Part IV of IV—A Brief History of World Credit & Interest Rates
by Martin A. Armstrong
As with most wars, noble motives are usually portrayed in some slogan that attempts to hide the true underlying financial incentives. The English Crown’s attempt to control and prevent irresponsible paper money issues among the Colonies, was a major cause of the Revolution. Of course, England for nearly 70 years, practiced extracting gold and silver from the Colonies in payment for taxes, leaving the colonists with less valuable coppers as well as a large barter system. Some argue that the Crown had left so little hard currency within the Colonies that it had forced them to issue paper currency. But if we look at the first two specific accusations, as set forth in The Declaration of Independence, we find that they centered on the paper money question. The first deals with the King’s refusal to give “assent” (consent) to laws permitting additional paper money issues. The second accuses the King of forbidding his Governors to pass laws on the issue of paper money for emergency purposes without obtaining his consent before hand.
“He has refused his Assent to Laws, the most wholesome and necessary for public good. “He has forbidden his Governors to pass laws of immediate and pressing importance unless suspended in their Peration till his assent should be obtained; and when so suspended he has utterly neglected to attend to them.”
With the breaking of ties with England, the Colonies began to issue paper money like the floodgates had just been opened. Backing was, of course, not there. In fact, on one paper currency issue in 1778 in Georgia, reference to its backing of the currency was plainly stated on its face. The notes stated that they were payable or redeemable from the proceeds of properties confiscated from Tories. Gold, silver and even copper coins disappeared completely from circulation once the war began. Paper money began to be printed for decimal coinage denominations as well. At first the money circulated freely and with support of the people. However, in 1777 what would become one of economic history’s most drastic examples of paper money depreciation began. Below are the official exchange rates as published by each Colony and the Federal Government. These rates were used for $1 worth of gold or silver as originally valued in 1775. However, it should be pointed out that those who held Continental Currency were, for the most part, unable to exchange them even at the official rates. Eventually, holders of this currency received nothing in return which prompted the saying, “not worth a Continental.”
|Continental Cur||$40.00 for $1 April 1780|
|N.Y. & Conn||$40.00 for $1 April 1780|
|South Carolina||$52.50 for $1 May 1780|
|Mass., NH & RI||$100.00 for $1 June 1781|
|New Jersey||$150.00 for $1 May 1781|
|Penn. & Delaware||$225.00 for $1 May 1781|
|Maryland||$280.00 for $1 June 1781|
|North Carolina||$800.00 for $1 Dec 1782|
|Virginia||$1000.00 for $1 Jan 1782|
|Georgia||$1000.00 for $1 Feb 1785|
Despite the fact that the Continental Currency ceased to circulate in April 1780 and the official exchange rate was set at $40 to $1, holders of this currency were unable to redeem it. Yet Continental Currency became a form of speculation. Even though the Articles of Confederation had promised payment, it was not until seven years later when the Constitution of the United States in 1787 recognized that there was an obligation to redeem these otherwise worthless scraps of paper. By October of 1787, Continental Currency was being traded at the going rate of $250 for $1 in gold. This meant that the 1780 official rate had further depreciated raising the value of gold from $800 an ounce in 1780 to $5,000 an ounce in 1787 in terms of Continental dollars.
The government was in no position to exchange the Continental Currency at any rate. The economy and lack of faith were simultaneously taking a nosedive straight down. Eventually, gold peaked in late December 1790 but only after Congress passed an Act on August 4th, 1790. This Act provided a means for refinancing debts and from October 1st, 1790 to September 30th, 1791, Congress agreed to redeem $100 in currency for $1 in bonds of indefinite maturity. Through this method of dealing with the worthless currency, Alexander Hamilton, Secretary of the Treasury averted a prolonged U.S. economic depression.
Many people refrained from exchanging their Continental Currency for bonds that paid 6% interest because the Act of 1790 provided that the currency would still be redeemed and that it was not mandatory to exchange it for bonds. The bonds were eventually paid in 1813 and those who held their currency in hopes of getting something more than a 1% return on what they had, received nothing!
