the panic of 1857

The current economic slowdown has many parallels with the slump of
1857. the root cause of both the current turmoil and the 1857 crash
was banks being allowed to lend more money than they have in reserves.
As president buchanan explained -

"It is apparent that our existing misfortunes have proceeded solely
from our extravagant and vicious system of paper currency and bank
credits, exciting the people to wild speculations and gambling in
stocks."

http://www.gutenberg.org/dirs/etext04/subuc11.txt

In other words, in 1857 banks created a huge amount of new credit
fueling a stock market boom. The credit they created was in the form
of bank notes, supposedly redeemable in US currency. In practise the
banks had only a fraction of the amount they 'promised to pay' in
reserves.

the practise of banks lending more money than they have is called
fractional reserve banking. The inherant danger is that a large number
of depositors may wish to withdraw their money at one time and the
bank may not be able to make payment. In 1857 the new york branch Ohio
Life Insurance and Trust was unable to make payment. This lead to a
bank run and the collapse of the bank.In his book 'a history of
central banking in great britain and the United states' john harold
describes the resultant credit cruch -

"The instiinct of each one was to curtail its loans and protect its
reserves, yet nothing was more certain to intensify the panic."

whenever banks gain controll over the supply of money they have
employed the same practice of expanding and contracting the money
supply. This has been true throughout history and the solution to the
problem in 1857 was correctly identified by president buchanan -

"the first duty which these banks owe to the public is to keep in
their vaults a sufficient
amount of gold and silver to insure the convertibility of their notes
into coin at all times and under all circumstances."
http://www.gutenberg.org/dirs/etext04/subuc11.txt

That is, to employ a system of full reserve banking.






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