Chapter 63: Finance and Turbulence

As industrialization drove economic growth all over the Western World, financial systems had to keep growing in complexity and value. And as they did, they continued to drive industrialization further in turn. And, then as now, they were susceptible to greedy players, bad decisions, and panic.

Sources for this episode include…

Beatty, Jack. Age of Betrayal: The Triumph of Money in America, 1865-1900. Vintage Books. 2007.

Herreld, Donald J. “An Economic History of the World Since 1400.” The Great Courses. 2016.

History of the Board of Trade of the City of Chicago. Vol. 1, Part 1. Edited by Charles H. Taylor R.O. Law Co. 1917.

“History of the CFTC: US Futures Trading and Regulation Before the Creation of the CFTC.” Commodity Futures Trading Commission. https://www.cftc.gov/About/HistoryoftheCFTC/history_precftc.html

Hobsbawm, E.J. The Age of Empire 1875-1914. Vintage Books. 1987.

Klitgaard, Thomas and James Narron. “Crisis Chronicles: The Long Depression and the Panic of 1873.” Liberty Street Economics. Federal Reserve Bank of New York. 5 Feb 2016. https://libertystreeteconomics.newyorkfed.org/2016/02/crisis-chronicles-the-long-depression-and-the-panic-of-1873/

Lee, Guy A. “The Historical Significance of the Chicago Grain Elevator System.” Agricultural History, vol. 11, no. 1, 1937, pp. 16-32. JSTOR, http://www.jstor.org/stable/3739439.

Lehann-Hasemeyer, Sibylle and Fabian Wahl. “The German bank-growth nexus revisited: savings banks and economic growth in Prussia.” The Economic History Review, vol. 74, no. 1, Feb 2021, pp 204-222.

Magnuson, William. For Profit: A History of Corporations. Basic Books. 2022.

Morris, Charles R. The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould, and J.P. Morgan Invented the American Supereconomy. Henry Holt and Co. 2005.

Weber, Ernst J. “A Short History of Derivative Security Markets.” University of Western Australia Business School. July 2008. https://math.nyu.edu/~avellane/Weber_History.pdf

Williams, Jeffrey C. “The Origin of Futures Markets.” Agricultural History, vol. 56, no. 1, 1982, pp. 306–16. JSTOR, http://www.jstor.org/stable/3742318

Full Transcript

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In early 1848, as revolutions were breaking out in Paris and Vienna, a pair of merchants met in the tiny but rapidly growing city of Chicago. One sold grains. The other sold elevators.

Now, one of the reasons the United States became such an economic success in the 19th Century was because of its ever-growing agricultural productivity. We’ve talked about this in the past with inventions like the McCormack reaper, the John Deere plow, the disassembly line process for meatpacking, and the refrigerated rail car – all of which have their own connections to Chicago. Well, one that I have only briefly mentioned before – but should really talk more about – is grain elevators.

As Homesteaders settled the American west, many of them took up grain farming. They used the expanding railroads, as well as navigable rivers and canals, to move these grains to markets across the country and across the globe. By the end of the century, grain was the nation’s most important export, feeding much of Europe, in fact.

Much of this grain was being processed into flour in a handful of cities in the Midwest, with Chicago – soon the nation’s top railroad hub – taking the lead. Between 1850 and 1890, grain production in the Windy City increased more than twenty-fold.

Grain elevators were a key reason why. Storing that much grain in a city like Chicago required skyscraping warehouses that could hold millions of bushels. Because of, you know, gravity, the grain would need to be lifted up to the top of those towers and dropped in to fill them. Good luck doing that without an elevator. Additionally, transporting grains off of boats and ships was much quicker and easier when using grain elevators instead of pulleys hoisted by laborers.

And it was grain elevators that brought those two merchants together in the early months of 1848.

