Economics / History / Warfare

Aggregate Demand Dominance: Lose on Silver (G&SI Part 2)

My previous posting ended with this event on 24 August 1814:

I might mention the British Army/Royal Marine contingent under the command of Major General Robert Ross burned much more than just the White House:

In addressing the history of the silver and gold standards as the two relate to inflation, my previous three posts have been aimed at correcting long-held misconceptions:

As it turns out, hyperinflation generally coincides with wars and a series of ill-advised and inflammatory fiscal policy decisions, but at the core is a result of a rapid increase in the money supply that is not supported by growth in the economy.

What does this have to do with the War of 1812 and the destruction of the American capital?  Notice how the “coincides with wars” is almost a throwaway line.  This ties into my theory that  discussions of the prime drivers of inflation all to often ignore the elephant in the room.  Imagine a massive leftward shift of short-run-aggregate-supply (SRAS)…


…wouldn’t the shift understandably send inflation skyrocketing?  But what causes a massive contraction in aggregate supply?  How about…


At its core, couldn’t hyperinflation be argued to be the result of large-scale devastation (most often wrought by war) itself?  The common element isn’t rapidly increasing the money supply (as the last five-plus years attest); the argument that hyperinflation is instead the result of what William Tecumseh Sherman termed “hard war” is even supported by the same CNBC piece where the above quotation originated:

The United States has never been a victim of hyperinflation but came close twice – during the Revolutionary War and Civil War – when the government printed currency in order to pay for its war efforts.  However, in both of the US cases, inflation never exceeded a 50 percent monthly inflation rate (an informal threshold for hyperinflation), which pales in comparison to history’s most dramatic cases.

50% seems to be an awfully high inflation rate—did the U.S. really experience such a high rate during the 1770s and the 1860s?

Nope.  I would mention that the Revolutionary War has the distinction of triggering nearly 25% annual inflation and 25% annual deflation (both records in American history), but far more important is the fact that at worst the United States missed the hyperinflation threshold by a factor of 515:

In February 2007, Zimbabwe’s inflation rate topped 50% per month, the minimum rate required to qualify as a hyperinflation (50% per month is equal to a 12,875% per year).

Hyperinflation is the point when reinflation starts a compounding effect on itself, turning a 600% annual inflation rate into a 13,000% annual inflation rate.  Who are the hippies that made this radical claim about the first recorded instance of hyperinflation in the Third Millennium?  The lefty communists at…the CATO Institute.

Notice that there is no fiscal prolificacy, loose monetary policy or currency debasement elements in this theory.  Such policies are at best ancillary but more often extraneous distractions—none of the listed economic “sins” could convincingly explain why during hyperinflation episodes supply expansion halts, let alone reverses or collapses outright. 

But the sins argument is very strong and ingrained in the U.S.  In my preceding piece, I related Ron Paul’s specie claims:

It was at this point that a fateful decision was made by the U.S. government and concurred in by the state governments outside of New England.  As the banks all faced failure, the governments, in August 1814, permitted all of them to suspend specie payments—that is to stop all redemption of notes and deposits in gold or silver—and yet to continue in operation.  In short, one of the most flagrant violations of property rights in American history, the banks were permitted to waive their contractual obligations to pay in specie while they themselves could expand their loans and operations and force their own debtors to repay their loans as usual.

…which I find to be completely specious:

The Congress, the president and many of the dignitaries had already fled the city when the British arrived in August 1814 to burn the capitol, the White House, and almost all the city’s public buildings.  The panic that occurred caused runs on the banks for specie, and all the banks in Washington and Baltimore immediately suspended payment of specie.  The suspension spread to the banks in New York, Philadelphia, New Jersey, Virginia, Ohio and Kentucky.  Only the banks in New England and the Bank of Nashville in Tennessee continued to make payments of specie. However, about eighteen country banks in the New England area occasionally used suspension as an excuse not to make specie payments.

For those that aren’t automatically upset with me kicking Ron Paul in the shins repeatedly, the obvious rejoinder is: why didn’t the burning of Washington trigger an instance of 13,000% annual inflation in 1814? 

