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Robert PattonAntebellum America

Panic of 1837

The cause of the Panic of 1837 has been an enigma right up to the present day. But there are

things that we know. The United States had no official currency even though the Constitution

reserved the right of coinage to the federal government. Instead there was a mishmash of

coins, gold, silver, banknotes and counterfeit notes that circulated and were used in trade. In

addition, after 1837 what has been called spurious currencies appeared. Unlike counterfeits,

spurious notes were legal. Corporations and individuals were authorized by emergency

legislation to issue notes that were printed in bulk by a state government, but were only

guaranteed by the issuing individual or group.

In some agricultural areas buyers and sellers resorted to barter because of the shortage of

both specie and trusted currencies. The conventional view is that the counterfeiters were

criminals riding on the backs of the legitimate creators of money, the bankers. But how

legitimate were the bankers? Most Americans as children learn the following story to explain

what banking is all about. Bankers take in deposits. This helps protect the depositors from

thieves that might take their money if stored in the hamper at home. As a bonus the banker

pays interest on deposits. This is a little surprising since the banker is providing a service to

the depositor, yet it is the banker that is paying. The explanation we learn as children is that

the banker can pay for holding the money because the same money can be lent out at higher

interest levels to borrowers who wish to start businesses or buy homes or cars.

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This is a very satisfying explanation but is quite untrue. Not only can the banker lend out

money from deposits held for customers, but when loans are made, they create new deposits

in the name of borrowers who, of course, do not spend the funds as soon as they receive

them. When loans are made based on the new deposits, that increases the money supply. The

process continues and for each dollar deposited by a saver, several dollars can be created. It’s

called fractional reserve banking. Today the government regulates the reserve requirements

of banks.

The situation in the 1830s was similar but more so--much more so, in fact. The large number

of banks chartered by states typically lent out five, ten, 20, and in one extreme case 30 times

their assets. One might guess that the banks were unregulated, but this is not true. In fact

regulation is what made this possible. Counterfeiters were not regulated. If caught, they could

be sent to prison. In practice this was difficult, but only because the counterfeiters outsmarted

the authorities.

The banks, on the other hand, were chartered, in other words licensed, by the state to conduct

business subject to certain rules. To be chartered, a bank might need to have a certain amount

of capital, say $200,000. No problem. The bank might line up an investor who supplied the

necessary capital, then receive the charter from the state. Once chartered, the bank could lend

the $200,000 to the original investor and suddenly the bank’s assets consisted of nothing but

credit. As bizarre as this sounds, in the wild and wonderful 1830s this was a very common

practice. Then of course the bank would welcome depositors and lend many times more

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money than what came in. Again this was the normal course of business in the years leading

up to the 1837 Panic.

These banks were extremely vulnerable to any loss of confidence on the part of their

customers. Once customers began to suspect that something was amiss they would attempt to

withdraw their money. Up to a point this was OK and a well capitalized bank might be able

to honor such requests long enough to restore confidence and the “run” might stop. If not, the

bank might be forced to suspend specie payments--in other words refuse to redeem its bank

notes for gold, silver or other hard currency. This also began to happen with increasing

frequency.

Given this approach to banking and the financial solvency of the nation it should be no

surprise that the system failed. However, there are other explanations offered by historians

and economists who feel that there must be an external explanation--that somebody other

than these bank practices was to blame.

There is the free banking theory. All this happened because bankers were free to do what

they wished, And as everyone knows, bankers are greedy and may do anything profitable

unless closely watched by invariably honest and altruistic politicians and bureaucrats. This is

nonsense. The banking practices outlined above were empowered by state governments and

people naturally assumed that they must be on the level. Imagine if an unchartered bank

opened in a town. How many people would be ready to trust their funds to its safekeeping?

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Companies sprang up to help individuals defend themselves against counterfeiters, but what

help was there to help individuals and small businesses to assess the solvency of the local

bank? The State charter was the only assessment on offer.

Then there is the theory that moving federal funds out of the 2nd Bank of the United States

was the key factor. In other words that if only Nicholas Biddle had been trusted with the

financial future of the nation, everything would have turned out all right.

