Tuesday, July 5, 2016

Wilson and the Fed, XIII: The Silver Question

Reform proposals to straighten out the financial system in the United States began almost immediately following the Panic of 1893. The most feasible was probably the “Baltimore Plan” of 1894.[1]

The Baltimore Plan was similar to what had been tried a number of times before, and rather successfully. The Plan itself was directly modeled on the Canadian system. Participating banks would contribute to a fund to cover note issues, thereby guaranteeing reserves in the event of a panic without the necessity of a central bank.[2]
Free Silver
Free Silver adherent run over by "Sound Money"
Before any action could be taken, however, the presidential campaign of 1896 diverted attention to “free silver.”[3]  This was not such a leap as might otherwise be presumed. The groundwork had been laid for the Panic by a sharp decline in the value of silver relative to gold. As a result, the Indian silver rupee dropped in value against the British gold pound.
Anyone in India importing goods from Britain (or, as in the case of British army officers paid in rupees sending money home), had, of course, to purchase British pounds to do so. As the value of silver relative to gold declined, British gold pounds[4] cost more in terms of Indian silver rupees. Imported goods also cost more in terms of rupees, and fewer pounds could be purchased to send home.
British India was at this time still the world’s largest market for silver. There were years in which “the Jewel in the Crown” bought up a third of total world production — and silver was a major U.S. export.
To try and drive up the market price of silver relative to gold, the British closed the Indian mints to free coinage of silver. This caused a significant drop in worldwide demand — and a serious drop in the market price of silver.
Gold, Silver, and Finance
The loss of a major silver market sent shock waves through world financial markets. These had already been weakened by a series of scandals and crises that had serious repercussions in the United States. Even then, the Panic might have been averted had American commercial banks continued to make loans and accept bills for discounting and rediscounting.
Unfortunately, with the shakeup in the world financial markets, foreign investors in U.S. companies stopped reinvesting their earnings. They demanded not only payment of dividends and interest that had previously been reinvested, but in some cases full liquidation of their holdings.[5]
Investors naturally wanted their money in gold, not silver or bills of exchange. This caused an immense drain of gold from U.S. reserves, both from private banks and from the U.S. Treasury.
Debt-backed National Bank Note reserve currency.
As gold was a reserve currency, this lowered commercial bank reserves. Given the fractional reserve requirement and an inelastic reserve currency that was being drained out of the country, banks in the U.S. prudently stopped lending. They began calling loans to maintain required reserve ratios.  Companies that a few months previously had been blue chip investments found themselves in receivership. The country suddenly found itself in a depression.
“Hard money” and even the debt-backed paper reserve currency — the United States Notes (the “Greenbacks”), the National Bank Notes, and the Treasury Notes of 1890 — were hoarded. A “currency famine” ensued.[6]
With the return of prosperity in 1897 and 1898 following bumper crops of wheat in those years in the U.S. coupled with crop failure in Europe, pressure for reform let up. The Indianapolis Monetary Commission of 1898 made recommendations for substantial changes in the banknote currency, primarily a shift from government debt backing, to private sector asset backing in the form of commercial paper, i.e., bills of exchange.[7]
The Spanish-American War intervened, however, and again nothing was done. The Currency Act of 1900 allowed for a rapid expansion of the debt-backed National Bank Note currency, but did nothing to shift to asset backing, or make the asset-backed reserve currency truly elastic, i.e., directly responsive to the rate and level of economic growth.

[1] Moulton, The Financial Organization of Society, op. cit., 526.
[2] Ibid.
[3] Ibid.
[4] Although the British pound was referred to as the “pound sterling,” having been based originally on the Roman pound of sterling (.925) silver, Great Britain had adopted the gold standard with the “New Coinage” of 1817.
[5] Cf. Harold G. Moulton, The New Philosophy of Public Debt. Washington, DC: The Brookings Institution, 1943, 84.
[6] Gerald T. White, The United States and the Problem of Recovery after 1893. University, Alabama: The University of Alabama Press, 1982, 3.
[7] Moulton, The Financial Organization of Society, op. cit.

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