Early in 1893, the American economy entered a prolonged economic slump from which a recovery would only truly get underway two years later. The financial panic ushering in this depression was global, but what was a mild downturn elsewhere was particularly severe in the US. The American economy, still largely agrarian, was hit by falling commodity prices and decelerating investment and continued to sputter partly thanks to evaporating confidence in the country’s ability to maintain its monetary standard. The Panic of 1893, like the more well-known one of 1907, saw the intervention of America’s premier banker, John Pierpont Morgan. However, unlike in 1907, he helped stop a run not on any private bank but on the US Treasury.
A Global Slump
The Panic of 1893 in the United States followed years of sagging commodity prices; this meant trouble for a country where 40% of the population worked in agriculture and many others in mining and forestry. In the two decades preceding the Panic, cotton prices fell from fifteen cents a pound to eight cents. Wheat fell from $1.17 a bushel to 71 cents. Falling prices begot more of the same overproduction that caused prices to slip to begin with. Shrinking farm incomes meant that farmers increasingly failed to service their mortgages and stress in the banking system rose accordingly.
This economic pain spread to other industries but struggling farmers alone would have been problematic. At the time, agricultural products composed 78% of US exports; though the country was rapidly industrializing, manufactured wares made up under 14% of exports. Roughly a quarter of American agricultural output was sent for export in the late-1880s and early-1890s, the largest fraction in history until then and about double the proportion fifty years earlier. Overall, the US was responsible for 13.2% of world exports at time when it comprised just 3.6% of world population. True, the American economy was not extraordinarily export oriented; exports made up just over 6% of GDP, a bit more than half of today’s level, but pressure on exports helped precipice the run on the Treasury.
However much pain was felt by the country’s farmers, agriculture was hardly a booming industry to begin with. Rather, the most over-invested sector in the late 19th century American economy were the railways. Railroad mileage more than tripled in the twenty years ending in 1880 and grew another 40% in the 1880s. This expansion accounted for 15-20% of national investment in the two decades before the Panic, much of it financed with foreign money, an inflow of capital that would soon reverse.
Indeed, the US was a large net borrower in the late 19th century with the net inflow of capital into the country averaging over $70 million a year. The railways absorbed much of this capital but hardly all of these ventures were profitable investments. Helping to accelerate the crisis was the failure of the Philadelphia and Reading Railway Company, which was forced to restructure in 1893. In time, companies owning about one-third of the nation’s railway mileage would go bankrupt. Industry was slowing on account of decreased agricultural and railway investment just as banks were facing losses on farm mortgages and other loans. A credit crunch was underway, soon to take down thousands of industrial and financial firms.
Still more American railroads were bankrupted by the contraction in credit, but these failures and depressed commodity prices were not the only factors driving the crisis. European economies were also slowing and 80% of American exports at the time were destined for Europe; 50% went to the UK alone. Part of the wider deterioration in financial conditions was driven by the losses European investors faced on speculative ventures in other ‘growth’ economies, namely in Argentina, South Africa, and Australia. This had helped cause outflows of capital from these countries as well as the United States.
A ‘flight to safety’ was underway, and unlike when these episodes occur today, the US dollar at the time was not what investors fled to when they wanted safety. International investors and financiers were redeeming their dollars for gold which they could then use to cover their liabilities in Europe, aggravating the credit crisis in America. The Panic underway in the US would cause 15,242 companies and 642 banks to fail by the end of 1893 alone. GDP contracted by perhaps 12% and unemployment had risen from 3% before the crisis to 18-20% by 1894 and there was no quick recovery either. Economic weakness continued through 1894 and 1895.
Run on the Treasury
The Panic had turned into an economic depression complete with a run on perhaps the most unlikely institution, the US Treasury. To understand why requires understanding the political battles around the nation’s monetary standard in the late 19th century. For decades, the country was divided between those who preferred a gold standard and those arguing for a standard based on both gold and silver, bimetallism. These debates were popular; they were not merely the pastime of economists and financiers. In a sort of compromise on the question, the US Congress passed the Sherman Silver Purchase Act in 1890; it required the Treasury to buy silver to the tune of 4.5 million ounces per month. This was a boon to the silver mines as silver was among the commodities subject to falling prices.
The run on the Treasury came at a time when foreign investors were redeeming their dollars for gold either due to a lack of confidence in the currency or to repay their obligations at home. However, not only were foreign investors withdrawing gold but so were arbitrageurs. A popular arbitrage trade of the time consisted of profiting from the official ‘mint ratio’ of 16-to-1, the ratio between the value of gold and silver underpinning the bimetallist system. The 16-to-1 ratio was also the product of an era when gold prices were depressed following gold finds in the US and Australia. In the 1890s though, it was silver that was cheapening. Had the mint ratio been re-established at newer market prices it would have been higher than 16-to-1.
