28 February 2010

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-0ne 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).



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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
beginningending£(Rupees)(£)(Rupees)(£)
186018640.09945,889,538585,27310,181,7811,011,814
186518690.09765,835,117569,6539,981,112974,406
187018740.09503,073,776292,0093,598,271341,836
187518790.0874639,59555,8986,408,692560,093
188018840.08244,128,613340,1816,205,349511,295
188518890.07623,083,670234,9636,896,685525,499
18900.06904,615,304318,57110,937,876754,987
18910.07545,636,172424,80314,175,1361,068,392
18920.06972,413,792168,2929,022,184629,034
18930.0624-2,812,683-175,58212,863,569803,008
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.



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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 port.

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.--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

Sources and 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

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23 February 2010

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 occurences.  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.


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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 exports 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.




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.


Sources and 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)

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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 &  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 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 flamboyent flapdoodle one gets from Chernow.


Sources and Additional Reading:

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

Lucy Newton &  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)

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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

I have leaned very heavily on O.M.S. Sprague's account of the crisis because his analysis includes the most careful examination of relevant data.  Other accounts, like Sobel's and Conant's, generally assumed the truth of prevailing theories, but did not examine the data in the sort of detail needed to falsify their pet hypotheses. Conant's account is valuable, however, because he includes many different countries and their reserve systems.

Stage I of the 1893 Crisis (26 February--10 June)4

Unless otherwise noted, I will be referring to Spague (1910), backed up NBER statistics. One point needs to be made in advance, which is the difficulty of making comparisons of 1893 monetary amounts with those of 117 years later. It's not just the price index, with controversial weightings of different mixes of "equivalent" goods; it's the macroeconomic impact of startlingly small amounts of money. In 1893, the GNP of the USA was about $448 billion (in 2010 dollars),5 and even then, the Treasury Reserves of $100 million would seem like a pitifully small amount of money. In fact, at the time, data on national income and product accounts were extremely limited, and there was a certain totemic nature to gold reserves anywhere. I say this because credit has always been by far the most important component of the money supply, and systems of credit have always made the difference between a resilient industrial system capable of surviving a crisis, and economic apocalypse.


Stage I of the 1893 Crisis was the collapse of the Philadelphia ξ Reading Railroad, followed by the National Cordage Company. The previous year had seen a collapse of the banking system in Italy, famine in Russia, and the Austro-Hungarian Empire's establishment of gold convertibility of its florin.6 Both Australia and the United States suffered from excess projected capacity ("projected" in the sense of planned, with capital outlays and investors), so of course at a certain point it was inevitable that many banks would accumulate nonperforming loans even in the absence of serious corruption.  Adding to the problem was a severe real estate bubble in the Southeastern USA and Australia.

(Unfortunately, I lack space to write much about the crisis in Australia.)

The USA mostly had a favorable balance of trade with Europe, although this balance oscillated over the course of the year; indeed, the private sector and the financial sector had a large net indebtedness to Europe; Markets for US securities were brisk, and there was a substantial net flow of finance capital to the USA from Europe. This was the case well into Stage I.  Moreover, the crop failures overseas led to high demand for US wheat, in a year of abundant harvest domestically.  However, as Sprague observes, this was offset by the limited means of Europeans to pay for this: the Europeans  responded by selling US securities for dollars to buy American wheat.

Following typical seasonal patterns, gold mostly flowed out of the USA in the first half of 1892, then inward in the last quarter.  The comparative size (and duration) of the two movements varied from year to year, and 1892 the gold import phase was smaller than the export phase by the amount of $50 million.7 Yet the money supply grew, in part because the US government was running a large budget surplus, so large in fact that it was buying back bonds and creating more high-powered money.  For this and several other reasons, Sprague rejects the hypothesis that money was tight.  Sprague observed that bank lending was contracting, but also that this was demand-driven: enterprise was interested in reducing its debt load.

