America's First Housing Bubble and the Panic of 1819
From the Roaring Twenties to the "great moderation," America has always shown a flair for labeling things, and speculative manias are no exception. Historians remember the ignorant, blissfully happy times that preceded the Panic of 1819 by the same label as those who lived through them—the Era of Good Feeling.
Like so much of what is fatal to civilized society, the Panic of 1819 was birthed in the turmoil of war, specifically the War of 1812, a now-largely-forgotten episode best remembered for delivering Francis Scott Key's hard-to-sing and harder-to-listen-to "Star-Spangled Banner."
As in every war, the host government's first battle was to pummel the local currencies, which in 1812 America consisted mostly of state bank notes redeemable in gold, or at least promised to be. Wars are always expensive and the government's inability to print paper money at will is a huge disadvantage to them. The America of 1812 adhered to a gold standard; it had to go, and by 1814 it went.
By that year, not being able to redeem in gold all the promises of gold they had printed, the state bankers were in a fine mess, and the politicians, instead of throwing them into jail for fraud, granted them legal immunity to continue the swindle. After all, these banks were printing like mad in part to buy all those government bonds, to lend those same politicians credit in time of war and, as you doubtless know, twenty-gunned frigates like the Hornet didn't come cheap.
Now freed from having to actually raise money (gold) prior to issuing paper promises for it, the banking system's highly inflationary printing binge went into overdrive. During the war's three years, domestic prices rose by 25% and import prices by 70%.
From 1811 to 1815, banks multiplied like mushrooms on a dung heap, lending out credit they didn't have as if it were manna from heaven. Where actual money in bank vaults had decreased by 9.4% during that period, paper bank notes and deposits, all with claims on that money, had increased by 87.2%. Keynes himself would have been proud (Rothbard 2002, p. 73).
By December 1814, the British, having decided that Napoleon was more interesting to fight than America, signed the treaty that ended the War of 1812. This outbreak of peace was accompanied by an upswing in trade between the two nations' businessmen.
British manufacturers were eager to begin trade again and the flood of goods and the easy availability of credit made Americans ravenous consumers. Imports, which stood at $12.9 million in 1814, reached $151 million within two years, and this during a period when imported goods, freed from the wartime risk of getting deliberately sunk in transit, were rapidly falling in price (Dupre 2006, p. 280).
During this orgy of consumption, "merchants throughout the country overextended themselves…aid[ed] in their efforts by the availability of bank credit" (Dupre 2006, p. 271). Whatever in 1819 qualified as a widescreen TV, I'm sure Americans had plenty of it because fusspots from that time, much as in ours, moaned about the people's sad attraction to wasteful spending on trivial luxuries. America as a whole was importing far more than it was exporting, as our exports were flat in volume and rising only in terms of depreciating paper bank notes.
In addition to our ancestors' heightened attraction to imports, "the sudden availability of vast new reaches of territory, combined with the loose money left over from the war" (Brands 2006, p. 66) ignited a real-estate mania in America, particularly along the young nation's frontier areas. Illinois, overrun with fevered buyers, was the epicenter with Ohio not too far behind. Cincinnati laid claim to being the Las Vegas of the mania, and, according to one historian, most of it was subsequently repossessed.
As 1815 came to a close, the proliferation of paper bank notes and credit had the financial system of the United States in a mess—a direct result of the political establishment deliberately allowing the state banks to counterfeit with impunity. Now, seeing the orgy of speculation, stockjobbing, and pursuit of luxury imports that their policies had created, Congress stepped in to clean up the mess.
Amidst much hypocrisy, backroom dealing, bribery, threats, and displays of great oratorical skill, they proposed for themselves more money and power: another central bank, America's second go at the institution. (We are now on our fourth.) The new Bank of the United States was up and running by 1816, with the ostensible purpose of bringing the state banks' inflation to heel.
Instead, the men who ran the new central bank promised not to demand redemption of any state bank paper notes until over one year later. And they bailed out the insolvent state banks with $6 million in taxpayer money. The more things change, the more they stay the same.
To add injury to insult, the men who ran the central bank "jumped on the inflationary bandwagon" themselves (Dupre 2006, p. 271). Printing paper and promises with Bernanke-like abandon, within two years of its creation they had loaned $41 million worth of gold promises and issued paper bank notes redeemable in gold worth $23 million, all on top of just $2.5 million worth of gold (Dupre 2006, p. 270), a level of leverage insane enough to make a Lehman Brothers risk manager feel right at home.
"Flood[ing] the market with bank notes it could not now redeem" (Dobson 2002, p. 105) between 1816 and 1818, the supply of paper bank notes and credit on the US market grew by 40.7%, "most of it supplied by the Bank of the United States" (Rothbard 2007, p. 87). The Philadelphia and Baltimore branches of the bank would prove to be the most profligate—and the most corrupt—of all.
