The French Panic

THE changes in the methods of foreign trade produced by the transatlantic cable and rapid ocean service, which have rendered the old-fashioned Salem merchant, with his enormous profits on an Indian venture, a thing of the past, have affected in an interesting way the great financial centres of the world. The check system and the extension of credit devices have wholly altered the character of business. The use of checks works so as to leave more of private deposits in every bank ; since A, the borrower of ten thousand dollars, does not in fact withdraw that money from the lending bank, but in the grant of a loan he gets in practice only the privilege to draw a check on the amount of the loan. Hence every increase of discounts (loans) by a bank at once means that there has been given to certain persons the right to draw on that sum at any time. So that, when a loan is made, the borrower is at once entered on the books of the bank as a depositor to the same amount. If, then, it is the custom of the community to use checks in making payments, there is nothing in the operation of granting a loan which necessarily implies a withdrawal of actual money. If A used his loan of ten thousand dollars to pay B, and drew a check on the bank, B is no more likely to want cash than A. If B has an account at A’s bank, the operation is simply a change on the books by which B is made a depositor instead of A. If B deposits at a different institution, then B’s bank has a claim against A’s. But in the practical multiplicity of loans B’s bank will have a number of claims, in the shape of checks or drafts, against A’s firm, and the latter will have a greater or less number against the former. Again, money does not really pass between these banks; but they, with the other banks of the community, meet at a common place, or Clearing House, and set off the claims of one against another, paying only the balances. And even these balances are paid by checks. It may be assumed, then, that checks greatly economize the use of money, and that an increase of loans has the general effect to increase the deposits.

A bank is liable to be called upon for everything put into it, — its capital, accrued profits, government and private deposits, and whatever use it has made of its credit by coining it into promises to pay, or notes; and these constitute its liabilities. Of course its demand notes and private deposits are immediate liabilities, and the bank must be ready to meet them at any moment. On the other hand the disposition made by the bank of that which is entrusted to it is the test of good management. First of all, it is necessary to keep in a cash reserve sufficient funds to meet the daily demands of depositors and note-holders. The tendency now is to keep a separate provision for notes, as in the Bank of England; or, if the bank does not issue notes, it may provide only for deposits. But just that amount of the resources which is kept in cash earns no profit. However, experience justifies bankers in retaining only from twenty-five per cent, to fifty per cent, of deposits as a reserve ; the remainder can be invested, and this disposition of the resources produces an income. A part of the funds must be kept in the best investments, generally government bonds, so that they can be easily and rapidly sold in order to reinforce the reserve in times when depositors demand ready money. The other funds may be loaned on safe securities of various kinds.

From this brief explanation it may be seen that the banks of two cities, between which a large trade is established, as between New York and Chicago, are related to each other exactly as the two banks with which A and B deposited. Their interests are so closely identified that a failure in either city affects the banks of both. The financial structure is like a card house. But, to extend our view over different countries, a vast trade is going on between New York, London, Hamburg, Paris, and all Europe, which in the same way connects the financial interests of each city with every other. A chill in the markets of Paris is felt, the same day, creeping down the commercial backbone of London and New York. To be sure, our own trade is vastly greater with England than with France, so that a disturbance on the Paris Bourse will first take its effects on London, and then, through London, on New York.

For evident reasons, arising from her wars, France had enjoyed a fortunate immunity from the speculation which culminated in the crash of 1873. The lapse of ten prosperous years, however, is sufficient to increase capital so as to excite speculative tendencies even in the French people, who, since Law’s day, have been rigorously disciplined by disastrous financial experiments, until correct and sound opinions are the rule, and not the exception. Of course this movement first showed itself in the stock market. New companies appeared like locusts; and if they had the semblance of value, or — what unfortunately took place too often — contained well-known names in their announcements, willing subscribers were abundant. The sequel is the same old story of misplaced confidence, resulting in suicides and insanity. A subscriber was not asked to pay in the beginning the whole par value of the stock ; the victim, consequently, proudly confident that the shares of so valuable a property were sure to go higher, bought as many as his means permitted, trusting that when the second installment on his stocks was called in he could sell a few of them at a gain, and thus meet the payment. It is pathetic to see how hopeful human nature is at such times. Even conservative merchants, seeing great fortunes made in a day, took a “ flyer” or two. In the month of January (1882) the sanguine condition was reflected in the production of enterprises whose very names would have excited distrust at other seasons. Forty-three new companies were chartered, with a capital of two hundred and twenty-two million francs, and twelve old companies increased their capital by one hundred and forty million francs. There appeared a company for the utilization of electric power (seventy-five million francs) ; one for working the mines of Rio Tinto (fifteen million francs) ; the Senegal and West Coast of Africa Steam Shipping Company (fifteen million francs) ; others for the establishment of seven new journals ; one for breeding ostriches in Algeria; and one for managing pigeon-shooting matches.