Stage II of the 1893 Crisis (10 June--12 July)8

Stage II was essentially a routine seasonal transition in currency flows that went terribly wrong.  During this period (Hayes through McKinley administrations), US imports tended to be low in winter, then surge between March and June (inclusive).  The variation in monthly imports was typically over 33%, meaning that a typical March meant an influx of imports 20% over the annual average, and a typical September meant 15% less than the annual average.  This seasonal variation was remarkably consistent with respect to composition: as total imports fell off in the 3rd quarter, imports specifically of manufactured items grew both absolutely and (obviously) as a share of the total quarterly import bill.9

This is important for understanding the financial situation that followed. The stock market collapse did not look as though it would have further repercussions for the credit markets, and reserves of the New York banks were recovering as the annual "flowback" of currency from the rest of the USA began. Around the beginning of June, however, exports of gold from New York banks to foreign destinations intensified.  At the same time, the lag effect of the first stage of the Crisis was now felt: 19 nationally chartered banks failed, plus several state and merchant banks. This meant that reserves in New York were redirected to the interior as depositors and bank managers warily anticipated a potential run on currency.

In later economic parlance, the liquidity preference of Americans shifted sharply in favor of holding cash.  Sprague notes that the amount of currency required to conduct business became absurdly large.  The banks resorted to a technical refinement, the "clearinghouse loan certificate" (CLC) to avoid the need for costly liquidation of bank assets. They would play a major role in mitigating the Crisis of 1907.10 CLCs were used like checks, only for fixed denominations (typically $1, $5, $10, or $20) and issued in lieu of currency.  They worked because banks were essentially told by their clearinghouses to accept them as tender during the subsequent suspension of payments by the banking system.

Loan portfolios by banks in all sections of the USA contracted by about 7%.


Stage III of the 1893 Crisis (12 July--2 September)11

Stage III of the Crisis saw a special session of Congress called to revoke the Sherman Silver Purchase Act of 1893.  At this time, there was a second wave of bank suspensions, much worse than the first.  By the 28th of July, banks were making the shift to payment of depositors (rather than other banks) in CLCs. 

In Stage I of the Crisis, the banks had a surplus of reserves; by Stage III, despite the contraction of loan portfolios and the currency shipments from the central reserve cities, the banking system had inadequate reserves (because of excessive withdrawals by depositors). Suspension of payment in cash by the banks became more complete and more widespread, leading to a premium charged on payments in cash.

The currency premium in New York seems to have created the shift in trade position of the dollar.  Note that, during the time of the gold standard, shifts in the exchange rate between major currencies were very small and had large consequences.  In the USA, the effect of the currency premium was to create a profit opportunity for people holding dollars.  The one way to buy dollars without paying a premium was to offer gold (certificates) or pounds sterling for them, then use the cash to buy future claims on dollars.  In a month, $40 million worth of gold flowed into the USA. Sprague notes that, if it were not for the currency premium, gold would have continued to flow out of the USA (p.191) because of the exchange rate.

In August, the Bank of England raised the discount rate from 2.5% to 5%, a catastrophic event then as it would be now.  This probably led to the further increase of the premium itself, and also led to money centers other than New York importing gold. It also created a vicious cycle in which a vastly increased amount of currency was required for a given number of transactions (p.195).  It is easy to see how this sharply increased liquidity preference could become semi-permanent.


Aftermath

Stage III was not the ending of the Crisis for millions of Americans. While output may have recovered by 1895, unemployment remained exceptionally high until 1900.12 Owing to the extreme concentration of income in time and household, the effect on the working class of North America was probably devastating. In the American Southeast, the campaign to disenfranchise and terrorize African Americans reached its post-Reconstruction peak (for example, all Southern states had policies to effectively disenfranchise non-White voters by 1893; that same year saw the Southern states completing their program to segregate all public transportation), while in the Midwest, the Pullman Strike was the occasion for extremely violent, unrestricted anti-union terror by state and federal governments.

The financial crisis was experienced very differently in different parts of the country, with New York's financial center being tightly squeezed between foreign demands for immediate gold payments, and "internal" demand for currency. Additionally, seasonal flows varied from region to region (for example, New Orleans suffered the effects much later than the rest of the country, and Chicago experienced an exceptionally high currency premium).

