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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