Brad DeLong: The Panic of 1825

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April 15, 2009

The Panic of 1825: We Are Live at The Week

The Panic of 1825 - THE WEEK: If you’re not satisfied with Paul Krugman or Nouriel Roubini as your guide to the current turmoil, you can always rely on E.M. Forster. It was Forster who grasped the essential drawback of the Internet long before anyone else, depicting, in his 1909 story "The Machine Stops" a world in which individuals communicate in isolation via machine. It turns out he’s pretty good on 21st-century financial crises, too, mostly because the underlying processes remain so similar to those of a financial crisis he studied. Only the scale has changed.

Forster’s great-aunt Marianne Thornton helped raise him after his father's death, leaving him 8,000 pounds upon her death, when Forster was 8. That legacy gave him the financial cushion to become a writer. So he wrote Marianne Thornton: A Domestic Biography 1797-1887, stringing her voluminous letters together with scene-setting prose. As it happens, the fortunes of the Thornton family turn on history’s first episode of successful central banking: the Bank of England's intervention in the 1825 financial crisis.

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And now let me turn the microphone over to 28-year-old Marianne Thornton. Writing in December 1825 to her friend Hannah More, she said: "There is just now a great pressure in the mercantile world, in the consequence of the breaking of so many of these scheming stock company bubbles."

Sound familiar? These were not bubbles in high-tech stocks or in mortgage lending and house prices, however, but bubbles in shipping lines, canals, and textile-spinning factories. And, of course, the bank of which young Henry had been a partner for only four months had gotten itself badly undercapitalized. The managing partner "had been inexcusably imprudent in not keeping more cash in the House, but relying on (the bank's) credit ... which would enable them to borrow whenever they pleased."

Except, of course, that in 1825 just as in 2009, no bank can borrow cash on the one day it really needs to, for every other bank really needs it on that same day. Which is why there came a “dreadful Saturday I shall never forget,” when a run on the bank was made, with “one old steady customer” withdrawing, without warning, his entire 30,000 pounds, leaving the bank vault “literally empty."

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When politicians wash their hands of a financial system in crisis and fail to intervene on a large scale, things do not turn out well. The most notable example was 1929–1933, when, at least according to Herbert Hoover, Treasury Secretary Andrew Mellon persuaded Hoover that "even a panic is not altogether a bad thing” because "it will purge the rottenness out of the system.”

Did 1825 turn out better? We think so. George IV was not executed on Tower Green. Lord Liverpool's head was not carried about London on a pike. The spinning of cotton into thread in Britain in 1826 was 11 percent lower than in 1825—the first serious industrial recession—but it bounced back and grew 30 percent from 1826 to 1827.

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1. Andrew Mellon's "liquidationist thesis"

Andrew Mellon's "liquidationist thesis"