(Part 3)

Notes:

  1. 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). I have addressed these in two posts, "Digression on the 1893 Crisis and Currency" and "A Digression on Crappy History: Ron Chernow's House of Morgan." One crucial point to be made here is that Chernow and Sobel support the idea of Conant (see p.527) that the Sherman Silver Purchase Act was to blame for the 1893 Crisis. Conant remarked on the correlation of gold exports to the period of the Sherman Act, but declined to implicate the Sherman Act as a primary cause, let alone the only cause, whereas Sobel was uninhibited in blaming everything on it alone.

    I suddenly switched Bible passages from Exodus 32 to II Samuel 2, where God punishes King David (actually, the Israelites--again!) for his temerity in making a census. It sounds like a very Austrian Bible story, in which God is Ludwig von Mises, and his wrath is kindled by the introduction of statistics to public administration.


  2. For a handy summary of the Act and objections to it, I recommend Grover Cleveland's message to Congress on the repeal of the Act. See "Grover Cleveland, Message on the repeal of the Sherman Silver Purchase Act August 8 1893," hosted by the University of Groningen, Groningen, NL.


  3. One point raised by Davis Rich Dewey, 1922--p.443 is that "nine-tenths or more of the customs receipts at the New York customhouse were paid in gold and gold certificates; in the summer of 1891 the proportion of gold and gold certificates fell as low as 12 per cent, and in September, 1892, to less than 4 per cent."  He includes a chart on the next page, which paints a murkier picture.  First, both 1891 and 1892 were under the same silver regime; and the payments of customs receipts in NY follow a seasonal pattern described below, with gold certificates predominating in the early months of the year, then declining as the year progresses. Silver certificates in both years rose as a share of payments in the spring, then gave way to Treasury notes in the summer, and United States notes ("Greenbacks") in the fall. 


  4. Sprague, 1910--p.162 and Conant, 1909--p.524.


  5. Balke ξ Gordon (quoted in Lord Keynes--pseudonym--2011). I converted Balke ξ Gordon's figures from 1982 dollars to 2010 dollars using the BIS Inflation calculator. The gross national product (GNP) differs from the gross domestic product (GDP) by the amount of net factor payments.


  6. Conant, 1909: Economic collapse in Italy, p.29; famine in Russia, followed by customs war with Germany, p.242; Austro-Hungarian Empire going on the gold standard, p.228, "The receipts of gold by the bank from April 11th to October 10, 1892, were 38,759,000 florins ($19,000,000), of which a large part was in pieces of American origin." Owing in part to conditions in the money markets of Germany (huge amount of failed Latin American securities in Berlin) as well as the crisis in the USA and Australia, the Austro-Hungarian banks did not actually achieve full gold convertibility. Russia began to shift away from a silver-based monetary system to a gold-based one in 1893, as did India.

    Conant pays special attention to the banking crisis in Italy, which created the need to recapitalize and reorganize the decentralized national banks (into the Bank of Italy).

    The banking crisis of 1893 in Australia is described on p.443.

    On the collapse of the National Cordage Company: "cordage" refers to rope and string. The National Cordage Company was the first of the major trusts of the Gilded Age, and is an interesting story in itself. See Arthur Dewing, A History of the National Cordage Company, Harvard University Press (1913).  Link goes to the full text hosted on the Internet Archive.
    [I]t showed the gradual concentration under one control of upwards of ninety per cent of the American production in an industry where every condition favored competition. It dominated the market for the raw material and controlled as well the essential machinery used in the process of manufacture. [...]

    The common stock was issued to the promoters and the preferred stock to the public; the stock was marketed by a professional operator; officers of the Company participated in speculative "pools"; a stock dividend was declared on the basis of fictitious earnings in order to aid the speculation in the Company's securities. Unable to carry the burden of an oversupply of raw material and finished product, with its trade position undermined by new competitors, the consolidation collapsed in a day.(pp.3-4)
    The "other" Sherman Act, against trusts, was passed 12 days before the Sherman Silver Purchase Act (2 July 1890); I suspect efforts to blame the silver purchase act for the 1893 Crisis was stimulated in part by the desire to poison public opinion against antitrust law. 


