1893, India, and the USA

(See also The Crisis of 1893)

In 1892 India was a colony of the United Kingdom.¹ It was governed from Calcutta by civil servants appointed in London, but susceptible to pressure from local plantation owners (who were mostly British), importers, and financiers. Prior to European colonization, India had had rulers who circulated silver coins known as rupees; until 1892, the rupee was defined as a unit of silver. In 1816, the UK moved to a gold coin standard, and after 1870, most of the nations of Europe and America did also. The USA went on the gold standard 1 January 1879 after 13 years laborious struggle retiring Civil War greenbacks.² India, Japan (to 1897), Korea, and the Qing Empire (China + Mongolia) continued to use mostly silver money. So did Latin America.³

India was at this time the largest market for silver in the world; the USA was the second largest. Russia, like the USA, had a large internal system of silver currency despite officially being on the gold standard. During the period 1873-1902, silver prices would decline relative to gold, pushing more countries to adopt the gold standard and demonetize silver. This further suppressed silver prices, until nearly the entire global consumption of silver was for commercial purposes (jewelry, chemicals, and photography).

Click on image to enlarge

Chart adapted from Milton Friedman, Money Mischief: episodes in monetary history, Houghton Mifflin Harcourt, (1994), p.72 Note: the ratio of 16-to-one was a legal ratio that applied at the beginning of this period. At earlier times in the 19th century, lower ratios obtained in bimetallic countries.

India's situation was especially problematic because it was economically and administratively integrated with the British gold zone. The US situation was problematic because it had a large residue of silver currency and a major silver mining economy; and because it was such a magnet for overseas investment. It was also unusual for a large country of the day in having representative democracy. Hence, it was politically difficult for the executive branch to impose austerity conditions required for a pure gold monetary system.

India operated under extraordinarily open markets in 1892; its duties on imported goods were virtually nil, and it had a policy of free coinage (no seigniorage; the rupee therefore floated against the pound sterling).⁴ The system was not self-correcting; India's government had to pay for the costs of occupying and exploiting its subjugated peoples, and these costs had been incurred in sterling. This was being paid off in a rupee whose value was falling. In the 19th century literature, moreover, one reads of constant "crises" in Victorian finances, in which national governments were constantly struggling to maintain either adequate reserves of gold, or else resisting an inflationary spike at home. In India, the part of the system that was particularly vulnerable were "council bills," or bills of exchange drawn against the national debt of India held in London. These were adjusted automatically in accordance with the daily exchange rate of silver, which was just fine for commercial transactions; but for government business, it was a chronic strain. Officers, for example, had to be paid in rupees and their pay schedule was set by legislation in Westminster.

The USA operated under extraordinarily closed markets; the McKinley Tariff (1890) was the highest tariff schedule in the nation's history. Countervailing the successful Republican push for ever-higher tariffs was populist pressure for cheap money (as desired by farmers and business projectors) based on silver (as desired by the Western silver interests). This took the form of the Sherman Silver Purchase Act, which required the Treasury to buy 4.5 million ounces of silver per month, to be paid for in legal tender treasury notes.⁵ The effect was, unfortunately, to create a de facto bimetallic standard with silver overvalued relative to gold. Hence, arbitrageurs pumped gold out of the US banking system, since they could buy undervalued gold with overvalued silver.

(See "Precious Metals Arbitrage")

At the same time gold was being pumped out of the USA, silver was flowing into India as a result of that country's long-running trade surplus with the rest of the world (see chart below).

Click on image to enlarge Values are in UK pounds sterling
India: Influx of Precious Metals Prior to 1893 Crisis
Five Years ended 31st March		Average Gold Value of the Rupee	Average Net Imports of Gold per Annum		Average Net Imports of Silver per Annum
beginning	ending	£	(Rupees)	(£)	(Rupees)	(£)
1860	1864	0.0994	5,889,538	585,273	10,181,781	1,011,814
1865	1869	0.0976	5,835,117	569,653	9,981,112	974,406
1870	1874	0.0950	3,073,776	292,009	3,598,271	341,836
1875	1879	0.0874	639,595	55,898	6,408,692	560,093
1880	1884	0.0824	4,128,613	340,181	6,205,349	511,295
1885	1889	0.0762	3,083,670	234,963	6,896,685	525,499
1890		0.0690	4,615,304	318,571	10,937,876	754,987
1891		0.0754	5,636,172	424,803	14,175,136	1,068,392
1892		0.0697	2,413,792	168,292	9,022,184	629,034
1893		0.0624	-2,812,683	-175,582	12,863,569	803,008
Report of the West India Royal Commission Great Britain, Eyre ξ Spottiswoode (1897) Appendix. C, p.209 table III

The conversion to what was, in effect, a gold exchange standard, reversed the balance of trade and the flow of gold. This, of course, made the next several years a crisis because India, while possessing decades of accumulated reserves of silver, had demonetized it and now required gold—which was leaving the country, not entering it.

India's demonetization of silver was widely seen as the the immediate trigger of the Crisis in the USA. The US Treasury, ultimately liable for the total supply of paper currency, was faced with a sharp increase in the flow of gold out of the country for purposes of arbitrage; it was providing a handsome subsidy for doing so.⁶ Strangely, the rate at which this arbitration occurred was quite low. One would have expected the Treasury to be wiped out within a few weeks, given the arbitrage opportunities; instead, there was a dangerous stream out of the Treasury for many months, but nothing like the capital flights from Asian countries during the 1997-1998 crisis, or from Argentina in 2002. It seems reasonable to surmise this was because metals arbitrage was logistically very difficult.

