Commercial Panics, Past and Future
OCTOBER, 1906
BY ALEXANDER D. NOYES
DISCUSSION of the nature and origin of trade depression, business disaster, and commercial panics may seem to be out of place at an hour when American finance and industry are simply repeating the story of overflowing prosperity. There is no doubt that such a discussion, at such a time, is to most of the business world unpalatable. If, however, it is true — and all experienced business men will admit that it is — that the real germ of severe financial reaction is found in the phenomena of an excited financial “boom,” then inquiry into causes of such reaction ought to be particularly timely while the country is riding on the crest of prosperity’s wave.
It has often been said of such familiar watchwords as “tariff reform” and “currency reform” that the trade situation itself, whatever that situation might be, was apt to be fatal to the success of the undertakings. In time of prosperity, things must be left as they are, lest prosperity itself be jeopardized. In time of adversity, business is so sensitive that tariff or currency experiments might make it worse. Hence the obvious tendency to do nothing at all. The same is true of causes imbedded in a money or investment market. This article may be useful if it can point out causes of financial trouble of a future day, visible in the present American “boom ” of 1906 as they were in the “boom ” preceding 1893 or 1873. We shall, at all events, after pursuing such an inquiry, be able to say whether the sequel to the existing movement of expansion and speculation is or is not likely to be the same as that which followed the similar movements of the nineties and the seventies.
Before inquiring into the causes of commercial panic, it may as well be asked just what such an occurrence is. One hears on Wall Street of “panics ” which seem perennial in their occurrence. The Stock Exchange tells of its “Lawson panic ” of 1904, its “rich men’s panic ” of 1903, its “Northern Pacific panic ” of 1901; but these are obviously not what we are discussing. Commerce and industry go their way, on such occasions, with hardly a sideglance at the twentypoint break in stocks and the twenty-five per cent rate for demand loans which throw Wall Street into a frenzy of excitement.
These episodes themselves no doubt possess significance, as reflecting, under interesting circumstances, the condition of the general money market; but they rarely leave a permanent mark on commercial history. The explanation of them usually is that the speculation of a season, conducted with borrowed capital, has forced prices of securities or commodities to so extravagant a height as to invite heavy selling by real holders of stocks or grain or cotton, and that these sales, breaking down the artificial prices, have involved in loss or ruin the more reckless of the speculators for the rise. In highly speculative markets such incidents are bound to be frequent; they are accompanied by a day or two of exaggerated fright among the gambling contingent on the Stock Exchange, and by sales at a reckless sacrifice; and that is usually the end of them. An artificially inflated market has simply been forced into line with real conditions.
The commercial panic means a good deal more than this; though, as we shall see, many of the weather signs in a great financial storm resemble those of the Stock Exchange teapot tempests. In a true commercial panic the entire credit system of a community is shaken. Failure of certain large banking or commercial houses — usually because of undue expansion of liabilities or misjudgment of the community’s consuming power — throws suspicion upon others. For their own protection banks set to work to reduce engagements; this means general calling of loans; and in the process some one who had relied on continued bank accommodation is driven to the wall. To avert insolvency, individuals or institutions involved in such a scrape endeavor to sell, at the best price obtainable, whatever of merchandise, investment securities, or other property, they may possess. But since these forced sales are at such junctures very numerous, and since they occur at a time when the usual buyers are timid and suspicious, they result necessarily in a violent fall of prices, which of itself cripples other dealers or operators, whose debts are secured by such property, pledged on the basis of the old valuations.
As this tangle of financial embarrassment grows more complicated, deposit banks go under, here and there, and the bank depositor takes alarm. If the strain continues without relief, the public proceeds to withdraw its bank deposits in the form of cash, and to hoard the money. Such a “run,” on the scale witnessed in 1873 or 1893, strikes at the foundation of the credit system; it strips the banks of whole communities of their means of paying depositors on demand, and at the very moment when such demands are multiplying. The natural recourse, in the face of such depletion of cash reserves, would be a still more resolute calling-in of loans, and thus a reduction of liabilities; but in the situation existing among the borrowers such a policy would precipitate general disaster. In this way is reached one climax of a commercial panic.
The other climax is a natural sequel to it. Merchants and manufacturers, confronted with loss or ruin, make haste not only to dispose of pending engagements, but to cancel engagements involving liabilities for the future. Some of them escape by this means from the financial storm; others do not; but the net result is enormous curtailment of production, decimation of profits, discharge of workers, and, therefore, decrease in the average income both of employers and employees. Since decreased income means decreased purchasing power, the effects of the movement are prolonged; business depression, discouragement, and stagnation may continue, and indeed usually do continue, throughout several years.