  7. Sprague, 1910--p.157. Sprague also mentions (p.161) "speculation in town lots and mineral lands" as "the most unsound element in the situation." Sprague mostly focuses on the reserves of the New York national banks because his book is about the national banking system in the USA, and during this period (1870s-1924) the national banks were dominant.  He mentions that the state-chartered banks suffered somewhat higher rates of suspension or failure in the Crisis, but cautions that the crisis hit Western states worst--where there was an unusually large concentration of state-chartered banks (except for Texas).

    The seasonal pattern of US finance is extremely pronounced, particularly prior to the 1920s.


  8. Sprague, 1910--p.167


  9. "Price Quantity Indexes and Values for U.S. Exports and Imports, 1879-1923," NBER (May 2004); data is "Appendix A Table A-29. Quarterly Values, Selected Major Import Classes (Millions of Dollars),"  worksheet A29.  Data collated by James R. MacLean for this essay.

    It would appear from the data that, during the 1st and 3rd quarters of most years, the USA imported larger than average volumes of manufactured goods, and less than average volumes of everything else.  In the 2nd and 4th quarters, imports of agricultural products like rubber, or minerals such as tin, increased. These more than offset an absolute decline in finished goods imports.  This pattern is consistent over the "Cleveland Era" (1885-1896) except for 1890 and 1893-1894.

    Year Q Agr. Share Manu. Share Total
    1888 1st 87 14.36% 59 46.28% 188
    1888 2nd 97 20.65% 42 52.72% 184
    1888 3rd 70 14.53% 58 40.70% 172
    1888 4th 93 12.15% 45 51.38% 181

    "Agr." is agricultural imports in millions of current (i.e., 1888) dollars; "Manu." is manufactured goods, also in millions of current dollars.  "Share" is percentage of "Total" [imports]; total imports is greater than the two categories shown.  Notice that the import bill for the 1st two quarters is somewhat greater than for the 2nd two quarters.  This is a pretty typical year, and in fact was chosen at random.


  10. For an introduction to the clearinghouse loan certificate, see any of the following:


    Clearinghouse loan certificates were inevitably used as a stepping stone to partial suspension of cash payment of demand deposits.


  11. Sprague, 1910--p.175


  12. Romer (quoted in Lord Keynes--pseudonym--2011).


Sources and 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).

Davis Rich Dewey, Financial History of the United States,  8th Edition, Longman, Green and Co., NY (1922). Excellent resource, and frankly a pleasure to handle.

Lord Keynes (pseudonym), "US GNP Estimates in the Recession of the 1890s," Social Democracy for the 21st Century: A Post Keynesian Perspective blog (18 Jan 2011)

  • N. S. Balke ξ R. J. Gordon, "The Estimation of Prewar Gross National Product: Methodology and New Evidence," Journal of Political Economy 97.1: 38–92 (1989); data found in "Lord Keynes" (2011)

  • Christina Romer . “The Prewar Business Cycle Reconsidered: New Estimates of Gross National Product, 1869–1908,” Journal of Political Economy 97.1: 1–37 (1989); data found in "Lord Keynes" (2011)

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), "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.

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21 February 2010

The Crisis of 1893 (1)

List of Depressions & 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.

Political Components

Then, as now, political parties were essentially coalitions of sectional parties. The Democratic Party consisted of an extremely large Southern (rural) section, plus a small and strategically weak non-Southern (and urban) section. The non-Southern section was essentially an opposition movement to the Northern industrial interests; in other words, labor and small businesses usually favored Democrats to resist the hegemony of industrial management; farmers in the Northeast tended to favor Republicans, while those in the rest of the country were divided.