Thus, speculators would sell silver to the government at artificially high prices. In return they received ‘coin notes’, a special currency issued in the early 1890s that was redeemable in gold. These speculators would then redeem the notes and profit off the difference between the ‘mint ratio’ and the actual ratio of the two metals’ market prices, which was then more like 20-to-1 and widening still further.
The gold redemptions meant maintaining the monetary standard would necessitate periodic injections of gold into the Treasury. In the past, the US Congress had mandated that $100 million in gold reserves be kept on hand at all times; in 1894, it fell below this threshold. However, though the American President, Grover Cleveland, was able to have the Sherman Silver Purchase Act repealed, the Congress refused to finance any additional gold purchases. By January 1895, the Treasury has only $68 million in gold reserves; a month later, it was down to $45 million.
Morgan Meets Cleveland
Hearing this news, one financier decided to act, and not by converting his dollars into gold, but by helping replenish the Treasury’s reserves. Though gold reserves were dwindling, John Pierpont Morgan Sr., eponym of today’s J.P. Morgan Chase & Co., believed there was enough appetite for American bonds that money could be raised to replenish the stockpile. All that was needed was for someone authoritative enough to convince Washington of the need. So, the banker took a train to Washington and met with President Cleveland who, although weary of dealing with the unpopular financier, needed little convincing. As for the Congress, Morgan pointed to an otherwise forgotten Civil War era law that authorized the Treasury to issue bonds to buy gold; no further congressional approval was necessary.
With the question of legality out of the way, Morgan proposed a $100 million bond offering, the proceeds of which would go towards buying gold. The President insisted only a smaller sum was needed. In the end, the Treasury paid $17.80 per ounce for 3.5 million ounces of gold using the proceeds of a $62.3 million 30-year bond issue sold to Morgan and the Rothschild banking family. Morgan and the participating banks profited by selling the 4% coupon bonds at a premium of $112.25 per $100 of par value. Despite the aggressive pricing, the issue was said to have sold out in 20 minutes.
Recovery
The perilous state of the gold standard in 1894-95 marked the nadir of the last panic of the 19th century American economy. The Treasury issued bonds three more times until 1896, with the $260 million in proceeds used to obtain specie to augment the gold reserves. The economy did not just begin to improve but underwent a transformation. For one, the US became less dependent on agriculture exports and more reliant on industrial exports, reducing the risk posed by fluctuating commodity prices. Railway investment also ceased to make up such an outsized part of the nation’s aggregate capital investment. The Panic of 1893 also kindled interest in a more systematic response to economic crises. Another panic not even fifteen years later also required Mr. Morgan’s intervention. After that, the die was cast; control over the nation’s monetary system was permanently transferred to the newly created Federal Reserve.
Lesson
Morgan’s intervention was perhaps more about the man than his money. His reputation and pulse on the nation’s financial markets meant he had the ear of its government. President Cleveland was said to have been quite surprised by how much the banker knew of the Treasury’s travails early in 1895. It is quite reasonable to presume that had Morgan not intervened, the nation’s experience with a gold standard would have come to a far quicker end. Indeed, the monetary standard was facing both political as well as economic pressure. Just a year later, the Democratic Presidential nominee William Jennings Bryan delivered his famous ‘Cross of Gold’ speech lampooning the gold standard.
In the mid-1890s, the American economy was essentially hit by a balance of payments crisis. Linking the currency to precious metals, much like a peg to another currency, can cover up weaknesses that would otherwise appear in exchange rates. However, when capital inflows turned into outflows and the value of exports fell, trouble was exposed. Normally, capital and trade flows balance each other out because a foreign holder of dollars can do only two things with them: buy American exports or lend in American markets. However, when a currency is backed by gold, there is a third option: redeeming the dollars for the precious metal and taking it abroad. Thus, the Panic of 1893 resembles the balance of payments crises of Asia and Latin America a century later, but where it was a peg to gold, rather than to another fiat currency, that was under stress. As these crises often do, the Panic of 1893 changed both institutions and the makeup of the economy.
Further Reading
1. Gordon, John Steele. “The Other Great Depression.” American Heritage, 1991.
2. Lipsey, Robert. “U.S. Foreign Trade and the Balance of Payments, 1800-1913.” NBER Working Paper Series, Apr. 1994.
3. Rowan, Lily. “During the Panic of 1893, JP Morgan Used $60 Million in Bonds to Bail Out the United States Government.” History Daily, 20 Apr. 2017.
4. Whitten, David O. “The Depression of 1893.” EHnet, Economic History Services.
5. Wile, Rob. “The True Story Of The Time JP Morgan Saved America From Default By Using An Obscure Coin Loophole.” Business Insider, 13 Jan. 2013.
