As we noted in yesterday's posting, the Panic of 1893 revealed serious structural and theoretical flaws in the financial institutions of the United States. Adherence of the National Bank system to the principles embodied in the British Bank Charter Act of 1844 had saddled the U.S. system with an inelastic, debt-backed currency for farmers, small businesses and wage earners/consumers, but an elastic, asset-backed money supply in the form of merchants, trade and bank acceptances for the rich financiers, industrialists and commercial interests.
Translation: the rich could get all the financing they needed or wanted for new capital formation, but the non-rich did not have enough money to be able to consume what was produced. Neither could the non-rich increase their own production of marketable goods and services — that with which you really purchase what others produce (Say's Law of Markets) — to increase consumption. Having finally restored the faith and credit of the government and brought the paper currency back to parity with gold, the government refused to inflate the currency to stimulate consumption artificially in the short run . . . which, frankly, only robs Peter to pay Paul, anyway.
There was a "money drought." There was more being produced than at any time in history, but because a majority of the people now relied on wage income instead of ownership income and a seriously flawed banking system, there wasn't enough money in small denominations to purchase all that was produced! There was a serious need to shift from an inelastic, government debt-backed currency in an economy in which capital ownership is concentrated, to an elastic, private sector asset-backed currency in an economy in which capital ownership is widespread.
Unfortunately, three immediate issues diverted people's attention from the important. One, there was a dire need to take care of people to prevent starvation. This was epitomized by the march of "Coxey's Army," which demanded government make-work financed with an increase in debt to create jobs.
Two, fiscal reform was thwarted by an 1895 Supreme Court decision that ruled that an income tax levied without apportionment among the states (which would have been unfair) was unconstitutional. This meant that the rich were escaping virtually all taxation, since they were able to pass any taxes on to the non-rich through increased costs for the goods and services they produced. The progressives, populists and socialists all viewed an income tax as the most just and fair tax. It came out of the "bottom line" (that is, after costs) and thus did not raise prices unfairly for consumers by adding the cost of the tax to the cost of the product . . . for personal income taxes, anyway. A corporate income tax does raise prices to consumers.
It's important to note that an income tax per se was not unconstitutional before the 16th Amendment. What was unconstitutional was a "direct tax" that was not apportioned among the states. There had been debate for decades on whether an income tax is direct or indirect — the real issue — and thus unconstitutional without apportionment or constitutional, respectively.
Congress was unwilling to cut off a potential source of tax revenue, however, and the income tax in the Civil War was allowed to lapse without a decision being made. The issue was not raised again until more people were non-owning wage earners, and thus concerned with added costs of production that were not due to wage and benefit increases.
Three, the brilliant and charismatic William Jennings Bryan diverted attention away from needed banking reform by focusing on what he perceived as an immediate need to inflate the currency by allowing "free coinage" of silver, that is, the government would be required to mint all silver into coins that people brought in — at taxpayer expense, of course. Silver at that time was cheap, and had finally been dethroned from its millennia-old position as the monetary metal of choice in favor of gold. The world was awash in cheap silver. Inflating the money supply by coining massive amounts of silver dollars would provide silver producers with a badly needed market, raise prices for farmers and small businesses, and allow debtors to pay back expensive loans with cheap money — or so the theory went.
Consequently, nothing was done. Fortunately (for the American farmer and small businessman), there were crop failures in Europe in 1897 and 1898 — and bumper crops in the U.S. The tremendous increase in wheat production allowed the people in Europe to have food at a reasonable cost even with crop failure, and provided a ready market for the American farmers, who could now pay their bills to the small businesses. Since the farmers and small businessmen owned the farms and businesses, the benefits all went directly into their pockets. The Great Depression was over and the American economy was saved . . . for now.
Unfortunately, the powers-that-be thought the problem was solved permanently, and proposals for reform of the financial system were shelved. This set the stage for the "Bankers' Panic" of 1907 — which, being artificially created by financier J. P. Morgan, never should have happened.