Depending upon where you were and what colonial currency you held, the exchange rate between paper currency and one ounce of gold varied from $800 to $10,000 per ounce. Despite Ben Franklin’s early warning in his publication of 1729, “A Modest Enquiry into the Nature and Necessity of Paper Currency,” America’s game with paper-economics was far from over. Before this experience with credit and money would end with the British Depression of 1815, many new economic theories would emerge from great men such as Adam Smith in his publication, “The Wealth of Nations.” In 1809 a pamphlet entitled, “The High Price of Bullion a Proof of the Depreciation of Bank-Notes” was published by a London broker named David Ricardo who was 37 at the time. This pamphlet eventually established Ricardo as a major economic theorist who became influential in shaping the 19th Century.
The final years in late 1700’s were filled with turmoil and speculation along with rising interest rates and inflation to varying degrees worldwide. In the United States, the year 1786 was marked by Shays’ Rebellion in Massachusetts during September. The uprising was aimed to prevent further foreclosures of farms in the country’s continuing economic depression that had followed the war and the debt crisis that resulted from the deep depreciation of the currency. State militia at the time prevented seizure of the Springfield arsenal in confrontation with over 800 armed farmers. This rebellion did succeed in having the state supreme court adjourn without returning indictments against the farmers. However, the entire affair only served to bring the attentions of the state to the severity of the depression at the time.
As economic hardship continued along with financial uncertainty, Benjamin Franklin was moved to write in a letter to a French acquaintance in which one of his immortal sayings was given birth – “Nothing is certain but death and taxes.” During 1791, the U.S. money markets collapsed following the failure of some land companies organized by the famous New York speculator William Deur. The failure of his land scheme to settle the Ohio Valley resulted in a $5 million loss to New York investors, which was equal to the total value of all the real estate in New York City at the time. Speculation had been quite rampant in numerous ventures and shares. United States bank script, originally offered for $100, had risen to $195 on the New York market but crashed back to $110. Alexander Hamilton authorized the Bank of New York to step in and buy government bonds and debt in an effort to inject cash into the system and lower interest rates.
By 1796, France suffered ruinous inflation as her assignats (currency) of 1790 declined in the face of nearly 2000% inflation within the past six years. Flour rose dramatically from 40 cents a bushel in 1790 to over $5 in 1796. Wood advanced from $4 a cartload to $250 while a pound of soap jumped from 18 cents to $8. Eggs, which had cost 24 cents a dozen in 1790, soared to $5. Interest rates in France skyrocketed. The 5% rentes of the government fell in price driving the effective yield on government debt to 40% on average. The implied yield of French government securities began to ease somewhat dropping back to 30.1% in 1798. But in 1799 there was some renewed fear and the implied yield rose once again to 34% as the price of government securities declined.
This devastating inflation in France led to the French Revolution which brought Napoleon to power. In 1800, Napoleon immediately reduced government spending and established the Banque of France. The implied yield on government debt issues (5% rentes) declined back to 16.28% in 1800 and continued to fall to 9.3% in 1801, 9% in 1802 and finally down to 8.8% in 1803. Napoleon was proclaimed emperor in May 1804 after selling the Louisiana lands to the United States in 1803 for $15 million in an effort to raise capital to fund his military ambitions.
In 1806, Europe was engulfed in war with Napoleon. The Holy Roman Empire that had existed since the year 800 came to an end on July 12 under French auspices. Napoleon occupied Berlin and placed his older brother on the throne in Naples while his younger brother assumed the throne in Holland. Britain announced a blockade of Europe that sent U.S. commerce falling by 66%. President Jefferson introduced a bill to exclude many British goods in retaliation.
