While Rothbard masterfully handled the economic history of both the Panic of 1819 and the Great Depression, as well as contributing to business cycle theory and providing economic insights on episodes of American history, not as much direct attention and writing has been devoted to the key depression of the Panic of 1893 from an Austrian perspective. One notable exception is Lawrence Reed’s A Lesson from the Past: The Silver Panic of 1893, including an excellent article and video on the topic.
While there were certainly economic crises before the Fed, Austrian theory provides analysis to understand and explain these unique historical-economic events. This article seeks to explore the depression of 1893 from an Austrian perspective. As for the depression of 1893, why study this depression in particular when there are so many—1819, 1837, 1857, 1873, 1884, 1893, and 1907?
The answer is because the Panic of 1893 was both consequential and has not received as much attention. According to Reed, “Strangely, the awesome Panic of 1893 seems to have escaped the careful scrutiny and exhaustive research of historians.” For advocates of the free market, “the story of the Panic of 1893 offers a treasure chest of empirical support. The lessons of this tragedy add up to a compelling indictment of government’s ability to ‘manage’ a nation’s money.” It also “is smothered with the fingerprints of politicians.” The century prior to 1893 experienced two central banks, a national banking system, issues with paper money, and attempts at bimetallism.
Further, Robert Higgs, in chapter five of Crisis and Leviathan, notes several key aspects of the importance of the Panic of 1893. For one thing, besides the Civil War, “no crisis in the nineteenth century challenged America’s political and economic order so profoundly as the mid-1890s.” The 1890s were pivotal years for agitation toward later interventions (e.g., income tax, central banking), but they also represent “the last major battle in which the forces of classical liberalism won a clear victory.” Rothbard describes the aftermath as the “cataclysmic year 1896,” in which “the face of American politics was changed forever.” He continues, “the old Democracy of free trade, hard money, personal liberty, and minimal government was gone forever. As Grover Cleveland mournfully pronounced, ‘…the Democratic party as we knew it is dead.’” Higgs also notes that,
Only the Great Depression of the 1930s was more severe than the depression of the 1890s. But because the earlier slump began at a much lower level of income—real GNP per capita in 1892 equaled only 55 percent of the corresponding figure for 1929—the collapse in the nineties pushed its victims to a much lower level of economic well-being than that reached at the bottom of the Great Depression.
Therefore, the Panic of 1893 is worthy of specific attention. Given the nature of the panic, it has important lessons and Austrian analysis provides a satisfying framework for understanding this event and other historic business cycles. In short summary, the Panic of 1893 (and the resultant depression) was the result of artificial credit expansion under the National Banking System (NBS) that fueled malinvestment—especially in railroads and other capital-intensive industries—followed by government-induced monetary instability from bimetallism and silver agitation, which triggered Gresham’s Law, drained gold reserves, and exposed the underlying fragility of the banking system.
The National Banking System (NBS) & Artificial Credit Expansion
It is key to understand that the period prior to 1893 was not a pure free market, especially in money and banking. While there was no Federal Reserve System yet, there were plenty of government interventions into money and banking, as well as other interventions (e.g., war, railroad cronyism), that led to the distortion of the structure of production—namely, the National Banking Acts (1863, 1864, 1865, 1866), the Legal Tender Act (1862), and the printing of Greenbacks. The banking acts created the National Banking System (NBS)—semi-cartelized, government-engineered, bond-based reserve pyramid masquerading as a gold standard, which funneled artificially-expanded credit through the major New York banks. In short, the Civil War brought about a permanent change in the banking system and “created a new, quasi-centralized, fractional reserve national banking system which paved the way for the return of outright central banking in the Federal Reserve System.”
Rothbard agrees that—despite phenomenal, true economic growth, alongside artificial growth—“Indeed all during this time there was never a completely free-market monetary system. The National Banking Acts of 1863–1864 had semicartelized the banking system.” This pertained to the 1890s and the Panic of 1893 in particular, as Rothbard explains further,
Only certain banks could issue money, but all other banks had to have accounts at these. The financial panics throughout the late nineteenth century [including 1893] were a result of the arbitrary credit-creation powers of the banking system. While not as harmful as today’s inflation mechanism, it was still a storm in an otherwise fairly healthy economic climate.
In general terms, Rothbard approvingly cites Klein regarding the Panic of 1893 and other pre-Fed panics,
As a general overview of the national banking period, we can agree with Klein that,
“The financial panics of 1873, 1884, 1893, and 1907 were in large part an outgrowth of . . . reserve pyramiding and excessive deposit creation by reserve city and central reserve city banks. These panics were triggered by the currency drains that took place in periods of relative prosperity when banks were loaned up [Klein, Money and the Economy, pp. 145–46].”
And yet it must be pointed out that the total money supply, even merely the supply of bank money, did not decrease after the panic, but merely leveled off.
