The Panic of 1893 and the ensuing Great Depression of 1893-1898 revealed serious flaws in the American financial system, flaws that caused the system to operate to the detriment of the non-rich. The National Bank system Salmon P. Chase established during the American Civil War had imposed an inelastic banknote currency on the country. This forced farmers and small businessmen into dependence on existing accumulations of savings to finance capital acquisition and development. This shut the great mass of people out of the phenomenal expansion of commercial, industrial and financial capital that characterized the latter half of the 19th century in the United States.
Only the Homestead Act of 1862 made capital available to the non-rich, and then only in the form of land. Further, developing the relatively small freeholds (a quarter section — 160 acres — in most cases) still relied almost exclusively on past savings for financing — and there was a serious problem. During this period accumulated savings were rapidly depleted. Cash money instead of credit instruments assumed an increasing role in the everyday consumer economy as production for market instead of subsistence farming became the norm. Cash was also required to repay loans taken out during the war when the currency was inflated and prices high. Prices were now falling in response to the elimination of war demand and the boom in production.
To make matters worse, the federal government pursued a policy of deflation of the paper currency. This was to reestablish parity with gold and restore the full faith and credit of the United States after the financial chaos of the Civil War. Chase was in large measure responsible for this, due to his decision to finance the Union war effort by emitting bills of credit (mortgaging future tax collections) instead of raising taxes immediately. Chase wanted to be president, and thus tried to avoid raising taxes until he could no longer avoid it. Money for the average consumer and small producer (usually the same people) was thus becoming increasingly scarce.
At the same time, the rich were able freely to finance the rapid growth of commercial, industrial and financial capital. The rich financed new capital principally by drawing bills of exchange, that is, creating money upon acceptance of their bills. These bills could either be used directly as money through acceptance in the channels of trade and commerce ("merchant's" or "trade" acceptances), or discounted and rediscounted at commercial banks ("banker's" acceptances).
The National Bank system made large scale discounting and rediscounting through the banking system a much safer alternative than in the "wildcat banking" days before the war. This is because the National Banks functioned as commercial banks for the rich as well as banks of deposit for the non-rich and banks of circulation for the federal government. By accepting bills of credit as backing for the National Bank Notes, the federal government circumvented its lack of a specific enumerated power under the Constitution to monetize its debt. (The provision allowing the federal government to emit bills of credit — the "constitutional" or government version of private sector bills of exchange — had been removed from the first draft of the Constitution over this very issue.) The federal and state governments also fostered rapid capital expansion by the rich with land grants, subsidies, and favorable tax treatment.
There was thus the supreme irony — due almost exclusively to the flawed financial system and reliance on existing accumulations to finance new capital formation for small owners — of there being a virtually unlimited supply of money and credit to finance immense production for a few. At the same time, the small producer — the consumer — was faced with a rapidly decreasing supply of money and credit. The result was an enormous increase in production just as the capacity to absorb that production was evaporating due to the decrease in capital ownership among the general population.
As the "free" land available under the Homestead Act ran out, increasing numbers of people were forced into wage system jobs. This was both for their subsistence and for the cash income required to keep the new economy running. Unlike today when consumers can delay the day of reckoning for consumer cash expenditures out of an inadequate wage income, sometimes for years at a time, by creating money by means of the expansion of consumer credit, and through access to State welfare, the propertyless worker of the 1890s had nothing other than wages to generate cash. When forced into unemployment, immediate homelessness and starvation were often only staved off by reliance on private charity, or by simply disappearing to escape debt — creating the popular image in American folklore of the "haunted house" from which the inhabitants had mysteriously vanished.
The response from the populist movement to the Panic of 1893 and the Great Depression was to demand that the government engage in a massive public works program to create jobs. "Coxey's Army" was the first popular demonstration on a national scale that demanded action by the federal government to create jobs and control commerce and industry. After a cross-country march, with some elements coming from as far away as California, remnants of the "army" camped out for months around Washington, DC, living off of charity until finally evicted by the police after accomplishing nothing.
Demands of Coxey's Army and others were similar to those of today, and would have been just as ineffective. Job creation would (allegedly) be financed either by inflating the National Bank Note currency (issuing more federal debt to back the new issues), or permitting "free coinage" of silver. This latter came to be called "silver socialism," as it would undermine private property by shifting purchasing power from creditors to debtors by basing the currency on cheap silver rather than expensive gold, lowering the value of the dollar and making it easier to settle debts.
A strong push was also made for an income tax to equalize the tax burden, the intent being to shift from the heavily regressive ad valorem ("value added") tariffs, sales and property taxes on producers passed through to consumers. An income tax was passed under the Wilson-Gorman Tariff Act of 1894 (ch. 349, §73, 28 Stat. 570) to make up for the anticipated fall in revenue from reducing the tariff, but was declared unconstitutional in 1895 (Pollock v. Farmers' Loan & Trust Co., 157 U.S. 429, 158 U.S. 601).
Contrary to popular myth, the Supreme Court did not declare an income tax unconstitutional per se. The issue was whether an income tax is a "direct" or "indirect" tax. The Constitution did not allow any direct tax to be imposed unless apportioned among the states on the basis of population. This would be manifestly unjust, for a poor state with many inhabitants would pay more in taxes than a rich state with fewer inhabitants.
The 16th Amendment did not make the income tax constitutional. An income tax is, and always has been constitutional (Penn Mutual Indemnity Co. v. Commissioner, 32 T.C. 653 at 659 (1959)). What the 16th Amendment did was make it possible for Congress to impose a direct tax without apportionment among the states on the basis of population, thereby removing, not imposing, an injustice.