You Can’t Crush US; We’ve Already Destroyed Our Economy

Fortunately for all Americans that have lived since, the British campaign that destroyed Washington, D.C. came to an end three weeks later when Major General Ross was shot dead by a sniper in Baltimore, leading to the withdrawal of the British land forces he had commanded from the area.  Days earlier an invasion force led by Lt. Gen. George Prevost from the north had been defeated at Plattsburgh and driven back into Canada.  As the British at Ghent had lost any pretense to ask for land concessions from the Americans after the twin September defeats, the treaty ending the war was signed on Christmas Eve, 1814. 

The fighting spilled into the following year due to the pre-telegraph snail’s pace (or to be literal, sailing pace) of communications 200 years ago, leading to a major battle whose results was eerily similar to September.  General Ross was replaced by Major General Edward Pakenham, who like his predecessor was cut down by hostile fire.  American artillery blasted the commanding British officer off his horse near New Orleans on 8 January 1815 before severing Pakenham’s spine with the next volley, heralding the end of the British southern campaign (and the war by happenstance).  

The near-destruction of the American republic in 1814-15 (and the bout of hyperinflation that would have accompanied the death throes) was essentially averted by the American tendency to kill the opposing side’s commanding officers in action.  I can already hear the libertarian retort. 

What does this prove?  The federal government still sanctioned the suspension!

Indeed, the number of banks, and bank credit, expanded rapidly during 1815 as a result of this governmental carte blanche.  It was precisely during 1815 when virtually all the private banks sprang up, the number of banks increasing in one year from 208 to 246.  Reporting banks increased their pyramid ratios from 3.17:1 in 1814 to 5.85:1 the following year, a drop of reserve ratios from .32 to .17.  Thus, if we measure bank expansion by pyramiding and reserve ratios, we see that a major inflationary impetus during the War of 1812 came during the year 1815 after specie payments had been suspended throughout the country by government action.

The federal government approved of specie suspension carte blanche?  Then explain to me how this disaster

The suspension of specie payment had devastating impact on the government.  It was now forced to receive its revenues in state bank paper and treasury notes of all degrees of depreciation if it wanted to collect taxes and imposts due it.  Congress had made no provision for the treasury to make allowances for the discounts, and the government was unable to use the notes of one state in another state.  Nor could the treasury notes be used to pay debts, for by law they were issued at par, but were now depreciated in the open market.  After the war, [Treasury Secretary Alexander] Dallas was prohibited by law from accepting depreciated banknotes and could not withdraw funds from some of the banks in which the government had kept accounts.

…was the desired, accepted result when American banks unilaterally suspended specie payments. 

The government is always to blame!

The federal government, not the state banks them selves, is largely to blame for encouraging new, inflated banks to monetize war debt.  Then, in particular, it allowed them to suspend specie payment in August 1814, and to continue the suspension after the war was over, until February 1817.  Thus for two and a half years banks were permitted to operate and expand…


Ron Paul cannot be bothered to look for the source of the suspension…

…let alone the notice that the piecemeal spread of the suspension indicates a startling truth: the bankers realized that the federal government, fleeing from the British onslaught, was in no position to stop them.

The state banks were solely to blame—as I evidenced in Part 1, these banks weren’t falling over themselves to purchase federal wartime debt instruments yet they still managed to run up astounding debt ratios and spread across the land like dandelions.  Faced with financial ruin, these same banks took advantage of the potential destruction of the United States to vitiate paying their debts.  Why does this sound familiar…

As for the two years and a half years before suspension ended, who forced the banks to stop “flagrantly violate property rights?”

On the 21st of February, 1817 the United States government refused any longer to receive the notes of non-specie-paying banks in payment of public dues.

That’s right.  Supposed governmental carte blanche still required the federal government to not put up with what the banks were shoveling.

But…but…but…inflation…(**door slams shut and is locked**)

This raises an important point, though not about bank inflation.  The War of 1812 accompanied an inflationary period—when in history has war not accompanied inflation?  But in 1815, the year the war ended, another financial panic hit.  Panics until the Second World War tended to usher in deflation.  Some have postulated that American inflation hit a high of 17% during the War of 1812 before sinking into deflation postwar; I cannot find corroborating evidence for this figure.  However, the St. Louis Fed’s information does have significant corroboration:

The economy grew rapidly in 1810, according to Thorp (1926, p. 116), and began a period of “rapid expansion” of bank notes and rising commodity prices.

Note: this was occurring prewar.

The War of 1812 put a “temporary check” on economic activity, though commodity prices continued to rise sharply. The year 1814 was characterized by “active speculation, large imports, and no exports,” according to Thorp (1926). 

