Already everyone is speaking about the impending crisis. Each expert and «expert» is trying to analyze from every source of information the causes and consequences of the impending crisis. At first they talked about 2016, but the Central Bank of China poured a bunch of fiat currency into the economy, then about 2018, the Fed has already joined it. Then the crisis was expected in 2019, but the markets grew by 20-30%, and the developing ones were even bigger. Now they are talking about the Trump`s election, allegedly the crisis will begin immediately after it or before it (if the Fed doesn`t want to support it).
What can we as a cryptocurrency community get from this? Many suggest that during the crisis, bitcoin will become a protective tool like gold and will correlate with a precious metal. We cannot answer the question «Will it really be like this?», because we don’t know.
We also cannot answer the question «When will the crisis begin and what should we expect from it?», because we also don`t know. Moreover, we assure you that no one knows, because in the very term «crisis» the word «unexpectedness» is encompassed. But if the crisis is expected, it is not a crisis.
With this material, we begin a series of review articles on the most famous financial crises. Consider the causes and consequences of each of them, and you can make the appropriate decisions. Our first contender for the review is the crisis of 1857.
The first world financial crisis
First, let’s fantasize a bit and imagine the time of the mid-19th century. That time, life was radically different from ours, as did the financial system.
• First, all money could be exchanged for a precious metal (silver or gold). No dollar as a reserve currency.
• Secondly, there was no monopolist in the person of the Central Bank who would print money and regulate this process. Each commercial bank had the right to print its own banknotes. They trusted this system, because, as we already found out in paragraph 1, each piece of paper was provided with gold. For example, here are 2 pounds from Evans, Jones, Davies & Co., and 5 pounds from Fox Bank, Fowler & Co.
By the way, all crises are somewhat similar to each other. At first some new idea appears, a technology that then swells and bursts.
The first world financial crisis began, oddly enough, in America. At that time, a new progressive technology appeared – railways. In 1830, the railway boom began. If at that time the total length of railways was 37 kilometers, then after 10 years the figure was already 4 519 kilometers. The indicator increased 122 times over 10 years. But over the next ten years, almost 10 thousand more kilometers were built. It all began in the northeastern part of America- the state of Pennsylvania and Massachusetts, and then this direction gradually developed towards the west.
It was a real boom. All the country’s free money was invested in the construction of railways. Other countries have also begun to look into this area. France, Germany, Britain begin to invest in railway companies, hoping to make a profit. Shares of these companies are growing rapidly. US citizens themselves also want to capitalize on this. Someone buys company securities, and someone decides to go west to buy land. After all, when trains begin to run there, they will significantly increase in price. However, this method of earning was not as simple as we are now describing. The then adventurers couldn`t predict the plots of land on which the road will be built, and therefore they tried to predict or guess.
So how is this all?
• Railway workers earn.
• Banks issue loans for road construction and also earn.
• Foreign organizations invest and also earn.
• Ordinary citizens buy still undeveloped land and also earn.
All participants in the system are positive. But there also gold is found in 1848 in California. This is an additional investment in the state economy. A year later, approximately 300,000 people came to California to mine gold.
Probably, one of you has already asked the question: «How did they find out everything about gold so quickly?» After all, before the first cars appeared, another 30 years. Surely, the information was carried on carts? Or carrier pigeons? And there is another important puzzle of the system, which will soon collapse – the invention of the telegraph.
The first telegraph message was sent in 1844. This was done by Samuel Morse. It looked like this: «That’s what God is doing». This is a phrase from the Bible. Now there was no need to wait all day for mail. Messages arrived in minutes across the country.
Well, actually, that’s how the Americans learned about gold. In history, this event is commemorated as «Gold Rush». That is why the 2017 cryptocurrency boom is also called a rush. But we are considering the year 1850. And built 14 517 km of rails.
Before considering the collapse of the system in 1857, it is still worth mentioning about farmers. In 1853, the Crimean war began. Russia has reduced the supply of grain, and accordingly, an additional market appears for exporting countries (including the United States).
Notice, how the supply of Russia decreased and the supply of the USA increased. Besides, prices also almost doubled.
Farmers, of course, wanted as much profit as possible. They took loans to expand land. Well, here is the pyramid built.
The other side of the coin
Farmers were the first to shift this sustainable system. The Crimean War ended in 1856 and Russia returned to the list of international exporters. Supply increases – prices go down. And the farmers then laid other expectations. And they have loans that were taken to expand the land. But this is only the beginning.
