#72 The Panic of 1819

In our post of The Panic of 1837 I briefly touched on how the Panic of 1819 led to a revival in Jeffersonian economic thinking. The Panic of 1819 was the first widespread financial crisis in the young nation.

Traditionally, American wars have coincided with expansion and consolidation of banking powers which brings with it massive expansion of a worthless monetary base, to an economic peril. This panic was caused by a massive monetary expansion created by banks during the Napoleonic wars, particularly the US’s involvement in the War of 1812.

The war of 1812 was essentially a trade war, the far less often discussed second war with Britain who was blockading French-American trade routes in the greater context of the Napoleonic Wars. In order to procure the necessary goods required for the war, huge quantities of new bank notes were created in order to purchase government bonds.

To quote Rothbard:

“from 1811 to 1815 the number of banks in the country increased from 117 to 212; in addition, there had sprung up 35private unincorporated banks, which were illegal in most states but were allowed to function under war conditions. Specie in the 30 reporting banks, 26 percent of the total number of banks of 1811, amounted to $2.57 million in 1811; this figure had risen to $5.40 million in the 98 reporting banks in 1815, or 40 percent of the total. Notes and deposits, on the other hand, were $10.95million in 1811 and had increased to $31.6 million in 1815among the reporting banks.”

Essentially, the US government was financing its war operations with massive amounts of inflated bank notes, which when called due to be settled in specie sparked a near nationwide bank insolvency. In 1814, the US government gave the go ahead for all banks to temporarily suspend redemption of specie, but to remain open and continue their expansion of debt unabated.

Rothbard explains:

“Reporting banks increased their pyramid ratios from 3.17-to-1 in 1814 to 5.85-to-1 the following year, a drop of reserve ratios from 0.32 to 0.17. Thus, if we measure bank expansion by pyramiding and reserve ratios, we see that a major inflationary impetus during the War of 1812 came during the year 1815 after specie payments had been suspended throughout the country by government action.”

Rothbard goes on to explain that although during this particular point in time there was no central bank in the United States (the National bank charter had lapsed under Jefferson) and historians often point to this as the reason for such unchecked credit expansion, that this monetary expansion was similar to other expansionary periods which happened under the First and Second National Bank and under the Federal Reserve system. It was coercion by the Federal Government, to secure war time funding, which drove such a massive expansion of bank notes and credit, despite the lack of a central bank overseeing the process in this particular instance.

The Federal Government also issued large amounts of treasury notes which were “quasi-legal tender” and redeemable in specie one year after issuance. These notes took on a monetary role and were widely circulated and drove specie out of circulation (Gresham’s Law).

The effects of this massive monetary and credit expansion should be no surprise if you’ve been paying attention.

Rothbard:

“Wholesale price increases from 1811 to 1815 averaged 35 percent, with different cities experiencing a price inflation ranging from 28 percent to 55percent. Since foreign trade was cut off by the war, prices of imported commodities rose far more, averaging 70 percent.44Butmore important than this inflation, and at least as important as the wreckage of the monetary system during and after the war,was the precedent that the two-and-a-half-year-long suspension of specie payment set for the banking system for the future.From then on, every time there was a banking crisis brought on by inflationary expansion and demands for redemption in specie, state and federal governments looked the other way and permitted general suspension of specie payments while bank operations continued to flourish.”

All of this new money and credit, in conjunction with rising commodity prices, set on an inflationary boom in 1817 which led to the deflationary bust in 1819 as the economy was snapped back to reality.

“Contraction of money and credit by the Bank of the United States was almost unbelievable, total notes and deposits falling from $21.9 million in June 1818 to $11.5 million only a year later. The money supply contributed by the Bank of the United States was thereby contracted by no less than 47.2 per-cent in one year. The number of incorporated banks at first remained the same, and then fell rapidly from 1819 to 1822,falling from 341 in mid-1819 to 267 three years later. Total notes and deposits of state banks fell from an estimated $72million in mid-1818 to $62.7 million a year later, a drop of 14percent in one year. If we add in the fact that the U.S. Treasury contracted total Treasury notes from $8.81 million to zero during this period, we get the following estimated total money supply: in 1818, $103.5 million; in 1819, $74.2 million, a con-traction in one year of 28.3 percent.”

A massive liquidation event followed this contraction, as widespread mal-investment across the country was realized. Real estate values crashed and commodity prices across the board plummeted as well. “Bankruptcies abounded, and one observer estimated that $100 million of mercantile debts to Europe were liquidated by bankruptcy during the crisis.”

-Collin

Book of the Month:

The Road to Serfdom by F A Hayek

-“The word ‘truth’ itself ceases to have its old meaning. It describes no longer something to be found, with the individual conscience as the sole arbiter of whether in any particular instance the evidence (or the standing of those proclaiming it) warrants a belief; it becomes something to be laid down by authority, something which has to believed in the interest of unity of the organized effort and which may have to be altered as the exigencies of this organized effort require it.”

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