New York Fed: "Crisis Chronicles: The Panic of 1819—America’s First Great Economic Crisis"

From the Federal Reserve Bank of New York's Liberty Street Economics blog:

As we noted in our last post on the British crisis of 1816, while Britain emerged from nearly a quarter century of war with France ready to supply the world with manufactured goods, it needed cotton to supply the mills, and all of Europe needed wheat to supplement a series of poor harvests. The United States met that demand for cotton and wheat by expanding agricultural production, facilitated by the loose credit policies of a growing number of lightly regulated state banks. Meanwhile, the Treasury needed revenue to pay off debts from the Louisiana Purchase and the War of 1812, so the government turned to selling land acquired in the Louisiana Purchase. But the increased agricultural demand and easy credit policies led to a speculative real estate boom, particularly in Alabama. So when the Treasury started to pay off its debts, the specie drain caused a painful but necessary contraction and the boom went bust. In this edition of Crisis Chronicles, we describe America’s first great economic crisis.

Loose Credit and Lax Standards
In the mid-1810s, the nation was still sparsely populated at just 7 million inhabitants, the economy was agriculture-based, specie was scarce, and barter was extensive on the frontier. While some cotton and wool was used for domestic mills in the Northeast, the majority was produced for export, with Boston, New York, and Philadelphia serving largely in an export/trade capacity.

     The nation was also in debt. The government had borrowed heavily to finance the War of 1812, and the debt payments for the Louisiana Purchase were looming. State banks issued their own paper money and specie payments were suspended in 1814. Without a requirement to convert notes into specie, expansionist Western banks issued notes far beyond their ability to eventually redeem them in gold or silver. But banks in the Northeast remained more conservative and were even reticent to lend to the government.

The Second Bank of the United States
The expansionist note issuance led to a chaotic money situation, with different notes from different banks trading at different discounts. As a result, many argued for creation of a second national bank (the first one had ceased operation when its twenty-year charter expired in 1811). The Second Bank of the United States was chartered with a primary goal to create a uniform national currency by printing paper money convertible into specie. But the Bank undermined its own credibility by accepting IOUs for capital, and it did little to rein in the expansionist money policies of the state banks. It even contributed to the monetary expansion, particularly in its western branches.

     But the loose monetary and credit policies spurred investment in transportation infrastructure, such as turnpike construction and shipbuilding, and in agriculture-based real estate. And while investors, merchants, and farmers took on debt, those investments were initially profitable, driven by the demand for cotton in the British mills, the demand for wheat across Europe, and the need for transport to deliver the goods to market. Specie payments resumed by 1817, if only on a nominal basis, from the state banks...MORE