But the head and front of the speculation arose from a new banking house, the Union Générale. Its president, M. Bontoux, having risen from a subordinate railway position to the office of general director of the Southern Railway (Südbahn) in Austria-Hungary, had been driven from his post for mismanagement of the finances in 1878. At the time of the expulsion of the religious orders from France, Bontoux, himself a Roman Catholic, and having the ear of many trusting Catholic capitalists in France and Austria, took a masterly view of the whole situation, and turned it cleverly to his own uses by establishing in Paris an institution of credit for Catholics. In short, Bontoux was the child of the situation. And if any proof were needed that piety and finance do not necessarily go together, it is to be found in the fact that the originators of the Union Générale received an autograph letter from his Holiness the Pope, containing a special blessing. The company found many subscribers for its shares, and no lack of confiding depositors. It seems clear that Bontoux entered the field with no intention to do an honest banking business, and at once began a career of pure stock-jobbing. He established branches in Vienna, Berlin, and Pesth ; and the stock of the Union Générale was manipulated for speculative purposes. Last November its capital was increased from one hundred million francs to one hundred and fifty million francs, and the public supposed that its profits were very large. The new institution fathered a great number of fresh enterprises, subscribing enormous sums, with the purpose of selling the shares at an advance to a sanguine public, who trusted to the representations of a banking house seemingly so strong and well connected. So long as the market continued buoyant and speculative, these tactics proved successful. But at the time when some holders would think prices could not go any higher, there would arise a strong inclination to sell and realize their profits. Purchases of stocks, however, are never made unless there is a belief in a rise. When the turn in the market comes, there are absolutely no purchasers ; it is a truism to say that no one buys in a falling market. This was the condition of things on the 17th of last January. The more cautious began to sell and securities to fall; then, two days later, the holders of Union Générale stock, and of those stocks belonging to the " Union Générale group,” suspecting that all was not right, were taken with a panic, and eagerly sold at any offer. Prices fell enormously. In the general disappearance of confidence and credit, the tension became very great, and that link in the chain which happened to be the weakest naturally broke. Union Générale stock, being that in which there had been most speculation previously, now fell most rapidly, and in a week shrank to less than one half its former value. But this was only a part of the violent reaction throughout the whole market, and owing to the strong disposition, at all times when there is a loss of confidence, to sell and turn stocks into cash, even investment securities and rentes shared somewhat in the fall. The following brief table will show the effect: —

The panic took place while Bontoux was absent from Paris, and on the 1 9th the Banque de Paris had granted the Union Générale assistance by a loan of three million francs. On the return of M. Bontoux, on the 21st, having secured the promise of eight million francs from the Laender Bank of Vienna, he applied to the Haute Banque for an additional loan of ten or twelve million francs more. There was a meeting of the representatives of the Haute Banque and the principal joint-stock banks, and this loan was granted ; but, at this juncture, the Laender Bank, snuffing danger from afar, refused the eight millions. By the 28th Bontoux was asking for twenty millions more from the same banks, who complied under the condition that the Laender Bank would furnish its proportion. This was refused, and the next day the Union Générale suspended.