Click on image to enlarge

Values are in current US dollars While the USA usually ran a trade surplus with the rest of the world, India ran large surpluses with the USA (and most other nations) every year. Data from the 1889 and 1897 Statistical Abstracts of the USA

A limiting factor, however, was always the very large trade surpluses the USA had with the rest of the world; this meant that Usonian institutions (and ultimately, the US Treasury as the supreme reserve) held a massive surplus of liabilities against non-Usonian individuals and institutions. This would not have prevented massive metals arbitrage over time, since large claims on US assets did exist in the hands of foreigners; but these (a) were tied up as foreign direct investment (FDI) or portfolio investment in the USA, or (b) tended to be small enough that they restricted arbitrage to lots of small, marginally profitable steps.


However, note that India was a rare exception: trade between the USA and India was small, but consisted of huge surpluses (relative to the volume of US exports to India. This was in large measure an artifact of the underdevelopment of India; but that is outside the scope of this post.

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NOTES:

1. At this time, "India" included Pakistan, Bangladesh, and Burma (Myanmar). For a map online, see the Schwartzberg Atlas. About one third of Indians lived in the 500 princely states that enjoyed financial and internal autonomy from the capital in Calcutta. India and Burma[h] shared a currency, the rupee. Princely states also issued rupees, although the value was supposed to be the same for all varieties of the rupee. See also The imperial guide to India, including Kashmir, Burma and Ceylon, John Murray (London, 1904) p.195; also, Lawson (1894), p.443


2. Milton Friedman, Anna Jacobson Schwartz (1963), "The Greenback Period"


3. Matias Romero, The silver standard in Mexico, The Knickerbocker Press (1898); for Japan and Korea, see n.587; for China, see n.606; for several Latin American states (other than Mexico), see p.576. Silver standard nations often had enormous local supplies of silver, such as Mexico; or else, were more likely to use metal coins to the exclusion of paper money or bills of exchange. The Qing Empire had floating trimetallism at the time of the 1893 crisis, meaning that copper, silver, and gold monetary systems existed concurrently with no fixed relationship to each other.


4. Lawson (1894), p.453; floating of rupee pre-1892, see Palgrave (1894-III), p.396. For a modern summary, see Tapan Raychaudhuri, Dharma Kumar, Meghnad Desai, Irfan Habib, The Cambridge economic history of India, Volume 2, Cambridge University Press (1983), p.587. As a general rule, countries with the power to do so implemented tariffs; countries under foreign occupation, such as India, or else under foreign hegemony, such as Japan (1856-1897), had free trade imposed at gun point.


5. For the McKinley Tariff, see Joanne R. Reitano, The tariff question in the Gilded Age: the great debate of 1888, Penn State University Press (1994), p.129. The previous tariff had been 38%, so prices of imported goods were effectively increased 8.33%. For the Sherman Silver Purchase Act, see Wesley Clair Mitchell, Business cycles, Burt Franklin (1913/1970), p.52.


6. For the perception of India's demonetization as trigger, see Conant (1909, pp.677-67). Regarding gold flows, see Friedman ξ Schwartz (1963) p.108 and table A-4 (Appendix A, p.769). Friedman ξ Schwartz do not mention the role of gold arbitrage, but include a lengthy footnote on the distinction between external and internal drains in the Treasury's gold supply. According to some commentators, such as Charles Conant (1909, p.671) and A.D. Noyes (Forty Years of American Finance, Putnam, 1909, pp.159-173), the problem was that the silver policy caused a loss of confidence in the integrity of the money supply. Friedman ξ Schwartz emphasize that silver probably only accounted only for the external (foreign) drain of gold

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SOURCES ξ ADDITIONAL READING

Charles Conant, A History of Modern Banks of Issue, G.P. Putnam ξ Sons (1909), esp. "The Crisis of 1907," p.698. Vital resource, although chapters on crises require close reading. Very useful to cross-reference with Friedman ξ Schwartz (1963).

Milton Friedman ξ Anna Jacobson Schwartz, A monetary history of the United States, 1867-1960, Princeton University Press (1971)

W.R. Lawson, "The Indian Currency Muddle," Blackwood's Edinburgh (March 1894), p.440-454. Describes the circumstances leading up to and following the momentous Indian suspension of silver coinage in 1892, which played a significant role in the 1893 Crisis.

R.H.I. Palgrave, Dictionary of Political Economy, Vol. 1, Macmillan (1894); "Exchange between Great Britain and British India," p.776; Vol. 3, "Silver, as Standard," p.395

The Panic of 1907

List of Depressions 🙵 Panics, 1821-1929

UPDATE (2 Aug 2013): This article has been substantially revised since initial posting.


The Panic of 1907 was historically significant for the United States because it triggered a wave of legislative activity that culminated in the creation of the Federal Reserve System in 1913.

