. But the new, unbalanced bimetallic monetary regime produced a major capital flight somewhat like the exodus of foreign investment that affected 1997 Asian Financial Crisis countries that devalued their own currencies.
For a British bank converting gold pounds to dollars to invest in an American enterprise wasn’t thrilled at the prospect of being repaid with the same number of dollars (plus interest) denoted in silver which only fetched half the price in Europe—all because U.S. Congress was foolish enough to overvalue the silver dollar by 100%.
Foreign speculators could also make easy profits by capitalizing on the government-created arbitrage. A European investor could sell one gold ounce for the market price of 32 silver ounces overseas, ship the 32 silver ounces to the United States where, by legal tender decree it could be traded for two gold ounces, and double his money (minus shipping costs).
The foreseeable consequence of these incentives was a domestic outflow of gold with overvalued silver pouring into the country (aka. Gresham’s Law).
Thus the rapid withdrawal of foreign investment, compounded by unit banking and NBS regulations, produced one of the worst banking panics in American history in 1893.
600 banks failed in 1893 alone with hundreds more avoiding failure only by suspending redemption of cash into metallic coin. About 75 bank clearinghouses also suspended operations and 16,000 businesses failed that same year.
Unemployment reached 18.4% in 1894 (Lebergott) before improving in 1895, but spiked again when another incipient panic struck in 1896 pushing joblessness back up to 14.5% in 1897.
It wasn’t until 1900 that the country finally achieved full employment of 5.0%, the same year that the Gold Standard Act of 1900 was passed, placing the dollar on the unambiguous monometallic gold standard.
And as remains the case to this day without exception, there was no financial crisis in Canada, although Canada did contract the effects of recession from its larger neighbor.
J.P. MORGAN SAVES THE TREASURY
President Grover Cleveland, the last Democratic president to ever embrace anything resembling laissez-faire capitalism, was inaugurated only a few months before the Panic of 1893 struck. He (correctly) blamed the Sherman Silver Purchase Act for the crisis. Congress successfully repealed the law in 1893 and the issuance of new Treasury Notes was halted.
However Cleveland faced another crisis in 1895 due to a lingering byproduct of the 1890 Act: the near bankruptcy of the U.S. Treasury itself.
With silver so absurdly overvalued, no one in their right mind would redeem the Treasury’s previously issued notes in silver and always demanded gold. Hence by 1895 the Treasury’s own gold stocks were running low and noteholders the world over were losing confidence in the United States government’s ability to keep the pledge written on its own money.
Banker J.P. Morgan was aware of the Treasury’s plight and organized a cabal of bankers to offer a gold loan to the government. However, Cleveland believed in separation of economy and state and wanted to solve the problem without private help.
But the writing was on the wall. The Treasury’s mistake was too grand and without help the government was headed towards bankruptcy.
Morgan secretly took a train to Washington D.C. and waited for the president’s inevitable call from a friend’s house—away from the prying eyes of journalists. Several days passed before the White House, in desperate straits with the Treasury literally one day away from running out of gold, called on Morgan and reluctantly agreed to the $65 million gold loan.
The gold drain stopped as confidence resumed, and the Treasury bought the time it needed to replenish its gold stocks with tax payments.
But among all the rightful complaints today about the federal government bailing out private banks, few Americans are aware that J.P. Morgan and the private banking industry bailed out the federal government in 1895.