The economic dislocations gained steam throughout 1816–1818, and prices in real estate, land, and slaves floated upward on credit. As 1818 feverishly arrived, though, it was only the greatest of the fools who were buying. The music would soon come to an end since the postwar prosperity was built on a foundation of nothing more than pieces of paper with promises scribbled on them. In the actual vaults, there was precious little money (the pledged gold) at all.
Soon enough this became a problem, as notes from the Bank of Kentucky promising gold wouldn't sit well with a merchant from Liverpool, England. Foreign merchants demanded payment in money, not paper. Plus, payment was coming due for the Louisiana Purchase and the French also wanted gold, not paper. The central bank was responsible for coming up with that money. Foreseeing disaster, it slammed on the monetary brakes.
So recently the Johnny Appleseed of credit, the Bank of the United States now returned as a loan shark's heavy. In one hand they held the state bank notes, with the other they demanded the gold pledged by them, which the state banks had little of.
When it was realized that many paper bank notes were just that, their values began to collapse, many to zero (the same amount of gold you could get for it), and the money supply contracted at a ferocious rate. From the fall of 1818 to the beginning of 1819, demand liabilities at the central bank fell from $22 million to $12 million (Dupre 2006, p. 272) and the total money supply fell about 28% (Rothbard 2007, p. 89).
Insolvent banks and overextended debtors alike collapsed, while prices, no longer pumped up by the bubble, raced downward to their equilibrium. As the money supply cleansed itself of the bad apples, time and effort had to be paid so that the flow of funds could adjust back to their best uses, following prices as their guideposts. It was a massive, countrywide downturn, and introduced a slowly industrializing America to a new experience—mass unemployment.
Compared to now however, the state and federal politicians did basically nothing to "help" the economy recover from the Panic of 1819, yet by 1821 the economy had begun to get back on its feet, which must seem a stunning outcome to anyone burdened with a degree in economics.
What a Difference a Few Centuries Can Make
The response of America's intellectual and political elite to the Panic of 1819 was, in most ways, vastly different from what it has been so far in our current "Great Unmoderationing." Although we live under the same legal constitution and within the same lines on the map, the America of 1819 had a citizen who was, culturally speaking, utterly alien to the modern American; that they adhered to a gold standard, however imperfectly, is but one example of this difference.
To reap the benefits of a gold standard requires a character and sense of honor that modern Western man no longer possesses. The 1819 man is so fascinating because he had enough character and honor to realize he had made mistakes and to clean them up far more quickly than we. In times of crisis, he had the advantage of firm principles to guide him.
That's not to say that it was an era of perfect laissez-faire; human beings are not capable of it and likely wouldn't want it if they were. A powerful voting bloc arose that clamored for continued government intervention since it was political manipulation of the markets that had created them in the first place. They desperately needed its continuance to sustain them. They demanded taxpayer money to lessen the blow of their mistakes, legal attack on their competitors, and license to disregard their pledge to the rule of law.
These people fell into three broad categories: the debtors looking for relief, businessmen seeking protectionist measures, and the politicians wanting power. Their arguments read like today's New York Times, and there is no need here to repeat them—you're no doubt already familiar with them.
It is the unusual that grabs the attention, and the ideas and beliefs of the majority of our ancestors on how best to clean up the mess of 1819 are vastly different from almost everything I see and hear today. From CNBC's cute little money honeys to newspaper op-eds to my coworkers on the trade desk, all cry that the government must do something. Many of the elite from 1819 believed the exact opposite—that government must do nothing.
The newspaper editors of 1819 in particular led the fight against continued government intervention in the market and, most surprising to a denizen of 2009 America, many politicians at both the state and federal level joined them. Dodo birds of a political kind once roamed our nation's capitals.
In 1819 America, nobody blamed the effects for the Panic of 1819, they rightly blamed the cause; they blamed (in Caroline Baum's words) the "friendly central bank." As Professor John Dobson points out, "the [central] bank's policies fueled inflation, and it was popularly viewed as a major contributor to the Panic of 1819." After this encounter with central banks, "hard money leadership was abundant and influential" (Rothbard 2007, p. 207).
The urge to bail out debtors was fought against not only from a practical but from a moral level as well. Besides Tennessee state representative Robert Allen warning his colleagues that "if people learn that debts can be paid with petitions and fair stories, you will soon have your table crowded" (Rothbard 2007, p. 43), the pages of the influential Pennsylvania Aurora argued that any such bailouts would not only be economically unsound, but unjust, being a special privilege to the debtor (Rothbard 2007, p. 56).
While the federal government was a heavy player in the housing speculation—having offered over $23 million in "affordable" but now mostly delinquent loans by 1819—for the most part it was the state capitals, where much of political power still resided in America's pre-Lincoln days, that were the scenes of battle.