There is nothing very novel in this review of the symptoms of commercial panics; but it is useful to set forth clearly each of the regular phenomena of such an episode. The mere recital of the incidents of a great panic is enough to show that they are abnormal and unnatural; that they apparently violate the ordinary laws and principles of finance. When, therefore, we ask what are the causes of commercial panics, we find ourselves confronted with another question: why should “panics ” and “hard times ” occur at all ? And the answer to this question leads to another and highly practical inquiry: whether we are destined to repeat in the future, at similar intervals, the experience of industrial reaction, collapse, and prostration which former years have witnessed.
The “ twenty-year panic,” the “twentyyear cycle of prosperity,” have become traditions of financial history. Emerging from one period of commercial depression and forced economy, circumstances conspire to revive the hope and confidence which had been virtually paralyzed. It is presently discovered that capital had really been accumulating, during the years of financial inertia, without being either spent or invested, and that the means for financing trade revival are at hand. This discovery is followed by a rush of the more adventurous spirits to profit by the new opportunities, and the profit is found to be large. Events very frequently come next which appeal to the imagination,— sometimes an abundant harvest in the face of foreign shortage, as in 1879 and 1897; sometimes a sudden and heavy European demand for our merchandise, as in 1898; often reform of a distrusted currency law, as in 1879 and 1900; and finally, as in 1880 and 1901, successful promotion of undertakings in the financial world, which both create and profit by the new wealth and new confidence of the public.
In the eager haste of capitalists, great and small, to anticipate further developments of the sort, use of credit for speculative purposes becomes more general than at any previous period. The public rushes in ; the “boom ” grows fairly wild. At the climax of excitement the “boom ” is invariably interrupted by severe reaction, correctly ascribed to the extravagance and suddenness with which liabilities have been expanded and floating capital absorbed. This “ten-year panic ” — so it has been described by high economic authority — is short-lived ; it rarely, even at such times as 1884, affects the commercial situation; the “boom ” is presently again under way, though not often with the former vitality, and usually with much more obvious signs of a strain on capital through the money market. The descending scale of strength and vitality — which, with various vicissitudes, and with frequent outbursts of new enthusiasm, lasts through another decade or thereabouts — ends, or at least has hitherto ended, with recurrence of the formidable “twenty-year panic,” into whose real causes we are inquiring.
We have first to ask: is it true that these great commercial panics recur at fairly regular intervals, — as a rule, once in every twenty years ? If this is so, it will be worth while to inquire the reason for such regularity. Are periods of commercial distress, and, therefore, the intervening periods of prosperity, thus separated ? The fact seems incontestable. Our own country’s record fixes the years 1837, 1857, 1873, and 1893 as the dates of our greater panics. England’s record is 1825, 1844, 1866, and 1890. In each case the twenty-year interval is preserved with reasonable accuracy. It will be observed that the “panic years ” in England were not the same as in the United States. Our commercial distress of 1893 and 1873 reacted, no doubt, on London, as the acute foreign troubles of 1890 and 1866 recoiled on financial New York. But the result was never a panic of the first order in the market indirectly affected.
If we grant the general uniformity of the “twenty-year interval,” then what is the factor that determines it ? One school of economic theorists ascribes the great forward and backward movements of finance and industry wholly to output of precious metals. Their position is thus stated by Alison in his History of Europe, in a passage which President Francis A. Walker deemed worthy of citation in full in his text-book on Money : —
“ The fall of the Roman Empire, so long ascribed, in ignorance, to slavery, heathenism, and moral corruption, was in reality brought about by a decline in the silver and gold mines of Greece. . . . Columbus led the way in the career of renovation; when he spread his sails across the Atlantic, he bore mankind and its fortunes in his bark. . . . In the renovation of industry, the relations of society were changed; the weight of feudalism cast off; the rights of man established. Among the many concurring causes which conspired to bring about this mighty consummation, the most important, though hitherto the least observed, was the discovery of Mexico and Peru.”
And the same reasoning applied to the great industrial depression and revival of history is also applied by followers of this school to industry’s minor vicissitudes. This argument had particular vogue during the panic of 1893, when repeal of our silver - purchase, treasury - note - inflation act, and the closing of India’s mints to free silver coinage, coincided with the hard times.
