Panic of 1819--and 2002
"Of all men's miseries the bitterest is this: to know so much and to have control over nothing." -- Herodotus
The ancient Greeks would have appreciated the current economic problems in America. With their affinity for tragedy, the Greeks would surely have marveled at the mysteries of the business cycle, particularly the destructive power of the bust. Thinkers such as Herodotus were sensitive to the precarious nature of prosperity and aware of the fickleness of fame. More than simple pessimism, the wisdom of Herodotus respected the uncertain future with caution and humility.
American business, held in high regard and master of all it surveyed during the frenzied booming 1990s, suddenly has found itself cast upon the rocks. Men and women who were once at the pinnacle of their celebrity and fortune rather quickly have found themselves turned into criminals, outcasts, and villains by public opinion. Prosperity has proven to have been temporary, if not altogether illusory, and a thickening gloom has settled in its stead. Politicians, ever open for an opportunity to garner votes, have begun their prattle and posturing, while the engine of government seems to surge forward with a renewed vigor and sense of purpose.
The economic cycle of boom and bust is fascinating stuff. Its essential elements are repeated endlessly throughout the dusty pages of financial history. All of this makes Murray Rothbard’s book, The Panic of 1819, particularly interesting, timely, and enlightening. This was Rothbard's doctoral dissertation, published originally in 1962 but very hard to come by until the new edition made available online through the Mises Institute - http://www.mises.org/rothbard/panic1819.pdf
Rothbard believed that the Panic of 1819 was America’s first great economic crisis. Unlike prior crises, which could be attributed to some specific government blunder or disaster, the Panic of 1819 seemed to originate within the economic system itself. Thus, its cause was not obvious to observers at the time. Confronted with something new, the Panic engendered much discussion and debate about possible causes and remedies. As Rothbard observed, the panic provides "an instructive picture of a people coming to grips with the problems of a business depression, problems which, in modified forms, were to plague Americans until the present day."
The Panic of 1819 grew largely out of the changes wrought by the War of 1812, the first war of the still-fledgling republic, and by the postwar boom that followed. The outbreak of war stifled foreign trade and spurred the growth of domestic manufacturing, which mushroomed to fill the gap left by declining imports and also served to satisfy the nation’s appetite for war goods.
The war also brought a rash of paper money, as the government borrowed heavily to finance the war. The government depended on note-issuing banks spread throughout the country. All of this put tremendous strains on the banks’ reserves of specie held against such notes. This would inevitably lead to suspension of specie payments in some parts of the country in 1814. Freed from the shackles of hard money, the suspension of specie led to a boom in the number of new banks started in the country, and a subsequent boom in note issuance. The credit expansion also predictably led to rising prices, of course. Cotton, for example, doubled in price.
The war altered the economic pattern of production in a way very different from what would have evolved in the absence of war, and thus it placed the economy on a sandy foundation, vulnerable to distress when the war ended.
So, when peace did come, it brought its own troubles. The revival of foreign trade began to reverse some of the trends started during the war. Swelling imports led to falling commodity prices. "The influx of imports spelled trouble for war-grown manufacturers, especially textiles, which suddenly had to face the onrush of foreign competition," Rothbard notes. For the modern reader, this paints an all-too-familiar scene: the plight of the domestic manufacturer--one that continues to bedevil steel, lumber, and others today. As with all economic phenomena, however, there is crisis for some and opportunity for others. Exporters, for example, would thrive.
Just as credit and monetary expansion helped fuel the speculative excesses of the late 1990s, so too did credit and monetary expansion fuel the post-1812 boom, particularly rampant speculation in land on credit. In addition to land, money poured into turnpikes and farm improvement ventures. Federal construction projects boomed. With some irony perhaps, the New York Stock Exchange was established in 1817, and the investment banking business was born. The boom was in full swing with all the tipsy mirth of boom-time optimism. Yet underneath this grand house, there were monetary termites gnawing at its foundations.
It soon became clear that the monetary situation was in bad shape, with a return to specie payments becoming increasingly untenable. A nationwide return to specie would not be possible without a massive contraction in credit. The Second Bank of the United States was authorized to help ameliorate the situation by issuing notes that were required to be redeemable in specie. Such high hopes for the Second Bank were soon dashed. As Rothbard reports, "the Bank, indeed, was not averse to a credit expansion of its own…The boom therefore continued in 1818, with the Bank of the United States acting as an expansionary, rather than as a limiting, force."
The bust phase of the business cycle plants its seeds in the rich soil of the preceding boom, fraught as it is with errors and malinvestments, and the Panic of 1819 was no different in this regard. "Troubles and strains … began to pile up as the boom continued," Rothbard observes.
Bank notes began to trade at significant discounts to specie. This made it particularly difficult for those banks that were redeeming notes with specie to maintain reserves of specie in their vaults. The banking system was suffering a specie drain, and it soon became evident that note expansion and specie payments could not coexist for much longer.
