Bull Market Gemütlichkeit — Bethel Henry Strousberg family 1870
Moving into a new year, we naturally look for interesting anniversaries, from which lessons can be drawn. In 2023, there are no centenaries, bicentenaries or tercentenaries of interest, while I have written extensively recently about the 1970s, in which 1973 of the “Arab Oil Crisis” is the crucial year. However, 2023 is also the 150th anniversary of the “Panic of 1873” about which much less has been written, in this column or elsewhere, and which has many lessons for us today.
The monetary conditions of 1873, in the two markets where the Panic was most severe, the United States and Germany/Austria, were remarkably similar to those in operation as we enter 2023. In both cases, a period of easy money and rampant speculation had been succeeded by a sudden and necessary tightening, although the price effects before the 1873 crash were not very significant – there was no equivalent of 2022’s double-digit inflation.
In the United States, monetary profligacy during and after the Civil War had caused a speculative bubble, with over-investment in railroads and a panic in the gold market in 1869. Then the Coinage Act of 1873, effective April 1 1873, demonetized silver, putting the U.S. firmly onto a Gold Standard. That caused a monetary tightening that affected the interests of debtors, especially Western farmers, for two decades afterwards and came to be referred to as the “Crime of 1873.” The monetary tightening in turn made it difficult to sell railroad bonds, reducing their secondary market value. On September 18 1873 this forced the Philadelphia bank of Jay Cooke & Co. into bankruptcy.
Cooke had gained a leading position in financing Union bonds during the Civil War, pioneering hard-sell tactics among retail investors, and after the war had used the same tactics to sell bonds in the Northern Pacific Railroad. The Northern Pacific was the equivalent of many modern start-ups with negative cash flow; it aimed to build a second transcontinental railroad line to the north of the Union Pacific (which had opened in 1869) and had been granted extensive land holdings by the Federal government to encourage its activities. The problem was: there was nowhere near enough transcontinental traffic to justify a second railroad, while the land grants, being in Indian territory while the Indians were still battling General Custer, were more or less worthless. Like a loss-making dot-com when the market turned, the Northern Pacific was thus forced into the first of its bankruptcies in 1875, its bonds having bankrupted its banker Jay Cooke & Co. two years earlier.
You will be happy to hear that the story ended well for both Cooke and the Northern Pacific, although not for Jay Cooke & Co., which before 1873 had been far more important than Pierpont Morgan’s embryonic operation. By 1880, Cooke had paid off his obligations, after which he made another fortune in a Utah silver mine and lived prosperously until 1905. As for the Northern Pacific, it drove the “Golden Spike” connecting its transcontinental track in 1888, suffered another bankruptcy in 1893 and then settled into a comfortable existence, marketing itself as the route of the “Great Big Baked Potato,” serving that delicacy, sourced from Idaho, on its passenger services until 1970.
The other major nexus of the Panic of 1873 was the German-speaking world, where monetary conditions were similar if not more extreme. Germany had demonetized silver over the period 1871-73, introducing the gold Reichsmark on July 9, 1873. However, the deflationary effect of this had been nullified in the short-term by massive reparations payments from France over the same period, following the end of the Franco-Prussian War. Euphoria over Germany’s victory and over the 1871 German unification (signed in the Palace of Versailles) combined with French reparations payments to produce a massive speculative boom in both Germany and in Austria, whose markets were closely linked. The ending of French reparations in September 1873, together with the deflationary adoption of the gold Reichsmark, caused money to tighten sharply.
On May 9 1873 the Vienna Stock Exchange crashed, leading to the bankruptcy of several medium sized Austrian firms and causing a credit squeeze in Germany, exacerbated by the ending of French reparations payments in September 1873, and the crash of the Bethel Henry Strousberg railway empire, which had been damaged by the failure of a Romanian project. As in the United States, sharply tighter money caused a crash in the stock exchange and a general economic downturn.
In the other two major financial centers, France and Britain, 1873 was less important. France was in deep depression in the early 1870s, from the effect of the war and reparations payments, and its politics remained highly unstable. German troops left in September but alas, the following month the last legitimate claimant to the French throne, Henri, Comte de Chambord, “the miracle child” at his birth in 1820, turned down the monarchy because the Third Republic refused to abandon the tricolor flag, which Chambord regarded as a symbol of regicide. The opportunity, once lost, was never regained and France subsided into big government socialism.
In Britain, 1873 was the year Anthony Trollope wrote “The Way We Live Now,” surely his finest novel, with Augustus Melmotte the first clearly defined prophet of globalist “funny money” bull markets, his image reappearing ubiquitously in real life in George Soros and other real-world tycoons of the late 1990s and since. (Melmotte turned out to be a swindler, as were many of his real-world successors.) However, the financial world had crashed as recently as 1866, with the collapse of Overend, Gurney & Co. and the Gold Standard was in full stabilizing effect, so the market had been less overblown than elsewhere, and the initial market downturn was less intense than in the U.S. or Germany/Austria.
Like 1929, 1873 became more significant in retrospect because of the depression that followed. The next two decades until 1896 were deflationary years, indeed the last lengthy deflationary period that the world has known. Only the first four years, 1873-77, saw a true economic downturn; after 1877 vigorous economic buoyancy returned, with real wages increasing as prices declined and employers kept wages stable, although individual sectors such as agriculture were depressed by the transportation revolution, which lowered prices worldwide. The period also saw an upsurge in protectionism, in Germany, the U.S. and France, which had the effect of “hollowing out” Britain’s previously magnificent manufacturing economy, leading to decades of relative stagnation while competitors soared ahead. Thus, while 1873 led to only a short-lived depression and the period thereafter saw rapidly increasing living standards, protectionism and deflation made the period very different from what had gone before.
So, what lessons can we learn? The economic situation as we enter 2023 has similarities to that in about June 1873. After a lengthy period of loose money and speculative excess, interest rates have risen sharply and M2 money supply has declined by 1.8% since March 2022 (although it has still risen by 6.1% annually over the two years to November 2022, following 21% growth in the year before that). As in 1873, that is causing strain in the more speculative borrowers and the more overleveraged projects (such as Northern Pacific). As in 1873, we can thus expect to see several bankruptcies and a further sharp drop in stock markets.
The question is: will we then get the two decades of deflation that followed the Panic of 1873? If we did, it would be extraordinarily good news. The deflation after 1873 squeezed out excess investment in speculative areas such as dodgy railroads and Western land and refocused it on the truly revolutionary technologies of electricity, telephony, chemicals and the beginnings of the automobile industry. Whereas in both Germany and the United States, investment before 1873 had been flowing into technologies that were already old and into real estate speculation (mostly rural in the United States), after 1873 it flowed into truly new technologies that revolutionized living standards and paved the way for the wonders of the 20th century.
If we are very lucky indeed, the Fed and other central banks will keep money tight, so that we too can enjoy the truly revolutionary technologies that will appear with well-directed investment. More likely, however, the monetary authorities will revert to printing money at the first possible opportunity, and we will be condemned to a world of real estate speculation, high asset prices, “tech” scams and decline. Alas, we have no Gold Standard to correct Man’s follies!
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)