As one Elias Colbert put it in his 1868 book, Historical and Statistical Sketch of the Garden City:

“Early in the year 1848, a time anterior to the introduction of the iron-horse, which now snorts over the broad and fertile prairies of Illinois – long before elevators of one million bushels capacity were even thought of – a time when the clearance of a lumber schooner from this port received a ‘local’ notice – when elevators used horses as a motive power, Thomas Richmond and W.L. Whiting discussed one afternoon the propriety of establishing a Board of Trade in Chicago. Mr. Richmond was then in the elevating business, and Mr. Whiting a grain broker – the first who pursued this avocation in Chicago. These gentlemen consulted with other businessmen, and the result of this consultation was an invitation (published at the time) for the merchants generally to meet together on the 13th of March, 1848, to take the initiatory steps in regard to the formation of the Chicago Board of Trade.”

After adopting a constitution and a committee to draft bylaws, the leading businessmen of the city agreed to regular meetings and activities. They advocated for the city’s commercial interests – critically, its transport infrastructure – and collected economic data. By 1859, the Governor of Illinois signed a law chartering the Chicago Board of Trade (or CBOT, as I’ll call it from here) so it could regulate the undertakings of its members by providing standardized grades and appointing grain inspectors.

But the big developments came in the 1860s. In 1865, the CBOT adopted trading rules for margin and delivery procedures. This was followed in 1868 by a rule banning “corners”, which they defined as “making contracts for the purchase of a commodity, and then taking measures to render it impossible for the seller to fill his contract, for the purpose of extorting money from him.” With this rule, the CBOT had created a standardized and regulatory framework for futures contracts. And thus, the institution had evolved from a little agricultural association into an important financial exchange.

Up until they went digital in recent years, the CBOT (now part of the CME Group) housed hundreds of traders in pits, who would shout and make hand signals to buy and sell these commodity futures.

That’s right: It’s time, yet again, for the booms and the busts.

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This is the Industrial Revolutions

Chapter 63: Finance and Turbulence

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Alright, so – as always – we gotta begin with a little admin.

First, a correction from last time. I was quoting the historian Frederick Jackson Turner and accidentally called him Frederick Jason Turner. My apologies. Shout out to listener Lauren S. Kahn who studied Turner in college and caught the mistake. I will also go back and fix it in Chapter 62 as well.

Second, I want to thank everyone supporting the podcast financially. Special shout outs this month go to Doris Houslander, Alonso Ibañez, and new patron, Russell Tanner, as well as John Bartlett, Adam Bibby, Chris Bradford, Elizabeth Brooking, Tara Carlson, Michael Hausknecht, Eric Hogensen, Naomi Kanakia, Brian Long, Mac Loveland, Andrew C. Madigan, Martin Mann, Duncan McHale, John Newton, Emeka Okafor, Ido Ouziel, Brad Rosse, Joshua Shanley, Kristian Sibast, Jonathan Smith, Tanner, Ross Templeton, and Seth Wiener. Thank you!

With that, let’s get the show going.

Part 1: Commodities and Derivatives

Did the industrialization of agriculture spur the creation of commodity exchanges? Well, in the case of the Chicago Board of Trade, yes. But that doesn’t mean agricultural industrialization was necessary for such exchanges. Heck, we’ve been talking about commodity trading since Chapter 1.

Before I explain, though, perhaps some definitions are in order. Personally, I’ve always loved how commodity trading is explained in the 1983 film, Trading Places. Here’s the Duke brothers giving an introductory lesson to Billy Ray Valentine, played by Eddie Murphy.

But of course, the Dukes aren’t really handling the direct exchange of gold or wheat or concentrated frozen orange juice – what they’re really exchanging is derivatives. A derivative is a transaction contract. So, rather than buying or selling soybeans, on a mercantile exchange, you’d be buying or selling the contract to buy or sell soybeans. This might be in the form of a future (that is, a contract to buy or sell soybeans at a specific price at a specific future time between a buyer and a seller unknown to one another); or it might be in the form of an option (that is, a contract with which you can choose to buy or sell the soybeans at a certain price by a certain date) or it might a forward (that is, a contract allowing one party to try shorting the soybeans), or it might even be a simple swap contract.

