A Brief History of Doom
Page 18
Europe saw some but much less distress, primarily because a relatively larger part of their railroad expansion was behind them. None of their railroad expansion was even a fraction as dramatic as that of the United States in this period. Yet there were still some international problems. Firms such as Baring Brothers had profited extensively by encouraging their clients to purchase risky Argentine bonds during the 1870s and 1880s. But in 1890, “a bloody revolution, crop failures, and rampant inflation” in that nation drastically reduced interest in this debt. Afraid that the instability in Argentina might spread to other financial markets, many European investors rushed to cash in their bonds in favor of hard currency. This, in turn, led to both the decline of Baring as “the Goldman Sachs of its day” and the beginning of a run on gold in the United States.161
U.S. unemployment reached levels that brought labor unrest, the destruction of property, and in some cases, the loss of life in places across the country. The effects of a crisis on the wage labor market, labor unrest, and misery, so evident in the 1873 crisis, were even more pronounced in this one. U.S. unemployment climbed.162 In the 1890s, Jacob Coxey—formerly a member of Grover Cleveland’s Democratic Party—would become involved in the Populist Party and challenge capitalism, even though he was a prosperous business owner. When the panic of 1893 hit, he was forced to lay off workers from his mining and manufacturing businesses. Facing that misery, he devised a plan of public works to improve the infrastructure of the United States while giving jobs to the unemployed masses. He spearheaded a protest with a band of the unemployed known as “Coxey’s Army,” which started with a hundred men in Ohio and grew to five hundred by the time it reached Washington. This march inspired thousands of others to organize protests around the country. Coxey would be arrested on the lawn of the Capitol—for trespassing on the grass—with his revolutionary ideas ignored.163
Conventional wisdom holds that this crisis had a great deal to do with silver and hard currency, in particular the enactment of the Sherman Silver Act in the summer of 1890 and its subsequent repeal in the summer of 1893 after the banking crisis began. Both have received much attention as well as blame for the crisis. However, what actually transpired in 1893 does lend much support to this perception.
The act increased the amount of silver the government was mandated to purchase to 4.5 million ounces monthly. It was passed largely because of a deepening agricultural depression brought on by years of drought, storms, and overproduction. Midwest and southern farmers were hit especially hard, and farmers “seethed with discontent” as “debt payments and low prices restricted agrarian purchasing power and demand for goods and services.”164 The Free Silver movement arose, gaining support from farmers, who sought to invigorate the economy and bring about inflation, thus allowing them to repay their debt with cheaper dollars, and mining interests, who sought the right to turn silver directly into money.
Yet the volumes and price of silver were such that it appeared to play little role in the creation of overcapacity during the crucial years of 1885 to 1890. After the Treasury silver purchases began in late 1890, when the act took effect, it did so at an overvalued price, which gave investors a silver-to-gold arbitrage, and the amount of gold at the Treasury dropped rapidly from $150 million to $80 million. This concerned the Treasury, but other than a brief, minor drop in GDP in 1890, both GDP and private debt moved ahead at a pre–Silver Act pace.
The Sherman Silver Act was quickly repealed in August 1893 after that year’s banking and stock market crash. But this was only after the crash had already happened. Gold and silver totals were stable, though specie declined by $139 million in two years—but, again, only after 1894. Inflation was low or negative, and long-term rates for the most part were stable during the period. The actual trends, flows, and aggregate value of silver would suggest its role was minor—especially when set against much larger GDP and private debt totals.
Historians have also made much of J. P. Morgan’s 1895 rescue of the U.S. Treasury. This is another factor that happened well after the crisis, so it was not causal but is worth comment. The depression that followed the crisis had reduced government revenues, and it ran a deficit in 1894 and 1895. Consequently, its gold reserves were rapidly declining. They were approaching a level at which the United States would not be able to redeem notes in specie, a potential disaster and profound international embarrassment in a gold standard world.
