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Panic of 1819 -- and 2002

verfasst von --- ELLI ---, 16.07.2002, 15:32

http://www.mises.org/fullstory.asp?control=1000

Panic of 1819--and 2002

 

by Christopher Mayer

[Posted July 16, 2002]

"Of all men's miseries the bitterest is this: to know
so much and to have control over nothing." --Herodotus

[img][/img] 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.

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,

<blockquote style="MARGIN-RIGHT: 0px">

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."

[/i]

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.

<hr align="left" width="33%" SIZE="1">

Christopher Mayer is a commercial lender for Provident Bank in
the suburbs of Washington, D.C.  Send him MAIL and
see his Mises.org Articles
Archive.



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Panic of 1819 -- and 2002 - --- ELLI ---, 16.07.2002, 15:32