The Other Great Depression

In 1937, the American economy, which had been slowly rising from the depths it had reached in 1933, suddenly reversed course and sank once more. While this new economic trend enlarged the misery of the American people, it also gave the economists a new problem: what to call it.

Since the start of the 19th century, an economic downturn had been called a depression, but in 1937, the country was already in a depression. So the economists, probably delighted to have a problem they could actually do something about, pressed the word recession into service. Because of the iron law of euphemism (weak terms drive out strong ones), recession took hold, and we have not had a depression since. Today that word effectively belongs to the 1930s and, indeed, is often capitalized to indicate its now unique meaning.

But the Great Depression was hardly the first major downturn in the American economy. In fact, a severe economic contraction followed hard on the heels of the Revolution itself. And in 1837, after several years of economic expansion that was reflected in Wall Street’s first big bull market, Wall Street was hit with its first big crash.

The depression that followed lasted well into the 1840s. However, while it deeply affected Wall Street bankers and merchants, it did not greatly alter the daily lives of a majority of Americans. Most citizens lived on farms, largely outside of what economists call the cash economy.

By the end of the century, however, millions of Americans had become dependent on weekly wages. In 1860, for every worker toiling in a factory there had been nearly four working on farms; by 1890, the ratio had dropped to two to one. In 1860, there had not been a single industrial concern listed on the New York Stock Exchange; by the mid-nineties there were twenty, each employing tens of thousands.

Therefore, the depression that struck the country in 1893 has a very good claim to being called the Other Great Depression, for it directly affected the livelihoods not just of the bankers and merchants but of millions. The GNP fell almost 12 percent. Unemployment, which had stood at only 3 percent of the work force in 1892, soared to 18.4 percent two years later. Hunger stalked the streets of the now vast slum districts in American cities, while only private charity was available to alleviate the misery.

The causes of the depression were partly the usual ones of overexpansion. In early 1893, the Philadelphia and Reading Railway Company and the National Cordage Company collapsed and touched off panic on Wall Street. By the end of the year, another 15,242 companies (and 642 banks) had failed. Before the great depression of the 1890s was over, nearly one-third of the country’s railroad mileage would pass through receivership.

But an equally important cause of the depression was that the government had been ignoring another iron law, this time economic, not linguistic.

It is hard to imagine today, but in the last two decades of the 19th century, the gold standard was the subject of numerous cracker-barrel colloquies, street-corner harangues, and bar-room brawls, reflecting a deep divide in American politics.

Being on a gold standard simply means that a country fixes the value of its currency in gold and stands ready to exchange any amount of it for gold at that value. The gold standard was extremely popular with the “moneyed classes,” the bankers, brokers, and established businessmen epitomized by Wall Street and J. P. Morgan. The Northeast strongly supported a gold standard.

The rest of the country, however, was still largely agrarian, and farmers are chronic debtors. Many people in the South and West thought that the gold standard was nothing more than a Wall Street plot to drive them into bankruptcy. A gold standard, you see, makes inflation nearly impossible. And inflation is always popular with people who owe money because it allows them to pay up in cheaper dollars. William Jennings Bryan would nearly reach the White House thanks to the inflationary schemes he advocated.

Faced with a strong demand for a gold standard by one powerful group, and an inflationary monetary policy by another, the United States government, as so often happens in a democracy, tried to have it both ways. In February 1873, the government began to move slowly back to the gold standard it had abandoned in the Civil War and stopped minting silver coins. The West, where vast new silver deposits were discovered in the mid-70s, promptly labeled this the “Crime of 73.” In 1878, however, Congress, while still moving toward a return to the gold standard, also passed the Bland-Allison Act, which required the Treasury to purchase between two and four million dollars’ worth of silver every month at the market rate and turn it into coins at the ratio of sixteen to one. (In other words, sixteen ounces of silver were declared by congressional fiat to be equal in value to one ounce of gold.) This had the effect of arbitrarily increasing the country’s money supply, the classic means of generating inflation.