The underlying problem was that the financial system lacked any means to deal with panics, manias, or crashes.¹ "No adequate lending power or surplus cash reserve was available at any time except during periods of trade depression when the banks were unable to find borrowers for all the loans they were prepared to make." (A reminder: the US financial system of the 19th century was very seasonal, with massive fluctuations in the quantity of gold reserves over predictable cycles. Despite the strong correlation of credit demand with region and recurring annual phases, the sheer size of the fluctuations seem to have often triggered bank failures).

In March 1900, Congress passed the Gold Standard Act; the main goal of this law was to further entrench the gold standard, ending prior arrangements that supplemented gold reserves with a limited amount of silver reserves, and so on.² A lesser-noted clause made it easier for banks to issue banknotes, and the money supply (in banknotes) more than doubled in seven years leading up to the crisis.  Net deposits also doubled, growing much faster than net reserves of the National Bank system.³  Bearing in mind that seasonal variations in gold reserves and issues of banknotes took the form of big, annual shifts in "net debtor" status for different regions, it is not hard to see how the New York banking system, emerging from its mammoth summer deficit, ran into trouble.

The Trust Companies

Usually, in the context of 19th/20th century business, we think of trusts as the systems of industrial organization that gathered up ownership of many different firms (typically competing in a single line of production) into a single decision-making body, usually for the purpose of monopolistic price-fixing.  Trust companies, on the other hand, were a type of under-regulated bank:

Beginning in the 1890s, trust companies took on most of the functions of both commercial and private banks.  They accepted deposits; made loans; participated extensively in reorganizing railroads and consolidating industrial corporations; acted as trustees, underwriters, and distributors of new securities; and served as the depositories of stocks, bonds, and titles. Corporations regularly appointed them as registrars or fiscal and transfer agents.  Very often they also owned and managed real estate.⁴ 

The trust companies were allowed to own equities directly, which may have tied them to the monopoly-trusts; they had lower reserve requirements than banks, but were not allowed to participate in the check clearinghouse system.  This was to prove deadly for them.⁵

The Knickerbocker Company was a New York firm founded in 1884 by Fred Elridge (making it one of the older specimens). It performed most types of financial services, including underwriting, but it also took deposits offered checking accounts.⁶

Fritz Augustus Heinze was a mining expert who built a copper empire in Montana, eventually inducing Amalgamated Copper (Anaconda 🙵 Standard Oil) to buy him out for $12 million.   He returned to New York and worked with a financier, Charles Morse, to create a bank that would serve as the linchpin of a banking trust; this bank was the Mercantile National Bank.⁷ At the same time, Heinze consolidated the rest of his Western mining interests into an entity called United Copper, and effectively managed that. while serving on the boards of many tightly-related banks/trust companies.

Unfortunately, Heinze bought a seat on the stock exchange for his brothers, Arthur and Otto, as well as setting them up on Broadway as brokers.  The brothers tried to corner the market on United Copper shares, forcing short sellers to restore their borrowed holdings at higher prices.  The stock market is often a very brutal, devastating place, and while the Brothers Heinze thought this would be easy to pull off, they were unaware of how many shares of stock were publicly circulating. They had involved the President of the Knickerbocker Trust, Charles T. Barney, in financing their corner, even though he had refused in the end to go through with the scheme. The United Copper squeeze initially did look like it was going to work, but on 4 October 1907, the corner broke and the price fell.  Otto Heinze's firm was bankrupt, and he was suspended.

Even more unfortunately, the failure of the United Copper corner led to a general panic about all things Heinze.  The Mercantile Bank was forced to suspend its operations; so was the Knickerbocker Trust Company.  Charles T. Barney committed suicide as the run took down his firm, and depositors began to lose confidence in most types of depository institutions.

Crisis

J.P. Morgan totally not clutching a knife

The drama surrounding the Knickerbocker T.C. and the Mercantile National Bank was confusing, complicated, and ridden with erroneous rumors.  Barney, Knickerbocker's president, was not involved in the United Copper squeeze, but was a close associate of Morse, Augustus Heinze's partner at the Mercantile.  Contagion spread like a shockwave, as banks tried to stave off ruin by renouncing any officials with a "blemished character."

After the run, the most obvious firewall was the NY Clearing House (NYCH), which had led the demands for a general purge of banking officials.  It was able to require member banks to suspend their arrangements to clear checks for affiliated trust companies, although Knickerbocker was allowed to resume clearing checks after it sacked its management.

Most histories lavish J. Pierpont Morgan with praise for having organized the rescue of the banking sector; most also approve of his use of the crisis to win permission from President Theodore Roosevelt to buy the Tennessee Coal 🙵 Iron Company, merging it to Morgan-allied US Steel. The Justice Department felt this concession was a mistake on Roosevelt's part, and tried to claw it back, to no avail.

The main part of the crisis narrative, in the minds of the many articles I have read about this, is that Morgan managed to squeeze the leadership of the American financial sector for cash reserves to rescue itself en bloc, in a time where bankers had every motive to hoard their resources. Let me pause and reassure readers that this was a fine accomplishment, and no doubt required a high degree of skill, determination, and physical fortitude on Morgan's part.  Morgan also had a staff of experts who covered themselves with glory, including George W. Perkins and Benjamin Strong (PDF).

