Financial panic,
that is. With the stock market going up
and down like a yoyo, many people are giving in to panic. The irony is that while some panic over the
effects of the Covid-19 virus is understandable if not entirely rational, the
frenzy over the financial markets is completely irrational. People appear to be confusing the secondary
stock market with the primary productive market.
Here’s a
surprising fact. The “financial panic”
is a fairly recent thing in human history and has an identifiable cause:
manipulation of the money supply combined with issuing money not linked to or
backed by something of value.
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| John Law and the Mississippi Scheme |
The first
financial panic of note in modern times was the so-called “Mississippi
Scheme” of John Law sponsored by the government of France in the early
eighteenth century. The idea was that
the development of the Mississippi Valley, then owned by France, could be
financed by issuing shares and money backed by the future profits of
development.
Two things went
wrong. One, instead of concentrating on
the potential for trade and agriculture, it was believed that there were
significant deposits of gold, silver, and gemstones such as the Spanish had
found in their colonies. There weren’t. Two, the speculative frenzy that seized
France caused many people to think that the shares in Law’s company and the
banknotes backed by the shares, were somehow valuable in and of themselves.
The Regent, duc
d’Orleans (after whom New Orleans is named), took over the project and — going
directly contrary to the advice of Law — cranked up the printing presses,
flooding the country with fiat money.
The economy crashed, and France took years to recover.
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| The South Sea Bubble |
The English
South Sea Bubble was a little different. This time it was not the government, but the
private sector that went wild. On the
strength of an ephemeral claim to be able to secure a license to trade with the
Spanish colonies in the Caribbean and along the Atlantic coast of South
America, the “South Sea Company” sold shares that almost immediately started
rising in price before any license had been secured.
People went
insane for stock speculation, thinking it the easy road to endless wealth. Companies formed for every conceivable reason
(even none), floated shares, and collected immense amounts in capitalization to (in one instance and this is not made up) generate sunlight from cucumbers. Everybody and his brother was buying and
selling shares in corporations. When the
crash came, tens of thousands of people were wiped out — and also found
themselves personally liable for the debts of the corporations in which they
had invested when the “projectors” who floated the companies took their loot
and headed for the continent beyond the writ of English law. (Limited liability was not generally
available for English corporations prior to the late nineteenth century except
by special act of parliament.)
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| The Bubbles of 1825, including the Republic of Poyais |
How about the
modern business cycle, which most authorities concede began with the
Panic of 1825? The main culprit
was (again) government having issued massive debt to finance the Napoleonic Wars instead of borrowing from existing
savings. The new “paper pound” was
backed by government bills of credit instead of private sector hard assets.
At the same time,
there were some shady private sector doings, such as the “Republic of Poyais”
organized by the Cacique and Knight of the Green Cross, Sir Gregor
MacGregor. The presumed country issued
currency and emitted debt that traded on the London Exchange. With both the government and the private
sector issuing unbacked paper, the value of shares on the London Exchange
plunged when the public lost confidence in the government and in the financial
system.
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| Hard Times of the 1830s and 1840s |
As for the
Panic of 1837, that resulted from the “War on the Bank” when Andrew
Jackson got mad at the Second Bank of the United States for not giving a job to
a friend of his. Then Nathan Biddle used
unethical, possibly illegal means to lock in the Bank’s recharter ahead of
schedule to forestall Jackson, whereupon Jackson used unethical, possibly
illegal means to remove federal deposits from the Bank and prevent the Bank’s
recharter.
Jackson then
issued “the Specie Circular,” prohibiting receipt of anything except gold or silver
in payment of taxes or for purchases of land from the federal government. As banknotes and credit instruments accounted
for 99% or so of the U.S. money supply at the time (and land sales were the single largest source of revenue for the federal government), credit dried up, a
depression immediately ensued and lasted until the mid-1840s, capital formation
virtually halted, and several states that had heavily invested in infrastructure
declared bankruptcy.
