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Washington Irving: Critic of Loose Money

February 27, 2007

Tags InterventionismMonetary TheoryMoney and Banking

 

In the aftermath of the War of 1812 — fought when the fledgling United States became entangled in the global conflagration raging between Napoleon and the British — the burden of government debt issued to finance the conflict became so onerous that recourse was soon had to that most traditional of quack remedies, monetary debasement.

As a consequence, the volume of paper money soared out of all proportion to the banks' underlying reserves and, before too long — in the summer of 1814 — they were forced to suspend payments in specie and, in so doing, unleashed a wild, inflationary orgy.

As the face value of bank notes in issuance doubled in the space of four short years, the gain was matched almost dollar-for-dollar by the rise in the price of that important export staple, cotton. Needless to say, the rise in the availability of credit, coupled with a lifting of the blockades and embargoes imposed by the Royal Navy, also began to make its impact felt upon the balance of trade, leading to an increase in the deficit of the order of 70% from its prevailing pre-war level.

Partly as an inverse of the monetary variation and partly the result of the extra real demand occasioned by the succession of bad harvests caused across the northern hemisphere by the aerosol effect of the violent eruption of Mount Tamboro in Indonesia, the price of agricultural exports also rose sharply and so the credit expansion swiftly found a further outlet in property speculation.

This fever was again intensified by the government's rush to sell public lands, all payable with the paper money which so glutted the nation. Furthermore, the eager vote-grubbers on the Potomac were quick to use the proceeds of theses sales for a rapid expansion of public works, stimulating yet more activity, even though this caused the Treasury headaches of its own as a gulf in value was opened up between its receipts of the more heavily discounted western banknotes and the expenditures largely conducted in relatively less depreciated eastern paper.

Realizing that matters could not continue as they were, the federal government eventually succumbed to the blandishments of that archetypal chancer, Nicholas Biddle. It granted him the charter for what came to be known as the Second Bank of the United States; an institution ostensibly charged with overseeing a regularization of the nation's money and even with facilitating a swift return to a proper, metallic standard.

Alas! The temptations of the boom proved too much for Biddle and his cronies. Far from acting as a restraint upon the expansion, the bank metamorphosed into its primum mobile, adding $41 million in loans to the ante in only the first year of its incorporation, and all on the scanty base of the bare $2.5 million in cash which resided within its vaults.

Characteristically, this wave of monetary excess also prompted an effusion of optimism about the prospects for gain associated with any manifestation of technological advance, especially where these related to capital-intensive, long-pay-off infrastructure projects. In this instance, this was realized in the form of farm improvements, turnpike (toll) road construction, the introduction of steamboat shipping, and the start of work on the Erie Canal.

In another, all-too-modern twist, this more ancient New Era was marred by the intense conflicts of interest that arose as insistent debtors and avaricious bank stockholders combined to deny creditors and depositors their rights to realize their holdings in sound money. Since the former visionaries were driving the boom onward and the latter curmudgeons were only threatening to asphyxiate it, it is no surprise that the former, by and large, prevailed.

Fittingly, such was the height of this incoming tide of financial speculation — and so many were the new companies which were formed and floated in order to cash in on the surrounding euphoria — that it was now that the curb traders of Wall Street at last quit the shade of their hoary old buttonwood tree for the more obliging, indoor surrounds of the infant New York Stock Exchange.

Ultimately, of course, the boom could not last. The Bank of the United States saw its own notes fall to an ever-wider discount to cash — despite an emergency infusion of coin from abroad. Finally, it began to restrict its advances, lest it be overwhelmed when the largely foreign-held debt contracted for the Louisiana Purchase fell due (for which payment it was responsible) and so exhausted its already dwindling reserves.

Thus was the Panic of 1819 ushered in and, as the icy blast of retrenchment collapsed the whole house of cards in a heap, such a severe depression was triggered that, at one stage, urban employment in Philadelphia was reckoned to have fallen by nearly 80%.