Large imports—while the Royal Navy had the American coast locked down?  No increases in economic activity but commodity prices rose?  That’s fascinating—the inflation the U.S. experienced from 1810 through 1814 wasn’t war related. 

Monetary conditions grew tight in the second half of the year, however, and banks outside of New England suspended payments in August.

The year 1815 witnessed “continued speculation, especially in land,” but then a sharp decline in commodity prices and “financial chaos” (Thorp).

The banks, however, were running up debt in land speculation schemes.  This sounds familiar as well…

As with the crisis of 1797, the Panic of 1815 occurred early in a disinflationary period that followed a substantial inflation.

The next panic occurred in 1819.  Deflation was the rule from 1815 to the mid-1830s, with an average annual rate of price change of –4 percent between 1815 and 1833.  The commodity price decline was especially sharp in 1818-19.

The U.S. was definitely suffering deflation postwar—horrific levels of price declines.  This wasn’t good for the economy, for it sank into depression for at least six years.  But something’s not right here.  Where is the commodity price run-up prior to the peacetime crash?  State banks (once again) suspended specie payments amidst the Panic of 1819.  Did the prices of commodities like gold trend upward after that act?


British Official Price
(British pounds per fine ounce
end of year)

U.S. Official Price
(U.S. dollars per fine ounce
end of year)

New York Market Price
(U.S. dollars per fine ounce)

London Market Price
(British £ [1718-1949] or
U.S. $ [1950-2011] per fine ounce)





£ 4.44





£ 4.36





£ 4.25





£ 4.25

No, they didn’t.  New York market prices were unaffected, and London was trending down, returning to par in 1820 the year prior to Britain resuming specie payments.  Were financiers betting on…prices declining?

As with the panics of 1797 and 1815, the financial crisis of 1819 was triggered apparently by prices and incomes that were below what borrowers and lenders had forecast.

No, they weren’t.  So, what was going on?  They had bet it all on gray…and lost.

Specious Silver Stability—Hyperinflation Meets Price Controls

I trotted out this historical list of silver prices previously:

…where prices first jump in 1814, by 12.4%.  Before continuing, I draw the reader’s attention to the fact that these figures are from the London Fix Average.  Britain had been on a de facto gold standard since 1717 (silver was barely in circulation) and suspended specie payments in 1797.  These are international silver prices, and the preeminence of the American market is evident.  The Coinage Act of 1792’s silver price control of P=1.293 had ruled for the first 21 years in the Kitco extract.  This leads to a logical question: what caused the rise?  Well, if a picture is worth a thousand words…

Burning Washington almost certainly is the culprit as high inflation since 1810 had not caused silver’s P=1.293 to budge at all.  When the silver-standardized American economy took a war-related hit to SRAS however, the results broke the $1.293 per ounce ratio.  In essence, the effect of destroying the American capital and threatening the largest center of commerce in the Chesapeake area was a 14.2% rise in the price of silver at its peak in 1815.

The rise was not permitted to last.  Silver sank 10.4% in one year before “stabilizing” at P=1.293 in 1817, the same year specie payments resumed.  I don’t think it is a coincidence that deflation set in as soon as silver proceeded downward—the silver standard in effect was enforced by triggering disinflation (followed by deflation) to offset the large run-up of the price level during the previous five years:

The nature of the monetary regime can affect the extent to which changes in the price level are predictable. Under a gold standard, for example, the price level tends to be mean-reverting. That is, offsetting increases (decreases) in the price level tend to follow declines (increases) in the price level (Bordo, 1981).

How can I use this as evidence when the U.S. was on a de facto silver standard in the 1810s?  Because the de jure American standard was bimetallism at the time and gold price controls similarly broke down in 1814:


U.S. Official Price
(U.S. dollars per fine ounce
end of year)

New York Market Price
(U.S. dollars per fine ounce)

























Gold peaked in 1815 as well before crashing back down to earth.  The silver standard functioned with an identical mechanism, which makes the St. Louis Fed’s following assumption puzzling:

Similarly, when the public views a government’s commitment to the gold standard as credible in the long run, it will come to expect that any inflation occurring during a period of gold suspension will be offset by deflation (Bordo and Kydland, 1995).

