Tuesday, January 27, 2009

Historical Perspective on Financial Crises

For many years it was regarded as appropriate to lay the blame for the Panic of 1837 on Andrew Jackson. In 1832 Jackson vetoed the recharter of the second Bank of the United States and began to place the government’s deposits in other banks. With the conservative influence of the Bank of the United States gone, his critics claimed, other banks over issued their notes, fueling a speculative boom. Peter Temin showed that this explanation of the Panic of 1837 paid insufficient attention to the international sector. If banks were over issuing their notes, he argued, then the ratio of notes to reserves should have been decreasing, but it was increasing. The number of bank notes in circulation was increasing, but bank reserves were increasing even more rapidly. Reserves were increasing not because of Jackson’s policies but because of international forces. Because the country was on a bimetallic standard, the supply of money was ultimately dependent on the amount of specie in the country. Temin argued that both the inflation of the early 1830s and the crisis were caused by specie flows that were driven by external events. While acknowledging the negative influence of external forces, Peter Rousseau has recently shifted attention back to internal forces. International forces set the conditions for the Panic, but the economy was pushed over the edge by distribution of the federal surplus and the Jackson administration’s requirement that land purchases be made in specie, both of which drained specie from New York City banks.
The Panic of 1837 has received far more attention than the Panic of 1839, but for many the real trouble did not begin until 1839. The Panic of 1839 initially appeared to be a sequel to the Panic of 1837. However, unlike the Panic of 1837, there was no quick recovery. John Wallis has attributed the difference between the two panics to the run up in state debt that occurred between them. The boom of the 1830s involved mutually reinforcing expansions of land sales and internal improvements. The prospect of low cost transportation fueled demand for western lands; land sales in turn raised the revenue of western states and promised even further increases in revenue in the future. People were willing to buy land because states were going to build railroads and canals, the states were willing to borrow for internal improvements because people were going to come and buy the land. The credit crunch brought and end to both. Land sales and prices fell, the market for state bonds collapsed.
Possibly the most useful lesson to be gained from this history is humility. More than a century and a half after the panics of 1837 and 1839 we are still trying figure out what happened. It might be useful to keep this in mind when reading (or writing) diagnoses of the current financial problems.

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