Panic of 1893

Posted by Marc Hodak on June 27, 2007 under History | Read the First Comment

On this day in 1893, the price of silver lost 15 percent of its value. This collapse triggered a panic that would eventually engulf over 600 banks and 15,000 businesses in bankruptcy, and lead to fifteen percent unemployment for the next several years.

What would cause such a drop in silver? How could a drop in one commodity have such a devastating effect? Just a few years earlier, the country was on a gold standard, which meant that the government had to keep gold reserves against which federal certificates could be redeemed. Since federal certificates were the basis for credit throughout the banking system, the gold standard, had the effect of keeping a lid on commodity prices and restricting the amount of credit that banks could issue. The resulting price stability and sound banking practices were beneficial to the East Coast money centers, but put a crimp on farmers and miners (i.e., commodity producers) who were subject to the tender mercies of fluctuating demand and (for the farmers) uncertain supply. This created the feeling among the western and southern population that the gold standard was mainly for the benefit of the urban bankers in the Northeast. Populist politicians fanned this suspicion, and in 1890 Congress passed the Sherman Silver Purchase Act which required the government buy 4.5 million ounces of silver per month, a dramatic increase from its earlier pattern of purchases.

This Act had several effects that would set the economy up for the Panic of 1893 and ensuing depression, including:

– Artificial increase in the demand for silver, creating a rapid rise in its price
– Higher effective demand for silver, which spurred more more supply (from western mines)
– Dramatic increase in the credit supply with the expanding supply of silver in what was, essentially, a bi-metallic standard
– Depletion of gold reserves used to buy up the growing amount of (artificially expensive) silver

This situation suited the rural, especially Western folks just fine, at least for a while. “Easy money” was a major goal of those who supported a bi-metallic currency, and that’s what they got. Of course, so did everyone else. Debt levels began to rise rapidly across the economy, not just with farms and mines, but with industrial manufacturers, railroads, trading companies, etc. The bankers were trapped in a credit bubble; they had to lend to compete, but they knew that the loans were getting riskier and riskier. The smarter and better capitalized banks (think J.P. Morgan) began to withdraw from this game of making bad bets.

As inflation began to grow, people began shifting into gold to protect themselves, which suddenly put pressure on silver prices by, in essence, bringing their relative prices back into balance. By early 1893, companies that had taken the biggest risks on steadily increasing prices began defaulting on their loans. Grover Cleveland had just been elected President, and his new Secretary of the Treasury announced that gold reserves were perilously low. The populists didn’t care, but the financial community was on edge. In March, the mighty Philadelphia and Reading Railroad went bankrupt. Two months later, National Cordage, a major trust, went belly-up. Soon after, silver collapsed, and silver “dollars” were worth about 58 cents, and the run on banks began.

President Cleveland quickly demanded and got repeal of the Sherman Silver Purchase Act, but by then it was too late. The turmoil that ensued would not be fully resolved until 1897. By then, farmers an bankers were finally bound together in a common struggle–a government induced depression.