Wednesday, June 23, 2010

American Depressions Before 1929

Before 1929, periodic booms and busts were a regular feature of the economic system. I focus on US booms and busts, not because no one else had them, but simply because the US is the country I know most about.

The panic of 1819. This can be viewed as a ,classic Austrian depression caused by the central bank continuing to spike the punch long after the party got out of hand, a lesson in the danger of slamming on the brakes too fast, or and adjustment to life after the Napoleonic Wars. The US government financed the War of 1812 without a central bank by loans from private banks. Private banks often over-issued currency, leading to out-of-control inflation and speculation. The Second Bank of the US was founded partly to finance government, especially any future wars, and partly to issue a sound common currency. Instead, it encouraged state banks in their lending sprees. People also took advantage of easy credit to buy western land from the government. At the same time, Europe was adjusting to life after the Napoleonic Wars. During the war and in the immediate aftermath, Europeans were importing vast amounts of American farm products and not competing with American industry. As Europe began to recover, its imports dropped and exports grew. The Bank of the US sought to curb inflation by calling in loans and demanding payment in hard currency. Crash ensued, many banks failed, and countless people went bankrupt. Growth resumed in about two years, though effects lingered well into the 1820's.

The panic of 1837. The US government deposited its tax revenues in the Bank of the US and borrowed from the Bank to fund its operations. The Bank also acted as a private bank, making loans to private parties. Andrew Jackson was an inveterate haters of all banks, especially the Bank of the US, in part because of the events of 1819. At the time Jackson became President, the US was running huge surpluses and rapidly paying down the national debt. Jackson resolved to refrain from either spending the surpluses or cutting taxes until the debt was paid off. His goal, in part, was that if the US government no longer had any debts, it would no longer need a bank. The plan succeeded. Jackson paid off the national debt (the only time in US history, and perhaps the only time in the history of any major country). He then vetoed a recharter of the Bank in 1836, withdrew all federal funds, and distributed them among private banks.

Private banks responded with a vast orgy of dubious lending, with rampant inflation and speculation. In effect, Jackson fired the people who take away the punch bowl before the party gets out of hand, raided their liquor cabinet, distributed the contents, and was shocked -- shocked -- when the party got out of hand. His shock was genuine, by the way; Jackson hated speculators as much as he hated banks; indeed, he hated banks for encouraging speculation. He therefore slammed on the brakes, demanding gold and silver for all purchases of federal land. (Selling federally owned western land to private parties was one of the biggest sources of speculation). The country plunged into depression and took six years to recover.

The Long Depression, 1873-1893. Though less steep than the Great Depression, the Long Depression was also world-wide and persistent. Its origins are somewhat mysterious, and there is some dispute whether it was a single depression or a series of recessions. A major cause in the US appears to have been overbuilding of railroads, which had reached its limit. When the Great Northern railway failed, it brought down the Jay Cooke Investment Bank, and panic followed. (Many European countries appear to have had similar overbuilding and crashes in railroads). Tight money policies in the United States and Germany, with a insistence on a gold-only standard also contributed. (This is not a favorite depression among Austrians). French war reparations following the Franco-Prussian War and a wave of international protectionism have also been singled out as contributing factors.

The Panic of 1907. Interestingly, this and not the Great Depression, is the one pre-1990's financial crisis that Paul Krugman's book describes at length. It began when the Knickerbocker Trust (similar to a bank, but not quite the same) lent too much money to a set of speculators trying to corner the market on United Copper Company stock. The effort failed and bankrupted both the speculators and United Copper. This started a run on Knickerbocker Trust and the speculators' banks. Soon panic spread to the other trusts and threatened banks as well. (There was no central bank at the time, but New York banks made some attempts to insure each other. Trusts were not covered by the agreement).

The problem was that J.P. Morgan was out of town that week. As soon as he got back, Morgan (who had already bailed out the US treasury in 1893!) audited threatened institutions and determined which ones were sound. He joined forces with John D. Rockefeller and provided a sufficient infusion of cash to keep the sound banks from failing. He then summoned the presidents of all the city banks to his office and told them the stock market would fail unless they raised $25 million to loan it within 10 minutes. He also directed how this infusion of cash would be used. He followed up by loaning $30 million to New York City to keep it from going bankrupt, buying out a failing brokerage firm, and order the stronger trust companies to put forward $25 million to protect the weaker ones. Finally he persuaded Teddy Roosevelt to waive anti-trust objections -- before the stock exchange re-opened.

If only we had had J.P. Morgan in 2008 to provide $700 billion in TARP money taxpayers would have been off the hook! But that sort of power in a private citizen scares people. Besides, although J.P. Morgan saved the banking system, he did not really save the economy. It had been in decline since before the crisis, and took a turn considerably for the worse after.

It was also this crisis that persuaded the United States that we really needed a central bank. J.P. Morgan was just not an adequate substitute. The Federal Reserve was established in 1913. Many conservative economists blame it for the Great Depression.



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