However, one of the problems was that Morgan and his allies were defending a system that was dependent not only on the good graces of a supreme moral authority like J.P. Morgan.  Morgan's tenure was closely tied to the willingness of his competitors to submit to him when it was clear that the system was genuinely threatened; that the system needed a small number of powerful arbiters who could, in turn, agree to the good-faith supervision of a super-arbiter like Morgan.  The system required an extreme attentiveness to character and the evidence of character; so, for example, when one gilt-edged bank executive was revealed to have conspired against the right of traders to short a copper trust, the moral horror supposedly blew up Wall Street.

The importance of character does indeed make this epoch look very virtuous; yet the judgments were usually poor. One pictures a system where people were under constant scrutiny for blemishes that might reveal their unfitness for fiduciary responsibility, and yet the people caught up in the collapse of the Knickerbocker Trust Company were usually chosen randomly: banks were stricken by runs that had no connection with the United Copper corner, and Charles Morse moved from scheme to scheme. People often substituted snobbery for judgment: antisemitism was a crushingly depressing feature of the financial world, for example.

The Crisis of 1907 did in fact dramatically depress industrial production through 1908, with a fairly strong recovery by autumn of 1909 (measured by employment).⁸ One factor was the sharp decline in cash for ordinary transactions; instead, a large proportion of Americans were induced to use clearing house certificates as money surrogates.⁹ As many as two-thirds of all US cities with a population over 25,000 issued these certificates, and they utterly dominated the money supply until March 1908.  The crash experiment in improvised money was one of the most successful I've ever seen, and probably contributed to the mild impact on labor demand.

The shortage of gold in a time of bank runs (in a country on a gold standard) is not surprising: the usual exchange of credit as a gold substitute in such economies was no longer as easy. As with the Crisis of 1893, the contraction of credit spilled over into a major shortage of paper money. All parties tended to hoard cash as well as gold, and the velocity of money fell.  Criticism of the banking response by Sprague (1910) was directed mainly at the timid character of the banks eager to restore their own reserves above all else.¹⁰

Postscript: the Creation of the Federal Reserve System

Regardless of how one describes it, the Panic of 1907 revealed the extreme dependence of the Usonian financial system on a smallish component of globalized commodity markets; and on the intervention in particular of J.P. Morgan. Even if one were to accept uncritically Bruner🙵 Carr's adoring hagiography, one would still have to recognize that Morgan was a mighty thin reed from which the financial system could hang.¹¹

In May 1908, Congress passed the Aldrich-Vreeland Act that provided a process of transition to an as-yet unknown national banking system. Aldrich-Vreeland provided firstly for the creation of "national currency associations"¹² and secondly for the convening of a National Monetary Commission (NMC) for addressing the chaotic state of the US banking-money system. The process of drafting a plan was quite complicated, and furnished ample material for critical accounts. Nevertheless, the plan was finalized during the (Republican) 62nd Congress and passed during the (Democratic) 63rd Congress. Most available data suggest that Pres. Woodrow Wilson's influence on the Federal Reserve Act was minor.¹³

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NOTES:

1. Sprague (1910), p.217


2. Frank W. Taussig, "The United States Currency Act of 1900," The Economic Journal Vol. 10, No. 38 (Jun., 1900), pp. 226-232.  Prof. Taussig acknowledges that the USA had long been under a gold standard since '79.


3. Sprague (1910), p.218.  The growth of the money supply following the passage of the Gold Standard Act was pretty much the opposite of what I would have expected, to say nothing of being a wildly dramatic development taking place in the Victorian/Edwardian Era.  The decline of cash reserves (as a share of outstanding loans) fell steadily from 17.9% to one 12.8% over this period.  Proponents of the act, as well as Robert Sobel, Chernow (1990), Bruner, and Carr, blamed the persistence of silver coinage (Sherman Silver Act of 1890); see "Digression on the 1893 Crisis and Currency," on this very blog (23 Feb 2010).


4. Vincent Carosso, Investment Banking in America, Harvard University Press (1970) p.99; cited in Bruner 🙵 Carr (2007), pp.66-67.


5. Although sometimes trust companies had bilateral partnerships with member banks.  See Bruner 🙵 Carr (2007), pp.67-68.  The Knickerbocker Trust Company had an arrangement with the National Bank of Commerce for check clearing.    


6. Information about the Knickerbocker T.C. comes from Bruner🙵 Carr. For detailed financial data of the state banks and trust companies, see Annual Report of the Comptroller of the Currency, Government Printing Office (1907).


7. Bruner 🙵 Carr (2007), pp.38ff ADDED: Gilbert King, "The Copper King’s Precipitous Fall," Smithsonian Mag (20 Sep 2012). 


8. Official national income and product figures were not available until later, but the NBER hosts ex post estimates of, e.g., industrial output and employment.  My impression is that the 1907 crisis was relatively minor in its impact on employment, and was completely over by September 1909, but readers need to understand that nationally aggregated effects are usually milder than regional effects.


9. James G. Cannon, "Clearing House Loan Certificates and Substitutes for Money used during the Panic of 1907"(PDF),  delivered before the Finance Forum, NYC (30 March 1910); housed by the St. Louis Federal Reserve Bank (accessed 25 Feb 2010).  This document is utterly fascinating!  It includes samples from dozens of US cities, including one from Harrisburg, PA with a legend in English, Polish, Hungarian, and Italian.