It will be seen from this that the quotations of stocks had been forced far above their real value, and that there had been going on in the Paris Bourse a gigantic “ bull ” speculation. A “ bull ” is one who asks his broker to purchase stocks with the expectation of a rise, and to whom he does not pay the whole par value of them, but only a margin of five or ten per cent. So long as the price does not fall, or if it rises, the stocks are worth as much as the broker paid, and the original deposit of “ margin ” is sufficient until there comes the order to sell. But if the buyer mistakes the course of the market, and stocks fall below the price paid by his broker, the latter loses by the difference between the present and the previous price estimated on the par value, unless the deposited margin is sufficient to cover the amount. If it is not, then the broker calls for greater deposits of money. Consequently, in a falling market there is a greatly increased demand on the banks for loans with which to maintain a hold on their stocks. But, on the other hand, it is the interest of “ bears,” who operate to depress the market, to force sales of stocks, lessen the amount of loanable funds, and raise the rate of discount. An “easy money market,” therefore, is as unfavorable for “ bears” as it is desirable for “ bulls.” At this time a strong league of “ bears ” existed in Paris, working to break down M. Bontoux.

In Paris the financial machinery, for our present purpose, consists of the Bank of France, under the control of the state; the Haute Banque, an expression used to include the few richest private banks, of undoubted standing (such as the Rothschilds’) ; a regular board, or Parquet, of brokers to the number of sixty, authorized and licensed by the government, known as the Syndicate of Agents de Change; and the large number of unauthorized brokers outside of the Parquet, termed the Coulisse. So far as can be ascertained, the Union Générale was operating on the market to raise the quotations of their old stock, and had been heavy buyers from the regular Agents de Change. When the crisis came, with its unexpected fall in prices, the Parquet were caught by their purchases of this old stock, and lost amounts variously estimated from thirty-three million to one hundred million francs. At the same time M. Bontoux had been trying to work off the new stock on the general public through the Coulisse, who thus became debtors to the Union Générale for more than one hundred million francs. The Coulisse, as well as the Parquet, when the fall in prices came, were in pressing need of loans. While in New York settlements between brokers take place every day, in Paris these are made usually at the middle and close of each month. To permit the Parquet to make their settlements at the end of January, the Haute Banque came forward to their aid with a loan of one hundred million francs. The Coulisse, however, is recognized neither by the Haute Banque nor by the state, and received no help. Throughout the Coulisse, therefore, suspensions were the order of the day.

Moreover, the affairs of the Banque de Lyons et de la Loire had become seriously involved, and the Lyons Bourse gave birth to an unhealthy panic of its own. At the end of the month, the Bank of France had sent to its Lyons branch seventeen million francs, to enable it to increase its loans ; but the brokers were obliged to borrow an additional eighteen million francs in order to meet their engagements. Here, too, there were many failures. But, more than this, holders of such stocks as fell in the Paris markets were to be found in Vienna, Berlin, Hamburg, London, and elsewhere, and they were all affected in the way previously described. Owing to the fondness of French capitalists for investing in Austro-Hungarian properties, Vienna suffered most.

But the greatly increased pressure for loans which attends a falling market was the means by which the effects of the French panic were transferred to London and New York. Because there is no confidence, that is credit, at such a time, the marked characteristic of every panic is a wild frenzy for ready money. Therefore, even solvent banking houses in France had a greater need of cash reserves with which to meet the demands of their depositors. The result of this movement, arising both from banks and individuals, was felt at the central institution, the Bank of France, and its accounts during this time reflected at once the financial situation. Two tendencies existed, both acting to weaken its position : (1) the enormous increase of loans, as explained above, added to the deposit liabilities and to immediate demands ; and (2) the distrustful condition of the public mind led each depositor to keep by him as much ready money as possible, and so withdrew from the bank, thereby reducing the reserve in a far greater ratio than the liabilities. To prevent being ground to pieces between these two mill-stones, the bank was obliged, while loaning freely, to increase its cash reserve. By selecting only the important items on the side of both liabilities and resources, the condition of the Bank of France during this period is given in the following table (amounts being stated in pounds sterling, and in millions and tenths of millions) : —

