What Really Happened – The Panic of 1873, pt. 3

Backbencher March 20, 2013 0

Allrik Birch,

 

The Panic of 1873 has many similarities to earlier crashes, with government investment helping to build an industry that later collapsed. As with other crashes, speculations were heavily involved in the Panic of 1873, as Stedman (who worked in the New York Stock Exchange at the time) explains; ‘every general breakdown [is caused by] boastful prosperity. This root is rank speculation, [the panic] of 1873 [was] a railroad panic, . . . the fundamental cause . . . was the excessive passion for speculation, which inflated credit to the bursting point.’[1]

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Of course, as mentioned, 1873 had its own bubble, and like many American panics before it, railroads were involved – although this time, much more centrally so. During the 1860s the federal Government gave out land grants, kept interest-rates low and introduced other measures to deliberately induce railway building. The famous and poorly built First Transcontinental Railroad was completed in 1869 with huge subsidies (although the lines had to be partially rebuilt taking the process of building up until 1874).[2] In the five years up to 1873, nearly 30,000 miles of railroad were built.[3] When the bubble burst, the blame on government was clear, ‘men were infatuated with projects for building steel highways, and they were aided and abetted by the Government. It is a question still debated, whether the Government ought ever to afford an artificial stimulus to any sort of industry. In the railroad era beginning with 1862 the wisdom of the Government’s interference was certainly not proved beyond doubt.’[4]

Stedman explains the failure as one of cheap credit from the civil war, and people amassing debts upon their perceived wealth. ‘Individuals borrowed heavily to invest in everything that promised quick fortunes, and controllers of Capital not only were eager to lend but actively engaged in helping out new enterprises.’[5] This then, was a speculative bubble based on cheap credit. As Sumner highlights in his History of American Currency, paper money systems are expansionary in nature, and no matter how much those in power promise not to over print, the money supply will expand; ‘A man might as well jump off a precipice intending to stop half way down.’[6] Sumner, in explaining the causes of these such crises, suggests that the expansion of credit is the cause, backing his case up with historical evidence from the Massachusetts colony.[7] The suspension of specie payments was down, he says, entirely to the over-issuance of paper currency, and ‘when the paper is withdrawn, prices fall, speculation is restrained, specie flows in.’[8] He strongly argues that the problems are down to the speculations caused by the expanded paper credit – not even mentioning silver demonetization in his conclusion. ‘The panic . . . of ’73 resulted from the schemes of men who succumbed to the hypnosis of railway projection.’[9]

Many states also offered huge financial aid to railroad building[10] during the 1860s, leading to a boom in railroads building and in related industries such as iron. There was a huge expansion in railway building leading up to and peaking just before 1873 (a similar situation is to be seen before the crashes of 1837, 1857 and 1893). Between 1865 and 1873 the railroad mileage was doubled.[11] Not only was mileage doubled, but the debt on railroads in the form of bonds saw a five-fold increase in just seven years from 1867 to 1874![12] During this period, paper circulation increased by 750 million dollars, hardly a sign of a constricted money supply.[13] These two points together paint a picture that should be clear to the reader now; a huge increase in the money supply helped to create a speculative wave, this time concentrated in railroads.

The debt seems massive in scope, to the point of absurdity, but: ‘All that was necessary was an economic situation where extreme pessimistic forces were absent.’[14] The bubble mentality, the idea that this time is different, once again took hold. Looking back it is easy for most to see the idiocy of many of the bad investments, but as always, only a very small (ignored) number understand and point out the problems in advance. Some people were indeed critical of the ongoing rush to build railroads, the great railroad tycoon, Cornelius Vanderbilt is recorded as saying “I am a friend of the iron road, but building railroads from nowhere to nowhere at public expense, is not a legitimate undertaking.”[15] Such comments from a man who made his fortune in the same sector should have forced ears to be opened, but as is typical when in the middle of a speculative craze, sober voices are ignored in favour of the prospect of quick profits.

The high investment in railroads led to the downfall of the industry, with Jay Cooke having to lend from his own bank to back up the Northern Pacific railroad that he had promised investors return of. When his bank was unable to meet it’s requirements in the autumn, it collapsed, being the spark that caused the panic.[16] As Jay Cooke was a highly reputable banker (at least in the eyes of the majority), the failure of his bank had a major impact on the views of other banks. It is apparently the case that a newsboy was arrested for shouting “All about Jay Cooke’s failure!”, such was the seemingly inexplicable nature of his downfall.[17] However, as Stedman notes; ‘The real crisis, the testing hour, arrived when the greatest banking house of America failed in its attempt to finance an unproductive railroad. This failure, which precipitated the crash, was typical of the whole depression. For the speculation of the era had taken the form of railroad building.’[18]

Following the failure of Jay Cooke & Co., the Union Trust Company and other companies suspended activities, and the New York Stock Exchange was closed for an incredible ten days. The government stepped in to aid the situation by issuing $26 million of Greenbacks, which seemingly did nothing to arrest the situation, the bad loans had been revealed as what they were. Speculation was halted and the market correction or liquidation of bad debt begun, but this process endured for another five or six years. The damage that results from this false boom was certainly of major consequence.[19]


[1]    Stedman, Edmund Clarence (Eds.), The New York Stock Exchange: Volume I, p. 261.

[2]    DiLorenzo, Thomas J., How Capitalism Saved America, pp. 116-7.

[3]    Collman, Charles Albert, Our Mysterious Panics 1830-1930, p. 98.

[4]    Stedman, Edmund Clarence (Eds.), The New York Stock Exchange: Volume I, p. 262.

[5]    Ibid., pp. 261-2.

[6]    Sumner, William Graham, A History of American Currency, pp. 214-5.

[7]    Ibid., pp. 219-20 & 14-39.

[8]    Ibid., pp. 330-1.

[9]    Collman, Charles Albert, Our Mysterious Panics 1830-1930, p. 110.

[10]  Moore, A.B., Railroad Building in Alabama During the Reconstruction Period in The Journal of Southern History, Vol. 1, No. 4, Nov., 1935, p. 422.

[11]  Isard, W., Transport Development and Building Cycles in The Quarterly Journal of Economics, Vol. 57, No. 1, Nov.,1942, p. 103.

[12]  White, R., Information, Markets and Corruption: Transcontinental Railroads in the Gilded Age in The Journal of American History, Vol. 90, No. 1, Jun., 2003, p. 22.

[13]  Collman, Charles Albert, Our Mysterious Panics 1830-1930, p. 99.

[14]  Isard, W., Transport Development and Building Cycles in The Quarterly Journal of Economics, Vol. 57, No. 1, Nov.,1942, p. 106.

[15]  Stedman, Edmund Clarence (Eds.), The New York Stock Exchange: Volume I, p. 261.

[16]  White, R., Information, Markets and Corruption: Transcontinental Railroads in the Gilded Age in The Journal of American History, Vol. 90, No. 1, Jun., 2003, p. 29.

[17]  Collman, Charles Albert, Our Mysterious Panics 1830-1930, pp. 102-4.

[18]  Stedman, Edmund Clarence (Eds.), The New York Stock Exchange: Volume I, p. 262.

[19]  Sumner, William Graham, A History of Banking in all the Leading Nations, vol. 1 (U.S.A.), p.420.

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