Now, the first consideration that will probably strike the reader’s mind is the fact that, if the rate of production of gold, or of gold and silver, governs the alternations of trade prosperity and adversity, then the periods allotted to successive “booms” or “reactions” should bear reasonably close relation to the movements of precious metals from the mines. But no such relation can be traced, unless under vague and indefinite classifications, such as occur in the foregoing citation. For instance, in the decade ending with 1850 the world’s gold output doubled as compared with the ten preceding years; yet that decade was a period marked, especially in its second half, by violent and world-wide financial reaction. The five years ending with 1855 were years of financial expansion on an extravagant scale; the gold output for the period, by the Sotbeer estimate, was $662,566,000. During the next five years the world’s output was $670,415,000; yet those were years of panic and severe depression.
Coming down to later years, it is true that interruption of Transvaal mining by the war, whereby the world’s gold output of $306,724,100 in 1899 fell to $254,556,300 in 1900, was accompanied by panicky collapse in Europe’s financial markets. But as against this may be placed the fact that the disastrous trade years 1893 and 1894 occurred with continuous increase in the world’s annual gold production and our own, — the one expanding $35,000,000 in the period, the other $4,900,000. I do not cite these figures for the purpose of economic controversy, but in order to show that if commercial “booms ” or commercial panics occur at regular intervals, their recurrence can hardly be ascribed to the waxing or waning of the output of the precious metals, which is not regular at all. That sudden and large increase in such production will help along financial expansion, and that a similarly sudden decrease must emphasize financial reaction, will hardly be disputed. But if it is true that our great panics are separated by reasonably uniform intervals from one another, other principles must obviously be at work.
In the first place, there is Professor Stanley Jevons’s famous “sun-spot theory,” elucidated in 1875, and now almost forgotten, except by the curious. After assuming the influence of recurrent sunspots on the weather of the earth, and hence on the earth’s crops, and endeavoring to establish a correspondence between maximum sun-spot years and years of deficient harvests, Professor Jevons proceeds as follows: —
“It is now pretty generally allowed that the fluctuations of the money market, though often apparently due to exceptional and accidental events, such as wars, great commercial failures, unfounded panics, and so forth, yet do exhibit a remarkable tendency to recur at intervals approximating to ten or eleven years. Thus the principal commercial crises have happened in the years 1825, 1836-39, 1847, 1857, 1866, and I was almost adding 1879, so convinced do I feel that there will, within the next few years, be another great crisis. Now, if there should be, in or about the year 1879, a great collapse comparable with those of the years mentioned, there will have been five such occurrences in fiftyfour years, giving almost exactly eleven years (10.8 years) as the average interval, which sufficiently approximates to 11.11, the supposed exact length of the sunspot period, to warrant speculations as to their possible connection.
“It is true that Mr. John Mills, in his very excellent papers upon Credit Cycles in the Transactions of the Manchester Statistical Society (1867—68, pp. 5-40), has shown that these periodical collapses are really mental in their nature, depending upon variations of despondency, hopefulness, excitement, disappointment, and panic. But it seems to me very probable that these moods of the commercial mind, while constituting the principal part of the phenomena, may be controlled by outward events, especially the condition of the harvests.
“Assuming that variations of commercial credit and enterprise are essentially mental in their nature, must there not be external events to excite hopefulness at one time or disappointment and despondency at another ? It may be that the commercial classes of the English nation, as at present constituted, form a body suited, by mental and other conditions, to go through a complete oscillation in a period nearly corresponding to that of the sunspots. In such conditions a comparatively slight variation of the prices of food, repeated in a similar manner, at corresponding points of the oscillation, would suffice to produce violent effects.”
Even the eminence of its author as an economist did not avail to save this singular theory from the amused incredulity with which the practical world received it. Most readers of that economist’s writings have, however, taken this explanation rather as an example of logical exercise than as a mature conclusion on a question of its general magnitude.
Among the more convincing explanations which have been offered of the regular recurrence of commercial panics is the supposition that they accompany the so-called cycle of agricultural prosperity. This theory does not, like Professor Jevons’s, assume that panic periods necessarily accompany periods of deficient crops ; such a coincidence cannot be traced in modern panics. What is argued, however, is that the output of the world’s agriculture, in a period of general prosperity and high demand for all necessaries and luxuries, will at first have difficulty in keeping pace with consumption. But in the end, with the capacity of the earth for new producing area, and with the strong inducement created by the high prevailing prices, agricultural output increases so rapidly as not only to overtake the normal demand of consumers, but to outstrip it. From this point on, the movement is in the direction of lower prices and excess of production over consumption, with resultant loss to producers, and diminishing prosperity in agricultural states. As in 1890, when England’s “Baring panic ” resulted directly from the diminished profits of the Argentine Republic’s grain fields, whereby London’s investments of capital in that country were swallowed up, so it is reasoned that other such periods of unprofitable farming are the true cause of financial and commercial trouble.
