Panic of 1837

In the panic of 1837, during the first three weeks of April 1837, 250 business houses failed in New York. Within two months the losses from bank failures in New York alone aggregated nearly $100 million. "Out of 850 banks in the United States, 343 closed entirely, 62 failed partially, and the system of State banks received a shock from which it never fully recovered."

History
The price inflation began long before the panic of 1837. The wholesale prices reached a trough of 82 in July 1830 and then rose by 20.7 percent in three years to reach 99 in the fall of 1833. The reason for the price rise is simple: The total money supply had risen from $109 million in 1830 to $159 million in 1833, an increase of 45.9 percent, or an annual rise of 15.3 percent. Breaking the figures down further, the total money supply had risen from $109 million in 1830 to $155 million a year and a half later, a spectacular expansion of 35 percent. This monetary expansion was spurred by the still-flourishing Bank of the United States, which increased its notes and deposits from January 1830 to January 1832 from a total of $29 million to $42.1 million, a rise of 45.2 percent. The total money supply rose from $150 million at the beginning of 1833 to $267 million at the beginning of 1837, an astonishing rise of 84 percent, or 21 percent per annum.

The notes and deposits of the BUS had risen, from January 1823 to January 1832, from $12 million to $42.1 million, an annual increase of 27.9 percent. This sharp inflation of the base of the banking pyramid led to a large increase in the total money supply, from $81 million to $155 million, or an annual increase of 10.2 percent. Clearly, the driving force of this monetary expansion of the 1820s was the BUS, which acted as an inflationary spur rather than as a restraint on the state banks.

Furthermore, the inflationary boom of the 1830s began, not with Jackson’s removal of the deposits in 1833, but three years earlier, as an expansion fueled by the central bank. Thus, the total money supply rose from $109 million in 1830 to $155 million at the end of 1831, a spectacular expansion of 35 percent in one year. This monetary inflation was sparked by the central bank, which increased its notes and deposits from January 1830 to January 1832 by 45.2 percent.

There is no question, however, that the money supply and the price level rose spectacularly from 1833 to 1837. Total money supply rose from $150 million at the beginning of 1833 to $276 million four years later, an astonishing rise of 84 percent, or 21 percent per annum. Wholesale prices, in turn, rose from 84 in the spring of 1834 to 131 in early 1837, a rise of 52 percent in a little less than three years—or an annual rise of 19.8 percent.

The monetary expansion, however, was not caused by state banks going hog wild. The spark that ignited the inflation was an unusual and spectacular inflow of Mexican silver coins into the United States—brought about by the minting of debased Mexican copper coins which the Mexican government tried to keep at par value with silver. The system of fractional reserve banking, however, fundamentally was to blame for magnifying the influx of specie and pyramiding notes and deposits upon the specie base. In 1837, the boom came to an end, followed by the inevitable bust, as Mexico was forced to discontinue its copper coin issue by the outflow of silver, and the Bank of England, worried about inflation at home, tightened its own money supply and raised interest rates. The English credit contraction in late 1836 caused a bust in the American cotton export trade in London, followed by contractionist pressure on American trade and banks.

In response to this contractionist pressure—demands for specie—the banks throughout the United States (including the old BUS) promptly suspended specie payments in May 1837. The governments allowed them to do so, and continued to receive the notes in taxes. The notes began to depreciate at varying rates, and interregional trade within the United States was crippled.

Aftermath and the crisis of 1839
The banks, however, could not hope to be allowed to continue on a fiat basis indefinitely, so they reluctantly began contracting their credit in order to go back eventually on specie. Finally, the New York banks were compelled by law to resume paying in specie, and other banks followed in 1838. During the year 1837, the money supply fell from $276 million to $232 million, a large drop of 15.6 percent in one year. Specie continued to flow into the country, but increased public distrust in the banks and demands to redeem in specie put enough pressure on the banks to force the contraction. In response, wholesale prices fell precipitately, by over 30 percent in seven months, declining from 131 in February 1837 to 98 in September of that year.