1857 year. 39 390 km of rail were built. 7 years ago there were 3 times less of them. But about this a bit later.
Banks. In any crisis, in the center of the system are banks with their loans. There are no exceptions. If in 1834 there were 506 banks and they had 26.5 million metal and 147.6 million loans with deposits, then in 1856 there were already 1253 banks with 60 million in precious metal and 417 million in liabilities. As we can see, in terms of equity, deposits and loans began to grow (there are more loans, their collateral is less).
Railway companies. Huge resources are being invested in them. Their shares are growing steadily, and they pay large dividends. However, at the same time, many of these companies are not actually building anything, they don`t have the resources to do this. They are just dummies.
So, on the one hand, we have laid the positive aspects. Markets are growing, roads are being built, farmers are getting richer, gold is being mined. On the other hand, farmers have loans, many railway companies are dummy, banks have a lot of loans. Let’s compare these two sides of the coin and find out what will happen in the end?
It all started with Ohio Life Insurance and Trust Company. The management of this bank invested all the funds of investors in the stock market (which supposedly grow all the time). On August 24, 1957, it stopped returning investor deposits, and exchanged the issued papers for gold (it should be reminded, that each bank had its own money, which was supposedly secured by gold). In 5 days, the shares of this bank fell 20 times, the bank’s capitalization decreased by 95%.
It turned out, that hundreds of enterprises don`t have liquidity to make payments on obligations. They received many loans only to speculate on shares of railway companies or to speculate with the land (remember the guys who went west to buy land in anticipation of higher prices?). No one gave loans secured by securities, because they fell at an accelerated pace in price. People massively stormed banking institutions with the goal of taking their gold and silver, while giving away pieces of paper from banks. This phenomenon is called «A Bank Run». On September 25, 175 banks already refused to fulfill their obligations. A week later, another 150. On October 13, 18 banks were closed in New York. The next day, another 32. The entire banking system was paralyzed until December.
What about financial markets? I think you guessed it. It turned out, that the money was actually invested in dummy companies. It didn’t matter whether your enterprise was operating or not. Confidence in the railroads fell to zero. Immediately after the situation with the bank of the Ohio Life Insurance and Trust Company Bank (the very first one that stopped returning money):
1. Chicago-Rock Island Railroad lost 5% in 5 days;
2. Illinois Central 7%;
3. LaCrosse-Milwaukee 33%.
Of course, this is not a 95% drop, but in the following months there was a stable downward cycle and many bankruptcies.
It should be reminded, the telegraph, which in 11 years managed to develop significantly. It ideally supported panic, because news of another bankruptcy spread instantly. There is also a ship full of California gold, sank with a crew of 420 people. It was heading to New York to raise bank liquidity.
Railroad stockholders sold them to record losses. Banks demanded a return of debts and investors had to sell shares even more. Banks didn`t give out loans that farmers had hoped so much for, which were head over heels stuck in debt.
«Trust is the spirit and soul of commerce itself. If you destroy them, or at least cause damage, the business comes to the end» The New York Times wrote on December 7, 1957.
We didn’t mention this quote in vain, because the title of our article is «The World Crisis», and not the American, right? When a ship from America sailed to Britain with news of the banking crisis in America, panic began there. And then in Ireland. Britain was actively buying up American stocks of iron companies and land, and then it all fell apart. An attack on English banks began, already known to us as A Bank Run. And banks began to go bankrupt, because their lion’s share of liquidity was invested in America.
The crisis didn`t last so long, but only a couple of years. However, this is the first and most striking example of a global collapse, or rather panic. But the reason for this event is risky investments and rash loans. But the effect was exacerbated by the new means of communication (telegraph) and the reassessment of new technology (railways).
The bloating of the problem became known long before August 24, 1957. Ohio Life Insurance and Trust Company simply clicked on the detonator, and the telegraph helped spread the information as soon as possible, which triggered a panic.
After this event, laws appeared that we still use. For example, it was decided that a bank should have $ 1 in precious metal as collateral for every $ 3 issued on credit. Today we are not talking about providing gold, but banks are also required to keep a certain percentage of reserves. And the size of this percentage is set by the Central Bank.
If you are asked why the crisis of 1857 happened, you can answer: «A bunch of companies in the wake of growth have accumulated debts, and when the problems started, there was nothing to pay». Moreover, this phrase is probably suitable for any crisis, but not only by 1857. More about that in the following publications.
This is our first review of the first financial crisis. In the future, we will talk about depressions, dot-coms, and mortgage speculations. Stay in touch!