Merchants and financiers in the 1810s clearly did not anticipate or understand this.  This extended to politicians in 1817.  They expected price increases that did not materialize after specie payment resumed, through to the next crash.  Two years of disinflation, deflation and depression did not turn to reinflation and recovery when the Second Bank of the United States began injecting its banknotes into the economy after the national bank opened its doors in January 1817.  Any push against the P=1.293 or P=19.39 price ceilings (inflation from finance) was pushed back in the commodities market (where gold and more importantly silver resided).  As the St. Louis Fed mentions, this decline was especially precipitous in 1818-19.

So when did the pressure abate?  It didn’t:

The economy began to revive in 1821, but prices remained stagnant. The CPI fell 11 percent in 1823 and 8 percent in 1824, and another banking panic occurred in 1825. According to Thorp, in 1825 commodity prices rose “with feverish speculation to autumn, when they collapsed.”  Economic activity then declined and unemployment was “severe.”

Move against the commodities market?  Not for long under the silver standard.  The embarrassing point is that P=1.293 was totally artificial.  What prevented a P=1.477, such as where silver stood before the deflation began (or better yet, get rid of the price control altogether and let equilibrium decide)?

Golden Years of Prosperity (Three of Them)

Nothing, really.  In fact, the price level limits that had prevailed for two decades eroded after 1833:

The early 1830s were generally prosperous, with moderate inflation that continued after the panic of 1833. Disruptions surrounding President Jackson’s “war” with Nicholas Biddle and the Bank of the United States may have caused the panic.  According to Thorp, “easier money became very tight,” and the panic came late in the year, following Jackson’s redistribution of public monies to the so-called pet banks in September and an “extraordinary” contraction of credit by the Bank of the United States.

Pent-up inflation (a definite byproduct of price controls) emerged, as if the silver cap had been lifted.  In 1834, someone had thought to do just that:

To make gold the new basis for American commerce, Congress first passed the Coinage Act of 1834, which went into effect on August 1.  It sought to change the relative values of silver and gold coins. 

Or not.

Congressional Democrats hoped that the newer and smaller gold coins—more convenient than the familiar silver dollars—might replace [Second Bank of the United States President] Biddle’s bank drafts.  They also hoped that new gold discoveries in Virginia, the Carolinas and Georgia would make it possible.

Possible to do what?  To what end?

In 1834 it was resolved to force gold into circulation by changing the mint ratio to 16:1.  This was accomplished my maintaining the silver content of the [silver] “dollar.”

What?  Leave silver unchanged and revalue gold?  Why?

As Preston made clear, [Andrew] Jackson’s war with the bank [(the Second Bank of the United States)] had unsettled national markets.

Oh great.  Biddle and the Second Bank of the United States’ bank drafts had run headlong into the prejudice of a powerful man of extreme influence:

For Jackson, the cornerstone of this crusade against big business was his opposition to extending the charter of the Second Bank of the United States. He felt the Bank, chartered and backed by the government, enjoyed too much unregulated power over the nation’s economy – especially with its ability to manipulate paper money.

And Jackson hated paper money.

In part because of a financial loss he suffered earlier in life from devalued paper notes, he felt that paper money was inherently evil, a device for enriching bankers and bilking farmers and workers of their hard-earned wealth.

In a perfect world, only gold and silver coin would be used for money.

The world was far from Jackson’s perfection:

One might have expected the crash to occur in 1834, but the seven houses appear to have profited from the chaos in the American money markets brought by the contraction.  With Biddle’s notes declining in volume and capital still cheap in Britain, the seven houses were in the enviable position of borrowing at 4 percent in the United Kingdom and lending at 10 percent or more in America.

Considering the president of the United States in 1834 was a noted Anglophobe, this wasn’t likely to end well.  Then the economy tanked:

Borrowing plummeted as lenders demanded an “extravagant premium…on the best security.”  Meanwhile, prices were dropping in “every species of public stocks,” while “every branch of business connected with the inland exchanges” as well as those involved in the “purchase and exportation of the produce of the country” were halted.  Suddenly many saw the virtues of Biddle’s bank drafts: they provided a uniform currency that made inland trade, export, and import possible.