There is some plausibility in this explanation. That the cycle of agricultural prosperity moves through pretty much the same period as the twenty-year cycle of business prosperity there can be little question. The trouble with any theory of crops as a cause of commercial panic is that it does not sufficiently distinguish causes from effects. The fact that consumption is largest during periods of a commercial “boom,” and that afterwards, at the moment when production has increased most largely, consumption suddenly declines, or at all events ceases to increase at the previous rate, may be itself ascribed to the influence of commercial prosperity or adversity. Certainly a community in which employment is abundant, wages high, and confidence in the future universal, will spend for food, as well as for luxuries, a vastly greater amount than a community where labor has suddenly found difficulty of employment, and where the future is full of uncertainty. From this point of view it is quite as reasonable to ascribe the vicissitudes of agricultural prosperity to the ups and downs of industry in general as it is to ascribe commercial “booms ” and crises to the vicissitudes of agriculture.
The most convincing explanation of the twenty-year interval between commercial crises is, I think, the fact that the period comprises what may be called a business generation. Men, for example, who went through the experience of 1873, and who, in that hard school, learned the lesson of caution and conservatism, would before 1893 rather generally have disappeared from the scene, retired from active business, or, at all events, surrendered to younger heads and hands the management of private business concerns and corporations which they themselves had conducted twenty years before. It is quite true that the younger men, under such circumstances, have before them not only the teachings of their older associates, but the actual record of the previous period of distress and of its antecedents. But as to this it must be observed that no two commercial periods exactly duplicate one another.
Invariably, when a time of commercial crisis is actually approaching, the new generation of business men will tend to the argument that certain factors and influences, which were all-powerful in the last preceding period of distress, do not on this occasion appear to operate at all. All of us, in the United States, grew familiar with this argument when the wild speculation of 1901 was at its height. Such inflation, every one admitted, was in 1872 the forerunner of 1873; but this was a very different country now; old rules would not apply. The result of such reasoning, on the community as a whole, is that the taking of risks, the parting company with conservative methods, indulgence in speculation because speculation on such occasions seems to be sure of success, become general in a degree not witnessed since the corresponding year in the previous twenty-year period.
The basis for such a “boom ” is always some unprecedentedly great achievement; but, as Professor Sumner has pithily put it, “Whenever we lose our heads in the intoxication of our own achievements, and look on the credit anticipations, which are only fictitious capital, as if they were real, use them as already earned, build other credit expectations upon them, do away with our value money, and export it to purchase articles of luxurious consumption, then we bring a convulsion and a downfall. The mistake is then realized, the lesson is taken to heart for a little while, a new generation grows up which forgets or never knew the old experience, and the mistake is repeated.”
The question of causes of commercial panic has, even outside of the theories already noticed,occupied many economic discussions and called forth a good deal of philosophic disagreement. As a rule these defenses extend to details rather than general principles. Clement Juglar, in his well-known Crises Commcrdales, names as the general causes of such episodes “the character and conduct of banking institutions; fictitious appearances; mischievous use of the savings of private capital; ” and further remarks that “the one cause of panics is the stopping of the rise in prices.” Of these assigned causes, particularly the last, it will probably be conceded that, failing that, they still fail to bring us to the heart of the matter. M. Juglar cites as instances of other views Leroy-Beaulieu’s judgment that the cause of commercial crises is the exhaustion of the community’s buying power, and the fact that a necessary interval of low prices must ensue before new buyers can be brought in; tins interval being what is called “commercial crisis; ” Max Wirth’s dictum that production and consumption are found to have broken apart; and M. Yves-Guyot’s conclusion, that the commercial panic is a result, not of over-production, but of over-consumption.
The truth of these various diagnoses will be as readily recognized as that of M. Juglar’s view or Professor Sumner’s; but they are still too vague. To get a view of the real origin of a commercial crisis, there is no clearer statement than that written sixty years ago by John Stuart Mill, in his Principles of Political Economy. After narrating the sensational forward movement of commercial prices in a period of speculation and prosperity, and the reaction from that upward movement, when the buyers attempt to realize, — phenomena as familiar then as now, — Mill goes on to say, —
“ Now all these effects might take place in a community to which credit was unknown; the prices of some commodities might rise, from speculation, to an extravagant height, and then fall rapidly back. But if there were no such thing as credit, this could hardly happen with respect to commodities generally. If all purchases were made with ready money, the payment of increased prices for some articles would draw an unusual proportion of the money of the community into the markets for those articles, and must therefore draw it away from some other class of commodities, and thus lower their prices. . . . But what they cannot do by ready money, they can do by an extension of credit. When people go into the market and purchase with money which they hope to receive hereafter, they are drawing upon an unlimited, not a limited, fund. Speculation, thus supported, may be going on in any number of commodities, without disturbing the regular course of business in others. It might even be going on in all commodities at once. We could imagine that in an epidemic fit of the passion of gambling, all dealers, instead of giving only their accustomed orders to the manufacturers or growers of their commodity, commenced buying up all of it which they could procure, as far as their capital and credit would go. All prices would rise enormously, even if there were no increase of money, and no paper credit, but a mere extension of purchases on book credits. After a time those who had bought would wish to sell, and prices would collapse.
