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Source link: http://archive.mises.org/9749/1819-americas-first-housing-bubble/

1819: America’s First Housing Bubble

April 7, 2009 by

From 1811 to 1815, banks multiplied like mushrooms on a dung heap, lending out credit they didn’t have as if it were manna from heaven. Where actual money in bank vaults had decreased by 9.4% during that period, paper bank notes and deposits, all with claims on that money, had increased by 87.2%. Keynes himself would have been proud . FULL ARTICLE

{ 28 comments }

greg April 7, 2009 at 9:44 am

I am going to keep this short. The market today is much more complex than it was in 1819. But thanks for the history lesson.

Josh April 7, 2009 at 10:18 am

“That’s not to say that it was an era of perfect laissez-faire; human beings are not capable of it and likely wouldn’t want it if they were”

I’m sure Rothbard would disagree.

Jonathan Finegold Catalán April 7, 2009 at 11:20 am

Greg,

I’m not sure if “the market today is much more complex than it was in 1819″ is relevant. Are you accusing Mr. Maloney of oversimplifying the similarities between the Panic of 1819 and the current economic recession? I believe you’re right in assuming that the causes of today’s recession are more complex, if only in the sense that there were more variables (although, I admit, I am not well read on the Panic of 1819 and so this is all just speculation).

But, this doesn’t mean that in the end the underlying causes for the panic or recession were the same (artificial expansion of credit and centrally planned intervention to avoid liquidation).

I’m afraid that your comment is oversimplified and falsely dismisses the article on the grounds that today’s economy is “more complex” (without substantiating what this has to do with the relevance of your comment to today’s article).

Mike Sproul April 7, 2009 at 11:20 am

If a bank has $3 worth of gold coins, plus $97 worth of miscellaneous assets, as backing for $100 in its own paper bills, then that bank is capable of buying back all of the bills it has issued at par. That is not “mushrooms on a dung heap”. It is “Free Banking”, and libertarians should be advocating it, not attacking it.

fundamentalist April 7, 2009 at 11:20 am

Greg, I think you would be surprised at how similar the economies of 1819 and today are. After all, the Dutch invented futures and options in the 17th century and their use was known to Americans. And the virtues of paper, gold and silver money were debated in the mainstream press. In fact, the common man understood economics better in 1819 than he does today.

Nevertheless, supposing that the economy today is more complex, that doesn’t mean that the principles of economics don’t apply. If complexity negated everything we knew about the past, then you would have to agree with the old Geman Historical school that no economic principles exist at all; every historical period has its own laws.

The only way that would apply to economics is if human nature changed drastically with each generation. For example, if in one generation people would by more of a product when the price increased rather than less (all other things being equal), and the next generation did the opposite, then you could argue that there are no principles of economics. But since there is little evidence that human nature has changed, then the same economic principles that applied in 1819 apply today.

Sovy Kurosei April 7, 2009 at 12:35 pm

Mike Sproul

If a bank has $3 worth of gold coins, plus $97 worth of miscellaneous assets, as backing for $100 in its own paper bills, then that bank is capable of buying back all of the bills it has issued at par. That is not “mushrooms on a dung heap”. It is “Free Banking”, and libertarians should be advocating it, not attacking it.

Only if those $97 worth of assets are liquid.

Inquisitor April 7, 2009 at 1:07 pm

“I am going to keep this short. The market today is much more complex than it was in 1819. But thanks for the history lesson.”

I am going to keep this short: I will disregard any lessons from history.

Magnus April 7, 2009 at 2:15 pm

I’m going to keep this short. Markets may vary in complexity, but economic principles are universal.

greg April 7, 2009 at 3:47 pm

Jonathan and Fundamentalist,

OK, let us take the media exposure today vs 1819 and its influence in the markets.

My example took place only 20 minutes ago. Maria B. of CNBC announced Alcoa’s earnings and reported the numbers as gains, when they were losses. Her initial response is they beat their numbers when they actually missed! The price of AA shot up as buyers poured in and then corrected when they realized they were wrong. Many investors kissed off on a quick 50 cents a share!

This small example shows you how much influence the media has and how fast the markets can react to it. Not anything like 1819! Hell, anyone with an internet connection and an online brokerage account can trade easier than those that had seats on the exchanges back in 1980, let alone 1819.

You need to look at the mechanics of the markets of 1819 and today to draw a true comparison. While money supply is a factor, there are other market influences at play that are magnified with increase activity and exposure.

BioTube April 7, 2009 at 4:05 pm

The biggest difference between now and yesteryear is the amount of money that has some solid form(paper, coins, etc) and the amount that don’t.

fundamentalist April 7, 2009 at 4:20 pm

Greg, That’s an example of how the stock market responds to news more quickly today than it did in 1819, not an example of how more complicated the economy is. The economy still responds to changes in the money stock just as it did in 1819 and all of the main principles of economics still apply. Prices are still set the same way, just faster.