The country finding virtue in Biddle’s bank drafts must have rankled the president from the Carolinas (Andrew Jackson is claimed both by North and South Carolina as its native son).  The Carolinian’s fondness for yellow and gray metals was on full display in the Coinage Act of 1834:

Previously, the official ratio at the mint for silver to gold was 15 to 1, though the actual ratio of values was closer to 15.85 to 1.  The Coinage Act changed that ratio to 16 to 1.  At the old 15-to-1 ratio, the gold in a $10 gold eagle coin had been worth $10.66, which made the coins quickly disappear from circulation.  Revalued at 16 to 1, the newer gold eagle was smaller, had less gold in it, and so was less likely to be melted down.  The principle involved was called Gresham’s law: bad money drives out good.

Before consulting the history that followed, I see the potential for the 1834 Act to backfire on the fundamentals alone.  I’m immediately reminded that devaluing gold…


British Official Price
(British pounds per fine ounce
end of year)







…accidently triggered the British gold standard in 1717, but maybe Secretary of the Treasury Roger Taney knew better than Isaac Newton…

Democrats hoped that the Coinage Act would make gold more popular than the currency issued by the state banks and the Bank of the United States’ own “bank drafts.”  It worked somewhat.  Some American banks shipped out silver and bought gold, importing it from wherever they could.  The seven houses, in particular, brought gold to America to cover outstanding debts.

The seven financial houses weren’t the only ones.  Andrew Jackson took advantage of the boom to retire the federal debt entirely in 1835.  However, the intended method to bring in gold seemed destined to spark a trade war:

With silver set to a slightly lower price (one-sixteenth of an ounce of gold), the “good” silver in a silver coin would now be too valuable for currency.  Silver-standard countries like France and Prussia would buy the undervalued American silver dollars to melt them down for their respective currencies.  With gold slightly overvalued, Congress hoped the precious metal would stream in from elsewhere, including gold-standard countries like Britain.

Well, at best the result might be a confrontation with English financiers.  At worst the British military still retained the ability to choke off American commerce and literally burn Andrew Jackson’s place of residence out from under the Carolinian’s feet:


Thankfully, the British central bank responded first:

Temin (1969) argues that the crisis came in two stages. The first stage came in 1836 when the Bank of England increased Bank Rate and refused to discount for commercial banks engaged in Anglo-American trade. These actions, which reflected the Bank’s response to a substantial loss of specie reserves, increased interest rates and restricted the supply of credit in the United States.

Temin’s Anglophobia is probably misplaced.  He acknowledges an outflow of specie (triggered by American coinage policy) spurred the Bank of England to act, but his natural tendency toward American ethnocentrism misses the storm that first struck on the far side of the Atlantic:

In August 1836 the Bank of England issued a warning to bankers in the American trade to curtail their credits.  It then denied credit facilities to the seven houses in particular.

In September an agitated William Brown of Brown Brothers traveled to London to meet with the banks treasury committee and convinced the bank directors that the American panic was temporary.  He also convinced them to accept the paper of the seven houses.  Then somehow the bank’s internal audit of the Northern and Central Bank of England in September 1836 was publicly printed.  In the audit, the Bank of England declared that the Northern and Central held “a class of paper hitherto unknown to bankers, viz. bills drawn upon America.”  These, it declared, were very likely worthless.  Other banks on Lombard Street [(the City of London financial center)] then began to question the paper of the seven houses.  The joint-stock banks that had been trading on American bonds and cotton bills began to fail.  As their banks failed, the textile factors of Liverpool with accounts in country banks, lacking cash or credit, began to suspend their orders.

So, the Bank of England reversed its policy, only to act again when British banks began failing due to the worthlessness of 1836 American banknotes.  The effects of this turned out to be cataclysmic:

The chill initiated by the Bank of England’s rate, combined with the doubts cast on American notes, led private bankers to bundle up their coats and hold back cash.  This would bring a snowstorm to America.  From August to December, the money market in the United States went crazy, with rates as high as 24 percent in August and September and 36 percent in October.  The price of cotton dropped 30 to 40 percent.  This was the death to the agency banks and most of the seven houses.  They had provided cash payments to planters for up to 80 percent of the quoted price of cotton.  They assumed that in the worst case cotton would never drop more than 25 percent in the month it took to arrive in Liverpool.

Hey, at least financiers 177 years ago acknowledged prices are volatile (in the run-up to 2008 housing bulls believed prices couldn’t drop at all). 

