The premium paid for cash had reached 4% over deposits, an unthinkably huge charge for liquidity. American economist Abram Piatt Andrew Jr. lamented how such a rate hadn’t walloped Britain once since the frightful Napoleonic Wars. France hadn’t witnessed 4% since its disastrous war with Prussia, and even then, Andrew committed, it happened in just a single instance.
Yet, New York City in October and November of 1907 stared into such a massive liquidity crunch its major businessmen had taken to renting safe deposit boxes and even safes into which to store their liquid money holdings; physically removing whatever cash and coin could be obtained from local banks and placing it elsewhere in caches all around the city.
Writing for The Quarterly Journal of Economics in February 1908, not long after the major crisis and while its consequences were still then unfolding, Mr. Andrew, having argued that a major panic was imminent the prior January, nine months before it happened, opened his review with maybe a well-earned I-told-you-so:
“It gave the lie directly to those who in recent years have contended that we should never again witness experiences like those of the memorable years 1837, 1857, 1873 and 1893.”
The American economy had been struck by repeated, almost regular bank panics that would whip up deflationary money to then provoke the most dastardly depressions forced onto mostly American workers via the businesses left to face making the choice between mass, enduring layoffs and their own survival.
Causes of the 1907 panic have been made plain over the hundred and fifteen years then to now, and these prominently feature all the usual human foibles, hubris, and, yes, ingenuity including what were then novel innovations in what today might be termed shadow banking (the notorious “trusts” of the first decade of the 20th Century).
However it began, once it did the familiar lines were quickly drawn. He who moved first got paid, while those who waited risked being caught up in the gathering whirlwind. Therefore, cash exited NYC banks to be hidden away; hoarded, the world Andrew popularized to title his 1908 piece.
Signs of trouble had been noted as early as October 14, 1907, the US economy already several months into what by that time had only been a mild recession. A little over a week later, October 22, infamous Knickerbocker Trust was forced to suspend and away it went.
Using Andrew’s contemporary survey of local newspaper dailies, all of whom began to actively quote cash premiums paid by the city’s typically underground money brokers on their front pages, by the end of October the highest premium was 3.5% already. It would get to 4% by November 6, then again two days in a row November 12 and 13 even though the US was at peace and no other grave historical disaster then occurring.
While the mythic action of JP Morgan has garnered much if not the vast majority of historical attribution in helping to stem the crisis, maybe one of the more interesting if largely forgotten of his activities is the commission of Astor Safe Deposit Company (October 26) to survey thirty-three of New York’s companies in that business. It would find 789 safes had been rented during the week of the panic, about six times what was deemed normal.
To have been a proficient safecracker in the mid-Autumn of 1907!
Cash was indeed being hoarded, and in a fractional reserve system every dollar pulled out as reserves unless replaced by something else creates a ripple effect multiplied by the fraction of deposits to reserves. In truth, it wouldn’t have mattered if a full reserve; money hoarded by the public is money that cannot be used in good times or bad.
Though there was no central bank in America at the time, there were indeed sources of exogenous liquidity available, mainly privately via clearinghouse associations. These were empowered with quasi-regulatory authority; able to examine the books of any members as well as to “print” reserves in times of emergency in the form of clearinghouse loan certificates.
Morgan’s consortium offered about $25 million in funds which was thoroughly outmatched by so many other sources – including a historic deposit of funds, about $36 million during the second half of October, from the Treasury Department into the most systemically important (too big to fail?) central reserve city banks in New York.
Obviously, that hadn’t been enough as cash was withdrawn locally in excess, and it would also disappear, as was usually the case, once out-of-town country banks began to get nervous for their correspondent holdings with big reserve city banks in New York then Chicago.
Altogether, Andrew estimated that about $233 million of cash must have been extracted one way or another from only the national banks located in the city. Their reported (to the Federal Comptroller) aggregate holdings had dropped by $41 million by December 3 even though Treasury would eventually deposit a total of $72 million in them to go with $70 million in gold which had arrived (mostly imported based on cash premium prices), and national bank note circulation expanding by around $50 million.
This was roughly matched by the issuance (according to Milton Friedman and Anna Schwartz’s estimates from A Monetary History) of $256 million of clearinghouse loan certificates. However, these were not evenly distributed by time, geography, nor by class of cash-starved participant.
In fact, one of the primary motivations for what would become the Aldrich Plan, later refurbished into the Federal Reserve Act, had been perceived tardiness on the part of the New York Clearinghouse Association. As is typical, some cited conspiracy and collusion as the reason for delayed liquidity, though simple incompetence along with real challenges over trying to monitor, measure, and react in real-time from incomplete information were more likely.
Either way, even had the association acted quicker, trusts had been purposefully excluded from it because its bankers, Morgan included, viewed them – with reason - as “unfair” competition to their traditional depositories. Those like Knickerbocker might have been doomed no matter how fast the New York association proceeded.
Elsewhere, in Chicago, for example, that city’s clearinghouse association hadn’t excluded trusts and when issuing emergency debt certificates, they were made available to any trust like depository so long as all had kept in good standing (upon thorough examination). As a result, despite the gravity of the situation as it spread nationally, not a single trust or bank failed in Chicago during it.
The 1907 Panic was characterized by, like 2007, a panic primarily on the “institutional” side; as Friedman and Schwartz noted, “loss of confidence was displayed less by the public than by country banks.” Andrew had previously stated that this one couldn’t be blamed, as prior panics had been, on the “little guy”, or girls:
“The general testimony seemed to indicate that this transfer of money was not attributable, as is so often implied, to women, clergymen, and other timid small depositors, but rather to large business interests that sought in this way to provide against any possible contingency which might prevent their meeting their regular obligations in the usual way.”
