The Panic of 1893

Antony — November 16, 2011

As a side-effect of reading our latest book “The Driver”, I have recently been doing some reading on monetary history. In particular, I have been trying to understand the conditions surrounding the Panic of 1893, the period in which the book is set. After a bit of reading, it becomes clear that the history of money is a story of chronic government meddling.

Pre-Fed U.S. monetary history has a very romantic feel, with battles between gold and silver proponents, and gold rushes and silver mining expansions affecting money supplies. But the economic principles are the same as today, with politicians seeking to inflate the money supply battling advocates of sound money. These battles were manifested in debates on bimetalism, whether gold and silver should both be recognized as money, and whether the government should keep their prices in a fixed ratio (a form of price control).

In the aftermath of a previous crisis, the Panic of 1873 (during which silver was de-monetised in favour of gold), proponents of loose money succeeded in introducing the Bland-Allison Act in 1878, which obligated the U.S. treasury to purchase silver at a high prices. Combined with this, large silver discoveries in the west (especially Nevada) resulted in an expanding money supply. This caused a boom in capital investment (in this case railroads) through the 1880s. In 1890, further fuel was added to the fire with the Sherman Silver Purchase Act, which required the US treasure to purchase increasing quantities of silver with notes backed by either silver or gold. Since the silver was purchase at artificial prices, shortages resulted, as with all price controls. Holders of silver rushed to trade in their silver for notes, which could then be redeemed for gold. The good times continued until the treasury ran out of gold in 1893.

This episode is a perfect example of Austrian Business Cycle Theory. A manipulated expansion of money and credit leads to an unsustainable boom in capital markets, which must inevitably crash. The pattern is almost exactly the same as our recent housing bubble, with the booming capital sector being housing rather than railroads. A key difference, however, is the increased degree of control that the state has over money these days, with central banking, fiat money, and the globalised financial institutions. This makes it more difficult to see the manipulation for what is is, gives the state more power to keep the artificial boom going for longer, and makes the unwinding more unpredictable and potentially more devastating.

Of course the solution to these problems is to allow the free market to function without interference, particularly when it comes to money. Advocates of sound money usually favour a return to gold, in some form. But it is worth keeping in mind why gold is valued; it is because that is what free markets have chosen as money historically. And this is what is important, not gold itself as a metal, but the freedom to choose it.


Ashley Johnston says

I liked the ‘plenty of food’ scene on the train. :)

— November 17, 2011

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