Crisis of 1772

The Crisis of 1772 was a financial panic impacting primarily Europe but also the American colonies. It commenced in June, 1772, and followed a period of credit expansion that had produced the boom of 1770–1772.

The crisis was precipitated by the failure of banks in London and Scotland, which caused crashes in the stock markets of London, Amsterdam, and Paris. Especially hard hit were shares of the East India Company, already facing financial troubles. In September, it defaulted on its payments to the British Treasury, harming the financial situation of the British government.

To raise money, Parliament passed the Tea Act of May 1773, which served to extend the East India Company's monopoly to cover America. This made it possible for the East India Company to circumvent American merchants and sell tea directly to Americans, undercutting existing free trade in tea with the Dutch, and raising the specter of the East India Company gaining a monopoly in America in other goods as well.

The act was widely opposed in the colonies, especially by American merchants, and led to the Boston Tea Party.

The Ayr Bank
In 1769 was founded the Ayr Bank in Scotland, on the inflationist schemes which the Scotsman John Law had tried unsuccessfully to get the Bank of Scotland to adopt in 1705.

In a mere three years, the Ayr Bank managed to create a tremendous amount of unbacked paper, and when it finally collapsed in 1772 losses amounted to two-thirds of a million pounds, a staggering amount for those days.

But the intriguing thing is that the Ayr Bank's collapse had limited repercussions. It took with it only eight small private banks in Edinburgh. This is largely because of a well-developed clearinghouse mechanism that the large Scottish banks employed. They accepted each others' notes and returned those notes to the issuing bank. Suspicious of the Ayr Bank's issue, other banks made a practice of quickly returning Ayr's notes to it. When the collapse came, they were not affected. Nevertheless, to insure public confidence (and get their own notes into wider circulation) the two largest banks, the Royal Bank and the Bank of Scotland, announced that they would accept the bankrupt bank's notes. This was not as mad as it may appear. The collapse had few rippling effects because of Scotland's extraordinary practice of unlimited liability on the part of the bank's shareholders. So Ayr's loss was borne completely by the 241 shareholders, who paid all creditors in full.

Links

 * White's Free-Banking Thesis: A Case of Mistaken Identity by Larry J. Sechrest, about the Scottish bankers after the crisis of 1772