Rothbard writes, "Faced with these threatening circumstances, the Bank of the United States was forced to call a halt to its expansion and launch a painful process of contraction." Monetary contraction is a tart but cathartic prescription for a return to sobriety and solvency. Notes were redeemed, loans were called, and the specie drain reversed. The monetary contraction, which lasted through 1820, was not without consequences, of course. For one, there was a wave of bankruptcies, bank failures, and bank runs. The financial panic led to a scramble for cash. Prices dropped, particularly for commodities, but also for real estate.
The country also began to experience a phenomenon that would characterize and dramatize later depressions: widescale urban unemployment.
As with all economic depressions, the Panic of 1819 brought forth many calls for reform and change. Much of Rothbard’s book discusses, in detail, the arguments and proposed remedies that were bandied about in the nation’s media outlets and political arenas. The proposed remedies that occupied much of the focus of the debate were debtors’ relief, monetary inflation, and a protective tariff.
Debtor’s relief--in the form of stay laws and minimum appraisal laws (which held that "no property could be sold for execution below a certain minimum price, the appraised value being generally set by a board of the debtors’ neighbors")--was adopted by several states. The collapse of money and credit during the depression had increased the purchasing power of the dollar, and land prices fell. Therefore, debtors were repaying debt with dollars that were worth considerably more than when they were borrowed. Among the debtors were those who had purchased public land from the government under liberal credit terms. By 1819, there was a sizable mass of debt payable to the government from these landholders. The federal government, too, liberalized these debtor contracts to assist debtors.
Opponents of these relief bills argued that such measures only worsened the depression and delayed the recovery, because creditors would become gun-shy about lending more money, which was seen as critical to the recovery. Further, there was moral argument that debtors sans relief would, in Rothbard’s words, "be forced to hew to the virtues of thrift and hard work, the only long run basis for prosperity."
There were also those who supported renewed monetary expansion. Since all banks, excluding the Bank of the United States, were chartered by the states, much of the debate took place at the state level. The arguments of the inflationists were little different from those used today. They argued that the increased supply of money and credit would stimulate business and restore prosperity. There were a number of schemes promoted with this goal in mind, most of which involved inconvertible paper money.
What was interesting about this debate was that Rothbard could write, "the sound money opponents of such schemes formed a majority of leading opinion." How different from today! The main charge against the inflationsists was the eminently sensible one that any such inconvertible currency would only ensure depreciation of the currency. However, in building their arguments, the hard-money men had begun to formulate a monetary explanation of the business cycle "seeing the cause of the depression in an expansion of bank credit and money supply, a subsequent rise in prices, specie drain abroad, and finally contraction and depression."
Counterproposals from these groups attempted to restrict the expansion of credit. Many plans were put forward including 100-percent reserves(!). A currency backed by 100-percent reserves would be unable to expand to create the kind of unstable booms of the pre-1819 period. Public opinion was also quite hostile to the Second Bank of the United States, which had started the contraction process going (albeit out of necessity).
Finally, too, there were those who argued for a protective tariff. They believed this would ensure a home market, as well as the prosperity of a number of domestic businesses. Opponents saw this for what it was: an added tax on consumption. These opponents also saw that such protective measures would aggravate the depression. These debates vary little in substance from what we hear today from protectionist groups.
Delightfully, there were still many laissez-faire partisans who argued against all of these interventions and believed that solutions could only come from the market itself through liquidation and a return to fundamental virtues (such as thrift and hard work). One of these expositors was Willard Phillips, a leading Federalist and New England lawyer. Rothbard writes,
Phillips declared it outside the province of the legislature or of political economists to concern themselves with the state of trade or its profitability. For this [quoting Phillips] "is a question which the merchants alone are acquainted with, and capable of deciding; and as the public interest coincides directly with theirs, there is no danger of its being neglected."
Unfortunately, economics is not a laboratory where we can implement each side’s proposals and compare the results. History will be subject to interpretation, and as a complex and unique experience, it cannot be made to prove economic theories. In any event, the economy did start to improve by 1821, and a slow recovery began to take shape. "The painful process of debt liquidation was over," Rothbard writes, "and the equally painful process of monetary contraction had subsided."
Unlike the cycles that occupied the thinking of the ancient Greeks such as Herodotus, business cycles are not destined by fate, nor are they natural events like tropical storms or volcanic eruptions. Business cycles are contrived; they grow out of previous errors made during the boom and are symptomatic of a rotten monetary system burdened with inconvertible paper money, and hence, credit and monetary expansion. Although there are many differences between today’s economy and that of 1819, the parallels and commonality are what make for absorbing reading.
July 17, 2002
Christopher Mayer is a commercial lender for Provident Bank in the suburbs of Washington, D.C. Feedback invited to: CWMAYER@provbank.com