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| The Panic of 1893 |
The Panic
of 1873? Banks overextended
credit to railroads that went on a building frenzy, temporarily outstripping
the market demand for rail transport. Most
farmers, ranchers, and western businessmen couldn’t get credit for development
the way the railroads and eastern manufacturers could, and demand for transport
lagged far behind supply. Railroads
couldn’t make debt service payments and failures had a ripple effect throughout
the economy. A serious drop in the price
of silver due to falling demand also sent shock waves through the economy. This caused the Great Depression of
1873-1878.
The Panic
of 1893? The price of silver
fell drastically, European investors liquidated their U.S. holdings, demanding
payment in gold. Commercial bank gold
reserves were depleted as foreign investors refused to accept the inelastic,
debt-backed National Bank Note reserve currency. With reserves depleted and no central bank to
supply additional reserves combined with an inelastic reserve currency backed
only by government debt, commercial bank reserves became inadequate, and the
banks began cutting off credit to businesses and calling loans. This caused the Great Depression of 1893 -1898.
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| They do start to look a bit alike, don't they? |
The Panic of 1907?
J.P. Morgan took the opportunity to shut down a competing bank that had gotten
into trouble speculating in copper. He
cut off clearinghouse privileges and refused to extend an emergency loan. As panic spread after the rival bank closed its
doors, Morgan offered to take over the rival bank’s assets and make good on all its
deposits and other obligations, bringing the panic to a halt. He then took credit for stopping the panic he
created.
The Panic of
1907, “the Bankers’ Panic,” resulted in the Pujo Commission, the 1913 report of which, Concentration of Control
of Money and Credit, was instrumental in the passage of the Federal Reserve
Act of 1913. Key goals of the Act were
to oversee clearinghouse operations, provide adequate liquidity for
agriculture, industry, and commerce, establish and maintain an elastic, stable,
uniform, asset-backed reserve currency, and retire the federal debt. (Today’s Federal Reserve still oversees
clearinghouse operations and provides an elastic reserve currency.)
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| Yeah. 1929. You can tell by the neat vintage cars. |
The Crash
of 1929. “The Big One” according
to most people. Massive money creation
by private sector banks for stock market speculation grossly inflated the value of shares on the
secondary market. When speculators panicked,
shares plunged in value. This began a
monumental sell-off, made worse by the need to meet margin calls on speculative
share purchases.
Based primarily
on the mistaken belief that commercial loans are made out of reserves, banks
immediately stopped extending all new credit for any reason, and were cautious
about renewing existing loans to business.
Instead of renegotiating loans for a missed interest payment or extending
time, banks were forced to “call” loans, i.e., loans became due and
payable in full as the result of a single missed payment. The fall in the value of assets used for
collateral contributed to the increase in called loans when borrowers couldn’t
meet the required ratio of debt to equity.
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| Harold Glenn Moulton |
In the opinion of
Dr. Harold G. Moulton, president of the Brookings Institution, the Great
Depression of 1930-1940 was greatly exacerbated by the Keynesian New Deal
intervention and the massive issue of inflationary fiat money backed only by
government debt. In Moulton’s opinion,
the real economic problem was a temporary overstock of certain consumer
durables, coupled with banks cutting off credit to productive businesses as
well as to the speculators. The real
answer, as he maintained in The Formation of Capital (1935) was to
restore a sound money supply, and limit new money creation by the commercial
banks to productive business purposes.
Instead, under
the influence of Fabian socialism and Keynesian economics, what the U.S. got
was a currency backed exclusively by government debt, inflation, growth of
government at the expense of the private sector, reliance on past savings to
finance growth ossified into political and economic dogma, and the “Depression
Within the Depression” of 1936-1937.
Instead of a Great Depression lasting five years like the previous ones,
it lasted more than a decade, and it took World War II, not Keynesian
economics, to end it.
The Housing
Bubble. In an old story, massive money
creation for home mortgages and a few shady practices among lenders and other
financial institutions led to a crash in the housing market that spread to
other sectors of the economy and resulted in “the Great Recession.” After nearly two-hundred years of currency
manipulation, and the powers-that-be still haven’t figured out that you don’t
solve economic problems by making them worse.
Anyway, that’s a
very brief summary of financial panics and their aftermath over the past two
centuries. In the next posting on this
subject we will look at the current panic and discuss what might be done about
it.
#30#
