Historians often view the Panic of 1857 as being caused, not by economic events, but political ones. Such disparate events as the end of the Crimean War in 1856 involving England, France, Russia and Turkey, the Supreme Court’s Dred Scott decision, the battle over slavery in the Kansas Territory, even the sinking of the SS Central America are all part of the developments bound together as causes of the 1857 panic.
The Banking Superintendent of New York, James Cook, called the panic “without apparent reason derived from past experience.” Charles W. Calomiris and Larry Schweikart wrote, “First, the period immediately prior to the panic was one of unusual calm in the markets for commercial bills.” “Second, the panic was resolved quickly.” “Third, few banks failed during the panic.” Really? 62 of 63 New York banks suspended specie payments.
Calomiris and Schweikart also wrote, “Explanations of the panic encounter difficulties in explaining the timing and location of its onset in the east.” While lasting only from October through December of 1857, the panic caused bank runs, paralyzed commerce, and created a crisis of confidence in securities markets both here and abroad. As Austrians understand that, if there’s a panic, there must be a mania, started by a monetary intervention, and then there are malinvestments to be cleared. Historians have controlled the narrative of the Panic of 1857, lumping it together with the Civil War. But there is an Austrian explanation for the panic.
One historian wrote there was “widespread prosperity” and a rapidly-growing economy in the United States from 1850 to 1856 but mentions no monetary stimulus other than the passing comment of, “People invested in western lands and railroads at unprecedented rates, based partly on a massive influx of gold from California.”
“In the United States alone, gold production multiplied seventy-three times during the six-year period that began in 1848…” Economist E. Victor Morgan wrote, “The most important single factor in monetary history in the third quarter of the nineteenth century is the great increases in gold output, following the discovery of the mines of California and Australia.”
Year Dollar Amount of Gold mined in California Ounces mined
1848 $ 245,301 12,958
1849 $10,151,360 491,116
1850 $41,273,106 1,996,764
1851 $75,938,232 3,673,838
1852 $81,294,700 3,932,980
1853 $67,613,487 3,271,093
1854 $69,433,931 3,359,165
1855 $55,485,395 2,684,344
1856 $57,509,411 2,782,265
1857 $43,628,172 2,110,700
1858 $46,591,140 2,254,046
Gold production soared each year from the initial discovery in 1848 to a peak in 1852. In February 1851, the state’s largest newspaper reported,
The real truth is, by far the largest part of the gold…[mined hitherto] was taken from the river banks, with comparatively little labor. There is gold still in those banks, but they will never yield as they have yielded. The cream of the gulches, wherever water could be got, has also been taken off.
The paper goes on to explain that capital would be required to mine gold, not just labor.
An increase in the supply of money engenders an economic “boom” followed subsequently by the correction of that malinvestment, or “bust,” characterized by less money or credit is the essence of the Austrian Business Cycle Theory (ABCT). Or, as Jörg Guido Hülsmann elegantly wrote, “Austrian business cycle theory explains clusters of errors by changes in the quantity of money.”
Monetary intervention could be in the form of the following, listed by Gottfried Haberler: (a) An increase of gold and legal tender money; (b) an increase of banknotes; (c) an increase in bank deposits and bank credits; (d) an increase in the circulation of checks, bills, and other means of payment which are regularly or occasionally substituted for ordinary money; (e) an increase in the velocity of circulation of one or all these means of payments.
While the money creation occurred in California and Australia, Great Britain, at the time, was the world’s financial center. And, “it was through Great Britain that most of the movements of the precious metals took place.”
The US and Australia mines shipped gold to Britain in exchange for commodities providing a positive trade balance and “very low interest rates.” The Bank of England’s bullion stock rose to £22 million in 1852 and the Bank’s rate was 3 percent or less from November of 1848 to June 1853. James Grant wrote the Bank of England’s Bank Rate was posted at 2 percent in April, 1852 and stood at 3.5 percent at the end of August 1853, rose to 4 percent on September 1, 4.5 percent on September 15 and 5 percent on September 29. The Bank of England raised its official rate from 5.5 percent to 6 percent on October 8. Just four days later, the central bank raised a full point to 7 percent and a week later to 8 percent. On November 5, the rate was raised to 9 percent and four days later to 10 percent.
Along with a 30 percent increase in metallic currency, there was a great increase in joint-stock banking in London. New banks formed and existing banks increased their business resulting in deposits in London joint-stock banks increasing from £8,750,774 in 1848 to £43,107,724 in 1857.
From July 1, 1848 to July 1, 1852, the amount of American railroad and municipal securities held by foreigners doubled, from £12 million to £24 million. By the beginning of 1861, British investment in America was £100 million with at least £20 million in railroad securities. British short-term credits also aided American railroads. However, Adler believes that’s a low estimate. “Some of the American municipal bonds as well as those of counties and states were issued to aid railways, and some of these were held abroad.”
The malinvestment? American railroad mileage expanded from 9,021 in 1850 to 166,703 in 1890. “In the nineteenth century no other single sector of the economy of the world attracted foreign capital as did the railroads of the United States.”
While there was no central bank, US banks issued notes and deposits on top of the increase in specie. President Buchanan was withering in his assessment of the panic. Buchanan,
…ascribed the crisis to the vicious system of the fiduciary circulation, and to the extravagant credits granted by the banks, although he was aware that Congress had no power to curb these excesses. When there is too much paper, when the public has created an endless chain of bank notes, representing no real value, it is enough that the first ring breaks for the whole gear, thus no longer held together, to fall to pieces.