“This is the ideal extreme case of what is called a commercial crisis.... At periods of this kind, a great extension of credit takes place. Not only do all whom the contagion reaches employ their credit much more freely than usual; but they really have more credit, because they seem to be making unusual gains, and because a generally reckless and adventurous feeling prevails, which disposes people to give as well as take credit more largely than at other times, and give it to persons not entitled to it. . . . As, when prices were rising, and everybody apparently making a fortune, it was easy to obtain almost any amount of credit, so now, when everybody seems to be losing, and many fail entirely, it is with difficulty that firms of known solidity can obtain even the credit to which they are accustomed, and which it is the greatest inconvenience to them to be without; because all dealers have engagements to fulfill, and nobody feeling sure that the portion of his means which he has entrusted to others will be available in time, no one likes to part with ready money, or to postpone his claim to it. To these rational considerations there is superadded, in extreme cases, a panic as unreasoning as the previous over-confidence; money is borrowed for short periods at almost any rate of interest, and sales of goods for immediate payment are made at almost any sacrifice.”
This is as clear a statement of the causes of commercial panic to-day as of the causes in 1844. It will now be in order to glance briefly over some of our recent serious commercial panics, and inquire, in the light of a closed and completed record, what was the specific cause — or causes — of each. After such inquiry we shall be better able to discover if similar germs of future mischief are present in our finances of to-day. We shall find a certain similarity of origin about all of them; and in every one we shall discover the influence of that inflated credit of which Mill makes so great account. The more one examines into this subject, the more will one be impressed with the fact that, while the whole history of the world’s commerce and industry is made up of alternate periods of elation and depression,— largely due to the same causes which influence them to-day, — the commercial panic, as we understand it nowadays, is strictly a modern institution. In its peculiar phenomena, described at the beginning of this article, it is, indeed, inseparable from the modern credit system.
Centuries ago a merchant might have invested all his own money in goods which he was unable afterward to dispose of, and might thereby have lost the bulk of his own fortune. But unless he had used the machinery of a modern money market and banking system, his misjudgment could hardly have had the instantaneous effect on an entire community which it will have to-day. In particular, the deposit of individual savings in banks, and the lending out of those savings by the banks to merchants, dealers, speculators in stocks and produce, who depend on continuance of such loans for their own financial safety, binds the community into a concrete body, each part of which must suffer with the rest. Failure of half a dozen large traders, loans to whom made up a good part of current banking assets, necessitates calling in of loans by the banks from other quarters. Ultimately, demand for repayment of obligations may become general all along the line, ending with demand of depositors for cash against their bank credits. Neither the banks nor the mercantile and financial institutions are ever prepared for such a demand, from every direction and at the same moment. If, as is highly probable, some of them show signs of unwillingness or inability to pay, the result is outright panic.
In all of our greater commercial panics it will be found that the fundamental cause of trouble was what Wall Street nowadays describes in the familiar phrase, “discounting the future.” That is to say, a period of real and genuine prosperity, with promises, afterward invariably fulfilled, of vastly greater prosperity, led to the capitalizing of industry and the incurring of debt on the basis of what was expected in the future. When this process had gone to a certain extent, a situation was created in which any accident of the moment, any failure of an agricultural crop, any disturbance in a foreign market which had been a profitable customer, even in some cases an unexpected war, with its interruption to industry, would not only upset all expectations of the immediate future, but would leave an entire community with demand liabilities which it could not meet.