The Republican Party was generally in favor of the gold standard and hard money, especially since 1873. The Democratic Party had a faction that was strongly in favor of hard money, but was usually assumed to favor silver. Both parties had leaders who were prepared to cede ground on this issue in exchange for cooperation elsewhere.3 Hard money advocates wanted the complete exclusion of silver from the monetary system; populists favored a diverse and expansive money supply. Silver was cheap and the USA had abundant domestic supplies. When the money supply shrank and banks failed, the populists argued that the problem was the tightness of the money supply; the hard money advocates argued that it was doubts about the integrity of the Usonian money supply, caused by the constant prospect of a "surprise" passage of pro-silver legislation.4


Click on image to enlarge
Gold & Cash Reserves, US Treasury; Monetary gold stock (1886-1898)
Source: Series m14137a, m14080a, and m14076a, NBER Macrohistory: XIV. Money and Banking

In 1890, the Republicans controlled Congress; Speaker Thomas B. Reed (R-Maine) achieved passage of the McKinley Tariff by agreeing to the Sherman Silver Purchase Act.5 The Republicans got an even higher tariff on imports than the already-high rate; Democrats in Western states got a commitment from the Treasury to buy 4.5 million Troy ounces of silver per month and pay for it in new currency. The silver was to have its value set at one sixteenth the value of gold, even though the real ratio was one twentieth. This stimulated arbitrage of gold out of the country, since silver was now overvalued in the dollar. Indeed, in the months following the passage of the Sherman Act, there was a dual process of arbitrage (see chart above) in which the banking system pulled gold out of the Treasury (by switching to silver reserves) and arbitrageurs pulled gold out of the nation's monetary gold stock.

The increase of the tariff failed to significantly reduce imports, but did result in a sharp spike in exports.6 The reason for the spike in exports was probably the result of US firms making a major export blitz financed by the surge in domestic revenues. In the USA, the firms benefiting from the tariff naturally were the ones whose foreign competition was priced out of the market. But the Usonian companies evidently raised their prices by an amount sufficient to make imports competitive again, while using the windfall profits to expand sales efforts abroad.

Congress therefore repealed the Sherman Act in November '93.7 One effect of this was a renewed plunge in prices. From a peak in February '93 to September, the wholesale price index fell 9%; after rebounding in September, it fell again by 11%. Industrial activity plummeted by 26% in four months (May-September '93), but rebounded very slightly towards the end of the year because of the seasonal spike in exports.8

Prior to January '93, bank suspensions averaged 70 per year; during the first eight months of '93, 415 banks suspended payments. Because of the sudden shortage of cash, firms could not pay workers even when the firms' books were in good order.9 Shortage of any form of acceptable currency was universally understood to be the immediate, proximate cause of the crisis.

The Crisis Begins

One important point needs to be made again, even though I have mentioned it in the footnotes: the USA, to an unusual degree even for the time, had a seasonal financial system.  Indeed, the evolution of US finance prior to 1908 mainly consisted of adapting to the exceptional strains faced by the Usonian system of banking and trade via the huge seasonal fluctuations.  The US economy was exceptional in so far as it was both predominantly agricultural, while at the same time commercial and industrial. Every step in the annual cycle of cultivation, sowing, harvest, and shipping of commodities was accompanied by a major shift in the inter-regional balances of the banking system.   Moreover, there was already a severe slump in Europe.10


(Part 2)


Notes:

  1. The value of the dollar was pegged to gold at a mint par of 4.8666 per UK pound (after 1837). However, convertibility was suspended during the US Civil War; until the end of the war, the US dollar fluctuated in value dramatically against gold. In the years that followed, the US government repeatedly phased out tranches of greenbacks. See, for example, Friedman & Schwartz (1963), "The Politics of Resumption." Most of the time between 1866 and 1879 bonds were repaid in specie, but during the frequent banking crises the Treasury re-circulated retired greenbacks.