At first, sixteen to one was approximately the market price of silver, but as the great strikes in the West began to come in, the price of silver dropped steadily, reaching about twenty to one by 1890. That year Congress passed the Sherman Silver Act requiring the government to buy 4.5 million ounces of silver a month, just about all the silver the country was mining. With the government price for silver well above the market price, this was a sure recipe for inflation.

But the year after Bland-Allison, the country had fully returned to the gold standard, with Congress mandating that the Treasury keep $100 million in gold on hand at all times to meet any demand for the precious metal. With its silver policy greatly increasing the money supply, and the gold standard keeping the value of the dollar steady, the government managed both to guarantee and to forbid inflation.

So, what happened? Well, as anyone who has studied economics anywhere other than on Capitol Hill could predict, Gresham’s law kicked in. This law, an economic truth recognized more than 200 years before Adam Smith was even born, holds that “bad money drives out good.” Silver, worth one-twentieth the price of gold in the market, was declared to be worth one-sixteenth the price of gold when coined as money. So, naturally, people spent the silver and kept the gold. Gold began to trickle out of the Treasury.

Because the government ran a persistent surplus all during the 1880s, the effects of the country’s schizophrenic monetary policy were masked. But when the crash of 1893 hit, the trickle rose to a flood. With government revenues plunging, Congress repealed the Sherman Silver Act, but the people had lost faith in the dollar and hoarded gold. The government issued bonds to buy more gold and maintain the reserve, but the metal continued to flow out of the Treasury.

Before long the situation was critical. The Treasury gold reserve dipped below the $100 million required by law in 1894 and reached just $64 million the following January. Congress refused to allow President Cleveland, a staunch supporter of the gold standard, to sell another public bond issue to replenish the vanishing gold reserve.

With a free-coinage-of-silver Congress and a gold-standard President, the government was paralyzed. Bets were being made on exactly when the U.S. government would be forced off the gold standard. Badly alarmed, J. P. Morgan took a train to Washington. President Cleveland, all too aware of how Wall Street was hated in much of the country, at first refused to see him.

“I have come down to see the president,” responded Morgan in his most imperial manner, “and I am going to stay here until I see him.” With the situation deteriorating by the minute, Cleveland relented the next morning.

The president, the Attorney General, and the Secretary of the Treasury all clung to the hope of persuading Congress to permit a new public bond issue, thus sparing them the political embarrassment of having the U.S. Treasury bailed out by the country’s ultimate plutocrat. Then a clerk informed them that the New York Subtreasury had only $9 million in gold remaining in its vaults. Morgan said that he knew of a $10 million draft that might be presented at any moment. If that draft is presented, Morgan warned, “It will all be over by three o’clock.”

“What suggestions have you to make, Mr. Morgan?” Cleveland asked.

Morgan made an astonishing offer. He and the Rothschilds, the two most powerful forces in international banking, would purchase for the government’s account 3.5 million ounces of gold in exchange for about $65 million worth of thirty-year gold bonds. Further, he promised that the gold, once in the hands of the government, would not flow out again, at least for a while. In effect, Morgan was offering to act as the country’s central bank during the crisis, insulating the Treasury from market forces. It was an awesome display of Morgan’s faith in his own power.

The scheme worked, and with confidence restored, the bonds were sold at a handsome profit to the bankers. Cleveland, a sound-money man to the core, never regretted taking Morgan up on the offer. But the silver wing of the Democratic party never forgave him for it.

The following year, the grip of the great depression of the 1890s began to lessen, and the political appeal of funny-money schemes therefore waned. But William Jennings Bryan swept to his party’s nomination by promising to prevent the crucifixion of mankind upon a cross of gold. He was soundly defeated, but for the next 16 years, as the country matured economically, the Democratic party dragged a cross of silver through the political wilderness.