This might sound unnecessarily complicated. And, to be sure, derivatives do add layers of complexity to, what would otherwise be, simple transactions. (Oh, and by the way, this is me keeping it simple. There are all sorts of derivatives I’m not going into for the sake of time in this episode.)

So, why do we have derivatives markets? Well, for the same reasons why we have any markets. One: There are people who have money who want to invest some of it to make more money. And, Two: Allowing the market to exist makes for economic efficiency. This way, farmers don’t have to make cold calls to food processors or grocers or – God forbid – households to try to sell their soybeans. The same way bankers have long used discounting bills of exchange to smooth financing, commodities brokers use derivatives to smooth the buying and selling of agricultural goods and mineral resources, by providing financial leverage and hedging risk.

Derivatives trading goes back centuries – even to ancient Mesopotamia. It picked up a bit with the rise of capitalism in the early modern period. But now, in 19th Century America, it flourished. Advertisements for over-the-counter derivatives sales could be found in newspapers going back to at least the 1840s. Now, with the CBOT, formal exchanges were being established too.

At the same time the CBOT was hashing out its trading rules for grains contracts, The Liverpool Cotton Brokers’ Association was developing its own regulations for cotton forwards back in England. The New York Cotton Exchange was established in 1870 for the regulated trading of cotton futures as well. Over the next 30 years, additional commodity exchanges were set up all over the country, including the Butter and Cheese Exchange of New York (later the New York Mercantile Exchange), the Kansas City Board of Trade, the Minneapolis Grain Exchange, and the Chicago Butter and Egg Board (later the Chicago Mercantile Exchange) to name a few of the famous ones.

Sure enough, such exchanges rapidly increased the scale of derivatives trading which, in turn, allowed American farms and mines to produce huge surpluses. Thanks, in part, to the CBOT – and, in part, to rail infrastructure and technologies like grain elevators – by 1890, Chicago was trading futures accounting for nearly 22 billion bushels of grain annually.

Yet, when trading in commodities, risk is pretty much constant. Bad harvests, miners’ strikes, global conflicts, and other unforeseen circumstances make forwards and futures inherently risky. Speculators can lose everything – including funds they don’t even personally have – if they become overextended in these markets.

And it’s important to remember that such markets have long attracted greedy and unscrupulous players to them. Recent research shows that making money can have the same effect on the brain that cocaine does. It spikes the amount of dopamine traveling between nerve cells, and – in order to keep feeling that pleasure – higher quantities of money need to be made. This is why gambling addictions are so common amongst gamblers. From what I’ve read, there are hedge funds today that now require prospective employees to take brain scans before they can be hired, to ensure the candidate is sufficiently risk averse.

But, of course, no such guardrails existed in the 1800s. There were always ways to hedge one’s bets, sure, but risk and investment go hand in hand. And taking on that risk, more and more during these years, were the world’s many banks.

Part 2: Investment Banking

If it wasn’t clear by the start of the Second Industrial Revolution, it was certainly clear by the end: Britain was falling behind. By 1913, both the United States and Germany had passed the UK in terms of manufacturing and mining output. In fact, the U.S. had more than twice as much industrial production as its former mother country. What’s more, Continental imports of British goods – which had once been significant enough to bury Europe’s traditional artisans – were now surpassed by imports from the Global South.

But while Britain was losing its status as “workshop of the world”, the country still managed to dominate the global economy thanks to one key sector: Finance.

British capital made the growth in places like the U.S. possible, with British investors bankrolling railroads, mines, and heavy industry across the planet. In 1914, Britain accounted for a whopping 44% of the world’s overseas investments.

In fact, it was British financial dominance that was driving its trade deficits and, thus, its slow growth of industrial output. Germany effectively adopted the Gold Standard in 1871 and the U.S. did much the same in 1873. Other countries followed their leads. As a result, the British Pound Sterling – long tied to the gold standard thanks to Parliament’s instance – became the favorite for foreign currency reserves in national treasuries around the world. The strong pound was great for bankers in the City of London, but not so great for Britain’s net-exports. Once the whole world had been at the mercy of low-, low-priced British goods (particularly textiles) that could destroy nascent domestic industries. Those days were now over.