As usual, we see in general that artificial credit expansion was the culprit of this panic, just like all boom-bust cycles, however, the specific details involved in each business cycle are unique. The artificial credit expansion due to the government-created banking system created the unsustainable boom, while the immediate panic or bust was triggered by fears that the existing bimetallic structure would be readjusted in favor of silver, a shift that brought Gresham’s Law into play and revealed the weakness of the banking system. This led to the bust and the following depression.
The Boom, Cronyism, & Railroads
Being both highly capital-intensive and major recipients of government subsidies, railroads were the ideal sector for an artificial credit-driven boom and for cronyism. As is common, genuine growth accompanied credit-fueled and cronyist growth, spreading to several sectors of the economy, bringing many other industries and people into dependence on the growth of these industries. These industries and people would be negatively impacted by the inevitable bust.
Similar factors were at play in the post-Civil War depressions prior to 1893. Writing concerning the Panic of 1873, Joseph Calandro explains that the causes of the panic were implicit in the Civil War expansion of money and credit “which was redirected from wartime military spending to industrial production (including railroads) after the war (the boom).” Obviously, during the Civil War inflationary credit expansion funded the military (and related industries), but after the war “inflationary finance shifted to industrial production, which included railroads.” Calandro further explains,
Significantly, “credit expansion always generates the business cycle process, even when other tendencies cloak its working” (Rothbard 2009, 1003); this occurred after the Civil War as demilitarization, Reconstruction, and industrialization combined to generate a great deal of economic activity that was financed by a credit-fueled investment boom. Then, as now, technological innovation can offer lucrative investment opportunities, especially during a boom. And then, as now, governmental grants/funding/guarantees can misdirect investment into channels that private investors would not otherwise pursue.
While I agree, I would emphasize that government subsidies and credit expansion not only “misdirect investment into channels that that private investors would not otherwise pursue,” but these factors also artificially expand activities to an extent that would not emerge on a free market. For example, there was a genuine market demand for and supply of railroads, as can be seen in James Hill’s successful construction of a transcontinental railroad on a market basis. However, while a certain supply of railroads would have been brought into the American market by the forces of supply and demand, the artificial credit expansion and cronyism toward railroads arguably overexpanded railroads in terms of time, location, and extent. Ironically, in the depression year of 1893, all the transcontinental owners except Hill were lobbying for more subsidies and Union Pacific, Northern Pacific, and Santa Fe would all soon go bankrupt (bringing retrenchment and unemployment). The abrupt reassertion of reality in effect revealed which railroads were on a sound, market basis and which ones were artificially-stimulated bubbles via inflationary credit expansion and government assistance.
While not in the explicit or technical language of Austrian economics, Frank Chodorov basically presented the boom-bust cycle, the connection to railroads, and the depression of 1893 in his Income Tax: The Root of All Evil (1954),
The period after the Civil War was characterized by the customary boom followed by the inevitable bust. War stimulates productive activity, and the habit carries over into the peacetime…. And everybody keeps on buying because everybody has a lot of the bogus money issued by the government during the war; also, everybody has bonds which can be cashed in or borrowed upon. The boom is on.
The post-Civil War boom was accelerated by the promise of the West; the prairie was being penetrated by miles and miles of railroad. It seemed that prosperity not only was here to stay, but that it would be a constantly expanding prosperity. Men gambled on it. They speculated on the future; they bought pieces of the future in the form of land and industrial securities, and paid prices that were based on the belief that people would grow richer and richer, forevermore.
In 1873 the inevitable depression set in…. They are compelled to curtail because they burdened themselves with obligations during the boom and now they are unable to meet the interest payments. Values did not rise as fast as they had expected; mortgages and other debts hang heavy on their necks, and in an effort to save their original investment they cut down on their consumption…. Only when the false values are liquidated, the mortgages wiped out, can there be a resumption of production. The depression is a period of deflation following a period of inflation….
But hungry people are impatient. They cannot wait for deflation to wipe out the debris of their own orgy. A much quicker cure is called for, and the medicine that promises a quick cure is money. During the war, it was reasoned, the government printed greenbacks and there was prosperity; why not print more greenbacks and force prosperity to come back? And so, during the depression of 1873–76, and for twenty years after [including 1893], there was a loud clamor for greenbacks, plus silver money to supplement the scarce gold. This was the principal recipe of the social doctors of the times, a loud-mouthed lot who acquired the generic name of Populists.
These do-gooders were most vocal in the new West, where the “hard times” hit hardest and held on for the longest time. The story of this area is the story of the railroads. In the light of later experience, we can describe the railroad expansion of the 1880’s as a make-work program, fostered by government subsidies and bounties [and credit expansion]. There was no economic need for most of these railroads. They were not built to serve an existing population, but to attract population from the eastern seaboard and from Europe. They amounted to a suburban land promotion. Even before they were built, when the companies had only pieces of paper giving them franchise rights, the bonanza that awaited prospective “empire builders” was advertised. All one needed to do to cash in on this promise was to buy a piece of land from the railroad companies, land which they had got for nothing from the government and which was still worthless and would continue to be worthless until settlers made them productive. With a gleam in their eyes, the settlers paid the companies’ price by pledging their future earnings on the land; they mortgaged themselves to the hilt. Of course, their earnings would prove for a long time to be insufficient to meet their living expenses as well as the interest on the mortgages….