What was a cotton bond or a private note worth?  No one knew.  High rates for cash coupled with anxiety about English bills of exchange, cotton notes, and Biddle’s notes.  In January 1837 the money market opened up “tight as a drumhead,” as one Boston banker put it.  With short-term rates at about 36 percent, any merchant who needed to borrow was sunk.  Crash was inevitable.  In England, the Wildes first fell in February, the other two Ws fell in March.  While cotton prices plummeted, the price of wheat rose quickly, partly because the Hessian fly had returned to damage crops in Pennsylvania, Maryland, and western Virginia.

British banks break, instituting American austerity and triggering price divergence throughout the American economy; plus SRAS declines due to pestilence.  What’s next, rioting in the streets…

By March 1837 a parade by radical New York Democrats—the Locofocos—turned to bedlam as rioters burst into a New York flour warehouse and emptied it.

Though unrest over hunger

The Panic of 1837—American history’s worst financial calamity until the Great Depression—had put one-third of the city’s labor force out of work. [Horace] Greeley ran poor relief in one of [New York] City’s wards, but available funds were meager and people were dying from lack of food and shelter. An angry mob became so enraged by the high price of bread that it rioted and looted the city’s flour merchants. Witnessing all this suffering and rage, Greeley concluded that the best solution would be for new entrants to the workforce to move someplace—anyplace—else. “Fly, scatter through the country, go to the Great West,” Greeley wrote. “Anything rather than remain here.”

…seems justifiable compared to the reactions of Mississippi lynch mobs:

Likewise, in the three black-belt counties east of Vicksburg, more than a thousand lawsuits had been brought against Mississippi debtors, totaling nearly $3 million.  Citizens there demanded a law suspending debt collection.  When the governor refused to call the legislature, mobs in these counties destroyed the courthouses, demanded the sheriffs resign, and threatened to lynch anyone who took their offices.

No, I didn’t use “lynch mob” pejoratively.  Almost sounds like slaveholding sentiments in Mississippi were stirred up in 1836-37…

As cotton prices plummeted, so too did slave prices.  Many English merchant bankers now discovered an ugly truth about the cotton commodity chain: the commodities that planters and factors had pledged to the agency banks for the future sale of cotton were the titles to black men, women, and children.  First the agency houses, then the seven houses and the Bank of the United States, and then rural joint-stock banks stood to become the owners of a vast number of slaves.

Oh.  Considering that Pennsylvania (the Second Bank of the United States was located in Philadelphia) in 1780 had set the standard for future American abolition laws for the most part, New York had emancipated all slaves by 1827, and Britain had abolished slavery throughout most of its empire in 1834, this turn of events clearly angered many Mississippians.

To prevent [the slave repossessions,] Mississippi’s governor pointed out to the state’s legislature that the Mississippi Constitution still prohibited the interstate slave trade.  If the legislature simply declared that this prohibition made slaves unsalable, then creditors could not take slaves out of the state to settle debts. 

Wait, was Mississippi Governor Charles Lynch encouraging his constituents to abscond from their debts?

He need not have worried: defaulting planters took the slaves off themselves.  Scores of slaveholders snuck their slaves out of the state at night to avoid creditors, bound for the contested, but seemingly independent, Republic of Texas. 

Sure seems like it. 

Because the Republic of Texas claimed to be an independent country, and was not yet in the United States, defaulting borrowers who settled there were safe.  Their slaves and other movable property were immune from seizure.  When sheriffs received writs of collection, they visited the now-abandoned plantations of Mississippi and Louisiana, then returned them with the inscription “G.T.T.”: gone to Texas.  Residents of the Gulf States coined the term “absquatulate” to describe the men who left the state to avoid their debts in order to “squat” in the new republic.  The Texas government, desperate for settlers, promised a “labor and league” of free land (roughly 4,600 acres, of which 177 could be on a river) to any family that rebuilt a plantation there.  Independent Texas became a new nation of deadbeats.

This turn of events makes me question how the Confederates were motivated by anything other than greed and selfishness 25 years later.  Naturally, the historical record (and the St. Louis Fed) seems largely devoid of the Southern angle to the origins of the Panic of 1837:

The second crisis stage came in early 1837, when the price of cotton dropped precipitously.  According to Temin (1969, p. 141), “as a result of this fall, debts secured by cotton became uncollectible, merchants holding such debt failed, banks found their assets illusory or at least illiquid, and they refused to honor their liabilities.”