And not all the states were clamoring for intervention. The Massachusetts legislature in 1820, referring to hastily passed monetary laws that forced people to accept worthless paper bank notes as if they weren't, stated "the exchange value of notes must be regulated by the community itself, according to public wants and needs" (Rothbard 2007, p. 99), plus many thought that such monetary measures were pure hubris. Virginia state politician William Selden warned, "Money itself is an article of transfer. Human legislation on the subject is worse than vain" (Rothbard 2007, p. 54).
Even many businessmen had the sense of justice to stay above the fray, the United Agriculture Society of Virginia, for example, flatly claiming, "we design not to harass our representatives with high wrought pictures of distress which their wisdom could not have anticipated and cannot remove" (Rothbard 2007, p. 287).
More paper money, in the view of many, was not the solution, as "bank notes came to represent the speciousness of a speculative economy driven by the hot air of credit," which enabled merchants to extend easy credit "almost at the door of every consumer" (Dupre 2006, p. 285). Having experienced its operation personally during the latter part of the Revolutionary War, the men of 1819 understood the law of marginal utility and knew it applied to money as well as any commodity.
The Pennsylvania Union derided plans to lend and borrow prosperity back, claiming that overextended credit was the very source of the panic and that "instead of looking for relief in the restriction of the credit system, we are to look for its extension" (Rothbard 2007, p. 105).
Rather than printing more paper money, claimed the Southern Patriot, it might be better to protect property, and called for "the rigid enforcement of specie payments" (Rothbard 2007, p. 90).
Besides the foolishness of monetary manipulation, the debasement of currency and the spur to gambling it engineered, the uncertainty that such artificial injections caused to business was well noted. Preceding by almost two hundred years the thesis of Amity Shlaes's The Forgotten Man, the New York Daily Advertiser lamented in 1820 "the shock which business of every description receives from these measures … is more than a counterbalance to any monetary relief" (Rothbard 2007, p. 51).
During the Panic of 1819's initial stages—as panicked legislators passed interventionist laws to soothe panicked voters—it was more than anything the uncertainty of the rule of law, the lifeblood of any economy, that was in short supply. Capital hates uncertainty in the law and flees from it in a blink.
The passage in some states of various interventionist measures during the initial stages of the panic gave way to the realization of their immorality, unconstitutionality, and ineffectiveness, and within a few years they were repealed or struck down in court.
The men of 1819 realized that a "free market" in order to work must be just that—free. They had in them what we completely lack: a trust in the American people to manage their own affairs. A trust in "free markets" is, at base, a trust in the people. Many look at freedom as a luxury today—one that we can't afford and dare not try. Our trust in ourselves is dead, but it wasn't always.
In May 1820, a Virginia representative of Congress wrote "let the people manage their own affairs … the people of this country understand their own interests and will pursue them to advantage" (Rothbard 2007, p. 32). Who in Congress today, the only place that matters politically, would dare express such heresy?
In my lifetime, I have never seen nor heard such thing and that's why the Americans of 1819—with their many held ideals long dead to my time—are fascinating. In order to hear them you need to stretch out flat on their graves and put your ear to the ground—dig up their bodies if you think it will help. But you'd better be quick about it: in the next row of graves, I spy Bernanke, Obama, and Krugman, shovels in hand, frantically digging up FDR, Lord Keynes, and the rest of the Keystone Kops.
The Panic of 1819 lasted about three years—the Great Depression lasted well over a decade. When looking for solutions to our current mess, we should study a winning team; instead we seem determined to channel FDR, the same arrogant fool who took an economic downturn and stretched it into a decade-plus tragedy.
Along with our having grown a sad, deep distrust of ourselves, we have lost any sense of humility and become a nation stuffed to the rafters with the hubristic strut of The Expert. We have forgotten that "men plan and God laughs." And while every dawn brings Washington, D.C., to birth another plan to pile on top of the others, the American of 1819 had studied economics and absorbed the ultimate lesson of the science—that when it comes to some things in this lunatic asylum, the best plan of action is no plan at all.
Adams, Henry. History of the United States 1809–1817. New York: Library of America, 1986.
Brands, H.W. The Money Men. New York: W.W. Norton, 2006.
Dobson, John. Bulls, Bears, Boom, and Bust. Santa Barbara, Calif.: ABC-CLIO, 2007.
Dupre, Daniel S. "The Panic of 1819 and the Political Economy of Sectionalism." In The Economy of Early America: Historical Perspectives and New Directions, edited by Cathy Matson, pp. 263–93. University Park, Pa.: Pennsylvania State, 2006.
Madison, James. Madison: Writings. New York: Library of America, 1999.
Rothbard, Murray. A History of Money and Banking in the United States. . Auburn, Ala.: Mises Institute, 2002.
———. The Panic of 1819: Reactions and Policies. Auburn, Ala.: Mises Institute, 2007.