Morgan offered his services to President Cleveland to replenish the Treasury’s gold by underwriting a $65 million U.S. debt offering. The Treasury’s negligence was the issue since this rescue could have been avoided had it forecasted the deficiency properly and planned for it. Under those circumstances, it could have executed a debt offering and used the proceeds to buy an adequate supply of gold well in advance of that need. Cleveland was loath to accept Morgan’s offer because he correctly feared a populist backlash, but he had no choice. Morgan’s firm profited handsomely on the transaction, which fueled the negative perception among voters of Cleveland’s obeisance to Wall Street.
This crisis harmed attitudes toward industrialization, government intervention, and basic tenets of capitalism. The era’s business distress led to the first huge wave of U.S. mergers and acquisitions, which began in 1895 and peaked in 1899. In turn, this brought a wave of antitrust activity.
The Crisis of 1907
The year 1907 saw the last financial crisis in which railroad overcapacity played a major role. The impact of railroads was joined by the impact of the emerging electric utility industry. This crisis is in some respects a bridge between the railroad century, which we might also call the age of steam, and the coming age of electricity. Edison had invented the first practical lightbulb in 1878, and by 1882 his Pearl Street power station—financially backed by the omnipresent J. P. Morgan—was providing lighting to homes and businesses in lower Manhattan.165 The 1907 crisis even foreshadowed the Great Depression, as New York saw its first, fledgling skyscraper boom.
With this dawning age of electricity, the world developed an insatiable appetite for copper. It was needed in the power-generating plants themselves, for the wires that brought electricity to houses, and in industry and transportation. A race was on to string copper wires across the United States, Britain, Germany, France, Japan, and beyond, a race that accelerated in the 1890s and 1900s. Copper mining surged, and many of the era’s fortunes came from it. As with railroads, the indirect construction activity that expanded alongside electricity industry–related expansion was as great as or even greater than the direct activity—and just as perilous.
The burgeoning electricity industry had a major impact on copper prices from almost the very beginning, with copper price spikes in 1888, 1899, and 1906–7 (Figure 5.11). These three price spikes reflected periods of rapid expansion and overcapacity, and the associated debt-financed copper speculation played a role in three calamities: the spectacular demise of Paris’s Comptoir d’Escompte in 1889,166 Germany’s crises of 1901, and the broader global crises of 1907.
Figure 5.11. Copper Price (per Ton), 1880–1913
Table 5.10. Germany Crisis Matrix: 1890s and 1900s
a1900–1901 change.
*Limited data points.
In the five years leading to 1900, Germany’s bank loans grew by 51 percent.
Germany’s rapid industrialization in the second half of the nineteenth century transformed it into one of the world’s leading industrial powers, including in electricity.167 Large banks played the major role in this industrialization.168 Germany’s growth required large mobilizations of capital and funding, and electric companies first obtained funds through issuing shares, then moved to loans,169 with bank loans peaking in 1900.
The signs of excess came in December 1900, when the director of the Allgemeine Elektricitäts-Gesellschaft (Germany’s General Electric Company) said “the electrical industry now has a productive capacity in excess of the demand for electrical manufactures.”170 Electricity company shares fell
.
