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Robert Patton Antebellum America

Panic of 1837

The cause of the Panic of 1837 has been an enigma right up to the present day. But there are things that we know. The United States had no official currency even though the Constitution reserved the right of coinage to the federal government. Instead there was a mishmash of coins, gold, silver, banknotes and counterfeit notes that circulated and were used in trade. In addition, after 1837 what has been called spurious currencies appeared. Unlike counterfeits, spurious notes were legal. Corporations and individuals were authorized by emergency legislation to issue notes that were printed in bulk by a state government, but were only guaranteed by the issuing individual or group.

In some agricultural areas buyers and sellers resorted to barter because of the shortage of both specie and trusted currencies. The conventional view is that the counterfeiters were criminals riding on the backs of the legitimate creators of money, the bankers. But how legitimate were the bankers? Most Americans as children learn the following story to explain what banking is all about. Bankers take in deposits. This helps protect the depositors from thieves that might take their money if stored in the hamper at home. As a bonus the banker pays interest on deposits. This is a little surprising since the banker is providing a service to the depositor, yet it is the banker that is paying. The explanation we learn as children is that the banker can pay for holding the money because the same money can be lent out at higher interest levels to borrowers who wish to start businesses or buy homes or cars.

This is a very satisfying explanation but is quite untrue. Not only can the banker lend out money from deposits held for customers, but when loans are made, they create new deposits in the name of borrowers who, of course, do not spend the funds as soon as they receive them. When loans are made based on the new deposits, that increases the money supply. The process continues and for each dollar deposited by a saver, several dollars can be created. Its called fractional reserve banking. Today the government regulates the reserve requirements of banks.

The situation in the 1830s was similar but more so--much more so, in fact. The large number of banks chartered by states typically lent out five, ten, 20, and in one extreme case 30 times their assets. One might guess that the banks were unregulated, but this is not true. In fact regulation is what made this possible. Counterfeiters were not regulated. If caught, they could be sent to prison. In practice this was difficult, but only because the counterfeiters outsmarted the authorities.

The banks, on the other hand, were chartered, in other words licensed, by the state to conduct business subject to certain rules. To be chartered, a bank might need to have a certain amount of capital, say $200,000. No problem. The bank might line up an investor who supplied the necessary capital, then receive the charter from the state. Once chartered, the bank could lend the $200,000 to the original investor and suddenly the banks assets consisted of nothing but credit. As bizarre as this sounds, in the wild and wonderful 1830s this was a very common practice. Then of course the bank would welcome depositors and lend many times more

money than what came in. Again this was the normal course of business in the years leading up to the 1837 Panic.

These banks were extremely vulnerable to any loss of confidence on the part of their customers. Once customers began to suspect that something was amiss they would attempt to withdraw their money. Up to a point this was OK and a well capitalized bank might be able to honor such requests long enough to restore confidence and the run might stop. If not, the bank might be forced to suspend specie payments--in other words refuse to redeem its bank notes for gold, silver or other hard currency. This also began to happen with increasing frequency.

Given this approach to banking and the financial solvency of the nation it should be no surprise that the system failed. However, there are other explanations offered by historians and economists who feel that there must be an external explanation--that somebody other than these bank practices was to blame.

There is the free banking theory. All this happened because bankers were free to do what they wished, And as everyone knows, bankers are greedy and may do anything profitable unless closely watched by invariably honest and altruistic politicians and bureaucrats. This is nonsense. The banking practices outlined above were empowered by state governments and people naturally assumed that they must be on the level. Imagine if an unchartered bank opened in a town. How many people would be ready to trust their funds to its safekeeping?

Companies sprang up to help individuals defend themselves against counterfeiters, but what help was there to help individuals and small businesses to assess the solvency of the local bank? The State charter was the only assessment on offer.

Then there is the theory that moving federal funds out of the 2nd Bank of the United States was the key factor. In other words that if only Nicholas Biddle had been trusted with the financial future of the nation, everything would have turned out all right.