10. Sprague (1910), "Expansion of the Circulating Medium," pp.314-320.  Sprague firmly insists that the cowardly reaction of banks, especially New York banks, in protecting their reserves by hording gold, was a natural consequence of the diffuse nature of the system. 


11. Bruner🙵Carr (2007) emphasize the rescue effort of Morgan to the exclusion of his prior role in the New York money markets. Chernow's account of the panic, while far briefer, likewise presents Morgan as a benign influence. But Chernow's account follows the longer history of Morgan's rise to preeminence in finance: not just the man, but the institution he created.


12. Text of bill, quoted in Barrons, p.199; mercifully summarized in Wells (2004), p.17; I noticed that the never-used bill issue clause was modeled on similar provisions of the Imperial Bank of Germany. See Conant (1909), "German Banks," p. 204.


13. See, for example, Friedman 🙵 Schwartz (1963), p.171, n. Their account emphasizes the research of different banking systems around the world, extracts of which are available online in Banking and currency in the United States, Vol. IV, No. 1, Academy of Political Science, (Oct 1913). See also Wells (2004), p.18. This is the view of authors who actually compared the two pieces of legislation. Wells mentions the difference was that the President of the USA would appoint the governors under the Glass Plan, whereas the boards of the regional banks would have appointed the governors under the Aldrich Plan.
    
    (Note: there are seven governors appointed by the President, with 14-year terms; one retires every two years, so the impact of presidential appointment is greatly reduced. Another five members of the open market committee that sets FRS policy are representatives of the regional banks, with NYC always represented. The Aldrich Plan provided for one universal discount rate; the Glass Plan allowed for 12 different ones. Soon after the FRS began operations, the 12 regional banks agreed to coordinate open market activities, and restored the single discount rate. So in that sense, the Aldrich-Vreeland Plan won out even though Congress actually passed the Glass Plan.)

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SOURCES 🙵 ADDITIONAL READING

Robert F. Bruner 🙵 Sean D. Carr, 1907: Lessons Learned from the Market's Perfect Storm, John Wiley 🙵 Sons (2007). Mostly focuses on contagion of crisis from United Copper Co. to Knickerbocker Trust , and J.P. Morgan's personal efforts to stem flight of capital from Wall Street.

Ron Chernow, The House of Morgan, Atlantic Monthly Press (1990), Chapter 7: "Panic"

Charles Conant, A History of Modern Banks of Issue, G.P. Putnam 🙵 Sons (1909), esp. "The Crisis of 1907," p.698. Vital resource, although chapters on crises require close reading. Very useful to cross-reference with Friedman 🙵 Schwartz (1963).

Milton Friedman, Anna Jacobson Schwartz, A monetary history of the United States, 1867-1960, Princeton University Press (1971), "Gold Inflation and Banking Reform, 1897-1914"

Robert Sobel, Panic on Wall Street: a Classic History of America's Financial Disasters, E. P Dutton (1988), "The Knickerbocker Trust Panic of 1907"; brief synopsis of the crisis dominated by colorful highlights and excitement of Wall Street trading. but generally unhelpful.

O.M.W. Sprague, History of crises under the national banking system (PDF), Volume 5624, United States. National Monetary Commission (1910). Discovered via Friedman 🙵 Schwartz (1963); totally indispensable resource. Detailed but concise.

Specifically Related to the Federal Reserve System

Clarence Walker Barron, The Federal reserve act: a discussion of the principles and operations of the new Banking Act, Boston News Bureau (1914); includes text of relevant acts

J. Lawrence Broz, The international origins of the Federal Reserve System, Cornell University Press (1997). I have not read this book. David C. Wheelock (Federal Reserve Bank of St. Louis) sympathetically outlines the book's thesis, that the Federal Reserve System was designed chiefly to establish the US dollar as an international currency. However, Wheelock doesn't say what design judgments—what sacrifices—were made to achieve this end. So I will have to wait until I have actually read this book.

William Greider, Secrets of the Temple: How the Federal Reserve Runs the Country, Touchstone (1987), "The Great Compromise," p.268. Mainly addresses the context of the Federal Reserve's creation and subsequent rise to supremacy in Usonian economic policy. The chapter on the FRS's creation is an essential addition to the arid tomes on gold points and discounting of commercial paper; it mentions many of the political compromises that molded the present institution.

Henry R. Mussey, ed., Banking and currency in the United States, Vol. IV, No. 1, Academy of Political Science, (Oct 1913). This is the most valuable resource I have found to date on the Fed and its development. It includes essays by key policy makers and opponents of the FRS, including some two hundred pages of analysis by Paul Warburg.

Donald R. Wells, The Federal Reserve System: a history, McFarland (2004)

Digression on the 1893 Crisis and Currency

This is yet another post that began as a footnote (the same footnote!) to my bigger post on the 1893 Crisis. Most historical crises anywhere have a short summary that most students of history take away, such as "Munich Crisis of 1938: Appeasement is bad," or "Jerusalem, 587 BCE: worship of gods besides Jehovah is bad."  The Crisis of 1893 was one of many depressions that hobbled industrial growth during the Gilded Age.  As with more recent crises, partisan writers immediately sought to enlist it as evidence for their own dogma, and did so with greater ease after years had passed.