In July, the Economist reported that “the manufacturers of structural iron, owing to the dullness in the building trades, are accumulating stocks of finished material, which cannot be disposed of,”171 and in September reported that “all mills in Western Germany that produce pig-iron and rolled goods are now accumulating supplies of these materials far beyond their immediate wants, since . . . they placed orders far ahead, and for quantities that could be consumed only under the continuance of demand as it then existed. But now demand has slackened remarkably.”172 Cement producers met in November and decided to halve production, given “very evident overproduction.”173 Even the coal industry, which had for most of the year been unable to meet heavy demand, eventually had to cut production “in the face of decreasing consumption.”174 Soon, “factories had trouble disposing of their products, stocks rose, orders became rare, [and] it became impossible to find new capital.”175
But, as a harbinger of other twentieth-century crises, it was the trail of real estate excess that accompanied the expansion of electricity that in October 1900, triggered the first stage of the financial crisis. In its October 27 issue, the Economist described a “sensational event.” Two mortgage banks—Prussian Hypotheken-Aktienbank and Deutsche Grundschuld Bank—had failed on certain financial commitments; consequently, their shares fell by about 20 percent each. Other mortgage banks convened to help them out, likely fearing that these banks’ troubles might affect them as well.176
But the two mortgage banks’ shares continued to fall, each declining 60 percent to 70 percent, and the Economist reported that they had been engaging in questionable lending practices. Grundschuld had replaced £2 million in first-class mortgages with “worthless” mortgages.177 The Economist also reported that £3 million of the Grundschuld Bank’s obligations were secured by “second-class mortgages,” which had only paid out less than a third of the interest they were obligated to pay that year. Eventually, both mortgage banks failed, along with two others, the Pomeranian Bank and the Mortgage Bank of Mecklenburg-Strelitz, which had also announced they too would be unable to meet certain financial commitments.178 Two large banks in Saxony, the Dresdner Creditanstalt and the Bank of Leipzig, failed in 1901: they had loaned too much money to industrial concerns.179 A run on Saxon banks followed.
Scientific American, in a scathing report on the German crisis of 1901, chided German capitalists for getting ahead of themselves and overlending to industry. “The banks were only too ready to lend money for industrial purposes,” the magazine wrote. “The censors who taunted the English manufacturer for his conservativeness,” the magazine wrote, “are silenced for the moment.”180
In 1901, Germany saw a drop in stocks, GDP, and loans, with reverberations felt across Europe. While Germany’s day of reckoning came early, it would take until 1907 for this copper and electricity frenzy to fully catch up to other countries.
In the global trading boom that began in 1904, stock prices in the mining sector outpaced manufacturing, railroads, and other industries. The price of copper had been 14 cents per pound in 1903 and soared to 25 cents per pound in 1906, but when production almost doubled to 1.6 billion pounds by 1907, prices dropped to 17 cents, affecting lenders to that industry. Lenders found themselves overleveraged on railroad lines, construction, and copper mines, and now faced the global crises of 1907 and 1908. Many view the October 1907 failure of New York’s Knickerbocker Trust as the onset of the global crisis. But this crisis erupted first in Alexandria, Egypt; then, Tokyo, Japan; Genoa, Italy; and Hamburg, Germany—and beyond.181
Japan, an exporter of copper, had emerged out of economic doldrums and into what the governor of the Bank of Japan called “a fever of enterprise,”182 with the number of its new businesses and the prices of its stocks rapidly increasing. But those stock prices declined steeply in early 1907, with the collapse of the Tokyo stock market. A fall in commodity prices, especially copper, and other financial difficulties resulted in a 12 percent decline in Japan’s exports between 1907 and 1908. Bank failures and bankruptcies would continue until 1908. By October 1907, twenty-four banks had already closed and fifty-eight were under pressure.
Table 5.11. France Crisis Matrix: 1900s
*Limited data points.
In the five years leading up to 1906, France’s bank loans grew by 57 percent.
The collapse in copper prices led to the Ashio riots, in which workers at the Ashio copper mine—Japan’s largest mining concern and one of the largest in the world—rioted for three days against the Furukawa Company in February 1907.183 The Japan Times luridly described the scene: “Towards evening the mob assembled at Motoyama, set warehouses on fire, and the whole mountain side was enveloped in smoke.”184
France saw rapid lending growth in the early 1900s that led to financial turbulence as well. France’s bank loans grew by 57 percent from 1901 to 1906. Its investment in Russian enterprise between 1900 and World War I hovered between 20 percent and 25 percent of GDP, increasing its credit risk and vulnerability. Domestically, France saw a collapse in the Lyon silk market.185 Two French banks suspended payments, Maurice Gallet and Company in Paris (with liabilities of £400,000) and the Société Lyonnaise de Crédit, as a result of its silk speculation.186
After Germany’s 1901 troubles, the country’s bank loans again grew rapidly in the five years leading up to 1907. In the wake of this growth, twenty-nine private banking establishments, eleven registered cooperative credit societies with limited liabilities, one industrial bank, one savings and credit bank, two loan and credit societies, one people’s bank, and two credit banks (the Solingen Bank in Solingen and the Bonner Bank für Handel und Gewerbe in Bonn) all failed.187
Table 5.12. U.S. Crisis Matrix: 1900s
aOne-year lag.
