(December 14, 2017) On September 18, 1873—a few days after he hosted President Ulysses Grant as a houseguest at his estate outside Philadelphia—Jay Cooke’s banking firm became insolvent. Cooke was not only the head of America’s most prestigious investment bank but was also the single largest contributor to Grant’s 1872 re-election campaign. There could hardly have been a bigger surprise to the public confidence than the failure of Jay Cooke & Company. One Philadelphia newspaper reported, “No one could have been more surprised if snow had fallen during a summer noon.”
Led by Cooke’s Ponzi-scheme-financed and government-subsidized Northern Pacific, railroads had overbuilt. The industry’s total bonded indebtedness was over $2.2 billion, which was nearly equal to the entire debt of the federal government. Huge blocks of railroad securities were quickly put on the market and price declines of 50% were common. Brokers called customers for more securities margin but too many did not have enough cash or liquid collateral to meet the calls. Cooke’s failure triggered a financial panic. The New York Stock Exchange amplified the distress by closing for ten days. Business failures in 1873 climbed to 5,000, from 4,000 in 1872 and 3,000 in 1871. Cooke’s bankruptcy was a tocsin for five ensuing years of depression.
Track construction declined by a third in 1874, causing 500,000 layoffs within the railroad ecosystem including the iron and steel industry. Prices fell. Philadelphia pig iron dropped from $56 a ton in 1872 to $17 five years later. Wages fell between 40% and 60% in the 1873 to 1877 interval. The country seemed to be overrun with hoboes and vagrants.
Consequently, Grant’s Republican Party lost heavily in the 1874 “off year” elections. The House of Representatives switched from a 65% Republican majority in 1873 to a 62% Democratic majority in 1875. Since the Democrats elected in 1874 would not take their seats in the first session of the Forty-Fourth Congress until December 1875, Grant and the Republicans rushed through their own economic response in the closing months of the Forty-Third Congress while they still controlled both chambers. Each of their two responses would defy the accepted economic theory of the 21st century but in combination they would absolutely confound modern economists.
First, was to raise taxes. Although Republicans lowered tariffs by 10% in advance of the 1872 election in an attempt to win votes, after losing the election they pushed tariffs up again and broadened the customs duty list to cover basic consumer favorites such as coffee and tea. They also raised some domestic taxes including those on distilled spirits. Notwithstanding that the federal budget was in surplus for the preceding year as well as the projected year, Grant wanted higher taxes.
Second, was to shrink the money supply. Despite pleas to increase the money supply in order to stimulate the economy, Grant’s interpretation of a wording ambiguity in the Specie Resumption Act cut the supply of paper currency even though the act was intended to modestly increase it.*
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*There were two types of paper currency at the time: greenbacks and banknotes. Greenbacks were similar to present day Treasury Notes. Banknotes were similar to Federal Reserve Notes, except that they were issued by private banks and backed by the government bonds those banks held as reserves.
The act required that the greenbacks be reduced by 80% of the amount of new banknotes. Thus, if $100 million in new banknotes were issued and $50 million were retired the net increase of $50 million in banknotes would require a $40 million (80%) reduction in greenbacks. Consequently, there would be a modest $10 million increase in all types of paper money circulating.
In contrast, President Grant’s interpretation applied only to the gross amount of new banknotes issued. Thus, if $100 million of new banknotes were issued and $50 million were retired, Grant would require that greenbacks be reduced by $80 million—80% of $100 million—thereby exceeding the $50 million net increase in banknotes by $30 million. In short, Grant’s interpretation virtually assured that the greenbacks in circulation would drop, even if the amount of banknotes in circulation also declined. The combined greenback-banknote money supply was certain to decrease.
Grant and fellow Republicans wanted to reduce the amount of greenbacks outstanding because the U. S. Treasury was obligated to start redeeming them for gold four years hence.
— Charles Calhoun, The Presidency of Ulysses S. Grant, 485
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