The Great Depression is a hot topic of conversation these days as we all wonder “how bad this could get.” It is therefore useful to revisit the Great Depression and other Panics in American history to find or dismiss parallels with our own time.
Most histories of the Great Depression involve complex discussions of government policies, monetary policies and stock market dynamics. Indeed, many people think of the 1929 stock market crash as the cause, or even the entirety, of the Great Depression itself.
Data analysis suggests that the cause of Panics and Depressions may be simpler than most historians suggest.
There have actually been two “Great Depressions” in U.S. history, the first one followed the Panic of 1873 and the second one followed the Panic of 1929. Looking at the 1873 Panic first is useful because it came at a “simpler time” and is easier to understand analytically.
Between 1867 and 1873, the post-Civil War United States connected itself coast-to-coast by rail. In six years the U.S. added 33,275 miles of new railroad to a base that, in 1866, had been 36,801 miles. This overall doubling of the rail infrastructure cost about $1.8 billion to install. In context, the investment in railroads equaled 2.3 times the entire deposit base of all the banks in the United States in 1870 ($775 million). It was a “bet the country” sort of investment.
It was also clearly not the sort of investment that could be made by reinvesting profits or by saving a bit here or there. The 1867-1873 investment was a “capital build-out” where national (and international) assets were turned into cash and reinvested behind a new and exciting technology (fast travel and fast-shipped goods). From an economic perspective, it was “unnatural”: a nonrecurring event that created nonrecurring demand.
Unnatural, maybe, but it must have felt good. Demand rippled through the entire economy, requiring iron and steel for rails, wood for ties, dynamite for blasting tunnels, coal for steam engines; workers to make the steel and mine the coal, workers to install the rails, foremen and managers to oversee the operations. Production of steel and iron for rails doubled from 413,000 tons in 1867 to 893,000 tons in 1872. But that wasn’t enough – an additional 532,000 tons were imported, creating demand for international financiers, shipping and land transport. The increased demand for everything in a young economy created new levels of activity and generated vast amounts of wealth in a country that had never known it before.
Then it stopped.
It stopped for a good reason: the capital build-out ended. It could have stopped the day the Golden Spike was driven in 1869, but the rush to complete the link-up had resulted in a lot of sloppy work that had to be re-done. There were also other huge railroad projects that began before the Golden Spike and took a while to be completed or to fail. In fact, it was the collapse of the Northern Pacific, an also-ran in the race to connect the coasts, which was the immediate trigger of the 1873 Panic.
By 1873, a forward-looking person had a lot of things to panic about:
- The next five years saw railroad construction fall to roughly 2,300 miles per year. That is $274 million less per year than the peak in 1871. If build-out costs were, say, 30% labor, that would be $82 million worth of jobs lost in a time when a Carpenter on the Erie Canal made $2.50 per day.
- Imports of steel rails fell from 532,000 tons in 1872 to 149,000 tons in 1874 on their way to 11 (not 11 thousand, just 11 tons) by 1878.
- Iron horses don’t eat Hay: the value of a ton of Hay dropped from $14.52 in 1872 to $8.59 by 1877.
- Fast shipping opened vast new areas of land for agriculture, resulting in an agricultural price collapse: Corn prices fell from 65 cents a bushel in 1874 to 42 cents in 1875 on their way to 35 cents in 1877.
Ironically, it was a primary objective of the build-out that created many problems: productivity. Improved shipping resulted in higher yields that resulted in lower prices and economic hardship. 1873 was a double whammy: the end of the build-out and the beginning of a productivity boom.
To the financial markets of 1873 the only companies that mattered were the Railroads. As late as 1907, Railroads accounted for over two-thirds of what we would call “Wall Street Activity”. In the 1870s, it would have been virtually 100%.
To the Railroads, the capital build-out carried within itself the seeds of its own destruction. It put capacity in place ahead of demand, resulting in a rate collapse. Rates to ship a bushel of Wheat fell from 34 cents in 1872 to 20 cents in 1877. Railroad profits peaked at $189 million in 1874 before eventually falling to $170 million in 1877. Massive growth in infrastructure, equity and debt had generated no new profit and had seriously destabilized the Railroad companies.
Railroads by 1874 carried a crushing debt burden of over $4.2 billion. In 1874, the leverage (total debt/net earnings) of the Railroads was 22 times. By 1877 it was 27 times earnings – Railroads had become “junk” well before the term had been invented. When this outlook became clear, investors of capital justifiably sought to get back what remnants of their capital that they could by selling stock and calling in loans.
From a historical perspective, it seems clear that the Panic of 1873 was probably not a “panic” at all, but rather a sudden recognition that economic activity was about to rapidly decline and that a meaningful portion of the stock market was in danger of bankruptcy.
Government land grants tied to the speed of the build-out acted as the “easy credit” that helped fuel the boom, but they weren’t the reason the railroads were built. “White collar crime” as exposed in the Credit Mobilier scandal made the build-out more expensive, but not meaningfully so in aggregate.
If the Panic had become inevitable by 1873, could the Depression that followed have been avoided? The decision to build Railroads coast-to-coast had been a strategic one based on sound principles and good intentions. Building out half a network to limit the costs would not have achieved the project’s goals. Slowing the build-out might have been helpful, but natural forces of competition and the “unnatural” force of government incentives conspired to accelerate the process.
Could the impact have been softened? Build-out related spending of about $274 million per year had evaporated overnight. Total government revenues at the time were only $333 million. Spending the small surplus of $43 million would have covered a small fraction of the $274 million hole in the economy. Railroad debt exceeded $4 billion, about twice the federal debt of just over $2 billion (itself swollen by Civil War costs). Bailing out the Railroads would have meaningfully increased the National Debt that was already six times revenue.
It is possible that the Government could have “taxed the boom” early on, essentially forcing savings to be drawn later, but that would have taken a degree of foresight that Governments rarely achieve. By 1873, it was too late, the hole was too big and the shovel too small.
Ultimately, the impact of the Panic and subsequent six-year Depression was an echo of the enormity of the activity undertaken in the period 1867-1873. The time taken to work through the Depression was the time it took to grow out of the “hole” ($274 million per year) plus the time it took to mop up the productivity improvements generated by the build-out.
The next Great Depression was to be eerily similar.
Data from the Statistical Abstract of the United States, various years
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