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
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| 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.
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| 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.
#30#
[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.