Biddle did an excellent job of selling this idea, He was able to move is bank to Pennsylvania as the United States Bank of Pennsylvania. He threatened the state with the idea that any delay would allow another state, such as New York, to charter his bank. This was no empty threat. Both Pennsylvania and New York as well as other states had been engaged in an orgy of canal and railroad building. Huge debts had been assumed on behalf of state taxpayers to fund these grandiose dreams.

Back in those days as today, governments were quick to spend money whether they had any or not. Without tangible assets a government, whether state or federal, could use the fictional asset known as the full faith and credit of the government entity. And this is why Biddles offer was so attractive. As long as credit was available the construction binge could continue. All this was a disaster waiting to happen.

Helping the destructive process along were a few other difficulties. Crop failures were experienced in many agricultural areas. This was partly a result of a trend toward

monoculture starting with tobacco, then cotton. The extreme South was especially affected. Small slaveholders with their backs against the wall were forced to sell slaves but a slave that had been worth around $1500 might now bring as little as $250. One owner of 22 slaves had to sell a few just to buy food for the rest.

In the Old South there were some positive results, particularly a trend away from monoculture toward diversification. The motivation was survival: when there is no cash, you cant eat cotton.

Meanwhile, in the West, there was an orgy of land speculation. Buyers of government lands could turn quick profits. Between 1834 and 1836, 37 million acres were sold by the government and by the end of this period land prices were ten times higher than they had been in 1830.

To damp the speculative fever Jackson had issued the Specie Circular; land sales required payment in gold or silver. The result was disastrous. The specie requirement only applied to the first buyer and land often changed hands several times in a relatively short period of time so the net effect was to limit initial sales to those who had or could borrow hard money. The regulation led to hemorrhaging of gold and silver from Eastern banks to the West causing extreme hardship, especially in New York. Roughly 250 New York businesses failed in a relatively short time.

Monetarist Milton Friedman later compared the Panic of 1837 with the Great Depression that came almost 100 years later. In 1837 about a quarter of all banks failed, while in the 1930s it was a third. In both the Panic and in the Depression, the money supply dropped by a third. For Friedman the monetarist, of course, this may have been the most important parameter.

Another theory (Temin) blamed the debacle on specie inflow from Mexico. Because the British were using less silver in trade with China (because of a switch to Indian opium), there was an excess of Mexican silver that made its way north. In addition, plummeting cotton sales caused a drop in Northern manufacturing. But the reduction in cotton shipments resulted in a drop in specie from England which tends to cast doubt on the Mexican liver idea.

Included in many theories is the idea that the loss of the restraining influence of the Bank of the United States was a significant factor. This seems rather far fetched. If Biddle was so good at restraining and moderating monetary excesses, one would have expected Pennsylvania to benefit from his financial wizardry. This was certainly what Pennsylvania expected when they chartered the United States Bank of Pennsylvania. Instead Pennsylvania was one of the hardest hit by the panic and the recession that followed.

By the time Martin Van Buren entered the White House the Panic was underway and there were those who advocated and expected a return to central banking. Instead Van Buren pushed for what was called the Sub Treasury bill. The reason for the name is not clear but the

idea was that government funds would be held in depositories under the U.S. Treasury as opposed to Private banks.

An interesting sidelight is that it was around this time that the expression OK entered the American (and world) vocabulary. Van Buren was from Kinderhook, NY and the expression Old Kinderhook emerged during his campaign. The abbreviation OK survived and took on the meaning it has today,

NOTES Standard analysis Jackson kills Bank of US Biddle moves it to Pennsylvania Freed of regulation, state banking abuses proliferate Result is often interpreted as proof of the evil of free banking and the need for a

strong central bank

Silver inflation theory British reduce shipments of silver to China; switch to opium

Land boom retarded inflation because land prices were fixed and pent up demand

absorbed much of the increased money supply Meanwhile cotton demand weakened and prices fell reducing flow of specie from

England to the US.

Austrian theory Influx of silver added fuel to inflationary fires because every dollar of silver

generated five or more paper dollars Money moved from central to state banks added more fuel to inflationary fires After 1833 land sales exploded and while prices were fixed for first purchaser, many

of these were speculators who flipped purchases at higher price

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