A panic started a depression

The panic of 1873 triggered a worldwide recession, starting in the US. On September 20th the New York Stock Exchange suspended trading for the first time, and closed for 10 days. The panic resulted from speculative over-investment in railroads that followed the end of the Civil War. In the five years from 1868 - 1873, some 33,000 miles of track was laid, some resulting from government land grants and subsidies, but mostly funded on borrowed money from the sale of bonds. Vast amount of capital went into railway projects that seemed to offer no immediate or early returns.

By November some 55 railroad companies had folded, and a further 60 went bankrupt within a year. Construction of new track dropped 80 percent, and within two years 18,000 businesses failed. Building stopped, real estate values fell, and profits vanished. In the US the depression was dubbed the “Great Depression” until the crash of 1929, after which it was renamed the “Long Depression.” It lasted until 1878/9.

Its ripples caused an economic depression that lasted longer in Europe. In Britain it began two decades of economic stagnation. Part of it was a consequence on the US Coinage Act of 1873 that had stopped redemption of currency in silver. Part of it was President Lincoln’s printing of paper money to finance the Civil War. But for the most part it was brought about by uninhibited enthusiasm for railroad expansion, the new craze.

A pattern seems to repeat itself in the history of finance. Tulips, the Darien Scheme, the South Sea Bubble, and more recently the dotcom bubble, all seem to involve enthusiastic over-investment followed by a crash and shakeout when panic grips the market and more sober calculation takes over.

Some paint this as a failure of capitalism, but it could be argued that this is part and parcel of how capitalism works. Investment in new ventures that can boost productivity and profit takes place all the time, but at times people are carried away by “animal spirits” and throw caution go the winds in their desire not to miss out on the new big thing. The panic and the collapse redistribute capital, that which is not simply lost, and more balanced judgement leads people to invest more cautiously. Panic and market collapse constitute the ‘error’ part of the trial and error that characterizes how the market progresses and how wealth is gained.

Some economists theorize that the business cycle is part of the process, and a valuable part at that, in that it clears out the deadwood and the marginal, and concentrates resources where they can add value. They suggest that when people such as Alan Greenspan and Gordon Brown try to smooth it, to abolish its downturns, they are doing the economy no favour, but are allowing anomalies to build up to make the ‘bust’ bigger and more damaging when it comes.

Certainly the post-Greenspan crash of 2008 outdid all the smaller downturns that had been previously smoothed added together. And when Gordon Brown, a year before the big Financial Crisis claimed to have abolished boom and bust, he turned out to have been only half right.