Thanks to the strong pound, though, those London bankers amassed huge fortunes from their foreign investments. And this came in the wake of significant financial deregulation.

In recent episodes, we’ve talked more and more about corporations growing in size. As I put it in Chapter 57, “Increasingly, companies that once would have been small partnerships with relatively simple structures were being crowded out by larger, more complex, limited liability corporations, owned by pools of investors, often with ownership shares traded on a public exchange.” Railroads had led the way, and firms like General Electric, Standard Oil, and U.S. Steel followed their model. Well, so too did financial outfits.

Take, for example, Lloyd’s of London, the insurance market I first mentioned all the way back in Chapter 3. In 1871, Parliament passed the Lloyd’s Act, incorporating it into a body of syndicates so as to reduce individual liability and, thus, risk. This followed a few new laws passed in 1858, which allowed for more joint-stock, limited liability companies to form – and without Royal or Parliamentary charter. Critically, this included joint-stock, limited liability investment banks.

But this wasn’t a British innovation by any means. Such banks were popping up across the world.

Back in 1822, the King of the Netherlands ordered the establishment of a Société Générale, an investment bank specifically chartered to “promote trade and industry.” After the southern part of his kingdom split off to become Belgium in 1830, it became the new country’s national bank, and it was instrumental in providing the capital for heavy industry like railroads. But the Société générale de Belgique didn’t just invest directly in industry, its bankers also pushed their clients to transition from privately-held partnerships or family businesses into joint-stock corporations themselves.

Despite the small size of the country, Belgium proved to be a significant economic success story. And the model provided by its bank was, in time, adopted in France.

Now, France had long been weary of modern banking practices (thanks, in part, to John Law’s Mississippi Bubble of 1726 - shout out Chapter 27). But gradually, throughout the 19th Century, this began to change. Napoleon I had set up the Bank of France, which served as a stable Central Bank going into the Bourbon restoration and later the July Monarchy. What’s more, France had numerous high-profile bankers like James de Rothschild, Jacques Laffitte, Casimir Périer, and the Pereire brothers. Still, France was considered “underbanked” in these years. There wasn’t much in the way of joint-stock banks. And outside of Paris and the other major cities, there existed virtually no financial infrastructure. Rural borrowers essentially relied on loan sharks.

The Revolution of 1848 was waged partially out of anger toward the French bankers of the time. But ironically, it was that same revolution that would kickstart a banking boom in France. The Second Empire of Louis Napoleon fostered more and more modern banking practices and even saw the establishment of joint-stock, limited liability investment banks, namely, the Sociétés Générale du Crédit Foncier (which made mortgages possible in rural France) and Crédit Mobilier. The latter, established by the Pereire brothers in 1852, loaned tens of millions of francs to industrialists across the world for new mines, steamships, railroads, public utilities, and even the Paris transit system. Despite numerous scandals and other mistakes, it was one of the world’s most important financial institutions going into the late 19th Century.

Germany also looked to the Belgian model, although they created a more mixed system of so-called “universal banks” which combined traditional banking with industrial investment. In this way, everyday German savers were helping build their national economy.

The German banking system had been virtually nonexistent during the fractured age of the Holy Roman Empire and German Confederation – but now, thanks to German unification, modern finance could flourish under a unified monetary system and currency. Joint-stock universal banks also held shares in the corporations they lent to, which turned them into industrial firms in their own right. German banks were major owners of coal mines, iron works, and other industries. In fact, the German banking sector was likely the strongest in the world by 1900, and it – probably more than anything else – is what led to such rapid and massive industrialization in Germany during the late 19th Century.