    Specie, here, is gold coin with an intrinsic value

  2. See National Bureau of Economic Research (NBER) Macrohistory IV: Prices, "U.S. Index of Wholesale Prices, Variable Group Weights 01/1850-12/1894." Note that, even in the period 1879-1895, when prices declined at an average rate of 1.53% per year, there were years like 1882, when inflation reached 10.4%. Quarterly inflation was often much, much higher; one five separate occasions it exceeded 20%. I am deliberately ignoring the two years after the resumption of conversion, when inflation briefly exceeded 75%. ). All rates given are annualized rates.

  3. E.g., Salmon P. Chase was Secretary of the Treasury during the War and supported the creation of the greenbacks, but in 1870 as Chief Justice ruled (Hepburn vs. Griswold) that it was not constitutional for the government to make greenbacks legal tender. Numerous examples of shifts in movement identification for Republicans can be found in Carl Sandburg, Abraham Lincoln (1926). Matthew Josephson's The Politicos, New York: Harcourt, Brace (1938) includes a detailed account of the tendency for individual Republicans to move among different movements in their career trajectory. For example, Rutherford B. Hayes had a reputation as a Reformist upon coming to office, but became the main target of the Reformist faction in their 1880 battle for the nomination. Roscoe Conkling and Chester A. Arthur were Radicals who became leading Stalwarts.

  4. For an example of a hard money advocate's position, see Conant (1909), "The Crisis of 1893," p.668ff. For a rebuttal, see Sprague (1910), p.161-162; and Friedman & Schwartz (1963), pp.108-109. See also the subsection "Changes in High-Powered Money" (p.124). Conant uses statistics of gold exports (p.671) to argue that the crisis essentially consisted of a hemorrhage of gold from the Treasury, and that this was correlated to silverite agitation plus the passage of the Sherman Silver Purchase Act (1890). Friedman & Schwartz discuss this in detail, with graphs illustrating (p.126) the net gold outflow from the Treasury. They conclude that the silver purchases did not directly stimulate the crisis, but did create reluctance on the part of foreigners to hold dollars.

  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. Imports to the USA in the 1880's and '90's were highly seasonal; on an annual basis, the impact was not very strong. See "1893, India, and the USA," chart 3

  7. For the perception of India's demonetization as trigger, see Conant (1909, pp.677-67). Regarding gold flows, see Friedman & Schwartz (1963) p.108 and table A-4 (Appendix A, p.769). Friedman & 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 & Schwartz emphasize that silver probably only accounted only for the external (foreign) drain of gold.

    In my view, this neglects the well-established role of metals arbitrage (which provided the motivation, for one thing, to physically relocate the gold abroad); and it imposes a distinction of the sort that doesn't really obtain in finance. Foreign actors are indistinguishable from domestic ones.

  8. National Bureau of Economic Research, Macrohistory: VII. Foreign TradeMacrohistory: XII. Volume of Transactions; Data downloaded include a wholesale price index (base 1926), US (merchandise) exports and imports, and index of industrial activity. All data monthly. Most economic indicators vary by season; exports, for example, peaked in December and sagged in July or August. Each year the index of industrial production surged slightly in response to the rise in exports. as firms replaced inventories; but the response of industrial production to exports was quite small.

  9. Conant (1909), p.679.

  10. Sprague (1910), Chapter IV: "The Crisis of 1893," p.153ff.  Unless otherwise noted, all references that follow come from here.

Sources and Additional Reading:

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), "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 & Schwartz (1963); totally indispensable resource. Detailed but concise.

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17 February 2010

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.

1815-21Post-Napoleonic War Depression
1829-331832 Panic (per Conant, p.623)
1830-'33 Depression (per Handcock, p.228)
Numerous banking failures in UK
1837-44Commercial Crises of 1836-39
(Handcock, p.240)
(Conant, p.623)
Crash, Wall Street
(Sobel, p.32)
1854-57Depression of 1854 (UK)
1867-69Failure of Overend Gurney and Co
(Conant, p.643)
1876-79Crisis of 1876
(Conant, p.648)
1893-96Crisis of 1893
(Conant, p.668)
1920-22Post-WW1 Depression
1929-1939Great Depression

Major Panics & Localized Crises

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



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),

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