How good are your pattern recognition skills? If you remember our previous two posts covering the panics of 1907 and 1893 you would recall that a common theme presents itself. Periods of artificial monetary expansion, which sends false signals to the markets, followed by periods of monetary contraction or a stop to monetary expansion, leading to a ripple effect of painful mal-investment liquidation. And secondly, government spending artificially moving the needle for speculators in particular industries.
Well if you remember that, this panic will be eerily familiar to you.
Following the end of the American Civil War, a railroad construction boom took place across the continental United States. Between 1868 and 1873 33,000 miles of railroad track were laid across the country, creating countless new jobs and a boom in manufacturing and procurement of the necessary raw goods. At the heart of this expansion was government land grants and subsidies to the railroads, inviting a large influx of speculators into the booming sector.
In 1871, the German Empire halted minting of its silver Thaler coins, and as much of the global silver production was happening in America at the time, this caused a global depression of the demand and price of silver. In response to these events, the US government passed the Coinage Act of 1873.
The Coinage Act of 1873 repealed the ability of individuals holding silver bullion to have their metal minted into coins (at a considerable premium paid at the expense of the US government) and moved the nation strictly to a gold standard. Prior to this halt in monetary expansion the pegged exchange rates between gold and silver, which were set by the treasury, created a fiat face value on US minted silver dollars.
As a result, money supply contracted and interest rates rose as the painful effects of the liquidation of mal-investment rippled across the country. These two events (the end of a government induced railroad boom and a government decreed period of monetary expansion) set the country into a time of economic crisis remembered as The Panic of 1873. Demand for railroad bonds became almost non-existent, and financial firms and insurance companies found themselves in dire straits. Farmers could no longer meet their debt obligations as they had overextended their operations thanks to the false signals of monetary expansion.
Following the collapse of The Cooke & Company financial firm in 1873 a cascade of bank failures followed, including a 10-day closure of the New York Stock Exchange. 55 of the nation’s railroads went belly up and an additional 60 went bankrupt over the course of the following year. New rail line construction dwindled from 7,500 miles in 1872 to a mere 1,600 miles in 1875. Over 18,000 businesses failed between 1873 and 1875.
Every sector of the US economy suffered as a result. But rest assured every fiat historian and economist seizes this as yet another example of the “the failure of the gold standard”, refusing to acknowledge the role government monetary policy played in pumping up the crisis before poking it with a red hot pin of deflation.
The refrain of gold standard era monetary crises, you will find, is consistent. Artificial expansion of the money supply via a fiat bimetallism peg, followed by a painful snap back to reality and the liquidation of mal-investment. Distortion of market signals hurts everyone.
Book of the Month:The Price of Tomorrow: Why Deflation is the Key to an Abundant Future
-“Today we are in that scenario. The continual growth and inflation we expect- the system we’ve built our nations’ economies around- is ceasing to exist. Technology is a deflationary force so great that, in the end, nothing we do will stop it.”
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