Largely through the efforts of William Jennings Bryan, the presidential campaign of 1896 was diverted from the need for a fundamental reform of the financial system to a focus on the currency. This was a fatal distraction at a critical time. Coin and banknotes (including the Treasury Notes of 1890 and gold and silver certificates) accounted for only 25% or less of the national money supply.
The bulk of the money supply in the 1890s was, as always, in the form of private sector bills of exchange. Acrimony over "the silver question" ensured that deeper problems were ignored. The problem seemed to have solved itself as the Great Depression ended with nothing other than superficial legislative action on the part of the federal government. This was only whitewashing the problem, however, for the acrimony remained, creating deep divisions in the country. As Dr. Harold G. Moulton related,
"With the return of great business prosperity the need of reforming the banking system appeared less pressing to our legislators, who at best perceived none too clearly the fundamental weaknesses inherent in the system. The return of the Republicans to power, coupled with the establishment of a gold standard, undoubtedly satisfied most congressmen that henceforth financial difficulties would be unknown." (Harold G. Moulton, Financial Organization and the Economic System. New York: McGraw-Hill Book Company, Inc., 1938, 343.)
Failure to reform the system led directly to the Panic of 1907. The Congressional committee formed in 1912-1913 under the leadership of Congressman Arsène Pujo of Louisiana to investigate the causes of the Panic determined that it had been caused by concentrated control over money and credit. Ironically, the Panic occurred at a time when Theodore Roosevelt, the acknowledged leader of the progressive movement who was in the middle of his second term, seemed unstoppable, and followed hard on the heels of legislation that, as noted, had been thought to make future panics and depressions impossible.
Appearances were deceiving. Roosevelt worked long and hard to lay the groundwork for sustainable reforms of the system that avoided the anti-property orientation of the now-decayed populist movement. The Old Guard Republicans who tended to view any limitation on their exercise of property as socialist were still extraordinarily powerful, however, and in control of Congress. At the same time, the remnants of the populist movement could still count on the hearts of many Americans, having been captured by the brilliant oratory and sterling personal character of William Jennings Bryan — at this time more powerful as a private citizen than many elected officials.
It is probably not an overstatement to say that only Theodore Roosevelt could have kept the vision of Orestes Brownson and America's Founding Fathers alive at this time. Bryan had the personal integrity and charisma to do the job, but his principles, while held with deep conviction, were not adequate. Bryan focused — apparently unconsciously — on undermining the natural rights of private property and freedom of association. This was through manipulation of the currency and a State-created money supply to guarantee results. This was, in effect, a sort of monetary Fabian socialism, justifying the label "silver socialist" applied to Bryan.
Roosevelt, just as charismatic and with fully as much integrity, managed to steer a middle course — a just third way — between the logical (if completely erroneous) insistence of the conservative Republicans that their exercise of property and liberty were absolute, and the emotional humanitarian insistence of the populist wing of the Democrats that liberty (freedom of association/contract) and private property must in all cases be subordinated to the demands of the majority.
Roosevelt's genius gave him an enormous power base among moderate Republicans and Democrats. Roosevelt's just third way, unfortunately, alienated him from the entrenched power centers. These were the radical Democrats who had a virtual monopoly on socialist rhetoric — the most vocal and emotional form of "people power" — and the conservative Republicans who monopolized the capitalist money power.
The conservative Republicans and the radical Democrats were both wrong, but in a way that made their errors particularly attractive to many people even today. Both camps lost sight of the fact that the right to be an owner is inherent — absolute — in each and every human being, but that the exercise of property is necessarily limited by the rights of other individuals and groups, and the common good as a whole. Similarly, the natural right of liberty is constrained by the requirement that no one can legitimately use his or her liberty to harm even him- or herself, other individuals or groups, or the common good as a whole. As Roosevelt would later summarize his position,
"Nothing is more true than that excess of every kind is followed by reaction; a fact which should be pondered by reformer and reactionary alike. We are face to face with new conceptions of the relations of property to human welfare, chiefly because certain advocates of the rights of property as against the rights of men have been pushing their claims too far. The man who wrongly holds that every human right is secondary to his profit must now give way to the advocate of human welfare, who rightly maintains that every man holds his property subject to the general right of the community to regulate its use to whatever degree the public welfare may require it." (Theodore Roosevelt, "The New Nationalism," Social Justice and Popular Rule. New York: Charles Scribner's Sons, 1926, 17.)
As Pius XI declared twenty years later,
"[T]win rocks of shipwreck must be carefully avoided. For, as one is wrecked upon, or comes close to, what is known as "individualism" by denying or minimizing the social and public character of the right of property, so by rejecting or minimizing the private and individual character of this same right, one inevitably runs into "collectivism" or at least closely approaches its tenets. Unless this is kept in mind, one is swept from his course upon the shoals of that moral, juridical, and social modernism which We denounced in the Encyclical issued at the beginning of Our Pontificate." (Pius XI, Quadragesimo Anno ("On the Restructuring of the Social Order"), 1931, § 46.)
As Roosevelt's second term came to a close, it appeared that matters were well in hand. Thanks to prompt emergency measures, the country stabilized after the Panic of 1907, and there was increasing agitation for lasting financial reform. The groundwork had been laid for a restoration of the natural law as understood by the Founding Fathers and embodied in the Constitution. Roosevelt's intelligent assessment of the hardening of the conflict between individualism/capitalism and collectivism/socialism and his energetic action (combined with the inherent decency of Bryan who refused to countenance violence and who gave Roosevelt credit when he felt it was due) had, to all appearances, saved the country from a second Civil War, this time between capitalism and socialism instead of two forms of capitalism.
The battle, however, was just beginning.