At this very juncture, the well-known American author, Washington Irving (of "Sleepy Hollow" fame), was enjoying a prolonged trip to Europe. During his sojourn there, he turned his hand to a treatment of that earlier moral fable of financial hubris and nemesis, the Mississippi Bubble — that sovereign bail-out, debt-for-equity swap, "national champion," emerging market, option-issuing, securitization vehicle conjured up by the father of modern central banking, John Law — "le calculateur sans egal."

To read the prefatory paragraphs with which Irving opened his narrative of Law's ill-starred "System" is to gain the irresistible sense that the author was not so much referring to the faraway events of 1719, but was rather using them as a lens through which to refract the contemporary drama of their centennial, 1819 itself.

So vivid is the description of the background to the folly — and so utterly unchanging is the course of the pathology there laid out — that an extended quote, taken from the collection of essays entitled "The Crayon Papers," is surely merited for our instruction:

[There occasionally arise] those calm, sunny seasons in the commercial world, which are known by the name of "times of unexampled prosperity" … Every now and then the world is visited by one of these delusive seasons, when "the credit system" … expands to full luxuriance, everybody trusts everybody; a bad debt is a thing unheard of; the broad way to certain and sudden wealth lies plain and open; and men are tempted to dash forward boldly, from the facility of borrowing.

Promissory notes, interchanged between scheming individuals, are liberally discounted at the banks, which become so many mints to coin words into cash; and as the supply of words is inexhaustible, it may readily be supposed what a vast amount of promissory capital is soon in circulation. Every one now talks in thousands; nothing is heard but gigantic operations in trade; great purchases and sales of real property, and immense sums made at every transfer. All, to be sure, as yet exists in promise; but the believer in promises calculates the aggregate as solid capital, and falls back in amazement at the amount of public wealth, the "unexampled state of public prosperity."

Now is the time for speculative and dreaming or designing men. They relate their dreams and projects to the ignorant and credulous, dazzle them with golden visions, and set them madding after shadows. The example of one stimulates another; speculation rises on speculation; bubble rises on bubble; every one helps with his breath to swell the windy superstructure, and admires and wonders at the magnitude of the inflation he has contributed to produce.

Speculation is the romance of trade, and casts contempt upon all its sober realities. It renders the stock-jobber a magician, and the exchange a region of enchantment. It elevates the merchant into a kind of knight-errant…. The slow but sure gains of snug percentage become despicable in his eyes; no "operation" is thought worthy of attention that does not double or treble the investment. No business is worth following that does not promise an immediate fortune….

Could this delusion always last, the life of a merchant would indeed be a golden dream; but it is as short as it is brilliant. Let but a doubt enter, and the "season of unexampled prosperity" is at end. The coinage of words is suddenly curtailed; the promissory capital begins to vanish into smoke; a panic succeeds, and the whole superstructure, built upon credit and reared by speculation, crumbles to the ground, leaving scarce a wreck behind…

When a man of business, therefore, hears on every side rumors of fortunes suddenly acquired; when he finds banks liberal, and brokers busy; when he sees adventurers flush of paper capital, and full of scheme and enterprise; when he perceives a greater disposition to buy than to sell; when trade overflows its accustomed channels and deluges the country; when he hears of new regions of commercial adventure; of distant marts and distant mines, swallowing merchandise and disgorging gold; when he finds joint-stock companies of all kinds forming; railroads, canals, and locomotive engines, springing up on every side; when idlers suddenly become men of business, and dash into the game of commerce as they would into the hazards of the faro table; when he beholds the streets glittering with new equipages, palaces conjured up by the magic of speculation; tradesmen flushed with sudden success, and vying with each other in ostentatious expense; in a word, when he hears the whole community joining in the theme of "unexampled prosperity," let him look upon the whole as a "weather-breeder," and prepare for the impending storm.