Take Deutsche Bank, for example. It was founded in Berlin in 1870 by a cadre of interesting entrepreneurs, including lawyer Adelbert Delbrück, economist Ludwig Bamberger, and Georg von Siemens, a nephew of our old friends, the Siemens brothers. In addition to being successful bankers, these three were also liberal politicians who stood opposed to the rule of Otto von Bismarck. (Bamberger had even fought on the frontlines during the 1848 revolutions – shout out Chapter 47!)

With a keen eye on overseas investments, Deutsche Bank raised capital and opened offices across the world. But it was also a key driver of German economic growth, helping finance the expanding Krupp steel empire and lifting a new chemicals company called Bayer off the ground. And much like Bayer, Deutsche Bank remains a global powerhouse to this day.

And in the United States, the banking sector also helped drive domestic industrialization here. But in the case of this country, many of the big industrial success stories were financed by one banker in particular.

John Pierpont Morgan was born in Hartford, Connecticut, in 1837. His grandfather had helped found a successful insurance business (it still exists today, in fact), and his son – Morgan’s father, Junius – had started as a dry goods merchant before moving into banking in London.

Like most bankers at the time, Junius Morgan focused mostly on discounting bills – that is, short-term lending to merchants to help facilitate their transactions. He did help underwrite some government and corporate bonds as well. It was his son whose banking practices were so revolutionary, at least for an American.

As a teenager, Pierpont – yes, he went by his middle name – attended boarding school and university in Europe before returning to the United States to launch his own banking career. Among other things, he financed a large sale of rifles to the Union Army during the Civil War. It was actually a bit of a scandal – not only because Morgan had circumvented the draft by hiring someone to take his place, but also because the Union already owned the rifles. Essentially, a cash-strapped government armory wanted a larger contract to actually deliver the guns to a western general who was much in need of them, and so Morgan raised the capital to make it happen, securing a nice commission for himself in the process.

After the war, Morgan was brought into his father’s transatlantic banking business. He gradually built his reputation as a gifted financial manager into the 1870s and 80s. He also picked up a longtime business partner in one Tony Drexel, becoming the senior partner at the bank only after Drexel died.

Furthermore, Morgan was on the cutting edge of a new trend in banking. Much like our old friends, the Rothschilds, had done earlier in the century, Morgan worked closely with his customers and helped mediate between them. But unlike the Rothschilds, his customers weren’t primarily governments. Morgan’s customers were primarily corporations. And while he did mediate their disputes to prevent wars – they weren’t the literal wars the Rothschilds were trying to prevent. He was trying to prevent “ruinous competition.”

Now, this phrase, “ruinous competition” has come up a few times on the podcast recently. Multiple writers I’ve read lately have commented on how this phrase was practically a single, hyphenated word in the late 19th Century, since it was so commonly used by American capitalists.

And when you consider the so-called “wars” that broke out in those days – between, for example, Cornelius Vanderbilt and Jay Gould, or Thomas Edison and George Westinghouse – you get a sense of why. From their perspectives, competition wasn’t driving the market toward innovation or an efficient price equilibrium – it was setting everybody up for failure.

Perhaps nobody was as convinced of this as J.P. Morgan. As Charles R. Morris put it in his book, The Tycoons, “he railed against the madness for progress and change that wiped out perfectly respectable businesses of perfectly respectable gentlemen, against the gale winds of technology that turned economic assumptions upside down and made it impossible for his clients to pay their debts!”

With a small team of only about 80 employees total – including just a dozen or so partners– Morgan’s firm came to dominate the American economic landscape. By the turn of the century, they were responsible for roughly 40% of the nation’s liquid industrial, commercial, and financial capital. No other bank in the world came close to that kind of primacy. Most of that capital went into the expanding railroads of the age. But Morgan was also a major financial backer of industrialists like Edison and Carnegie as well.

And his prestige gave him immense clout in the business world of the Gilded Age. He could take control of corporate boards of directors without much pushback. He could easily raise overseas investments because European investors had such great trust in his instincts. And his public hatred of “ruinous competition” helped him swing markets to his favor, knowing that other banks and financial institutions were typically willing to follow his lead.