The most familiar account of the 1893 Crisis for most readers will most likely be either Ron Chernow, The House of Morgan, Atlantic Monthly Press (1990), Chapter 5: "Corner" (p.71) or else Robert Sobel, Panic on Wall Street, Truman Talley Books (1988), Chapter 7: "Grover Cleveland and the Ordeal of 1893-95" (p.230). The rumor has it that the Crisis was caused by "debauchery" of the currency by the accumulation of silver reserves courtesy of the Sherman Silver Purchase Act of 1890.

One obvious problem with this claim is that the Sherman Act replaced the Bland-Allison Act of 1878, which also provided for the coinage of silver.  Neither bill "watered down" the national reserves with silver.  If Chernow wants to make the claim that wild-eyed silverites tampered with the currency shortly before the Crisis, causing a run on reserves, he is stuck with the problem that the silver policy was only slightly changed from 1878, and that the US dollar had been fully convertible to gold since 1879.  Another problem is that the gold reserves of the US Treasury and the private-sector fluctuated immensely between 1890 and 1893, as they did before that time. There is no evidence that any of the people who owned American securities at any time between 1889 and 1896 decided to sell them off in bulk because of a fear that the US currency was "debauched" by its coinage of silver.

Sobel's silver monomania leads him to lard every paragraph with some mention of people refusing to accept silver.

During July, as Congress prepared to convene [for a special session called by Pres. Cleveland to repeal the Sherman Silver Purchase Act], news of bank failures and business foreclosures were daily occurrences.  The issuance of clearing house receipts once more helped save some institutions, but they could not prevent the fall of others.  No one would accept the silver certificates.  Anxious Americans, in their flight from the dollar, began to buy pounds sterling with silver... (p.253)

Once Sobel has it stuck in his mind that silver coinage is causing a panic, nothing will distract him.  If the silver is radioactive as an asset, which Sobel claims, then the fact that the Treasury has a lot of physical coins and silver certificates is not going to alter the supply of high-powered money. There is no causal connection to it causing banking failures or tight money.  Sobel constantly alludes to gold "fleeing" the faithless USA for anywhere, implying that the USA was the only country in the world with a public feckless enough to waver on the pure gold (coin) standard.  By refusing to examine what was actually going on in other countries, Sobel allows readers to nurture this absurd delusion.

(Sobel's account includes tables showing the monthly prices of major issues during the Crisis. The accompanying text makes no effort to connect these to the currency crisis.)

Sobel and Chernow therefore propagated the claim that J.P. Morgan heroically and single-handedly saved the US Treasury from default by insisting on a bond issue, then ginned up the necessary gold. By 7 February 1895, the New York Subtreasury had less than $9 million on gold coin and, according to J.P. Morgan, there was a check against it for $12 million.  Cleveland authorized an issue of $65.1 million in bonds at 4% interest to buy 3.5 million ounces of gold, underwritten by the syndicate Morgan arranged. The influx of gold did not reverse the flow, and by January 1896, Treasury reserves were again at dangerously low levels. Morgan and Cleveland again arranged a much larger bond issue, but this also failed to restore the gold cover. According to Sobel, the defeat of William Jennings Bryan and the 1897 boom in gold were the real cause of economic recovery.

What Really Happened?

First, fair is fair: the Sherman Silver Act did create a significant opportunity for arbitrage by some financial actors.  Some financial entities were able to get silver certificates converted to gold, then use the gold to buy assets at an "above-point" rate, and repeat the cycle.  Every creditable observer admits that.  But the allegation that this was going on because the currency was debauched, or some violation of faith and credit was going on—that is absurd.

The populist movement from 1881 to 1897 was an extremely diverse and complex movement that encompassed conservatives and radicals, dozens of state governments, and dozens of varied reform programs.  In the more mainstream accounts of the late 19th century, both the radicals and the repression have been redacted out. In Chernow's account of the crisis, following Sobel, the populists are assumed to be "venomous" and deranged; they all have some mania for silver or (shudder) Greenbacks, and probably want to hang the bankers too.  He quotes Anthony Sampson claiming populists "banned bankers" (p.72), which struck me as one of his more egregious feats of fabulism.

Click for larger image

In reality, this period was accompanied by a global depression in trade, during which the balance of trade began a gradual downward slide (masked, of course, by the seasonal fluctuations).   During the early years of the Crisis, the boom in exports apparently followed yet another tightening of the tariff rate (McKinley tariff of 1890) during which manufacturers did as they were supposed to—viz., they used the monopoly rents from protected domestic markets to "subsidize" their own exports. But the headwinds of the global economic system were against them and the exports in the second half of 1893 were a disappointment.  By 1895, declines in imports had resulted in a soaring trade balance, and probably explains the inflow of gold that J.P. Morgan had been able to take credit for.

This is a fairly conventional reading of the data: the big trade surpluses of 1892 was an intended outcome of industrial policy by the 1889 Congress, while the big trade surplus of 1895 was the result of the gold squeeze.

Additionally, surveys of the banking crisis reveal that the gold withdrawals went to the US interior in response to distressed banks.¹ As with a lot of bank runs, the soundness of the banks were not a direct factor in suspension.  Some large firms, such as the Philadelpha ξ Reading Railroad were massive and misguided industrial investments; when they became illiquid, it naturally caused a lot of suppliers to suffer strains.