Irving, among his many literary bequests, is said to have coined the phrase, "The Almighty Dollar," and he is also credited with having popularized the name "Knickerbocker" (in reference to New York's significant Dutch heritage).

It therefore carries more than a hint of historical irony that — some eighty-eight years after the above crisis blew up — the former came under renewed threat, thanks in part to the signal failure of a high-profile financial company bearing the name of the latter.

For it was in 1907 — exactly a hundred years ago today — that yet another period of bullet-proof optimism saw the heightened application of financial "ingenuity" to the question of how to run an increased level of speculative risk. Then, a series of what we would now call the leveraged buy-outs of numerous banking interests, as well as the legal exploitation of the loosely worded trust company regulations, allowed the credit creation needed for a new breed of gamesters to fuel the outbreak of a classic investment mania.

Once again, infrastructure featured heavily in the excess — this time in the shape of railroads, streetcar (tram) lines, and shipping. Once again, there was intense activity in the commodities market, amid dark mutterings of pools and squeezes. Once again, the withdrawal of international liquidity (here on the part of the Bank of England) led to the first tremors being felt in the fringe of "emerging markets" (namely, those of Egypt, Chile, and Japan). Once again, the failure of an aggressive gambit (the attempted corner of the stock of United Copper) by the leading financial buccaneers of the day — Heinze, Morse, and Thomas — sparked a freezing of credit and an instant collapse in both the securities and the operations of overstretched firms everywhere.

Rescued almost solely by the will and ability of Old Man Morgan — who famously prevailed upon the illustrious stock operator Jesse Livermore to refrain from selling the market even further at its lows — the financial system staggered, but survived and, fortunately for the bewildered many, the resulting business depression was short and sharp, rather than the protracted agony to which such fiascos tended to give rise in the interventionist age which followed.

Not so auspiciously, the whole salutary experience was instrumental in the campaign that culminated in the passage of legislation, in late December 1913, which founded the Federal Reserve and so ushered in the era of permanent inflation, political expansion, and endemic moral hazard in which we still must conduct our affairs.

If there is a lesson to be drawn from the foregoing it is that we would be wise to bear these precedents in mind when we observe the prodigies of today's infrastructure funds fighting among themselves to gobble up the turnpikes and steamship harbors of our modern world, or when we are told of the titans of private equity paying ever higher multiples and ever more enormous sums for the access to the debt-light balance sheets of outwardly average companies (the fatal power of "watered stock" and "overcapitalization" was well remarked upon by our grandfathers).

Rather than succumbing to the fallacy that "this time it's different," when we find the newspapers crammed with half-wondering, half-resentful tales of eight-figure investment bank bonuses and of the record art sales and smiling Ferrari salesmen which follow in the wake of their disbursal, or when we hear the giddy rise and Icarian fall of hedge fund "projectors" (as men of Law's era would term them) featuring on the evening news, we should reflect upon how very mundane this latest Gilded Age actually is.

Nor should we find it a fillip to our self-important sense of modernity when the talk is of avid crowds of equity-impoverished CDO buyers elbowing traditional bond funds out of the credit market, or when discussions turn to the scale on which the "Gnomes of Zurich" and "Mrs Watanabe" are jointly offering up their savings to help finance record-setting equity flows into Vietnam and Vilnius, into Botswana and Bogota.

Among Irving's more enduring fictional characters was Rip van Winkle — a ne'er-do-well with a nagging wife who famously fell asleep for twenty years and who hardly noticed the change when he finally regained his wits.

If Mijnheer van Winkle had nodded off in 1719, only to wake a hundred — not merely twenty — years thence, he'd have noted that though fashions and technology had altered unimaginably during his slumbers, the heady mix of human credulity and overeasy money was still producing the same old, intoxicating brew in the marketplace.

If he'd repeated the process in 1907, to stretch and blink his way back to consciousness a century later, today, he'd surely smile contentedly at finding himself wholly confirmed in his initial hypothesis.

 


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