Now, while Gilded Age industrialists had for years tried to prevent “ruinous competition” by creating price-fixing pools, there were all too often a few bad apples who spoiled the bushel – most famously, our old friend, Mr. Gould. And so, by the 1890s, Morgan was left unconvinced that pools were the right way of doing things. Gentleman’s agreements did not cut it – such partnerships could not be trusted. Order and control were needed. The best way to prevent ruinous competition, he believed, was in corporate mergers.

And so, the Great Merger Movement began. It would last between 1895 and 1904, when over 3,000 companies combined in just 157 mergers, for a capitalization totaling nearly $7 billion in value. The peak came in 1899, which saw some 1,200 companies disappear. Those firms that remained wound up controlling huge market shares in their respective industries, with 42 of them controlling at least 70% of their markets.

Morgan was instrumental in many – if not most – of these mergers, including the formations of U.S. Steel (shout out Chapter 59!), General Electric (shout out Chapter 60!), General Motors (shout out some future episode), several consolidated railroads, and many other such corporate colossi. Thus, he was doing much the same thing the investment banks in Belgium and Germany were doing. And when President Teddy Roosevelt waged his antitrust crusade during the Progressive Era, his #1 enemy was J.P. Morgan.

To be sure, Morgan’s track record was far from perfect – he did make a fair number of mistakes and lost a fair bit of money here and there – but the trust that was placed in him not only helped him consolidate much of American industry, it also made him a leader in times of crisis. And the result of that leadership would be perhaps his most enduring legacy.

Part 3: Scandals and Panics

On the 4th of September, 1872, the New York Sun published a shocking story about the famed Transcontinental Railroad. As the politician Charles Francis Adams (of the famous Adams clan from Massachusetts) predicted of the road years earlier, it “will one day be the richest and most powerful corporation in the world; it will probably also be the most corrupt.” But for the Americans who once celebrated the completion of this railroad, what came was a disheartening revelation.

First, some background: When Congress approved the funding to get the Transcontinental Railroad off the ground, they did so with some strings attached. These regulations made it difficult for shareholders of the Union Pacific – remember, that was the eastern part of the railroad – to sell their shares. So, rather than merely invest their fortunes in a high-risk, low-reward venture, the principals of the Union Pacific came up with a way to make it profitable for them. They bought a failed corporation called the Pennsylvania Fiscal Agency with the broad charter of engaging in “the purchase and sale of railroads bonds and other securities, and to make advances of money and credit to railroads.” This second company would finance construction services for the Union Pacific. Renaming it after the French bank, the Union Pacific executives dubbed this company Crédit Mobilier of America.

And sure enough, Crédit Mobilier of America charged the Union Pacific almost twice as much as it cost to build, reaping a huge profit off the taxpayers without any real transparency. If that wasn’t bad enough, it seems they also bribed at least a couple Congressmen with Crédit Mobilier shares to get the job done. In fact, among those politicians the New York Sun helped bring down was Schuyler Colfax, who – by this point – was President Grant’s running mate for the 1872 election.

The Crédit Mobilier Scandal, as it was known, massively rocked the U.S. financial system. It was the key event that sent the Union Pacific’s stock price plummeting until Jay Gould bought it up and turned the company around. (Shout out Chapter 57.) And the scandal also spooked investors when it came to financing new rail construction. That would become a bigger issue the next year as another new railroad, the Northern Pacific, was desperately trying to raise the additional capital it needed to finish construction.

The man behind this Northern Pacific Railway was a banker by the name of Jay Cooke.

Born into a political family in Sandusky, Ohio in 1821, Cooke moved to Philadelphia as a young man and took a job as a bank clerk. By the time the Civil War kicked off, he had started his own firm, and he used his position to sell war bonds for the Union. He managed to raise about a billion dollars in support of the war effort while making himself extraordinarily wealthy in the process.