Biddle did an excellent job of selling this idea, He was able to move is bank to Pennsylvania

as the “United States Bank of Pennsylvania.” He threatened the state with the idea that any

delay would allow another state, such as New York, to charter his bank. This was no empty

threat. Both Pennsylvania and New York as well as other states had been engaged in an orgy

of canal and railroad building. Huge debts had been assumed on behalf of state taxpayers to

fund these grandiose dreams.

Back in those days as today, governments were quick to spend money whether they had any

or not. Without tangible assets a government, whether state or federal, could use the fictional

asset known as the “full faith and credit” of the government entity. And this is why Biddle’s

offer was so attractive. As long as credit was available the construction binge could continue.

All this was a disaster waiting to happen.

Helping the destructive process along were a few other difficulties. Crop failures were

experienced in many agricultural areas. This was partly a result of a trend toward

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monoculture starting with tobacco, then cotton. The extreme South was especially affected.

Small slaveholders with their backs against the wall were forced to sell slaves but a slave that

had been worth around $1500 might now bring as little as $250. One owner of 22 slaves had

to sell a few just to buy food for the rest.

In the Old South there were some positive results, particularly a trend away from

monoculture toward diversification. The motivation was survival: when there is no cash, you

can’t eat cotton.

Meanwhile, in the West, there was an orgy of land speculation. Buyers of government lands

could turn quick profits. Between 1834 and 1836, 37 million acres were sold by the

government and by the end of this period land prices were ten times higher than they had

been in 1830.

To damp the speculative fever Jackson had issued the Specie Circular; land sales required

payment in gold or silver. The result was disastrous. The specie requirement only applied to

the first buyer and land often changed hands several times in a relatively short period of time

so the net effect was to limit initial sales to those who had or could borrow hard money. The

regulation led to hemorrhaging of gold and silver from Eastern banks to the West causing

extreme hardship, especially in New York. Roughly 250 New York businesses failed in a

relatively short time.

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Monetarist Milton Friedman later compared the Panic of 1837 with the Great Depression that

came almost 100 years later. In 1837 about a quarter of all banks failed, while in the 1930s it

was a third. In both the Panic and in the Depression, the money supply dropped by a third.

For Friedman the monetarist, of course, this may have been the most important parameter.

Another theory (Temin) blamed the debacle on specie inflow from Mexico. Because the

British were using less silver in trade with China (because of a switch to Indian opium), there

was an excess of Mexican silver that made its way north. In addition, plummeting cotton

sales caused a drop in Northern manufacturing. But the reduction in cotton shipments

resulted in a drop in specie from England which tends to cast doubt on the Mexican liver

idea.

Included in many theories is the idea that the loss of the restraining influence of the Bank of

the United States was a significant factor. This seems rather far fetched. If Biddle was so

good at restraining and moderating monetary excesses, one would have expected

Pennsylvania to benefit from his financial wizardry. This was certainly what Pennsylvania

expected when they chartered the “United States Bank of Pennsylvania.” Instead

Pennsylvania was one of the hardest hit by the panic and the recession that followed.

By the time Martin Van Buren entered the White House the Panic was underway and there

were those who advocated and expected a return to central banking. Instead Van Buren

pushed for what was called the Sub Treasury bill. The reason for the name is not clear but the

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idea was that government funds would be held in depositories under the U.S. Treasury as

opposed to Private banks.

An interesting sidelight is that it was around this time that the expression OK entered the

American (and world) vocabulary. Van Buren was from Kinderhook, NY and the expression

Old Kinderhook emerged during his campaign. The abbreviation OK survived and took on

the meaning it has today,

NOTES

Standard analysis

- Jackson kills Bank of US

- Biddle moves it to Pennsylvania

- Freed of regulation, state banking abuses proliferate

- Result is often interpreted as proof of the evil of free banking and the need for a

strong central bank

Silver inflation theory

- British reduce shipments of silver to China; switch to opium

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- Land boom retarded inflation because land prices were fixed and pent up demand

absorbed much of the increased money supply

- Meanwhile cotton demand weakened and prices fell reducing flow of specie from

England to the US.

Austrian theory

- Influx of silver added fuel to inflationary fires because every dollar of silver

generated five or more paper dollars

- Money moved from central to state banks added more fuel to inflationary fires

- After 1833 land sales exploded and while prices were fixed for first purchaser, many

of these were speculators who flipped purchases at higher price

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