To be sure, the banks were far from innocent victims in the crash:

Between March and May 1837 the New Orleans failures moved up to New York.  New York banks suspended specie payments on May 10, the Boston banks shortly afterward.  The panic of 1837 was the first fully national suspension of bank payments in the United States.  From 1837 to 1838 it surged across Britain and then continental Europe.  In June 1837, the Leeds Mercury haughtily complained that “there has been immense overbanking and overtrading in America” and that because “the perfectly democratic nature of the American governments is greatly against the adoption of wise and timely measures,” their own country banks were doomed to fail.  “Our Joint-Stock Banks followed at a humble distance,” the paper complained, “drawn along by the mighty gulf-stream of American speculation.”

I’ve read that during the nineteenth century “the very word “democracy” had pejorative overtones, summoning up images of disorder, government by the unfit, even mob rule,” but seeing a British quotation from 1837 is jarring.  Thankfully Scott Reynolds Nelson took the Leeds Mercury to task:

The paper neglected to mention that the English country banks failed in large measure because they eagerly sought to loan to the seven houses to provide cotton for English textile mills.  With cotton so low in price after 1837, a final monetary settlement for the loans would require the sheriff of Leeds to go to the Republic of Texas to repossess slaves and horses, a rather unlikely scenario.

The Silver Vise Grip

While I have called into question the St. Louis Fed’s conclusions; beyond the missing Southerner slave sojourn story the Missouri branch’s history of the Panic of 1837 is comprehensive:

The Panic of 1837 was accompanied by some 600 bank failures—a “slackening and depression; many failures; unemployment; complete collapse of the cotton market…and commodity price decline” (Thorp, 1926). A “slight revival” in 1838 and early 1839 brought a revival of land speculation, according to Thorp, but prices collapsed again, and another banking panic occurred in the fourth quarter of 1839. In all, the price level fell 23 percent between 1837 and 1843 (David and Solar, 1977).

Temin’s conclusions about disinflation, however (and by extension the St. Louis Fed’s), are a bit lackadaisical:

The Panic of 1837 was triggered by credit contraction and a precipitous drop in the price of cotton. The 1839 crisis followed a second collapse in commodity prices. One might question how much disinflation, as opposed to a shift in relative prices, contributed to the panics. Hard evidence of a disinflationary role is illusory; however, the fact that the panics occurred after several years of a rapid increase in the money supply and rising inflation, followed by a collapse in the prices of output in the economy’s dominant sector—agriculture—suggests that unanticipated price decline played an important role in the crisis. Moreover, as Temin (1969, p. 146) notes, “it is a peculiarity of the antebellum financial structure that in a time of very flexible prices, many of the credit arrangements depended on the movements of a single price (the price of cotton).” A crisis of some severity would have occurred almost certainly in 1837, but the preceding inflation and the dominance of commodity prices in the aggregate price level indicates that price level instability exacerbated the financial distress.

Disinflation’s role was illusory?  At issue here is a singular lack of awareness.  SRAS crashed in 1836-early ’37—the bank failure contagion spreading back and forth across the Atlantic several times presaged the Southern absconding exodus to Texas and collapse in food production due to the Hessian fly.  Similarly, it shouldn’t be surprising that credit arrangements revolved around single important price–everything revolved around the price of silver in the 1830s silver-standardized American economy.

Just like the confluence of events that had struck 23 years earlier, the 1837 crash broke silver’s price controls…

…rising 4.4%.  This final spike unleashed a powerful disinflationary wind to bring silver back to par.  It would be four long years before silver sank back down to the level set in 1792.

But inflation had been nonexistent for almost two decades after the Battle of New Orleans.  The United States of 1837 was not embroiled in a major war, unless one considers the Hero of New Orleans’ struggle with the Second Bank of the United States the “Bank War” (hard to consider this combat without Andrew Jackson having British commanding officers to kill).  What exactly had triggered the 1830s inflation in the first place?

Temin argues silver flows are the culprit:

Inflation, caused by inflows of Mexican silver (Temin, 1969), had prevailed since 1833, accompanied by “active speculation, especially in land” (Thorp, 1926). Thorp writes that “great activity and excited speculation” prevailed in the first quarter of 1837, but by mid-year the banking system was in crisis.

An interesting theory, but the Kitco chart belies the claim–silver prices remained locked at P=1.293 in 1833, 1834, 1835 and 1836.  For a commodity to cause inflation, a price needs to actually rise.  So, how about cotton?