After the war, Cooke turned his attention to the railroads. He effectively took control of the Northern Pacific in 1870, believing it would be a reasonable substitute for the long-sought-after-but-never-discovered Northwest Passage. Essentially, ships could sail through the St. Lawrence Seaway to the Great Lakes and make port at Duluth, Minnesota. From there, the goods they brought could be shipped west by rail until they made it to the Pacific Ocean. Not to mention, agricultural goods from the prairies could ride the rails to Duluth and be shipped back east. And, with its proximity to some of America’s best iron ore in the north country of Minnesota, Duluth really did seem like an ideal place to build such a port. Cooke even envisioned the city becoming the next Chicago.

But it was not to be. Cooke overextended his resources, pumping capital into the Northern Pacific. So, when he failed to sell the necessary construction bonds to continue building, he was left with no other choice but to declare bankruptcy.

And so began the Panic of 1873.

At first, few could believe the downfall of Jay Cooke. He was widely viewed as America’s most prominent banker – practically a hero for his bond sale drive in the Civil War, with a global preeminence almost on par with the Rothschilds and Barings. The Commercial and Financial Chronicle noted the news of his downfall was “received with almost derisive incredulity on the part of the mercantile public.” What’s more, the Chronicle doubted the “present Jay Cooke panic” (as they called it) would spread, writing “Since the close of the war there has never been a time when our mercantile community have been in a better condition than now.” Little did the Chronicle realize just how precarious the situation really was.

The Northern Pacific was not the only railroad struggling to raise capital, and Jay Cooke was not the only banker having trouble with a railroad venture. After his bankruptcy hit the papers, several Wall Street firms collapsed. Clearinghouse banks closed for over a week to prevent a run while the New York Stock Exchange suspended trading.

Ultimately, the railroads had expanded too fast, creating a liquidity crunch. Bankers failed to recognize the impending crisis – profits from rail operations had been looking good, yes, but the 19th Century was an age of deflation, so the railroads’ profits were being outweighed by their growing debt. On top of all that, several other economic stressors – great fires in Chicago and Boston, a sizeable horse flu epidemic, and Jay Gould’s disastrous attempt to corner the gold market (shout out Chapter 57 again) – also contributed to the woes.

And then there was the Coinage Act of 1873, passed earlier that year. Congress had effectively tied the dollar to the price of gold, leaving the nation’s western silver mines reeling. And these were relatively new mining ventures, at that. Plus, the act curtailed the nation’s money supply, leading to higher interest rates and, thus, higher rates of farm foreclosures.

All these factors combined for a massive gut punch to America’s post-war economy. The country went into a deep recession for the next year or so. The business bankruptcy rate doubled. Railroad construction came to a screeching halt, hurting not only those construction jobs but also the industries supplying railroads, like iron mining.

And the United States wasn’t alone. Railroad bubbles burst in Germany and Austria following Berlin’s adoption of the Gold Standard. Falling silver prices also damaged the Indian rupee and the currencies within our old friend, the Latin Monetary Union. And as a result of all the above, global trade slowed significantly, hurting economic output in virtually every corner of the globe. Nowhere would this trade slowdown hurt more than in the United Kingdom, which subsequently entered its so-called “Long Depression” and battled bouts of high unemployment for the next two decades.

In fact, falling prices and a dwindling money supply were hurting employment everywhere. But the ways the industrializing powers handled the situation varied dramatically – especially when you compare and contrast Germany and the United States. In Germany, Chancellor Bismarck followed one American example by introducing new tariffs, much to the chagrin of the empire’s liberals. But unlike the Americans, Bismarck’s government also introduced a slew of new social insurance programs. More about these in a future episode.

The U.S., by contrast, did little to mollify the concerns of its working classes during these years of economic uncertainty. When New York City charities noted the number of relief-seekers at their soup kitchens had quadrupled, The Nation complained, “Free soup must be prohibited, and all classes must learn that soup of any kind, beef or turkey, can be had only by being paid for.” Other publications referred to the downtrodden in these years as “ineffable asses”, “loud-mouth gasometers”, and “disgusting.” One journalist even wrote of how she hoped “cholera, yellow fever, or any other blessing” would kill them off.

