Causes of the Panic of 1819: Part Two

As the Transatlantic trade flourished, the American credit market continued to boom. As 1815 came to a close, essentially unregulated banks issued another $22 million in bank notes. The amount of currency floating around began to present a problem for the US treasury: one of the government’s primary sources of revenue was from the sale of public lands in the west, but the money issued by western banks was considered to be worth less than the notes issued in the east, where the government spent most of its money. In order to solve this problem of standardization, as well as hopefully curtail inflation, the Second Bank of the United States was authorized by Congress in 1816. The new bank’s first task was to restore the nation’s currency to par by forcing the various state banks to resume specie payments (although bank notes were nominally backed by silver coins in the bank vaults, most of the state banks had no real specie to speak of).[1] But both the State banks and the Bank of the United States dragged their feet on the convertibility issue, although the state banks did restrict their lending a little bit and at least nominally began to resume specie payments. But this supposed return to convertibility was dwarfed by the Second Bank’s own inflationary policy-the organization was run as a profit making enterprise, with branch managers loaning heavily and accepting promissory notes as capital.[2]In other words, the National Bank was doing exactly what it had been created to curtail.

By 1818, the American economy was booming. A farmer could sell his flour for export to the Caribbean at a high price, and purchase previously unattainable British made woolen jackets on layaway. He could also speculate heavily in Western lands; after all credit was easy to come by, and the increasing value of agricultural products like wheat and cotton meant that land prices would only go up. Unfortunately, the American economy was held up on two shaky pillars. Firstly, it was highly dependent on international trade: those living in the West and in the South relied heavily on exporting wheat and other staples.  At the same time, cheap British made textiles were wildly popular, with a whole new sector of merchants (known as “jobbers”) devoted to selling them. Meanwhile, banks were issuing tons of money and credit was extremely easy to come by. Their notes were supposedly ba The economy was growing by leaps and bounds, and speculation and investment were at all time highs. The first formal indoor stock exchange in the country opened up in New York in March 1817; traders had been buying and selling stocks to each other in curbside stands on Wall Street since the 18th century, but the new flows of credit made a more organized trading system necessary.[3] Commercial banks began to venture into investment banking by buying and selling blocks of stock.[4] But banks, both commercial and state, had very little real capital: they were essentially issuing money backed by IOUs-“paper backed by paper.” However, these banks were supposedly able to redeem their notes in specie. Although the National Bank was tasked with redeeming their notes for silver, if they were forced to pay back depositors with silver they didn’t have, there could be a disaster. State Senator Condy Raguet described the situation in no uncertain terms:

“You state in your letter that you find it difficult to comprehend, why persons who had a right to demand coin from the Banks in payment of their notes, so long forebore to exercise it…The whole of our population are either stockholders of banks or in debt to them. It is not in the interest of the first to press the banks and the rest are afraid. This is  the whole secret.”[5]

As Raguet explained, the banks relied on people not attempting to redeem their money for specie However, if people were to begin to demand specie, or if they began to doubt that their banknotes were backed by silver, there could be serious problems. Thus, while the American economy from 1815-1818 was booming, it was built on two shaky pillars- the complex and unreliable Transatlantic trade and an overextended banking system with too little capital. In 1819, both of these pillars would collapse.

The principle causes of the Panic of 1819 were the contraction of the money supply and the reduction of American wheat exports. These two factors were interrelated, and their combined effects were enough to create one of the deepest depressions of the 19th century. The contraction of the money supply, which is usually listed as the primary cause of the Panic, began in the summer of 1818.

By  late 1818 the Bank of the United States was faced with serious problems. The national bank had greatly expanded its loans to the state banks and its notes outstanding in 1816-1818, but its pledge to redeem its notes in specie was beginning to take its toll. The Western branches of the National Bank issued notes that were then redeemed with silver in the Northeastern branches-unfortunately there was not enough specie to go around . Silver was being drained from the vault; the Bank could not continue to issue notes at its current rate and still be able to pay out specie.[6] The silver drain was compounded by the retirement of Federal debts: the government was scheduled to pay back the bonds it had issued to finance the 1803 Louisiana Purchase in autumn of 1818.[7] These bonds were to be repaid with silver, and the payments were supposed to come from the Bank, which served the repository for the United States Treasury. In order to survive, the bank would have to retrench. In the fall of 1818, the Bank began to call in the many loans it had made to state banks.

In order to pay back their debts to the National Bank, the state banks had to contract as well- this meant contracting their own loans and demanding repayment from their debtors But in 1818, their debtors faced an enormous problem-the collapse of commodity prices. Beginning in the summer of 1818 and continuing through 1819, the price of such important staples as wheat, cotton, and tobacco began to decline precipitously-Wheat was valued at $2.41 a bushel in 1817, but was worth only 88 cents a bushel by 1821.[8] Thus, just as the banks began to call back their debts, their debtors were in the worst possible position to pay them back.  They had speculated wildly on land, hoping that the then sky-high commodity prices would keep the value of land up. Now that these commodities were worthless, the land that they were to be grown on was worthless as well.  A wave of bankruptcies swept through the country as the state banks frantically tried to contract. The United States entered a depression, thanks to a combination of contractionary policy and a decline in international trade.

[1] Haulman, Virginia and the Panic of 1819, 14.

[2] Ibid.

[3] Rothbard, The Panic of 1819; Reactions and Policies, 9.

[4] Ibid.

[5] Ibid, 10-11.

[6] Ibid.

[7] Ibid.

[8] Sellers, The Market Revolution, 136.