In 1807 a British man-of-war fired upon the U.S. frigate Chesapeake and removed four alleged deserters. President Jefferson closed U.S. ports to all armed British vessels. By 1810, duties on U.S. customs fell to $6 million as a loss of trade with Britain and France drastically reduced revenue to half that of its 1806 level. That same year, a bullion report issued by the British government economists established the “intrinsic value” theory of money. Bank notes may be useful as a medium of exchange, however the notes must bear a definite ratio to the amount of coin and bullion in the vaults. The report proclaimed that government cannot create money, which is in reality, a token of labor performed. Government can acquire money only through taxation or by borrowing. For government to issue irredeemable paper money is to violate the sanctity of contracts, to cheat creditors, to increase prices and to disrupt business. Largely the economic theory that was published that year supported Smith and Ricardo.
By 1812 Napoleon invaded Russia and the beginning of a series of defeats caused Napoleon to retreat from Russia on October 19th. The British defeated Napoleon’s forces in Spain during July of that year. Despite these events, interest rates in France declined to their lowermost level of 5.98% in 1808. Confusion over Britain’s 1807 ban on U.S. imports eventually forced the US to declare war on Great Britain as an economic depression widened due to the serious loss of trade with Europe.
Interest rates in the United States on long-term government bonds had declined from the 8% high of 1799 down to their lowest level of 6.02% in 1802. The peak in British government interest rates came in 1798 at 6.35% and had also declined to their lowest point of 3.8% in 1802.
The Rothschilds began to become quite prominent during the early nineteenth century. Back in 1801 the German moneylender Meyer Amschel Rothschild, 58, became financial adviser to the landgrave of Hesse-Casal. Rothschild served as an agent of the British Crown in subsidizing European opposition to Napoleon. In 1812, the Duke of Wellington was financed with gold coin smuggled south by the eight sons of Meyer Rothschild. With no language other than Yiddish, the Rothschilds used fake passports, false names, disguises, and bribes to elude the French in what became one of the great international loans of modern times. One of the sons, Nathan Meyer Rothschild, 38, established a banking house in London. In 1815, he used carrier pigeon reports from Belgium that advised him of Napoleon’s defeat at Waterloo. Rothschild depressed the price of British consols by selling aggressively short on London markets. He then used his agents to buy the consols back at distressed prices and when the news reached London of the British victory, prices soared reaping himself a huge fortune as consols rose in price from 61 to 72.
By 1814, Europe’s 22 years of war came to an end along with America’s 3 year War of 1812. In the aftermath, depression began to set in moving into 1815. British government interest rates fell from 5.49% in 1814 down to their lowest level of 3.56% in 1817. The first U.S. Panic of 1818 was initiated in part by the failure of the Baltimore branch of the second Bank of the United States. The U.S. entered an economic depression in 1818 that had led to appeals by U.S. manufacturers for higher protective trade tariffs. The depression became worldwide sparking political repression in Spain, Latin America and Great Britain as illustrated by the Peterloo Massacre which was a public appeal to reform the tax laws. Britain instead passed laws banning public speaking and private training in the use of firearms. In Spain the infamous Spanish Inquisition was put to an end as the result of revolution. In Greece a war of independence broke out in 1821 that continued into 1831. Mexico declared independence from Spain in 1821 and Guatemala and Peru soon followed. Riots appeared in Ireland and the Ashanti War broke out in 1822 in Africa. Brazil proclaimed independence in 1822 from Spain and in 1823 the Monroe Doctrine was proclaimed in the U.S. that opposed European influence in the Western Hemisphere. In 1823 France invaded Spain and the Burma Wars involving Britain emerged in 1824. By 1830 cries were being heard from the south within the U.S. for secession. Clearly, war broke out in the aftermath of economic hardship as history had so often revealed.