In the five years leading up to 1907, U.S. private debt grew by 42 percent. Railroad bonds, utility bonds, and mortgages showed strong growth.
Yet the signature moment of the 1907 crisis was the demise of New York’s Knickerbocker Trust Company, with its loans to speculators in copper. Historian Alexander Noyes notes that the United States was already heading toward its financial nadir in 1906. The American money market could not absorb “new stock and bond issues . . . and railroads and industrial companies alike were borrowing enormous sums on two- and three-year notes, paying high rates of interest.”
“In the two years of 1905 and 1906, $872,000,000 in new bonds, were listed on the New York Stock Exchange,” Noyes writes, “whereas, even in the extravagant promotion period of 1900 and 1901, the total was only $367,000,000.”188 It was an ominous sign of a fulminating credit crisis. In the vulnerable commodities sector, high prices, a decrease in exports, and overcapacity also portended trouble.
Overcapacity brought an aggressive downward spiral: “Average prices of commodities on the world’s markets lost, in the fourteen months between June, 1907, and September, 1908, nearly all 21 per cent.” Before 1908 came to a close, trade had fallen to 26 percent of the 1907 value.189
Frank Fayant, an acerbic wit, pilloried stock market fraudsters with his “Fools and Their Money” column of 1907. He noted that copper-mining fever attracted investors ready to risk their fortunes on ludicrous promises. A common thread in every crisis was the volume of bad stock—often bought on loans. Fayant analyzed over 150 companies that sold millions of dollars of stock to the hungry public. He found that of all the offerings broadcast and issued during the 1901–2 period, 104 were “dead and gone” when the panic began, and only one company—just one—was paying dividends. And that one company’s stock was “selling in the market at less than half what investors paid for it five years ago.”190
In the 1907 panic, it was “trust companies,” a secondary type of lending institution, that loomed large, including the Knickerbocker Trust Company. Knickerbocker was connected to Otto and Augustus Heinze, who had unsuccessfully tried to corner the copper market in October 1907, and the company had been one of the lenders supporting their copper scheme.
Most vulnerable were the trust companies, which, in New York, suffered total deposit withdrawals of over 36 percent between August 22 and December 19, 1907. The effect on the trusts was deep and corrosive. They fell like dominos—with the Lincoln Trust Company and the International Trust Company of New York among them.
J. P. Morgan corralled New York’s bankers. He told them bluntly that they needed to raise $25 million immediately or risk at least fifty stock exchange houses196 utterly failing. They were able—barely—to keep the day’s trading afloat. The following Monday, $100 million in loan certificates were issued for trading and to fortify cash reserves. Morgan also agreed to purchase $30 million in bonds to rescue New York City from bankruptcy. Though the economic damage was extensive, Morgan’s money and status were arguably instrumental in keeping the worst of the financial demons at bay—at least for a time.
The National Monetary Commission opened an investigation, chaired by Senator Nelson W. Aldrich, who was associated with the Rockefeller family, to understand the panic and propose new regulations for banking. This investigation was the first in a series of events that finally led Congress, in December 1913, to pass the Federal Reserve Act and establish the Federal Reserve System. This was designed in some measure to fill the lender-of-last-resort role in times of crisis that Morgan had played and provided the first glimmer of what would become a robust, activist involvement of the Federal Reserve and the U.S. Treasury over the next century.