The most important of all these effects for the United States was a new demand for cotton. Cotton was at that time the commanding article in the foreign trade of the United States. In value it constituted from 35 to 55 per cent. of the exports of the United States, and therefore might be regarded as the chief thing with which we paid for our imports. It was a natural monopoly. Its value rose steadily in spite of a very rapid increase in production. Inasmuch as the facts in this connection will demand our attention frequently as we pursue the history of this period, the following statistics of the production, in million pounds, and of the annual average price, in cents, will be found useful for reference.*

Year. Crop. Price.
1820 160 million pounds. 17
1830-1 350 million pounds. 9
1833-4 445 million pounds. 11
1834-5 460 million pounds. 12
1835-6 550 million pounds. 16
1836-7 570 million pounds. 16
1837-8 720 million pounds. 14
1838-9 545 million pounds. 10
1839-40 870 million pounds. 14
1840-1 654 million pounds. 8
1841-2 673 million pounds. 10
1842-3 942 million pounds. 8

We’re on the right track–cotton was certainly rising.  But it began rising before 1833, and its behavior during the crisis leads me to suspect cotton was subjected to powerful outside forces–the 24.3% crash in cotton production after demand peaked in 1837-38 was followed by a rapid surge; cotton production reaching a level 20.8% greater than the previous peak.  The second 24.8% crash in cotton production was accompanied by a 42.8% reduction in cotton prices, a contraction 14.2% worse than the previous hit.  With these swings, one might expect massive disruptions to the cotton supply chain.

Until one considers that within two years cotton surged back 44% despite the fact that the price was less than where it stood 12 years earlier.  Mississippi and Louisiana planters may have fled to Texas, but they had set up new plantations–given 4,600 acres of free land by the Republic’s government undoubtedly the slaveholders went right back to churning out cotton.  While Northerners were starving on account of pestilence-damaged wheat harvests, the staple Southern crop was unaffected.  But if supply disruptions wasn’t the core problem, what was the central issue?

Temin and the St. Louis Fed also state “the panics occurred after several years of a rapid increase in the money supply and rising inflation,” implying the former caused the latter.  Temin apparently believes an influx of Mexican silver has increased the money supply even as Jacksonian Democrats have engineered the American silver supply to fly across the Atlantic to European treasuries.  Furthermore this explanation utterly fails to account for how the massive paper expansion inaugurated by the Second Bank of the United States in 1817 needed a decade and a half to take effect.  There must be a proximate cause for the inflationary turn…


U.S. Official Price
(U.S. dollars per fine ounce
end of year)

New York Market Price
(U.S. dollars per fine ounce)

























Oh, right—the Coinage Act.  Jacksonian Democrats permitted the price level to rise 6.7% in the furtherance of the Carolinian’s obsession for the glittering yellow metal:

Jackson and the Democratic Congress hoped that this gold inflow would reverse the apparent tightening of credit.  But hard times would soon drive Americans to hoard both gold and silver, making it disappear as currency for a decade.

The Carolinian’s gambit had failed spectacularly, setting the stage for another hard decade under the yoke of the gold and silver standards. 

Oddly enough, in the worst economic contraction in the first 150 years of American history a golden opportunity (pun may or may not be intended) was squandered.   The deviation in gold and silver prices in 1837 were far less severe than 1815, yet the vise grip around the economy’s neck was far more intense during the latter depression.  Clearly the commodities market reacted much faster and viciously to sustain gold and silver price controls in 1837, which begs the question: why allow the needless suffering?  Free the gold and silver!

Almost two centuries later it might be easy to claim that removing P=1.293 and P=20.67 and permitting commodities to find equilibrium is an obvious choice, but could contemporary financiers and governmental administrators understood this without the benefit of hindsight? 

Yes: there was no reason for policy makers to misunderstand how central set gold and silver prices were in the pre-1973 American economy.  The terms gold standard came into use no later than 1835.  If 1830s policy makers did not understand how the system of fixed exchange enforced itself, those people were not up to the task entrusted to them.  Then again, some policy makers today clamor for a return to this accursed exchange system…

One thought on “Aggregate Demand Dominance: Lose on Silver (G&SI Part 2)

  1. Pingback: Aggregate Demand Dominance: 300 Years of War Finance | In The Corner, Mumbling and Drooling

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