What followed was a decade of intense labor unrest. Railroad workers, steelworkers, miners, and factory hands carried out bloody strikes. New labor organizations formed – including some national organizations for the now-broadly-interstate economy. But more about all these trends in another future episode. (I’m actually hoping to have that one done for you before the end of the year. Knock on wood.)

But you know what the crazy thing is? The economy was actually pretty strong in the 1870s. GDP expanded somewhere between 4.5% and 6% per year. Most workers, at least outside of the rail and rail-adjacent sectors, saw their real wages grow.

But how? Because, remember, this was a period of significant deflation. Manufacturing and agriculture were becoming so productive that prices plummeted about 25% between 1870 and 1880. In fact, per capita consumption grew by 50%. But falling prices put downward pressure on nominal wages. So, while a worker’s real wages might have gone up, that was not the worker’s perception. It didn’t matter that his purchasing power was skyrocketing – all he knew was he was taking home less pay at the end of the week.

Now, there was one man who came out of the Panic of 1873 relatively unscathed – J.P. Morgan. Seeing the crash coming earlier than almost anyone, he began calling in debts and reigning in credit before news of Cooke’s downfall. Not only did this set him up to take the place of America’s most prominent financier, it also made him trusted in times of crisis. And at the tail-end of the Long Depression came yet another crisis – the Panic of 1893.

Now we’ll talk more about the Panic of 1893 in the future, but for now, let me tell you about Morgan’s role in managing the crisis.

As Wall Street crashed that summer, gold reserves started plummeting. The world’s major currencies were tied to the Gold Standard, thus, speculators were trying to exploit the situation by selling the gold that was the source of their stability. Things got to the point where the nation’s reserves of gold started to approach the minimums that American banks needed to maintain to ensure greenbacks could be converted. In other words, it was shaping up to be a run on the gold market.

The Bank of England, in particular, wanted to keep the dollar from imploding. They had no interest in the American economy going under. But they had no counterpart in the U.S. to work with. Ever since President Andrew Jackson refused to renew the charter for the Second Bank of the United States in 1836, the country had been without a central bank. The U.S. Treasury, meanwhile, did not believe they had the statutory authority to intervene in the crisis – and they were probably right to think so.

Morgan offered to help by teaming up with the Rothschilds to secure a $100 million gold loan to the Treasury. When the Treasury refused, Morgan travelled down to Washington, went to the Treasury Department, and threatened to withdraw $10 million of gold that he had claim to – enough to literally crash the U.S. Treasury then and there. And so, the Treasury acquiesced. They agreed to a generous loan package whereby Morgan would be tasked with managing the greenback-sterling exchange rate in the international market.

In other words, J.P. Morgan had effectively made himself the central bank of the United States.

The Panic of 1893 had peaked, and the economy was gradually pulled back from the brink of ruin. It is little wonder then that in 1907, as another panic spiraled out of control, the Treasury Department turned to Morgan– as did the banking community as a whole. The stock market had experienced one of its worst years ever, to the point that the New York Stock Exchange was insolvent. Several major companies, including some of the leading banks, were about to collapse. And so, at age 70, Morgan gathered a small and informal committee of bank leaders in his home library to manage the crisis. Putting in 12-to-15-hour days, they held meetings with major executives to shore up their capital. They made loans where needed and let companies fail where needed. Eventually, the crisis passed.

Ultimately, it was the role Morgan played in this panic that had the greatest impact on American history. As Morris puts it, “regardless of whether one thought Morgan was a patriot or a plutocratic puppeteer, this was no way to run a country.” Six years later, the United States created what was effectively a new central bank – the Federal Reserve System.

As you can imagine by these stories, the Second Industrial Revolution was a period of unique economic successes and stressors alike. So, I think it’s about time we got back to talking about the economic thinkers of the age. Next time, it's the Marginal Revolution.

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Dave BrokerMay 1, 2023

Episodes

Chapter 63: Finance and Turbulence