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NOTES

1. See, for instance, Elmus Wicker, Banking Panics of the Gilded Age, p.54 (and table 4.1, p.55).  Wicker (p.58) and Sprague both remark on the fact that most of the banks suspended soon resumed normal operations without being insolvent.

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SOURCES ξ ADDITIONAL READING

Charles Conant, A History of Modern Banks of Issue, G.P. Putnam ξ Sons (1909), esp. "The Crisis of 1893," p.523. Vital resource, although chapters on crises require close reading. Very useful to cross-reference with Friedman ξ Schwartz (1963)

Robert Sobel, Panic on Wall Street: a Classic History of America's Financial Disasters, E. P Dutton (1988), "Grover Cleveland and the Ordeal of 1893-1895."

O.M.W. Sprague, History of crises under the national banking system, Volume 5624, United States. National Monetary Commission (1910). Discovered via Friedman ξ Schwartz (1963); totally indispensable resource. Detailed but concise.
 
Elmus Wicker, Banking Panics of the Gilded Age, Cambridge University Press (2000)

A Digression on Crappy History: Ron Chernow's *House of Morgan*

Researching the many crises of the 19th century requires discrimination about one's sources, and I therefore felt the need to get the following off my chest. This post began as a footnote to my post on the Crisis of 1893 (2), and the following sentence in this essay appears there also.

The most familiar source on this subject for most readers will most likely be either Ron Chernow, The House of Morgan, Atlantic Monthly Press (1990), Chapter 5: "Corner" (p.71) or else Robert Sobel, Panic on Wall Street, Truman Talley Books (1988), Chapter 7: "Grover Cleveland and the Ordeal of 1893-95" (p.230).  Both books were extremely popular, measured by sales and by critical reviews, but my opinion of both is unfavorable.  Both are collections of low-hanging fruit: facts readily available without effort, including a few curios thrown in for historical color, and amply garnished with cliches. Sobel is preaching his doctrine of hard money and free markets, and hence needs to turn everything to that purpose whether it fits or not.

Chernow's narrative is a less coherent version of Sobel's, and almost wholly reliant on popular books for information. For example, on p.72, Chernow, who despises populists, claims that several Western states including Texas "venomously" outlawed bankers. His source for this astonishing claim was Anthony Sampson, The Money Lenders, Viking Press (1981), p.60. This is a common problem: popular "historians" whose sources are confined to highly remote writers, like Sampson (whose book had nothing to do with banking in Texas and should never have been consulted on that subject).  To make matters worse, Chernow carelessly paraphrases Sampson, who never said bankers were banned.

Why didn't Chernow wonder how a state functioned without banks or bankers between 1836 and 1904?  For that is an obvious question raised by his bald claim.  Or California?  The short answer was that Chernow didn't care if his information was correct, and most of his readers don't either.

For those actually curious about the claim in Sampson/Chernow, what actually happened was that the Texas state constitution (like English law to 1826) forbade banking by joint-stock corporations; banking was performed by partnerships. For the history of early bank corporations in England (with some references to Scotland), see Lucy Newton ξ  P.L. Cottrell, "Joint-Stock Banking in the English Provinces 1826-1857: to Branch or not to Branch?," Business and Economic History, vol.27.1 (Fall 1998). For banking regulations in Texas, see Avery Luvere Carlson, Texas, A Banking History of Texas, 1835-1929, Copano Bay Press (2007/1930). Please note Carlson's book is explicitly about banking in Texas during the relevant period, and hence, a valid source of information.

In Texas, the Constitution of 1861 (passed after secession from the United States) and the (pre-Reconstruction) Constitution of 1866 both prohibited corporations from forming banks.  The Reconstruction Constitution of 1869 allowed for the creation of a state banking system; at the same time, 10 bank corporations received national charters in Texas (between 1866 and 1874). By 1893, Texas had 254 national banks (Carlson, 2007, p.76). This data is available from the Comptroller of the Currency, of course.

Texas passed section 14 to its constitution in 1876, banning the award of state banking charters to corporations.  This allowed existing incorporated state banks to continue in operation, although the last one ceased to operate as a state bank in 1898. In 1904, section 14 was altered to allow state banks again.

Populist reform legislation did have some impact on banking practices, mainly through demands for reporting and regulation of banking services.  This is a lot less interesting than the flamboyant flapdoodle one gets from Chernow.

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SOURCES ξ ADDITIONAL READING

Avery Luvere Carlson, Texas, A Banking History of Texas, 1835-1929, Copano Bay Press (2007/1930)

Lucy Newton ξ  P.L. Cottrell, "Joint-Stock Banking in the English Provinces 1826-1857: to Branch or not to Branch?" (PDF), Business and Economic History, vol.27.1 (Fall 1998)

Robert Sobel, Panic on Wall Street, Truman Talley Books (1988), Chapter 7: "Grover Cleveland and the Ordeal of 1893-95" (p.230).

