When Panic Hits

Rolf Strom-Olsen

It began with a period of unfettered growth, lax monetary policy and a sharp increase in speculative investing in a sector that seemed to herald unlimited growth and opportunity. Credit was easy to come by and it seemed a safe bet, especially since the most trusted financial entities were all heavily involved. A raft of new players offered increased investment opportunities and investors flocked to the market: there was money to be made, and plenty of it. Concerns over the underlying financial viability became increasingly ignored. Then, in late summer, one of the major players abruptly discovered it was overextended and was unable to obtain the credit it needed to continue operations. It went bankrupt and the resulting shock wave induced investor panic that roiled financial markets.

This was the Great Panic of 1873, a cataclysmic event that touched off a deep recession that engulfed the United States through 1877 and led to generally lowered economic output globally for two decades, often referred to as the Long Depression. The touchstone for optimism ahead of the collapse was the strength of the US economy after the end of the Civil War in 1865. With the defiant southern States now firmly under heel, future US prosperity was backed by a belief in the potential of Western expansion. That required railways. The advent of a new and extensive railway infrastructure was the logical culmination for the Age of Capital, as the British historian E.J. Hobsbawm has phrased it. The political wrangling over the first US transcontinental railway was sorted out in the tumult of the Civil War - the route was authorised in 1862 and the necessary land grants soon followed. When the War ended, there was a headlong rush to fund and build a vast new rail network all across the United States. The lax monetary policies of a US government still trying to cope with the aftermath of war financing meant that credit was easy to come by. Money poured in. One of the most exciting new players in the sector was the Northern Pacific, chartered in 1864 to build a second transcontinental route across the northern US. The effort to produce a second, northern-running line was significantly bolstered in 1870 when the Philadelphia-based financier Jay Cooke became heavily involved in its financing and raised millions to fund construction.

Heady with the promise of enormous increases in freight and passenger traffic, banks and investors were eager to extend credit. An investment bubble formed, intensified by the continuing availability of cheap capital. But the promise of high returns from freight fees was undermined by heightened competition and lower-than-expected demand. Faced with the prospect of dwindling returns, and exacerbated by rumblings from Europe (the Vienna bourse had collapsed in May of that year), American investors started to sour on the sector. In September of 1873, Cooke's company found it was unable to raise the funds it needed in the marketplace to continue operations. Unable to meet the obligations of its earlier borrowing, the firm abruptly closed its doors on September 18th.

That touched off a profound panic. The New York Stock Exchange closed for two weeks. After years of extending easy credit, banks across the nation suddenly demanded repayment, precipitating a large number of foreclosures. Credit evaporated and the country fell swiftly into a profound recession. Between 1873 and 1877, thousands of businesses collapsed, including half the nation's railroads and, along with them, half the nation's iron producers. A cyclical upturn after 1877 was met with further turbulence and the US economy did not fully recover until the mid 1890s. Faced with the crisis, the administration of Ulysses Grant, a weak and ineffectual president, dithered. To be fair, there was probably not much it could have done. The panic of 1873 was the result of years of cheap money and highly speculative investment, secured more by promise and hyperbole than actual returns.

Financial panics can have many unforeseen consequences. They tend predictably to produce, among other things, a regulatory backlash, changes to monetary policy, populist political grandstanding and protectionism. But they can also have more far-reaching effects.The financial crisis of 1873 led directly to a political realignment in the United States. In 1874, a disenchanted electorate, already fed up with Grant's scandal-plagued administration, gave a decisive victory to the Democrats. That effectively ended hopes of Republican efforts to further reconstruction in the South and improve conditions for millions of newly freed slaves. As the sociologist Charles Lemert has put it, "for Blacks freed after Emancipation in 1863, the Long Depression meant the end of Reconstruction... Freed men and women were thrown back to feudal conditions...." The promise of civil rights for America's former slaves would be tragically deferred (to quote Langston Hughes) by another five generations.

Comments

[Bucephalus]

This is a good posting but I must cavil about one thing :

" The lax monetary policies of a US government still trying to cope with the aftermath of war financing meant that credit was easy to come by. "

The above claim is technically incorrect. After the civil war the US government was on a path toward the resumption of the gold standard which had been suspended during the war. Furthermore it was committed to resuming specie payments at the pre-war parity. That is, since the quantity of the money stock had tripled because greenbacks had been freely printed, returning to a prewar parity meant that the greenbacks were being slowly pulled out of ciculation. So there was actually deflation at the time of the 1873 Panic.

[SRQ]

2008 maybe eerily similar to 1873.