The story of the panic of 1837 has been told frequently, and in great detail. The country had then begun for the first time to understand the immense opportunities for internal development which have since so altered the face of the American continent. Canal building and the pushing of immigration to the Middle West had opened up new fields of wealth and production. The result, as is usual under such circumstances, was, first, a legitimate advance in the price of land, due to the enthusiasm over the new opportunities of the country; then, when the excitement had reached a high pitch, a speculation in real estate, which practically absorbed the entire surplus capital of the country. Along with this movement came an excited speculation in produce, notably cotton, conducted under the auspices of banks which were organized and managed with a minimum of conservatism. The capital of the country being already inadequate for these large speculations, capital was borrowed abroad in quite unprecedented volume. The country did not meet these new obligations by increase in its excess of exported merchandise, probably because it could not. During these years prior to 1837, the demand for foreign products and luxuries, which always appears at such a time, led to an excess, very large for those times, of merchandise imports over exports. Our foreign debt increased, and it followed, naturally, that the first sign of distress on any foreign market would lead to recall of its portion of this debt, at an hour when it could least readily be spared. This is exactly what happened; it occurred simultaneously with a rash experiment by our government in demanding instantaneous return to a specie basis on the part of banks which had recklessly expanded loans and over-issued notes redeemable in specie. With these two stocks, the whole structure of speculation went to pieces; general suspension of banks at the larger cities followed, with the disorganization of industry and commercial panic which were the natural accompaniments.
Prior to the great reaction of 1857, the country had again been indulging in land and produce speculation, largely originating in an immense extension of the American railway system. The new gold production, following the California discoveries of the fifties, had been utilized to the full in promoting and encouraging speculation of the day. Then, as twenty years before, foreign capital was borrowed to make good the deficiency in domestic supplies. The banks, as in the earlier period, had overstrained their resources to provide the means for continuing the speculation. This was a situation in which the failure of one or two large banking institutions, unable to realize on their assets, brought searching inquiry into the condition of all the rest. The effect of such inquiry was most unfavorable; it resulted in one of those general runs upon the banks which reduced practically all of them to a position where they could not provide for even their regular customers.
In each of these panics, the reader of history is apt to be impressed with the important part played by improperly secured bank-note issues. The panic of 1857 is particularly remembered in the traditions of business history as a time when bank notes, making up the bulk of the currency in many sections of the country, became practically worthless except at large concessions from their face value. It is true that an unscientific note-issue system aggravated the troubles of those years; but it must always be kept in mind that in the last analysis the bank note is no more troublesome an obligation to the institution which issues it than is the bank deposit account on the books of the institution . It may, indeed, be said that runs of depositors are more formidable than runs of note-holders. Notes are certain to be more or less widely distributed; with the deposits no such protection exists. In either case, the question is equally one of prudent and scientific financiering, which should keep the institution always in the position where it can pay off at the shortest notice its demand liabilities.
The period preceding the panic of 1873 had been one of wild and extravagant speculation. That the excesses of the time were greatly increased by the government’s paper money issues, and the speculation in gold which accompanied them, may be readily conceded; it is not, however, true that these paper money issues were the primary cause of commercial panic. As in the two other panics which we have just reviewed, the real mischief originated at a time when apparently boundless prosperity, based on genuine industrial development, was the governing influence. The country’s industrial expansion in the years succeeding the Civil War was quite without precedent in our history. Within eight years after Appomattox, the railway mileage of the United States was actually doubled. Immigration from foreign countries followed this increase of transportation facilities; development of the grain-producing country came with it, and an immense increase in the country’s productive capacity ensued.
This was genuine prosperity and real wealth; yet it was patent, even at the time, that absorption of capital into these thousands of new enterprises was proceeding at a rate which immediate returns from the newly opened territory could not possibly offset. In the excitement of speculation, fomented undoubtedly by the paper money issues, prices for everything were raised to extravagant heights; and all this happened at a time when the waste of capital through the Civil War had destroyed or absorbed a good part of the country’s surplus wealth. The immense increase in imports of foreign merchandise gives some notion of the extent to which we were then relying upon foreign capital. In 1872 our excess of merchandise imports over exports was $182,417,000, which exceeded by nearly $25,000,000 the largest excess of the sort even in the Civil War, when our cotton exports were cut off, and the country unusually dependent for necessary merchandise on the foreign mills.
Even before 1872 signs of this strain on domestic capital had become manifest. They were accentuated by the FrancoPrussian War of 1870, and the enormous indemnity which, imposed by Germany on France, had to be raised from the European markets where our floating debt was heaviest. The New York money market, always an accurate barometer of such insufficient supply of capital, ranged throughout 1872 at rates which might have been considered prohibitive of progressive industry. Not only did Stock Exchange demand loans repeatedly go to 125 per cent or higher, but notes of commercial houses in good standing, discounted in New York, had to pay during a period of four months such rates as 10 and 12 per cent per annum. At the same time the phenomenon which frequently marks the culmination of a financial “boom ”
— a violent rise in the price of real estate
— became the conspicuous movement of the markets.