Addressing the lack of a central bank, Murray Rothbard wrote,
…inflationary bank credit can only lead to a destructive boom-bust business cycle.… Any bank credit expansion in commercial loans is sufficient to generate the business cycle, whether a central bank exists or not.
In the twenty years from 1837 to 1857 the amount of paper money more than doubled from $6.5 million to $14.3 million. But, more importantly, the paper-to-specie ratio increased from 6-to-1 to 8-to-1, backing up Buchanan’s criticism, “The banks had attracted deposits by high interest, and loaned the money to wild speculators….” In The Merchants’ Magazine and Commercial Review: February 1858, Vol. XXXVIII, No. II, it reads,
Thus, in 1834, the banks of the United States, 506 in number, had $26,500,000 in specie to $147,500,000 for their liabilities, including deposits as well as circulation, or nearly six to one. In 1846, 707 banks, $42,000,000 in specie to $191,500,000 or less than five to one; but in 1856, 1,253 banks had $60,000,000 to $417,000,000, or nearly seven to one.
Between 1850 and 1857, the number of banks doubled to more than 1,500. Most were located in the east with sixty-three of the banks located in New York City. Foreign immigrants provided both the labor and domestic market for goods. “In addition, the flow of gold from California increased specie reserves and thus enlarged the basis for bank loans to railroads, industry, and agriculture.”
The New York Clearing House of bank notes had been organized in October 1853. Specie was kept at 25 percent of deposits. However, with the banks’ harmonious expansion the specie percentage fell. The percentage of specie would fall to 18 percent by 1857.
Loose money led to wild speculation in land and railroad securities. The Cincinnati Enquirer reported “railroad fever” associated with the completion of the Southern Illinois Railroad through Ohio, especially the Cincinnati-St. Louis link. Historian Allen Nevins wrote, a “fever of speculation in Kansas lands was raging, men selling homes, giving up well paid positions, and even borrowing money at ten percent to purchase farms.”
Early 1857 newspapers printed along travel routes to Kansas described “a veritable torrent of humanity.” As railroads pushed westward, Kansas was believed to be the land of opportunity with the territory expected to “increase by seventy thousand people that year.” In April settlers arrived at the rate of 1,000 per day.
Land speculation became a mania with merchants, lawyers, and farmers putting aside their businesses to “turn land agents and real estate dealers.” Lots on Omaha’s best streets which had sold for $500 in the spring of 1856 went for $5,000 a year later. More than half the land sold in a Kansas land sale went to eastern speculators.
While specie production grew exponentially, and then fell, United States banks doubled loan volume from 1851 to 1897—from $400 million to $800 million. “But what is most noteworthy is, that, so far from a proportionate increase of the specie average, the stock, which was then wholly inadequate, has only increased some three or four millions.” The writer says if banks held specie totalling $18 million in 1857 it would have been considered inadequate. “[I]n fact up to the time of the panic the stock of specie in that year was only about $10,500,000.” An appropriate amount of specie would have been four times ($40 million) what the banks were holding at the time of the panic.
On August 24, the New York branch of the Ohio Life and Trust Company had failed, marking what most historians cite as the official beginning of the 1857 panic. However, trouble had been brewing long before. J.S. Gibbons wrote in 1858 of New York’s banks,
It is manifest that the rules of sound discretion in our bank management were lost sight of as far back as July, 1855; and since the expansion was not arrested at any subsequent period, when it was possible, but one result could follow. In fact, it appears that the escape from panic in the two previous years was remarkable.
Early in the decade, the number of banks grew in New York, not with real capital but,
…it was mostly fictitious—merely paper capital—nothing, in fact, but the creation of a book debt, with hypothecated stock certificates as collateral security…. This was the expansion that prepared the crisis of 1857. It was an overgrowth of banks, and an overtopping of credit on the overgrowth…
On August 24, the New York branch of the Ohio Life and Trust Company failed: “It struck on the public mind like a cannon shot.” Stock and money dealers failed. “On the ordinary securities of merchants, such as promissory notes and bills of exchange, money was not to be had at any rate.” James Grant wrote, the panic caused panic borrowing with interest rates exploding to 24 percent or even 60 percent were on offer.
Sixty-two of sixty-three New York banks suspended specie payments. The Bank of Pennsylvania failed along with other banks in the region. “The bank suspension of New York and New England, in the middle of October, was the climax of this commercial hurricane.” It was described as the “most extraordinary, violent, and destructive financial panic ever experienced in this country.”
Gibbons provides the sequence of events causing the panic:
If country banks are borrowers No. 1; and were called by their depositors, the country banks called on the city banks;borrowers No. 2; which were called by the large broker;borrower No. 3; and the large brokers then on the small brokers;borrowers No. 4,
…in whose hands the money spread out into various channels of fluctuating investment, if not further loaned to a fifth series of borrowers. The difficulty of collecting loans is in proportion to the number of borrowers between the first and the last.
The Panic of 1857 was not caused by the end of the Crimean War in 1856 involving England, France, Russia and Turkey, the Supreme Court’s Dred Scott decision, the battle over slavery in the Kansas Territory, nor the sinking of the SS Central America. This episode from 1849 to 1857 embodied what the Austrian Business Cycle Theory (ABCT) explains. That is, a massive amount of money was created, interest rates fell below the natural rate, money flowed into malinvestments of higher-order goods like land and railroad construction.
When the panic arrived via a run on an important institution operating via fractional reserves, money market rates soared, if liquidity was available at all. In turn, the liquidation of malinvestments began. And in the absence of central bank intervention, the panic was over in just three months.
