America’s Long Journey: The Panic of 1837

The Panic of 1837

Brace yourself: This entry is about economics. But actually it is neither as dull nor as dismal a subject as you might expect. It is curious that the Great Depression of the 1930s, which was the nation’s worst financial crisis ever (at least, so far), was mirrored a century before by the nation’s first.

The business cycle consists of alternating expansions and contractions of credit, that is, loosening or tightening of the conditions under which banks will lend money. A sudden contraction of credit, leading to business slowdowns, used to be called a “panic,” perhaps because of its connection with bank failures.

The Panic of 1837 was the first contraction of credit since the country began to industrialize, and it touched off the nation’s first major recession. In the new economic and social conditions, the panic’s effects manifested in unfamiliar ways. Nobody quite knew what was going on, and so everybody blamed it on somebody else’s villainy or stupidity. (Where was the Internet when it was really needed?) Vindictive and fearful know-it-alls spread conspiracy theories with their usual certainty, although not at electronic speed, and it helped poison the body politic.

Today, we know some of the factors that helped cause it.

As usual, the financial crisis was the result of a previous period of expansion, in which the prices of land, cotton, and slaves had risen sharply. Abundant amounts of silver were coming into the United States from Mexico and China. Land sales and tariffs were generating substantial federal revenues. Cotton exports and the marketing of state-backed bonds in British money markets attracted significant capital investment from Great Britain, which financed railroads and canals and industrial growth.

Then, in 1836, directors of the Bank of England raised interest rates in order to rebuild its financial reserves, for reasons that had little or nothing to do with the United States. But Great Britain in those days was what New York is today, and the British Pound Sterling was the world’s reserve currency. When British banks said “frog,” American banks in the United States had to say, “how high?”

On May 10, 1837, banks in New York City announced that they would no longer redeem commercial paper in specie (coin) at full face value. They scaled back on lending, and raised interest rates, which forced down the price of American securities. The demand for cotton fell by 25% in two months, and the price per bale followed the drop in demand. This was disaster in itself, as the country depended heavily on stable cotton prices to balance its trade deficit and procure foreign exchange earnings, but its effects down South were just catastrophic. The sharp decline in cotton prices led to over-extended plantations being foreclosed, and banks (from whom they had borrowed money on future expectations) collapsing.

This rippled through the economy, and the reduced availability of capital led to the collapse of the contemporary land bubble. Over the next seven years, banks collapsed, businesses failed, prices declined, and thousands lost their jobs. (You might think that declining prices are a good thing, but they aren’t so good if you are a producer, or if you are a consumer who loses his job because the producer he worked for has to reduce his outgoes, or goes out of business.)

Virtually the whole nation felt the effects of the panic. Of 850 banks in the United States, nearly half either closed entirely (343) or failed partially (62). In the absence of deposit insurance, runs on banks were common, bringing down even banks that were healthy, or at least forcing them to call in loans and demand payment from their borrowers, which further restricted the circulation of money in the economy, and made things worse.

In some places in the cities of the East, unemployment was later estimated to have been as high as 25 percent, as in the Great Depression of the 1930s. The agricultural states of the Midwest (then referred to as the West) were unaffected until 1839, when crop prices fell, and then they joined their compatriots in economic misery.

The cotton states of the South got the worst of it. Many southern planters speculated in land, cotton, and slaves, taking out loans from banks under the assumption that cotton prices would continue to rise. When cotton prices dropped, and the planters could not repay their loans, many of their banks were jeopardized.

Many individual states defaulted on their bonds, which hurt British creditors, who had long memories. It made it harder to obtain international finance to help build future railroad and other infrastructure. In fact, the United States withdrew from international money markets until the late 1840s.

None of this was particularly the fault of President Martin Van Buren. He was in office only five weeks when the panic began. But, like Herbert Hoover nearly a century later, he was blamed for being the heir of the policies of his popular predecessor, and for not finding a way to fix what was broken. As happened to Hoover in the 20th century, Van Buren’s opponents maintained that the damage and duration of the panic had been worsened by his refusal to respond with government intervention. Perhaps so. In any case, the panic and its consequences shook the nation’s confidence as never before.

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