The American economy experienced a great boom after the Civil War. In particular, railroad construction was thriving, with over 35,000 miles of track laid between 1865 and 1873. The industry attracted big money but was also a source of big risk, with capital tied to long-term projects. The industry grew to be the largest non-agricultural employer in the US, and numerous banks, as well as investors, were continuously injecting capital. But a stock market crash in Europe inspired panic among European investors, and they started dumping their railroad bonds in the United States. Railroad companies started having problems, and the trickle effect led to the collapse of one of the biggest banks in New York, Jay Cooke & Company. The panic then quickly spread throughout the country, claiming multiple railroad companies and over 100 banks.
How it Started
The panic of 1873 had its origins in Europe. Several countries in the continent had to deal with different economic shocks that eventually culminated in the stock market crash. In Britain, the opening of the Suez Canal in 1869 meant goods from the Far East that were transported via the Cape of Good Hope would no longer be stored in British warehouses. This collapsed the business transhipment ports in the UK and triggered a mild economic downturn.
In Germany, positive political developments paved the way for unsustainable growth in the country. The German Unification happened as a result of the war victory over France, and the newly founded German Empire liberalised the economy to promote new and existing enterprises. The empire also started the process of demonetising silver, eventually introducing the gold standard. The military victory, as well as capital inflows in the form of war reparations from France, fuelled heavy investment and speculation in industries such as railroads, steamships, and factories. These were the same industries experiencing unsustainable growth in the US. But in May 1873, the Vienna Stock Exchange collapsed with manipulations, insolvencies, and fake expansions cited as reasons. A major German railroad company also had to deal with an unfavourable settlement with Romania, and reparations from France were concluded. The German economy contracted, and the trickle effects poured into England, Russia, France, and Belgium.
How it Unfolded in the US
During and after the Civil War, the US government printed more money; promissory notes were issued to cater for war expenses and military salaries, while grand infrastructural plans were drawn out with the intention to open up the country for commerce and education. Railroads were relatively a new invention around this time, and they soaked up the bulk of this cash. Companies were borrowing heavily to lay new track lines. Railroad bonds were particularly very appealing as the government provided land grants and other related subsidies. It was easy times, and despite the huge amounts of cash tied up in projects that could not deliver short-term returns, nothing could stop the euphoria.
Railroad company stocks and bonds were in high demand, and they attracted even investors from abroad. But while things seemed smooth in the US, activities outside the country started having some impact within. When Germany stopped minting silver coins and made the transition to the gold standard, the German currency saw its value rise relative to the US dollar. The US was minting coins in both gold and silver, but the German development led to a shift in policy. The Coinage Act of 1873 was passed and the US could only mint silver coins for export and not domestic circulation. There was now some perceived risk in the US market, and investors started being cautious about maintaining or taking on long-term investments. There was no clear monetary policy direction, and the Coinage Act had effectively limited the money supply in the economy. Furthermore, silver prices became depressed, and this hurt the individuals who carried huge debt loads, such as farmers.
The Collapse of Jay Cooke & Company
Jay Cooke & Company was a major New York bank during the Civil War (actually the chief financier of the Union military). After the Civil War, the bank grew to become very influential in the US establishment. It was also the chief federal agent for financing railroad construction. After the completion of the first intercontinental railroad in 1869, a second mega project dubbed ‘Northern Pacific’ was planned. Jay Cooke & Company became the main financier of this project. The bank had overextended itself in the hope that it would attract investors from abroad, especially Europe. But after the liberalisation of the economy in Germany and other developments throughout Europe, opportunities became available closer to home. Then in September 1873, Jay Cooke & Company found itself unable to sell railroad bonds that were previously in high demand. Europeans were already selling their railroad bonds and railway companies could not find new investors. Many railroad companies went bankrupt, as did Jay Cooke & Company.
The collapse of Jay Cooke & Company, a bank heavily interconnected in the economy, burst the railroad bubble and set off a chain of events that eventually impacted the economy deeply.
The Impact of the 1873 Crash
The panic of 1873 is one of the deadliest financial crises in the history of the US. Out of the 364 railroad companies at the time, 89 plunged into bankruptcy. The collapse of Jay Cooke & Company eventually dragged over 100 banks into bankruptcy as well. Throughout the country, over 18,000 businesses closed shop, and even the New York Stock Exchange was temporarily closed for 10 trading days.
Railroad construction activity was cut down massively, from over 7500 miles of track laid in 1872, to just 1600 in 1875. Corporate profits disappeared, wages were cut, and real estate values plunged. There was an attempt to alleviate the situation by allowing the government to print more money. The plan was approved by Congress and vetoed by President Grant, but the runaway inflation was real. But in 1874, Congress passed a bill that backed the US dollar with gold, helping to stabilise the currency as well as curb inflation. The economy went into a prolonged negative spiral and by 1876, unemployment peaked at over 14%. The impact of the stock market crash was massive, and it went beyond the economy.
Continued wage cuts in the railroad sector triggered the Great Railroad Strike of 1877. That year alone, companies cut wages 3 times, and this eventually led workers to the streets. Trains were pelted and tracks plucked. The violence began in West Virginia and quickly spread into other cities such as New York, Illinois, Pennsylvania, Missouri, and Maryland. At its peak, over 100,000 workers supported the unrest and it took the intervention of national troops, unofficial militia, and private militia to suppress it. The unrest took 69 days and claimed over 100 lives. The threat of social disruption was real and these events led to the founding of the Employee Relief Association in 1880, which provided health and death cover. By 1884, workers started getting drafted into pension plans, with added benefits coming in overtime.
There were also grave repercussions politically. Workers fell out with the dominant Republican Party, paving the way for the Democratic Party to win the 1874 congressional elections, controlling the house for the first time after the Civil war.
Overall, the crash of 1873 came to be known as the Long Depression, and to date, it represents the longest period (65 months) the American economy has ever been in contraction. Even the famous Great Depression of the 1930s lasted ‘only’ 45 months.
The Stock Market Crash of 1873 is a clear illustration of the dangers of industrial capitalism. This type of capitalism is characterised by access to venture capital and the productivity of premium assets such as stocks, bonds, and heavy machinery. In such a structure, the owners of capital gain money and power, but the middle-class wallow in poor working conditions with no real prospects of economic mobility. This very much explains the workers’ unrest that succeeded the collapse.
Additionally, industrial capitalism relies on the financial markets. This makes it very easy for the markets to plunge into instability or to experience crashes because financial markets tend to go through periods of boom and bust. The danger is that during periods of boom, markets tend to be overextended. Overconfidence creeps in and it gets easier and easier to access capital for both investment and speculation. And when market sentiment turns negative during overextended booms, a crash is almost unavoidable.
Industrial capitalism also easily creates monopolies and inertia of both capital and other factors of production. During the 1873 crash, Jay Cooke & Company grew to become an influential bank with deep roots within the financial system. As well, the railroad industry became so mainstream and concentrated on both capital and labour. When just a single bank and industry failed, the knock-on effects were harsh and unforgiving. In an ideal scenario (free market), it should have been easier to move capital and labour to an alternative industry that was least impacted by the crisis so as to lessen the overall impact.
Ultimately, the 1873 crash serves as a warning on how far-reaching a financial crisis can become in society.