It is not difficult to see that the boom and the bust were stimulated, if not caused, by acts of government, aided and abetted by the natural cupidity of people….
In 1893 the country had a new depression and a new president. Grover Cleveland, though endowed with more integrity than the run-of-the-mill politician, nevertheless had to “do something” to satisfy the dissident elements….
While there are certainly statements in the quote above needing tightening and even correction, Chodorov presents a narrative that is conceptually aligned with Austrian business cycle theory, especially in his emphasis on government-inflated money, artificially stimulated booms, speculative malinvestment, and necessary liquidation. Railroad cronyism alone produced waste and corruption, but without the NBS and its artificially-expanded credit, the politically-favored railroads could never have raised enough capital to distort the entire capital structure of the US economy; therefore, the spectacular malinvestment of the 1880s-1890s was possible only through the combination of subsidies and artificially cheap credit.
Bimetallism, Silver Agitation, & Gresham’s Law
The US had officially been on a policy of bimetallism, under the direction of Alexander Hamilton, since 1791. Bimetallism involved an attempt to legally fix price ratios between two currencies, in this case, silver and gold. The official rate was set at about 15 to 1, that is, 15 ounces of silver were to be legally equated to 1 ounce of gold. The problem with this price-fixing is that, due to changes in supply and demand, the prices of monies (silver and gold) change relative to other goods and to each other.
Bimetallism was pursued as an inflationary policy. While not complete, the inflationary momentum following the Civil War was imperfectly halted with the Specie Resumption Act of 1875 (implemented in 1879), however, it would be left to later political decision-makers to move in a more or less inflationary direction. Unfortunately, “Bimetallism would become the adopted approach and result in the Panic of 1893 (Laughlin 1896; Reed 1993).” Inflationists favored bimetallism because it legally overvalued silver, expanded the money supply beyond gold alone, raised prices, lowered the real burden of debts, and temporarily stimulated economic activity, especially for debtors and politically-favored sectors. By promising monetary expansion through the legal overvaluation of silver (16:1), bimetallism appealed to inflationists as a means of raising prices and relieving debt, but it also destabilized the monetary system and ultimately set the stage for panic.
Bimetallism brought Gresham’s Law into effect. This law is often simplified as “bad money drives out good,” but, more precisely, it operates when governments impose legal tender laws and fixed exchange ratios, thereby artificially overvaluing one money relative to another. Rather than allowing the relative prices of gold and silver to be determined on the market through changes in supply and demand like all other goods, the government declares a fixed ratio (e.g., 15:1) at which the two monies are legally equal. This incentivizes people to spend the artificially-overvalued money (such as silver) to settle debts and taxes, while simultaneously encouraging them to hoard or export the undervalued money (such as gold). Foreigners, recognizing this distortion, may require contracts to be settled in gold, accelerating gold outflows. When holders of silver or paper claims are permitted to redeem them for gold at par, gold is withdrawn from banks, exposing the systemic fragility of a credit structure built on thin reserves.
During this period (1873–1893), the silver agitation was so powerful that it threatened the “gold standard” and led to a monetary panic. As Friedman and Schwartz wrote in A Monetary History of the United States (p. 133), “Treasury action was on a scale large enough…that…if indefinitely maintained, would have driven the United States off the gold standard entirely by its direct effects on the money stock.” From 1873 to 1893, the Coinage Act of 1873, repeated silver-purchase mandates (Bland–Allison [1878] and Sherman Silver Purchase Act [1890]), silver-backed paper issuance, Treasury actions signaling retreat from gold, and sustained political agitation for free silver (i.e., Free Silver Bill passed in the Senate [1892]) steadily undermined confidence in gold redemption. These policies activated Gresham’s Law, drove gold out of banks and the Treasury, and triggered the panic that collapsed an already-fragile, credit-expanded banking system. People rationally redeemed paper and overvalued silver claims for gold, draining Treasury and bank reserves, which destabilized the fractional-reserve banking system and helped produce the Panic of 1893.
Rather than a simple return to the gold standard, which would be an additional intervention that would further harm those under previous bimetallic disruption, there ought to be a return to monetary competition and separation of money and state. But, as Rothbard explains, “Full monetary freedom, after all this time, was considered absurd and quixotic; and so the gold standard was generally adopted.” Unfortunately, this period, including the depression, would lead to a set of interventions that would ultimately lead to central banking and the income tax. It was due to the monetary interventions and their consequences that gave the “gold standard” a bad name, and led to agitation for the Federal Reserve.
