The roots of the 1873 panic were in the Civil War, during which banks and currency were nationalized for the first time. This consolidated wealth like never before, and favored businesses lobbied for government subsidies on an unprecedented scale. These new practices formed an economic bubble that was bound to burst.
Nationalizing the U.S. Economy
A national banking system was created during the war, in which state and private banks were required to join the system or else pay heavy taxes. This was the forerunner of the Federal Reserve, and it enabled politicians to centralize banking power in Washington. This centralization allowed Wall Street to exert greater influence on the economy.
A nationalized paper currency was also introduced. Before the war, state banks had issued their own currencies backed by specie (i.e., gold or silver). Because the new paper money was not backed by specie, the U.S. Treasury could print as much as was needed to fight the war. This massive influx of new money led to rampant price inflation.
Also during the war, the federal government began subsidizing favored businesses on a large scale for the first time. Railroads were the main recipients, as rail companies were given land and money to build new rail networks, including an historic transcontinental route. Like most government spending, allocations were based on politics rather than business, leading to greater waste, inefficiency, and corruption.
The Railroad Crash
Government subsidies enabled the railroad industry to boom after the war. This prompted investors, speculators, and banks to put hundreds of millions of dollars into railroads, which created a false prosperity. Within a decade, railroad supply far exceeded consumer demand, and the industry was bound to crash.
In September 1873, Jay Cooke & Company, one of the largest national banks in the U.S., declared bankruptcy due to heavy railroad overinvestment. Because most of the nation’s banks were financially linked under the new national banking system, Cooke’s failure caused a chain reaction of bank failures throughout the country.
The banking failures sparked a stock market crash, forcing the New York Stock Exchange to close for 10 days. As stocks became worthless, businesses were forced to close. This led to drastic increases in unemployment and poverty.
The Inflation Bill of 1874
By the end of 1873, over 5,000 businesses worth over $200 million had failed. Wages were cut by over 25 percent, and nearly one million industrial workers lost their jobs. Of the nation’s 364 railroads, 89 declared bankruptcy.
After heated debate, Congress passed the Inflation Bill, which proposed to print $18 million in paper money to stimulate the economy. However, President Ulysses S. Grant vetoed the bill, arguing that printing money out of thin air cannot provide stimulus.
Grant was harshly criticized for failing to provide aid to the needy. However, the veto may have kept the crisis from getting worse because inflation would have increased the cost of living through price increases. In 1875, Grant further angered stimulus supporters by signing a bill into law that stopped the printing of paper money and backed the money in circulation with gold.
The Depression Ends
Government-funded railroad expansion, unbridled Wall Street speculation, and the nationalization of finance led to a railroad bubble that burst in 1873 and caused a six-year depression. Many sought more government intervention in the economy, but the Grant administration took an alternate view.
Overall, Grant’s efforts to curb inflation and stabilize the currency with gold caused more misery in the short term, but they were necessary corrections in an economy that had been poisoned by bad investments, excessive paper money with little worth, and crony capitalism between government and business. The pain caused by Grant’s corrections reduced the long-term pain, which is primarily why this severe depression lasted only six years.
Sources
DiLorenzo, Thomas J.: How Capitalism Saved America (New York, NY: Three Rivers Press, 2004)
Schweikart, Larry and Allen, Michael: A Patriot’s History of the United States (New York, NY: Penguin Group, Inc., 2004)
Walter Coffey - Walter Coffey is a freelance writer who resides in Houston, Texas. Walter has written several works of historical fiction and non-fiction, ...
Join the Conversation