Mike Sproul April 7, 2009 at 5:14 pm

Sovy Kurosei

As long as the assets are worth $97 they can be sold for $97, and used to retire $97 that was issued by the bank. Banks normally have capital of their own to prevent losses to customers, but if worse comes to worst and the bank can only get $87 for the assets, then the bank now has $90 of assets backing $100 that it issued and the bank’s dollars will fall to 90% of their original value. That’s a chance people take when they put money in a bank, and there is no reason for government prohibition.

Travis April 7, 2009 at 9:27 pm

This article is well written. Wonderful. I would like more articles like this.

“As long as the assets are worth $97 they can be sold for $97, and used to retire $97 that was issued by the bank. Banks normally have capital of their own to prevent losses to customers, but if worse comes to worst and the bank can only get $87 for the assets, then the bank now has $90 of assets backing $100 that it issued and the bank’s dollars will fall to 90% of their original value. That’s a chance people take when they put money in a bank, and there is no reason for government prohibition.”

Perhaps there is no need for prohibition but certainly a disclaimer informing depositors what will happen to their money when a bank holds it for them.

Debt is highly volatile and gold, not so much.

Ruda April 8, 2009 at 12:19 am

Great article and enjoyed reading it. And there is just, really, never a wrong time to reference dung heap in discussing economics. Just a few nits….

One item concerns the disposition of Napoleon in December 1814 (i.e. the British had already won by December 1814 and had sent him on all expenses-paid-vacation to Elba. Later in 1815, Napoleon activities would again arouse British interests eventually leading to his Waterloo).

Another concerns the emotional response in 1814 to the burning of the capital to how we would respond today as we have no option to exchange specie for actual gold.

The bank was actually proposed in October of 1814 by Alexander J. Dallas, it just took a few years for congress to act. It would be interesting to compare and contrast those actions with what is taking place today.

Mark Y April 8, 2009 at 3:51 am

The problem is not with free banking, but with government intervention. Let’s say that I have 1,000 oz of gold. In a free market I may have the following choices:

1. Put it in a safe at home.
2. Exchange it for receipt where I can obtain 1,000 oz of gold on demand. The receipt specifically states bailment.
3. Exchange it for a note where I can obtain 1,000 oz of gold on demand. The note may or may not specify what the business can do with the 1,000 oz of gold. The note specifically states my rights as a creditor if the business defaults on its obligations.

Many will opt for option 3. Bank runs occur. Those that pick option 1 or 2, such as people on this board, will be able to pick up assets below their intrinsic value. I believe I read somewhere that Rothschild once said “Buy when the streets run with blood.”

The cycle will go on and on. Those that learn from their mistakes will prosper. Those that do not will suffer.

With government intervention – legal tender, taxes, bailouts, etc. – it seems that people who opt for option 1 or 2 lose out.

Prof. Sproul: I enjoyed your Econ 101 class back at UCLA. It would have been great if I had a chance to debate with you on the Real Bills Doctrine and with Prof. Levine on Intellectual Property.

Sovy Kurosei April 8, 2009 at 12:20 pm

Mike Sproul

As long as the assets are worth $97 they can be sold for $97, and used to retire $97 that was issued by the bank. Banks normally have capital of their own to prevent losses to customers, but if worse comes to worst and the bank can only get $87 for the assets, then the bank now has $90 of assets backing $100 that it issued and the bank’s dollars will fall to 90% of their original value. That’s a chance people take when they put money in a bank, and there is no reason for government prohibition.

That is called embezzlement as bank notes are a promise by the bank to give the holder some asset (precious metals like gold for example) upon request in exchange for the bank note.

What you are talking about is common stock masquerading as bank notes. That can work too but I wouldn’t call it banking.

Gerry Flaychy April 8, 2009 at 2:33 pm
“Mike Sproul
If a bank has $3 worth of gold coins, plus $97 worth of miscellaneous assets, as backing for $100 in its own paper bills, then that bank is capable of buying back all of the bills it has issued at par.”

If I deposit $100 of gold coins in this bank in return of $100 in bank notes redeemable in gold coins on demand, and after that, this bank lend to some other peoples $97 of those gold coins in exchange of IOUs redeemables in gold coins in, say, 60 days, then, if I come back to the bank to redeem my bank notes in gold coins 40 days before this 60 days term, this bank will

*not* be ” capable of buying back all of the bills it has issued at par”,

and this bank would be in a state of bankruptcy.

Mark Y April 8, 2009 at 3:27 pm

Gerry
“if I come back to the bank to redeem my bank notes in gold coins 40 days before this 60 days term… this bank would be in a state of bankruptcy.”

Not necessarily. Maybe the bank can borrow $97 of physical gold from someone else to pay you. In 20 days they get paid $97 in gold from their debtor then the bank can pay $97 to their creditor. Maybe the bank can issue additional stock certificates. Businesses that do this well will prosper. Those that can’t will fail.

Of course there will still be bank runs, bank failures, etc. It’s up to you to decide what to do with your money.

Mike Sproul April 8, 2009 at 3:54 pm

Sovy and Gerry:

If the customer agrees that the bank will operate on fractional reserves, there is no embezzlement. Banks have operated this way for centuries, and fractional reserves is a well-known practice. People take their chances when they use bank money, and government officials have no business dictating the terms of deposit or loan.