The statement for January 26th, the first after the suspension of the Union Générale, and the last before the settlements at the end of the month, shows the effect of the increased demand for loans by a change in the column of Other Securities (Loans) of five million pounds over the previous week. But the government opportunely deposited four million pounds in repayment of a loan from the bank, which greatly strengthened the reserve. More than this, the situation necessarily changed the rates of exchange between London and Paris, so as to warrant importations of gold. It may seem trite to give a brief exposition of the exchanges here, but when a senator of the United States expressed to a friend, whom he was introducing at a Washington bank, his wonder how the bank would ever be able to get the money for that bit of paper (a check on a New York bank), it may seem unjust not to grant the same privileges of explanation to the general reader as to a senator. A bill of exchange on London is simply a paper title to money in that city belonging to the drawer of the instrument, and he sells it to any one wanting to make a payment in London. When exchange between London and Paris is “ at par,” a sovereign in London can be bought for 25 francs 22½ centimes. When many persons are trying to draw funds from London, many bills on London will be offered, and the price will fall. The expense of transferring coin from London to Paris is about ten centimes for every sovereign. Therefore, when the price of exchange falls more than ten centimes below par, as to 25 fr. 11 c., the man owning gold in London can ship it, and gain one centime by the transaction. For, his title to the sovereign selling for only 25 fr. 11 c., and being able to bring over a sovereign so that it is worth, expenses paid, 25 fr. 12½ c., the last operation gives him a profit. After the culmination of the speculation in Paris, bills on London fell to 25 fr. 11 c., and in ten days £2,500,000 in gold left London for Paris, almost the whole of which went into the Bank of France. This movement of specie was natural, for several reasons. The greater demand for money gave a higher profit on it in Paris than in London, and afforded cause for withdrawals of specie from the Bank of England for shipment to France. Then, there were large sales in London “ on French account; ” that is, solvent houses and holders of securities which were salable in London, with the plan of increasing their cash reserves, sold these, and drew bills on London for the amount. Also, the depression in French stocks led many observant capitalists to buy them at these panic prices, and remitted money for that purpose. These, in short, were the causes which led to the passage of gold from London to Paris, and strengthened the reserves of the bank. The settlement day, at the end of the month, however, was the object of dread ; and its coming was watched as about to give the best evidence of the extent of the losses and the general ability to meet engagements. The combination of the leading houses with the Bank of France was the means by which the expected difficulties were successfully met. Indeed, the fraternal union of the great financial managers which can take place in Paris is impossible in London or elsewhere, and it was this union which checked the progress of the panic. Although the losses of the Syndicate of regular brokers were not far from forty million francs, the Haute Banque readily advanced to them a loan of one hundred million francs, payable in twenty years, at five per cent. The government also announced that it would advance one hundred million francs to the Parquet for taking up purchases of rentes. The common interest to be advanced by keeping the Bank of France intact led the private banks to increase their deposits there to the greatest possible extent. These movements were shown in the report of February 2d : private deposits had increased five million pounds ; the cash had gained two million pounds ; government deposits rose two million pounds ; and the great demand for loans had been successfully met by giving more accommodation to the amount of six million pounds during the week. It was during the previous week that the bills of the Union Générale had been returned unpaid, and so the house was declared insolvent by the Tribunal of Commerce in the usual manner. Although the account for February 9th shows an expansion in the already large item of loans, there was a gain in specie. The large increase in private deposits was due to the advances of the treasury to the Parquet, and caused a great transfer of funds on the books of the bank from public to private deposits. On the 23d the Bank of France reduced the rate of discount, and the report for the succeeding weeks showed a falling-off in loans, which implied a restoration of confidence. At this time the exchanges had risen to 25 fr. 29 c., or above par. But in the time between January 26th and February 23d the Bank of France gained five and one half million pounds in gold, of which two and one half million pounds came from England, and the rest from Spain and Continental sources. Yet England was acting only as an intermediary, and the two and one half million pounds lost by her were exactly made up by the amount which passed from New York to London.