Benjamin Cooper Wright, Banking in California 1849-1910, H. S. Crocker Company (1910)

The Crisis of 1893 (2)

Note: this post has been substantially updated (26 Feb 2014)

(Part 1; 1893, India, and the USA)

Click for larger image Nicholas Poussin, "The Adoration of the Golden Calf"

One misleading rumor of the 1893 Crisis focuses on the currency situation. This claims that the currency was "debauched" by the Sherman Silver Purchase Act, which was the result of wild-eyed radicals; that sober heads were overruled by the contumacious mob. The Crisis raged and raged, as Old Testament smitings do, until the Lord J.P. Morgan called on David Grover Cleveland to repent because the Treasury Reserves were down to $9 million.¹ Morgan then led the Israelites Americans out of the house of bondage into possession of $65 million worth of additional gold via a bond syndicate, and the Republic was saved.

Like a Shakespeare history play, the plot requires one to ignore major lapses of time. The Sherman Act was passed on 14 July 1890 and revoked by special session of Congress 8 August 1893.² Morgan's intervention was 7 February 1895, and failed to stem the hemorrhage of gold for another year (even after it was repeated).  The Act seems to have allowed metals arbitrage, and this probably may have led to another sort of economic crisis than the one which actually happened if the Act had not been repealed in 1893.  The gold import phase that followed the Act's repeal seems to have begun even before it was formally repealed, which suggests that perhaps metals arbitrage was a minor factor in the gold outflow in the lead-up and Stage I of the Crisis.³

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The Crisis of 1893 (1)

 List of Depressions ξ Panics, 1821-1929

In the latter third of the 19th century currency was a major political issue in the USA. The dollar's value was tied to gold, although from 1862 to 1879 it was not redeemable in specie.¹ During this period, the nation suffered from repeated contractions, depressions, panics, and crises. There was severe sectional controversy over monetary policy; in parts of the Southeast and West, political movements appeared that were based on cheap money, while in the Northeast and Old South, the political establishment favored hard money policy.

Part of the problem was that having a gold-backed currency had little to do with price stability; prices mostly declined after the Civil War, but sometimes spiked upward dramatically during short periods.² When this happened, the US trade balance would swing into negative territory as imports would flow in, leading (months later) to a liquidity crisis. Another problem was precious metals. The USA was officially on a gold coin standard; the government was ultimately responsible for ensuring its paper currency was convertible into gold at a fixed rate. Fixed exchange rates were, in turn, regarded as essential to international trade.


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A brief list of Depressions

This is an edited version of an entry posted on the Urban Dictionary under the name, Abu Yahya.

A depression is a prolonged economic crisis characterized by drastic (i.e., >20%) decline in output, reduction in employment, and deflation. Other technical conditions include a liquidity trap and "permanent" (i.e., persisting in many sectors for several quarters) failure to reach equilibrium.

Difference between a Recession and a Depression

The technical distinction between a recession and depression can vary depending on the school of economics, although economists usually agree on which event is a recession, and which is a depression. In Keynesian economics, a depression is defined by the existence of a flat liquidity-money (LM) curve (which means that interest rates have no influence on people's determination to hold their wealth as cash); and/or a nearly vertical investment-savings (IS) curve (which means interest rates have no influence on the willingness of entrepreneurs to expand/continue operations).

In contrast, a recession is a much less drastic event. Interest rates still have influence on investment and liquidity, and there is no deflation. Conventional fiscal policy and monetary policy, combined and in moderate doses, can restore full employment.

(Please see the CEPA Economics Site for Keynesian theories of the business cycle)

Neoclassical economics/New Classical economics defines a recession as a shift in people's income/leisure preferences as the result of a technology shock. The technology shock sharply reduces the returns to labor, so workers are paid less and many withdraw their labor from the market. In a depression, the technology shocks are compounded and cause a permanent change in the production function; large numbers of enterprises are no longer viable.


More generally, a recession involves the downward phase of a routine business cycle; these typically occur every three to seven years. A depression represents a partial collapse of the industrial system, usually brought about by failed financial intermediaries.

Partial List of Depressions

Here follows a short list of economic crises that were regarded as possible depressions at the time. Items and resources will be added as they become available.

1815-21	Post-Napoleonic War Depression
1829-33	1832 Panic (per Conant, p.623) 1830-'33 Depression (per Handcock, p.228) Numerous banking failures in UK
1837-44	Commercial Crises of 1836-39 (Handcock, p.240) (Conant, p.623) Crash, Wall Street (Sobel, p.32)
1854-57	Depression of 1854 (UK)
1867-69	Failure of Overend Gurney and Co (Conant, p.643)
1876-79	Crisis of 1876 (Conant, p.648)
1893-96	Crisis of 1893 (Conant, p.668)
1920-22	Post-WW1 Depression
1929-1939	Great Depression

Major Panics & Localized Crises

1825	Crisis of 1825 (UK) (Conant, p.619)
1847	Commercial Crisis of 1847 (UK & France) (Handcock, p.259) (Conant, p.631)
1857	Commercial Crisis of 1857 (UK) (Handcock, p.292) Crash, New York ("Western Blizzard") (Sobel, p.77)
1861-1863	Cotton Famine (UK) US Civil War
1907	Knickerbocker Trust Panic (USA) (Sobel, p.297) (Conant, p.698)

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Sources & Additional Reading

W. D. Handcock, English Historical Documents 1833-1874, Routledge (1996), p.228; this table cites the official Poor Law Report of 1909.

Robert Sobel, Panic on Wall Street: a Classic History of America's Financial Disasters, E. P Dutton (1988)

Charles Conant, A History of Modern Banks of Issue, G.P. Putnam & Sons (1915),