In 1837, the United States entered another economic depression following the failure in March of the New Orleans cotton brokerage firm of Herman Briggs & Company in the wake of yet another wild speculative boom. Inflated land values, speculation and wildcat banking contributed to the crisis which became known as the “Hard times” of 1837-1843. New York banks suspended payments in gold on May 10th and financial panic ensued. At least 800 U.S. banks suspended gold payments in total and 618 banks failed before the year was out. Gold completely disappeared from circulation and employers were forced to pay their help with what became commonly referred to as a “shinplater” which was private bank currency of dubious value and far too often outright counterfeit. Over 39,000 Americans went bankrupt loosing some $741 million as the depression reduced many to starvation. The depression spread to Britain and the rest of Europe as well. Congress authorized the issue of U.S. treasury notes not to exceed $10 million on October 12th in a move to help ease the devastating economic financial crisis. By 1839 the depression had not improved very much. Within the next few years, the states of Pennsylvania and Maryland defaulted on their bond issues.
As the U.S. debt crisis expanded, interest rates soared once again. From the 4.25% yield on government securities, which had been the low established back in the 1820’s, government yields rose to 6.14% by 1842. Eventually, government yields declined falling back to 4.02% in 1853. But the Panic of 1857 succeeded in sending government yields back up to the 4.81% level by 1858.
In California, the gold rush of 1849 had brought unbelievable levels of inflation and some outstanding records in interest rates as far as American history is concerned. The gold rush only complicated the transition from Mexican to American ownership at the time and a speculative bubble had developed going into the Panic of 1857. Cattle prices in particular multiplied rapidly at times reaching 400% gains or more depending upon the locality. The Mexican cattle rangers of Southern California became extremely wealthy overnight and borrowed against the substantial rise in land values. Interest rates up until 1854 were COMMONLY trading at the 60% level per annum with some isolated historical records illustrating 96% rates per annum. The creditors were some Eastern Yankees but mainly the Swiss, German and French financiers. Needless to say when the bubble burst, the large Mexican cattle ranchers went bankrupt losing vast portions of land that ended up in the hands of some wealthy families that lasted well into the 20th century.
With tensions remaining high in the East, U.S. government interest rates remained well above the 4% level. As the Civil War began, government yields in the North rose to levels in excess of 7% by 1861. Interest rates rose sharply during the Civil War but they did not reach the extreme levels that had been established during the War of 1812. This was largely due to the strong financial position in the North combined with heavy issues of non-interest-bearing legal tender currency called “greenbacks” – a term referring to the lack of backing other than the green ink on the reverse side of the note.
The greenbacks were traded as if they were a commodity on the New York Stock Exchange relative to gold. So although interest rates did not reach new highs – currency depreciation did! A gold panic struck in 1864 sending the value of the greenback down by nearly 80%. Another gold panic struck in 1869 which prompted the coining of the term “Black Friday” as gold soared once again and the stock market crashed.
Meanwhile, the Confederacy also used paper money to finance up to 60% of their war expenditures and 5% was funded through taxation while only 30% were actually raised through the sale of bonds. Initially, Confederate government bonds were floated in 1861 bearing an 8% yield. With some military successes under their belt, the issue of 1862 saw government bond yields decline to 6%. However, Confederate currency began to depreciate significantly. From the 100-par level of December 1861, the trading range of the Confederate bonds in 1862 was 103-104. The 1863 trading range moved to 109-200 illustrating a 50% depreciation in the currency. The Confederate government began to restrict the purchase of its bonds according to the issue date of the currency itself. Notes issued prior to April 20, 1863 could be used toward the purchase of 8% bonds, but after August only 7% bonds. From August 1863 thereafter, paper currency was no longer valid in the purchase of government bonds at all.
In 1864, the Confederate government forced the population to convert the currency into 4% yielding bonds by imposing a taxation rate of 10% per month on anyone holding large bills that had not been converted. The Confederate government issued a 6% bond backed by cotton at 8 pence per pound, which became known as the “Cotton Loan” issues. Of course the South lost the war and all Confederate currency, notes and bonds became worthless.