Another incident of the day, interesting because of the manner in which it has subsequently been repeated, was the inability of great railway corporations, bent on immediate extension of their lines, to sell their bonds to investors, home or foreign. Coming into the open money market to procure through short-term loans the necessary funds, these companies obtained the endorsement of their notes by banking houses in the highest standing. Before the notes came due the New York money market had fallen into such a condition of disorder that neither the borrowing railways nor the endorsing bankers were able to make good their obligations. One after another, the banking houses suspended payments, and, as usually happens at such times, their failure merely served to show the extent to which the banking community at large was in the same position. So severe was this commercial reaction that fully half a dozen years elapsed before the mercantile and industrial communities regained their former footing.
The case of 1893 was in some respects unlike that of preceding financial crises. That it was a genuine commercial panic is sufficiently proved by the figures of the year’s commercial failures, showing that 13 American business houses out of every 1000 went to the wall in 1893, as against only 9 per 1000 even in 1873. But 1893 did not follow quick on the heels of a wild and extravagant speculation, with a disordered money market. On the contrary, the year before the panic had been a period of uncertainty, with depression rather general in finance and industry, and with quiet money markets. Such culmination of speculative excesses as did precede that panic occurred three years before, when an unwholesome, but not abnormally violent, movement of the kind greeted the passage of the silver-purchase law.
But the abuse of capital and credit was nevertheless a factor in the reckoning of 1893, quite as much as on previous similar occasions. Railway building, and issue of new railway bonds, had gone on at an extraordinary rate, and for many years. In 1887 was attained the high record of such construction, the figure aggregating 12,876 miles, more than double the largest annual construction even in the present financial “boom.” Railway mortgage bonds,issued in 1888 to foot the bill, and listed on the New York Stock Exchange, were double those of two years before, and in 1890 the listings of new stocks and bonds combined, $1,122,000,000, went 60 per cent beyond even 1888. Furthermore, these great sums of money were often invested in highly speculative railway undertakings, —sometimes in enterprises absolutely reckless. Parallel lines, built to compel the purchase of the new railway by the old one, led to cutting of rates below cost of transportation, to demoralization in railway profits, to frequent bankruptcies, and to enormous waste of capital.
What was perhaps an equally potent influence, in the strain on the country’s capital, was the heavy investment of Eastern funds in Western farm mortgages,— a movement which had the double consequence of encouraging unwise farming ventures by people thus supplied with credit, and of tying up Eastern money in a losing enterprise. For, as it happened, this sudden increase in loans on farming property was immediately followed by a series of years in which grain was produced in excess of the world’s consuming power, and when, accordingly, prices fell to a level which meant distress or bankruptcy to all heavily indebted farmers.
In the face of this situation our currency was on a basis confessedly insecure, and the country’s debt to European investors larger than it has ever been, before or since. London’s own financial crisis of November, 1890, led necessarily to recall, by hard-pressed English houses, of a good part of this foreign capital: that recall involved, first, sales of American securities in such quantity as to crush the market; second, export of gold in almost unprecedented quantity; third, as a consequence of this, the breakdown of the ill-guarded gold reserve against our currency. It was the final collapse of the country’s expanded credit structure, under this protracted strain, which occurred in 1893.
What, then, in the light of our examination of the causes underlying commercial panics, are we to say of the outlook for the future ? Exactly where does America stand to-day in the “cycle of prosperity ? ” Must we look for the final extravagances in use of credit which have brought disaster in other “twenty-year periods,” and for the commercial panic which ensues; and if so, when is that episode to be expected ? These are highly practical considerations.
Numerous conditions and circumstances, peculiar to the present forward movement in finance and industry, and differing widely from the phenomena of former periods,have encouraged at times, notably during the excitement of 1901, belief that the precedent of other decades might not be repeated. Much has been made of the facts that, between 1897 and 1900, this country had redeemed its foreign debt on an unprecedented scale; that in the last-named year our money market was itself a creditor of Europe and an investor in European public securities; that our excess of merchandise exports has reached unheard-of figures—$664,000,000 in 1901, and an average of $513,000,000 per annum for the past nine years, as against a previous annual high record of $286,000,000; that our interior communities have themselves become independently wealthy, lending money in the Eastern markets, instead of borrowing from them; that the currency is in a sound condition, as it certainly was not on the eve of 1837 or 1857 or 1873 or 1893. Finally, there is cited wholly unprecedented annual gold production of the world as a whole, and of the United States alone, both of which reached a maximum last year.