This healthy deflation brought about speedy recovery by 1838. Unfortunately, public confidence in the banks returned as they resumed specie payment, so that the money supply rose slightly and prices rose by 25 percent. State governments ignited the new boom of 1838 by recklessly spending large Treasury surpluses which President Jackson had distributed pro rata to the states two years earlier. Even more money was borrowed to spend on public works and other forms of boondoggle. The states counted on Britain and other countries purchasing these new bonds, because of the cotton boom of 1838. But the boom collapsed the following year, and the states had to abandon the unsound projects of the boom. Cotton prices fell and severe deflationist pressure was put upon the banks and upon trade. Moreover, the BUS had invested heavily in cotton speculation, and was forced once again to suspend specie payments in the fall of 1839. This touched off a new wave of general bank suspensions in the South and West, although this time the banks of New York and New England continued to redeem in specie. Finally, the BUS, having played its role of precipitating boom and bust for the last time, was forced to close its doors forever in 1841.

The crisis of 1839 ushered in four years of massive monetary and price deflation. Many unsound banks were finally eliminated, the number of banks declining during these years by 23 percent. The money supply fell from $240 million at the beginning of 1839 to $158 million in 1843, a seemingly cataclysmic drop of 34 percent, or 8.5 percent per annum. Wholesale prices fell even further, from 125 in February 1839 to 67 in March 1843, a tremendous drop of 42 percent, or 10.5 percent per year. The collapse of money and prices after 1839 also brought the swollen state government debts into jeopardy.

State government debt had totaled a modest $26.5 million in 1830. By 1835 it had reached $66.5 million, and by 1839 it had escalated to $170 million. It was now clear that many states were in danger of default on the debt. At this point, the Whigs, taking a leaf from their Federalist forebears, called for the federal government to issue $200 million worth of bonds in order to assume all the state debt. The American people, however, strongly opposed federal aid, including even the citizens of the states in difficulty.

The advent of the Jacksonian Polk administration in 1845 put an end to the agitation for Federal assumption of the debt, and by 1847, four western and southern states had repudiated all or part of their debts, while six other states had defaulted from three to six years before resuming payment.

The 1839–43 contraction and deflation was a healthy event for the economy, since it liquidated unsound investments, debts, and banks, including the Bank of the United States. But didn’t the massive deflation have catastrophic effects—on production, trade, and employment—as we have generally been led to believe? Oddly enough, no. It is true that real investment fell by 23 percent during the four years of deflation, but, in contrast, real consumption increased by 21 percent and real GNP by 16 percent during this period. It seems that only the initial months of the contraction worked a hardship. And most of the deflation period was an era of economic growth.

The Jacksonians had no intention of leaving a permanent system of pet banks, and so Jackson’s chosen successor Martin Van Buren fought to establish the Independent Treasury System, in which the federal government conferred no special privilege or inflationary prop on any bank; instead of a central bank or pet banks, the government was to keep its funds solely in specie, in its own Treasury vaults or "subtreasury" branches. Van Buren managed to establish the Independent Treasury in 1840, but the Whig administration repealed it the following year. Finally, however, Democratic President Polk installed the Independent Treasury System in 1846, lasting until the Civil War.

Links

 * Democracy and Laissez-Faire: A New York Case Study by Arthur A. Ekirch Jr., 1977
 * The Jacksonians, Banking, and Economic Theory: A Reinterpretation (pdf) by Jeffrey Rogers Hummel, 1978
 * An Austrian Perspective on Some Leading Jacksonian Monetary Theorists (pdf) by James P. Philbin, 1991
 * The Panic of 1837 and the Contraction of 1839-43: A Reassessment of its Causes from an Austrian Perspective and a Critique of the Free Banking Interpretation (pdf) by H.A. Scott Trask, March 2002
 * The Independent Treasury: Origins, Rationale, and Record, 1846-1861 (pdf) by H.A. Scott Trask, March 2002
 * New Technology, Old Scam by Clifford F. Thies, October 2002
 * In Defense of Bank Failures by H.A. Scott Trask, December 2003
 * The Panic of 1837 and the Contraction of 1839-43: A Reassessment of its Causes from an Austrian Perspective and a Critique of the Free Banking Interpretation (pdf) by H.A. Scott Trask, March 2002
 * The 19th-Century Bernanke by Daniel James Sanchez, September 2009
 * Martin Van Buren: The American Gladstone by Jeffrey Rogers Hummel, from Reassessing the Presidency: The Rise of the Executive State and the Decline of Freedom
 * Panic of 1837 on Wikipedia
 * Panic of 1837 on Wikipedia