And there is a clear difference between illiquidity and bankruptcy. If assets total less that $100, that is bankruptcy. If reserves total less than $100, that is illiquidity.

Gerry Flaychy April 8, 2009 at 6:27 pm

To Mark Y : bank notes redeemable on demand, means that the gold has to be there at the moment that I asked for it, not in a futur time. Evidently, if somebody comes in the bank at the same moment and make a deposit of gold coins for $100 in return of $100 in bank notes redeemable on demand in gold coins, the bank will be able to pay me, but even in this case, the bank will still be in a state of bankruptcy because the bank will not be in a situation to be able to redeem this new issue of bank notes.

Also, to be in a state of bankruptcy, and to declare bankruptcy, are two different situations. One thing is sure, it is that at this moment, this bank is *not* ” capable of buying back all of the bills it has issued at par”.

Gerry Flaychy April 8, 2009 at 6:53 pm

” Mike Sproul:
Sovy and Gerry:
… And there is a clear difference between illiquidity and bankruptcy. If assets total less that $100, that is bankruptcy. If reserves total less than $100, that is illiquidity.”

If we talk about bank notes redeemable in gold coins on demand, as in your example, and based on your example, and the bank that issues them is not able to redeem all of them on demand in gold coins because this bank do not have those gold coins in its reserves, then this bank is in a state of bankruptcy. In another words, this bank is then *not* ” capable of buying back all of the bills it has issued at par”, and this bank is then in a state of bankruptcy.

To be able or to not be able to get out of this situation, is another question.

Mark Y. April 8, 2009 at 7:41 pm

Gerry,

There are various ways in which businesses can deal with such liquidity issues. Those that do it well prosper. Those that don’t fail.

I reread your original post and I agree with your illustration of how fractional banking is in a constant state of bankruptcy. I mistook your original post as to conclude that because fractional reserve banking is fragile, it should be outlawed. Your post only showed the workings of fractional reserve banking.

Gerry Flaychy April 8, 2009 at 9:19 pm

To Mark Y.

What I was discuting is the example of Mike Sproul and his affirmation that “that bank is capable of buying back all of the bills it has issued at par.”

His example, as I understand it, refers to a system of independant banks where bank notes were IOUs redeemable in gold, on demand, by the bank who issued them, and wich bank was obliged to redeem them on demand, but not the other banks. This system is very different from the system of fiat money and central banking that is actualy in operation in the USA.

Thus, his affirmation that “that bank is capable of buying back all of the bills it has issued at par.”, means that the “buying back” has to be in gold coins, and at the very moment that the demand is made, not in a futur time, and for “*all* the bills”.
In the example submited by him, the bank is not able to do it.
His affirmation in his example is equivalent to say that if there is a bank run on that bank, that bank will be able to change *all* its bank notes for gold coins on demand !

If the deposits were term deposits, with different maturities, not deposits on demand, and the same with the terms of the loans, the situation then would be different.

Alexander Gorshteyn April 9, 2009 at 3:40 am

“The 1819 man is so fascinating because he had enough character and honor to realize he had made mistakes and to clean them up… In times of crisis, he had the advantage of firm principles to guide him.”

Priceless!

This should be tattooed on forehead of every one of 535 thieves we know as US. Congressmen.

Mike Sproul April 9, 2009 at 11:10 am

Fractional reserve banking, as practiced for centuries, involves banks that would not be able to instantly redeem all their liabilities in gold. So what? The customers understand that and they use the bank voluntarily. The bank’s temporary illiquidity is a relatively minor annoyance to the customer. The bank’s insolvency is a major annoyance, but it is a chance the customer willingly takes in exchange for the convenience of using a bank.

Also, the Fed (Until last year, maybe) has enough assets to buy back every paper dollar it has issued at their current market value. This means the dollar is not fiat money. It is backed by the Fed’s assets. While the dollar is not currently physically convertible into gold, it is financially convertible into the bonds held by the Fed.

Stephen Grossman April 9, 2009 at 4:46 pm

Mike Sproul says, “While the dollar is not currently physically convertible into gold, it is financially convertible into the bonds held by the Fed.”

When govt destroys the value of money, of what value are bonds? This is why Peter Schiff has fled dollar-denominated assets.

Gerry Flaychy April 9, 2009 at 9:11 pm
“Mike Sproul:
Fractional reserve banking, as practiced for centuries, involves banks that would not be able to instantly redeem all their liabilities in gold. So what?”

Then, if we take your example in your first post, the holders of the bank notes will get only $3 of gold coins instead of $100, thus losing 97% of their gold; the banker then could be forced to bankruptcy and to close his doors, his assets seized by his creditors, and probably losing some of his own money and assets in the process, plus his reputation: nothing interesting for anybody,
except for the banker who will come to take his place !

Rob April 13, 2009 at 10:15 am

Greg – typical comment based on “this time it’s different” and ignoring-of-principles thinking. Suggest you get your hands on Manias, Panics and Crashes by Kindleberger – it it ALWAYS the same. The complexity you claim is simply more smokescreens from the cretins in charge. The principles are always the same, and the appropriate solutions, as noted from 1819, are always the same. Unless, of course, you buy into the FDR school of economic insanity.

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