The Bank of England contains the great gold reservoir of the world. The issue of notes belongs to a separate department, and for every note emitted beyond fifteen and three fourths million pounds there is a deposit of specie to the same amount. The banking department has to do solely with the functions of discount and deposit, and it must pay the usual regard to the ratio of cash reserve to its immediate liabilities. All the causes, previously explained, which drew gold from London to Paris had operated to induce withdrawals by depositors of funds to be sent abroad, and under this influence the Bank of England lost eight per cent, in its reserve within one week. The uneasiness produced by the agitation across the Channel was aggravated by the fact that the reserve had been for a long time falling, until it then reached a point lower than it had been since the failure of the City of Glasgow Bank in 1878. The condition of the bank is given during this period in the following statements (amounts are given in millions and tenths of millions) : —

A glance down the column of Other Securities shows the increased demand for loans at and after the period of anxiety in Paris; a comparison of Other Deposits, a gradual withdrawal until February 16th; and the last column, a diminution of the reserve at the end of January. The first two movements both acted to lower the ratio of cash reserve to immediate liabilities. The situation was serious enough to warrant a rise in the rate of discount to six per cent., a step which had the effect to drive off all but the neediest borrowers, and, by checking new loans, allowed the stream of loans maturing daily to fill up the reserve.

This higher rate of discount had its effect on the quotations of exchange between England and such a country as the United States, with which England was most intimately connected*by trade. Then, there were sales in New York of American railway stocks to a considerable amount for London account, or, in different phrase, “ American securities were being sent home ” from London. Moreover, there had been a gigantic “ bull ” speculation in this country, acting to raise the prices of breadstuffs, on the exportation of which we depend for a very large supply of bills. This rise of prices prevented exports, and thereby exporters had less sums of money due to them from England, and could offer in the market fewer titles to such money, or bills of exchange. Of course, our imports remaining about the same, there was the same demand for bills with which to make payment in England for the imported goods, and so the scarcity of bills caused a rise in their price. When an equilibrium exists resulting from both the financial and commercial transactions, it requires $4.8665 in New York to purchase a title to a sovereign in London. When the price rises a little more than three cents above par, to $4.891¾ or $4.90, there will be a profit in sending specie across to London, and no one will pay more for bills. The three cents cover the freight, insurance, and brokerage ; and exchange can never move but slightly beyond this difference above or below par. During the excitement in Paris, the rate of exchange in New York rose to $4.90, and for the first time in several years it be came profitable to send gold abroad. This demand for specie was at once felt by the New York associated banks, in withdrawals by depositors and a drain upon their cash reserves. At this time the “ bull ” speculation in bread-stuffs collapsed, and a formidable “ bear ” movement was inaugurated in the stock market, which considerably lowered prices. In a falling market, as was before explained, there arose an increased demand for loans, for the purpose of holding on to stocks and the extent of this demand was a rough measure of the speculation which had been going on. The drain of specie from the reserves and the increased demand for loans both worked to make the position of the New York banks more insecure. The results are here collected (amounts being given in millions and tenths of millions of dollars) : —

By the middle of March there had been exported since January 1st, $12,041,340 in specie to England, and a glance down the column headed Specie, in the table above, will show the effect of the foreign demand on the banks. The total reserve, composed both of the specie and legal tenders, steadily diminished, until on the 25th of February and the 4th of March the actual reserve was below the reserve required to be kept by law. In the week following, however, the banks improved their condition materially through the action of the treasury. By the present sub-treasury system, the government withdraws all its funds from the open market, and secretes them in its own vaults. At this period more money had been going into the dark hiding-places of the treasury, in payment of customs and taxes, than was coming out in the disbursements for the interest and principal of the public debt. And so far as the banks were concerned, this disappearance of money had the same effect as its exportation from the country. At this time a Boston banking house of good repute, which had been subscribing too largely for railway bonds of uncertain value (to a less extent the same operation carried on by the Union Générale), suspended. However, the regular business interests remained unaffected by the continued uncertainty, and in the second week of March the treasury was enabled to make heavy payments for called bonds, extended at three and a half per cent., and the cash reserves instantly rose above the required limit.

At the present time, the lowering of the rates of discount by the Bank of England, the Bank of France, and Continental banks generally seems to indicate that the force of the storm is spent, and that all danger is past. But the operations by which the crisis was checked and the subsequent movements of specie show the intimate connection existing between all commercial countries, and furnish an interesting illustration of the working of the exchanges.

J. Laurence Laughlin.