Caused mostly by irresponsible banking practices, the Panic of 1819 set a trend for future economic crises in the U.S.
The Panic of 1819 was the first major economic crisis in U.S. history. It resulted in widespread bank failures, mortgage foreclosures, unemployment and price drops. There were many reasons for the crisis, but the primary cause was irresponsible banking practices, led by the Second Bank of the United States. Consequently this panic bred a suspicion of nationalized banking and set the trend for future economic downturns.
The Post-War Economy
The federal government had borrowed large amounts of money to finance the War of 1812. Since there was no national bank (the First Bank of the United States expired in 1811), the borrowing came from various state banks. These banks were allowed to print their own paper money, even if the money was not backed by specie (i.e., gold or silver). This lax printing policy not only led to more banks being established, but it spurred inflation.
Meanwhile, foreign trade was drastically curtailed during the war, leading to a boom in domestic manufacturing. This massive expansion, coupled with the rising inflation, caused the price of goods to soar. When the war ended and foreign trade resumed, manufacturing declined but something still needed to be done about the out-of-control inflation.
The Second Bank of the United States
In an effort to rein in state bank profligacy, Congress created the Second Bank of the United States in 1816. The Bank was designed to create a sound, uniform national currency by printing paper money that was backed by specie. This policy was meant to trump the paper money being printed by state banks, thus curbing their inflationary practices.
However instead of reining in the state banks, the Bank issued vast amounts of credit for these banks to cover their debts. This only encouraged the state banks to expand even further. The credit expansion helped fuel an economic boom that featured unsustainable business expansion and investment.
The federal government also sought to benefit by selling land with generous loan terms due to the abundance of paper money. This sparked a boom in real estate, construction and transportation.
The Second Bank of the United States, rather than curtailing the irresponsible practices of state banks as intended, encouraged them since the economic expansion led to increased government revenue.
From Panic to Depression
Realizing that the rapid and irresponsible expansion of the money supply and credit led to an overextension of the economy, the national Bank attempted to curb inflation by calling in many of its outstanding loans and contracting the money supply in late 1818. Many state banks could not repay their loans, and as a result they failed.
When cotton prices crashed in January 1819 after British investors switched to Indian cotton, land prices began dropping drastically and the panic began. The contraction of credit left many unable to repay their loans, leading to massive land foreclosures. Many sold off their investments in an effort to liquidate their assets, leading to a collapse in the investment markets.
The collapse soon spread to the cities, as businesses failed and millions were left unemployed. An economic depression ensued. Some blamed the depression on the contraction of the money supply. However they failed to realize that contraction was the necessary, albeit painful, correction to all the irresponsible inflation and expansion perpetrated by the banks.
Proposed Remedies
Many proposals were offered to relieve the depression. In the end, President James Monroe decided that the government should not intervene in the crisis. Adhering to free market principles, most believed that recovery could only come from increased production, coupled with more responsible spending and saving habits. This applied not only to the people but their government as well. Thus with the government cutting costs and leaving the recovery to the people, the depression ended within two years.
The Panic of 1819 had a profound effect on the U.S. economy. The inflation, price fluctuations, collapsing markets and mass unemployment were similar to modern economic shortfalls. The panic also caused much hostility toward the Second Bank of the United States, which was believed to have centralized too much economic power in a single body. The panic’s characteristics, along with a suspicion of central banking (now under the Federal Reserve System), still apply to economic downturns of today.
Sources:
- Rothbard, Murray N.: The Panic of 1819 (Auburn, AL: Ludwig von Mises Institute, 2007)
- Schweikart, Larry and Allen, Michael: A Patriot’s History of the United States (New York, NY: Penguin Group, Inc., 2004)
