Download Economic History of the US

Economic History of the US
Reunification Era, 1860-1920
Lecture #2
Peter Allen
Econ 120
1
Public Controversy over Monetary System,
1865-1913
 After Civil War…continuous controversy over
money
 Gold standard…
 + no central bank and
 + very rapid economic growth
 = inadequate money supply and deflation
 Hurt agriculture, helped industry
 Critics proposed inflationary schemes
culminating in W. Jennings Bryan in 1896
2
Classical Gold Standard
 After 1873
 Central benefit:
 …confidence in long-run
value of $
 The way S & D turned out…
 …tight liquidity
 …may have reined in
financial speculation and
panics
 Supported by political and
financial leaders
 Central costs:
 Inability to increase money
supply to needs of the
economy during rapid
growth
 MV = PY
 Deflation
 Hurt debtors…esp.
farmers
 Helped creditors, esp.
banks
3
End of Civil War, 1865 …
How to Resume Convertibility to Specie
 76% inflation during the War
 Options discussed…
1.
2.
3.
Keep greenbacks/fiat
Gold only
Return to Bi-metallism
 Preference for Gold
 No consideration to staying
off specie
 Hamilton system…
 US$ = 0.85 ounce silver

or 0.053 ounce gold
 Now, 76% or so too much fiat
money
 Options to get back to specie,
in whatever form…


Devaluation
Deflation
4
Resume Convertibility to Specie?




Options discussed…
Keep greenbacks
Bi-metallism
Gold
 Devaluation or
 Deflation
Republican-dominated Congress,
argued for resumption…
1. Gov. creditors deserved to be
paid in a gold
2. Fiat currency was dangerous
3. Restoration of prewar gold
parity necessary to maintain
US gov. credibility overseas
HOW TO RESUME CONVERTIBILITY
1861
1865
1873
1879
United States
Index
Inflation
100
176
76%
129
-27%
104
-19%
Gold
($ per oz.)
20.67184
36.38243
26.66667
21.49871
← Old Parity
← Resumption
5
Path Chosen…..deflation
 Contraction Act, 1865 – “Fast-track”





Fed. gov. runs a budget surplus…
…and “burns” the surplus, i.e. greenbacks
Caused a sharp drop in prices…but also…
MV = PY
Sharp contraction of the real economy
 Contraction extended in 1868



Grant‟s Treasury…gradual approach…
Hold money constant and allow economy to grow
Rough parity between US, British prices and gold reached by 1879
 Legal Framework for Resumption



Coinage Act of 1873, which specie
Resumption Act of 1875, timetable
Resumption planned for 1879
6
7
Coinage Act of 1873






Listed coins to be minted
Omitted the standard silver dollar
…simpler, solved Gresham‟s
$1 = 0.053 oz. gold
Resumption, successful January 1, 1879
Holy alliance…silver producer, farmers





“Crime of 1873”
“Free coinage of Silver,” 1873-96
Bland-Allison Act, 1878
Sherman Silver Purchase Act, 1890
William Jennings Bryan, 1896
8
Returning to the Gold Standard
1861
1865
1873
1879
United States
Index
Inflation
100
176
76%
129
-27%
104
-19%
Index
100
105
113
96
Britain
Inflation
5%
8%
-15%
Index
4.85
7.69
5.55
4.85
$ per £
Inflation
59%
-28%
-13%
9
1869 to 1879
200
End of the Civil War, Apr. 1865
180
160
price index
140
Resumption, 1879
120
100
80
1894
60
40
1860
1870
1880
1890
1900
1910
 Economy grew by 3%
per year in real terms
 Prices fell by 3.8% per
year
 Monetary base grew by
1.1% per year…
 …not enough to allow
prices to rise
 Brutal effect on
agriculture/West
10
Resumption didn‟t Stop Deflation




Deflation continued for another 15 years…
…roughly 1.7% per year until 1896
Forces pushing prices down continued…
Until the mid-1890s…
 Gold discovered in South Africa
 Use of cyanide to extract gold from ore
 1896-WWI – heyday of international gold standard
 Inflation, roughly 1.7% per year
 Ms and Md in balance
 Monetary base = gold in the ground
11
Monetary History of the US, 1867-1960





“…the drastic and sustained price
decline occurred, despite a mild
rise in the stock of money, because
of an exceedingly rapid rise in
output…” Friedman/Schwartz, 1963
MV = PY
Friedman is saying that with Y
rising “exceedingly,” V constant
(or falling slightly) and M rising
slightly, P has to fall
If inflation is: …”too much money
chasing too few goods…”
Then deflation must be… “too
little money chasing too many
goods…”
Friedman on Crime of ’73
•Gold standard was a mistake
•Bi-metallism in „79 would have
prevented deflation
•But, by 1896, i.e. campaign of Bryan
•for president on “Free-silver”
•…may have caused another bout of
deflation
12
Forms of
Currency in
the US,
1860–1915
13
Post-Civil War, Dual Banking System
 National Bank Act,
1863



National Banks
National Bank Notes
Only banks issuing currency
 State banks



Taxed 2-10% on note issuance
during War
1866, fewer than 100
Revived after 1870 with
business model of
deposit and loan
 Tight money and Free
Banking…
 …limited resources of
Commercial Banks
 Industrial Age…rise of
Investment Banks
 Peculiar to US
 Big companies raise money
from savers directly…
 …by issuing stocks and
bonds
 Underwriting and trading
14
Panics in 1873, 1893 and 1893
Same Pattern
 Despite tight monetary conditions overall
 Fractional reserve banking allowed banks to increase
profits with leverage
 commercial banks create money…on top of…specie reserve
 investment banks bought stock/bonds with borrowed $$
 Bank Run…fear of what a bank had done with “the
other fraction”…




...safety of banks‟ investment of depositors‟ money
can happen in all monetary conditions…though…
more likely when money supply is growing fast…inflation…
under gold or bi-metal standards
15
Financial Panics of 1873, 1893, 1907
 Panic of 1873







Occurred prior to Resumption, deflation
Railroad bonds…
Vast speculation, bubble
Bond default by Northern Pacific Railroad…
…triggered more defaults as indebted railroads couldn‟t refinance…and…
…failure of investment bank Jay Cooke and Co.
Chain reaction…contraction of Ms and bank failures
 Panic of 1893




Caused by re-emergence of the “Free-Silver” movement
Run on gold
Fear US was going to forced off of the gold standard
Suspension of specie payments by P. Grover Cleveland
16
Panic of 1907
 Prompted the Federal Reserve Act of 1913
 Preceded by boom in Trust companies offering high
interest on deposits and invested in stock of large
corporations
 failure of Knickerbocker Trust
 banking panic…suspension of convertibility…
 bear market in stocks and 13 month-long recession
 JP Morgan, lender of last resort, rescued…
 Citibank
 Chemical→Chase→JP Morgan
 consensus for a new central bank
17
What to do about Bank Panics?
 Three theories in 1865-1913
1. Hard money: no fractional reserve = no panics
2. “Sound Banking Doctrine:” somebody monitors
banks, usu. federal government






Fractional reserve, but with statutory reserve requirements
Present paper currency for specie
Clearing houses
National banking, standard currency
lender of last resort
Need a new central bank
3. Fiat money, “free banking” pure-competition
 Money, creation of free market not government
18
Federal Reserve Act, 1913









Sound money approach
12 Federal Reserve Banks
Permanent
Federal Reserve Board
Compulsory membership for National banks
Optional for state banks
Members, purchase Fed stock = 3% of its capital
Deposit reserves with the district Fed bank
Can create reserves in a crisis
19