The Panic of 1873

If you would like to know how, in my opinion, the Great Chicago Fire of 1871 was an indirect cause of World War II, read on. It's a bit long, but I think there's an important lesson to be learned.

While the current economic downturn is nothing to dismiss lightly, it pales in comparison to the full-fledged economic disaster known as the Panic of 1873. In the United States, this Panic or, in more a contemporary term, "meltdown," eventually led to what became known as the Long Depression of 1873-1879. Although some will state that the 1873 Panic was caused by the collapse of Jay Cooke & Company, the Philadelphia banking and investment firm, most economic historians now blame four causally-unrelated events that, when taken together, precipitated the crisis.

First came an attempt by speculators Jay Gould and Jim Fisk to "corner," or gain effective price control of, the gold market in 1869. Using borrowed money, Gould and Fisk (along with several hundred other investor/speculators) had purchased most of the publically-available gold in the United States with the aim of driving up gold's price before selling their purchases at a huge profit. The scheme collapsed when President Grant sold part of the United States' gold inventory on the open market, which caused the price of gold to fall. Over a thousand speculators, unable to cover their loans after prices fell, lost everything on "Black Friday," September 24, 1869.

Next, in 1871, the country was hit by an unusually long and severe drought. Although many farmers were devastated by this drought, the real damage to the national economy occurred when the City of Chicago was essentially destroyed by the overnight fire of October 8^th-9^th. Since Chicago was the largest railhead in the nation for the trans-shipment of food, farmers suddenly had no market for the few crops they had produced, which in turn led to a national food shortage and higher prices.

Then came the 1872 nationwide epidemic of the equine influenza virus. This month's-long epidemic either killed, or incapacitated, practically every horse in the nation. Without horses, the national transportation infrastructure of that era collapsed. Men had to pull wagons from warehouses and many cargo ships waited weeks to be unloaded simply because there was no way to transport their cargo. Without hoses to pull wagons of coal and wood to fuel its engines, the railroads either simply stopped running or operated on severely reduced schedules. In the American West, the situation became so bad that the army's cavalry units were forced to fight on foot.

Finally, in early 1873, came the decision by the Grant Administration (via the Coinage Act of 1873) to place the United Sates on the gold standard and to stop the government's purchases of silver, as well as to cease minting silver dollars and printing paper dollars that were redeemable ("backed") in silver. While the administration's decision may have been a boost to the eastern bankers and commercial interests, the Coinage Act shattered the remaining economies of the west (particularly areas that were heavily dependent on silver mining and related businesses) and in the south (where silver, rather than gold, was used in most financial transactions). The stage was now set for anything that would disturb the nation's financial house of cards. That "anything" was the September 28, 1873 collapse of Cooke & Company. Before explaining how this company's misfortunes killed the nation's economy, another brief diversion in history is necessary.

Previous major financial crises had been slow to spread from their country of origin to other financial markets simply because the speed at which information could reach those other markets was quite slow. As an example, news of a collapse of a European stock exchange would not have reached other European nations for several days because it would take that long for news of the event to be relayed by mail. It would have thus taken weeks for news of a European financial crisis to reach the United States, and vice versa. Furthermore, there was relatively little international investment among nations. This situation changed around the year 1866 with the completion of the first transatlantic telegraph cable.

After the cable was completed it became possible for a bank in, say, London to send an order to buy or sell some type of financial instrument, such as stock in an American railroad to, say, a bank or brokerage firm in Philadelphia in a matter of only a few hours rather than a few weeks. This removed any advantage that a financial firm would have enjoyed from having a few extra weeks of "transit time" to make good its obligations under buy and sell orders from overseas clients. This is precisely what killed Cooke & Company.

Cooke & Company had been the agent for the sale of bonds and stock of the Northern Pacific Railroad. Many of these sales were to European investors, primarily in England. When concerns over the poor state of the American economy (due to the combination of factors mentioned earlier) caused English investors to sell their holdings in American railroads, the prices of those investment instruments fell rapidly on the stock and bond markets. Cooke & Company, being the major American broker in such investments on behalf of its overseas clients, and being involved in some shady speculative investment deals on its own behalf, was unable to meet its obligations and went into bankruptcy. In turn, banks with an interest in Cooke & Company failed also. The fallout from these failures caused their business clients to also fail, and by Christmas Day of 1873 the American economy was a pile of smoldering rubble.

We may now return to the story of the Chicago Fire and World War II. Our story unfolds as follows.

At the conclusion of the Franco-Prussian War in 1871 the victorious Germans had forced France to agree to pay them a very large sum of money in "war reparations" (actually, the proper term would be "extortion money" but "war reparations" is more diplomatic-sounding). France, in order to pay its new debt, had to substantially raise its taxes which, in turn, killed the French economy. British investors, wishing to cut their losses after both the French economy tanked and the American railroad meltdown, sent out a huge number of "sell" orders, which kills the American and what was left of the French economies.

Now let's fast forward by forty-eight years.

France is, for one of only two times since the days of the Roman Empire, on the winning side of a war with Germany at the end of World War I. In addition to being heavily in debt to America and Great Britain, France is still mad at Germany over the reparations that it had to pay after the war in 1871. Since France is still broke, and the Americans and the Brits expect to be paid back (they remember what happened in 1873 when international debts killed their economies), France is in serious financial trouble. France, seeing a way out of its problem with debt, forces Germany to pay a stupendous sum in war reparations in the Treaty of Versailles and plans to use the reparations money to pay off the Americans and the British.

The French plan goes up in smoke after Germany, whose economy is ruined by its reparations debt, can't make its payments. The French then default on their loans to the U.S. and England. While all this is going on, the Great Depression of the 1930s begins and suddenly everyone is in the same shape as Germany. In Germany, the situation gets so bad that Adolph Hitler and the Nazis seem like a good idea. Hitler wants all of Germany's territory back that was taken in the Treaty of Versailles, so he starts building a new army, and so on, and so on.

And what are we supposed to learn from all this? For the incumbent American administration, there are three important historical lessons that are relevant in today's world:

1) There is no such thing as an event that happens isolated to itself. Every major event has both a cause and a consequence. The events of 1869-1873 were, in and of themselves, not sufficient to have caused major damage to the economy. In the gestalt of history, however, their result was far greater than the sum of the parts.

2) Do not make major changes (by adding or, as was the case with Grant, removing dollars) in the national money supply. Doing so is asking for future trouble. Corollary: You can't spend your way out of a recession without creating inflation.

3) Do not spend money that you don't have and expect another nation to take up the slack. Remember what happened when France tried it after World War I?

I doubt that anyone in the Obama Administration will heed these lessons, but at least I tried.