It's only when left unchecked that the crisis will go “too far” beyond some unknowable critical threshold.
In other words, Big Business (the entities who were renting out all New York’s safes) knew that banking illiquidity would interrupt its commercial activities and therefore began to prudently prepare. By hoarding cash, each could continue to make payroll and pay suppliers even if various banks closed down or restricted convertibility (as many would in that ’07).
This is where the rubber of elasticity meets the road of economy; banks suffer shortfalls of money which deprives the real economy of its necessary monetary tools, making regular and sustainable commerce that much more difficult, rigid, and costly than it ever needs to be. The typical result, if money becomes too scarce for bank and business alike, is the survival instinct to cut money needs therefore costs to the bone.
Depression.
While the US economy in 1907 (again, already in recession by the time the crisis began) and 1908 would suffer a serious setback, it was, like the 1920-21 depression, ultimately short-lived and left no major scars like those from 1893 or the so-much-more deflationary destruction 1929-33 had.
In fact, the banking system as a whole wasn’t much impacted beyond the short-term scarcity of money, meaning the capacity of that system to churn money through the economy, to transform it into new credit and other money, wasn’t as much impaired as in 1893 nor close to the extent of 1929-33 devastation.
Sourcing unpublished estimates gathered by the FDIC decades later, Friedman and Schwartz claim the data showed:
“If the comparison is based on the loss to depositors, the effect of the panic is equally apparent, yet equally moderate. In preceding years, the loss [to depositors] had ranged between 2 and 6 cents per $100 of deposits, except for 1904, when it reached 10 cents. In 1907, it was 18 cents and in 1908, 14 cents.”
Because of the combined if uncoordinated and ad hoc liquidity efforts across the national systemic landscape, the Panic of 1907 had been severe enough but hadn’t threatened let alone so seriously undermined the monetary and banking system’s capacity. Thus, unlike 1893 or 1929-33 (or 2007-08), after a sharp yet short economic contraction (true) recovery quickly emerged since the monetary system remained largely intact.
I’ll go back to A Monetary History one more time for what I think best sums up this outcome:
“Banks failed now [1907], as earlier, primarily because they were ‘unsound’ banks; and the failure of one bank did not set in train a chain reaction.”
This improvised, informal currency regime, confronting the downside from the lumpiness of free market affairs, performed reasonably well, including the natural desire even systemic need to cull the (bank) herd of its weaker or more irresponsible members without just wrecking everything while doing so (throwing the baby out with the deflationary bathwater).
What the government wanted, and convinced the public to agree, was to improve the efficiency, reach, and therefore effectiveness of that regime pursuing first the Aldrich Plan (sort of a national yet still private clearinghouse arrangement) before pivoting (after the infamous Jekyll Island meetings) to a public central bank.
It came to be widely believed that had one of those been around in 1907, it would have improved upon the reasonably favorable outcomes various regional and mishmash of bank/money components had otherwise achieved. And it sounded reasonable enough, to formalize, standardize, and nationalize what would then be a truly national currency.
This was, of course, a huge mistake (see: Great Depression).
But that mistake was not the pursuit of elasticity, rather how monetary elasticity was thought best to function.
And what we can learn from the centralized model’s even larger disaster not even two decades later was, like 1893, elasticity is as much an issue for long run money potential as it is to the real economy on the ground in whatever present day. Real economic agents must persevere and survive starved for money, and will do whatever needs to be done however it can be done, but the banking system tends to naturally overcorrect even more following the most severe of these bouts of inelasticity when not swiftly brought under control by whomever.
In other words, once inelasticity is allowed to become engrained too deeply, it alters the underlying fundamentals, the necessary capacity of the banking and monetary system such that an already-bad situation for money, finance, and economy becomes irreparable.
What could’ve been short, sharp recession transformed instead to prolonged depression.
Incidentally, there were no such bouts of inelasticity between 1955 and 2007 (at least not systemically), a positive result partially attributed by Economists James Stock and Mark Watson in 2002 to “good luck” when it had been anything but (eurodollar goes up).
Like the thirties, if to a lesser degree, we’ve been living with the consequences of a permanently shorn monetary system (eurodollar went down) forever laser-focused on liquidity therefore a cruel, persistent, and otherwise unnecessary drag on the entire global economy that monetary system serves (as unofficial reserve).
There are other issues tied to elasticity, too, much beyond my scope here, including how best to measure or perhaps influence the monetary situation on the other side of the spectrum – avoiding monetary and credit excesses which also lead to the predicate situation for deflationary depression. If there isn’t “too much” money in the first place, then no bubble and no monetary breakdown.
Yet, history shows no matter how restrictive, humans find a way to make money on any upswing.
The problem isn’t the pursuit of elasticity; it is how to go about it. The Fed version ain’t it, and never really was. Avoiding these worst downside monetary cases – by every judge of history – should be the world’s paramount focus and might’ve been following 2008’s outright monetary deflation if not for the dazzle of QE’s deception.
To that end, as financial chaos builds all over the planet again, T-bill yields are and remain incredibly low when by all assumptions they shouldn’t be. Compared to alternatives like the Fed’s (useless) RRP, the distance underneath is, and has been for some time, jaw-dropping.
Another way of saying that is, given how T-bills are a primary form of necessary monetary collateral in this 21st century monetary arrangement, the premium on the modern system’s paramount form of currency is enormous right now. The situation obviously isn’t directly comparable given so much distance in time and format, yet it might not be as far off, relatively speaking, from that historic 4% in 1907 as you’ve been led to believe by the QE-is-everything centrally planned model which has failed spectacularly, twice, in living memory.
As it is shaping up, to some as-yet unknown extent, again in 2022.