The Panic of 1873 in the U.S. was aided when Jim Fisk, the leading member of the gold ring from 1869, was killed by Edward Stokes. In the aftermath, it came to be known that Fisk had been raiding the treasury of the Erie Railroad. The famous Wall Street banking house of Jay Cooke & Company failed on September 18th creating what became known as “Black Friday” on the stock exchange. On September 19th, the stock market tumbled fiercely forcing the New York Stock Exchange to close for 10 days. By year-end, over 5,000 business firms failed while tens of thousands came close to starvation as soup kitchens opened in New York. But the financial panic was not limited to the United States. Panic also struck in Vienna during May 1873 causing European investors to withdraw capital from the United States as panic spread to other European nations.
Interest rates in the United States had risen moving into 1873. The yield on government securities moved back to the 5% level following a low of 4.07% in the wake of the Panic of 1869. Municipal bond yields rose to 5.58% while high grade railroad bond yields jumped to nearly 6.5%. Interest rates on French 3% rentes moved up to 5.25% in 1873 while British 3% consols moved up moderately to 3.21%. Interest rates in Switzerland moved up on an annual average basis from 3.22% in 1868 to 5.34% by 1873 while extreme intraday highs reached 7%. German interest rates at the Reichsbank moved up from the 1867 low of 4% to as high as 6% in 1873 but this was still significantly below the levels of 1866 when German rates topped at 9%. The discount rate officially rose in Belgium from the 2.5% low in 1867 to as high as 7% in 1873 but Dutch rates for the same period rose from 2.5% up to only 6.5% in 1873.
The economic depression in the United States following the Panic of 1873 continued well into 1878. Nearly 10,500 U.S. business firms failed in the process. In 1879, the United States resumed specie payments for the first time since 1861 in an attempt to help boost foreign trade and bring an end to the economic depression.
Following the major depression of the 1870’s, additional serious panics still inflicted the world economy in 1881, 1890, 1893, 1895, 1896, 1899, 1901, 1903, 1907, 1914, 1920 and 1929. Depression took place during 1883-1885, 1893-1894, 1896-1897, 1920-1921 and the Great Depression of 1929-1939. Periods of prosperity were the Gold Resumption Prosperity of 1879-1883, the Railroad Prosperity of 1886-1893, the 1895 Recovery, the Corporate Merger Movement of 1899-1903, the 1905-1907 Recovery, 1915-1919 World War I Boom, the New Era of Prosperity 1922-1929, also known as the Great Bull Market and the Roaring 20’s, and at last the 1940-1944 World War II Boom.
Although interest rates remained highly volatile during the later part of the nineteenth century, the shift in capital concentration was clearly underway. Each new panic that sent interest rates higher found U.S. peaks significantly lower than those in Europe with the exception of Britain. Government yields reached their lowest level on a global basis going into 1900 and private corporate rates began to command premiums well above those of government. This was not the case during the later part of the eighteenth century and certainly not during the early part of the nineteenth century.
By the mid twentieth century, capital continued to shift from Europe in the direction of the United States. Now even British rates were at a premium to those of America. As the inflation increased following World War II, capital concentration in the United States peaked by 1966 and began a trend of disbursement throughout the world. As capital concentrated in Switzerland on the back of excessively rising world taxation, Swiss rates became the lowest in the industrialized world. The sharp rise in interest rates following the birth of the world floating exchange rate system in 1971 began a clear and decisive new trend that was normal by all historical standards as the shift in capital flows began to realign national wealth on a global scale.
The lessons of history have a lot to offer us. To governments, history warns of the perils that await fiscal irresponsibility. Clearly, a little debt or the excessive use of credit now and then is not dangerous to the financial future of any nation. But when such irresponsibility continues without a view toward the future, that nation will perish in financial ruin. Thus far no nation or empire has ever resisted the temptation of credit. The question that history has left mankind is simply when will we ever learn from the mistakes of our past? When man borrows against his future income, he robs himself of the fruits of his own labor.