These are facts with an important bearing on the country’s power to withstand reaction from an over-exploited credit. That they can,however,alter permanently the law of financial inflation and depression whose repeated operation we have traced, is not reasonably to be supposed. Arguments very similar might have been used, and indeed were used, in the decades before 1893 and 1873, to prove that recurrence of the old-time commercial panic was impossible. Belief in a radically changed condition of American finance and industry was an important factor in the excited “booms ” which preceded all our years of crisis and reaction. In the fifties our gold discoveries guaranteed the American situation; in the seventies we had suddenly become the grain-producer for the outside world. Yet neither event, though each was equivalent to an industrial revolution, delayed for a year the arrival of the commercial crisis after the familiar interval.
The reason is simple. In the periods referred to, the greater the genuine basis of prosperity, the larger the balloon of inflated credit blown by the speculators and promoters. People who are inquiring whether another commercial crash, as a sequel to the present “boom,” is or is not a probability of the future, ought to devote their investigation, not alone to the underlying elements of strength, but to the manner in which those elements have been exploited. If it were to be discovered that credit had been employed prudently and conservatively, that fictitious values had been discouraged, and that the community as a whole had not been indulging in speculation, there would then exist reasonable ground for arguing that the experience of past commercial panics might be escaped.
It will hardly be alleged that the past five years have presented any such picture. Unparalleled as were the tokens of sound and real American prosperity, the fabric of paper credit built upon it even surpassed in magnitude and extravagance anything of the sort that the world had previously witnessed. Details are hardly necessary: to enumerate them would be to tell our financial history since 1898. Speaking generally, what has happened is that American industry as a whole has been recapitalized within this period, on a basis of immensely extended debt. The country has been speculating, sometimes with extraordinary rashness, in the shares of these and the older corporations; in this race for speculative profits some of the strongest private banking houses and some of the largest banks have, directly or indirectly, been engaged.
There have not recently been repeated all the excesses of 1899, when a great industrial company, inflating its capital from $24,000,000 to $90,000,000,disposed of $26,000,000 in such ways that the courts could not afterward learn what had become of it; or those of 1901, when $50,000,000 cash was paid to the Steel Trust “Underwriting Syndicate” merely for guaranteeing the sale of the company’s new stock. But we have seen the Wall Street stock market, within a year, jacked up to extravagant figures by the virtual cornering of properties with $150,000,000 stock,—this being done mainly with borrowed money, at a time when supplies of available capital were visibly running short. With all the outpour of wealth in American industry, the country’s capital has on at least three recent occasions shown itself inadequate to the home demand upon it. Wall Street has seen good commercial paper, at these times, selling at 8 per cent, short time loans at the equivalent of 12 per cent, and demand loans at 125 per cent.
A few years ago it was estimated in banking circles that the American market possessed a floating credit of not less than $200,000,000 at the foreign money centres. We have very lately been in debt to these same markets, on our bankers’ notes-ofhand, to a probably much larger sum. When railway companies in unquestioned credit were unable, this past year, to sell their bonds save at a heavy sacrifice, and were forced to borrow on their notes, at high rates and for short maturities, capital borrowed from European and American banks was used for concerted manipulation of Stock Exchange securities; the operation was continued at the very moment when some of the exorbitant money rates just cited were in vogue. No one familiar with the facts is likely to deny that for daring speculation, on a scale of enormous magnitude, and in merchandise as in securities, there have been few parallels to the decade in which we are living.
I do not state these facts with a view to moralizing or distributing the blame; nor have I any idea of predicting an early and serious commercial crisis. There are many reasons why no such event is considered imminent. But we are looking at our financial history, past and future, at long range; and what one must admit, in the light of these quite undisputed facts, is that financial America has, in the past half-dozen years, simply repeated the general story of those preceding “booms ” which ended in commercial crisis. That we shall some time —probably at a date sufficiently remote — witness another violent spasm of financial readjustment, such as 1893 or 1873, seems to me to be altogether probable.
Certainly, if our study of causes of commercial panics proves anything, it proves them to be a logical result of exactly such procedure as has distinguished the American markets for half a dozen years. We have no good reason for assuming that, in the end, a similar result will not follow the similar causes in the present period. It has, indeed,been not a little impressive to see how, even with the new and portentous influences at work in the present cycle of prosperity, its successive stages, at the usual interval, have repeated the history of preceding epochs of the kind.
We have even had our “little panic,” which traditionally comes midway between two larger commercial crises, and we have had it at the traditional interval. Such a year of Stock Exchange disorder, only partly accompanied by disordered trade, occurred in 1866 and 1884, and it occurred again in 1903. Whether the “twenty-year interval ” between the first-class panics is to be as scrupulously observed — its exact observance would bring the next one in 1913 — is a question for the prophets.