inflation led to social unrest. On February 14, a large assembly of angry men met in New York City to demand that the government curb exploding prices. When their demands for lower prices fell on deaf ears, the meeting turned ugly. The assembly turned into a mob and took to the street with torches. The military was called out to quell the violence, but before peace could be restored, several warehouses filled with grain were burnt to the ground. One of the unfortunate flour merchants noted with sarcasm that “burning the goods would not have a tendency to lower price.”
Commencing in April, a number of large dry-goods companies went under. These companies were the nineteenth-century equivalent of Walmart, and their demise shook the foundations of American finance. The price of cotton began to collapse; in less than six weeks, it lost 50 percent of its value. By the first week in May, the banking system was in a state of panic. On May 10, 1837, with cotton and land prices collapsing and with nowhere to turn for “a lender of last resort,” all banks in New York City stopped paying in Specie. Within two months of the New York Bank failure, 40 percent of the banks in the United States went broke. Interest rates turned negative as the ensuing panic drove the country into a financial depression.
Although not as famous as the Great Depression of the 1930s, the collapse of the banking system in 1837 led to six years of “unprecedented misery” in the United States. By some estimates, in the industrial areas of the Northeast unemployment reached a staggering 30 percent. It took another war to pull the nation out of the funk.
The Panic of 1893: Railroads Have No Upper Limit
Railroads had been a reliable form of transportation for nearly a quarter of a century in Europe before they arrived in America in the late 1820s. Between 1830 and 1860, America saw a great period of expansion when the country more than doubled in size. The nation needed a way to move goods and people to new markets quickly, and the railroad was the perfect vehicle. It combined the ability to move bulk goods, as the river and canal system had, and it added the value of speed. It could move goods up to 400 miles a day; a trip that used to take weeks could now be accomplished in a couple of days.
Prior to 1850, most of the railroads were short lines that joined with other short lines to form an irregular system. However, in 1850 the US Congress decided it was time to try and establish longer-haul routes that were contiguous and made available the first railroad land grants. During the next 20 years, legislators granted 170 million acres to roughly 85 railroad companies. Although substantial portions of the grants were never developed, the country still had enough track in place to circle the globe.
One of the problems that Congress had not foreseen was the standardization of track. There was no Bill Gates to figure out that if one railroad had a different width of track than the next, it could create a problem, and, unfortunately, it created a massive one. With hundreds of railroads across the land and several different gauges, it became increasingly difficult to move goods over large areas without transferring to a new railroad each time the track size changed.
The problem gradually resolved itself in the decades after the Civil War as the standardization of track took place and Congress continued to extend free land to the railroads in an attempt to connect the West to the rest of the country. As with any new technology, it seemed that this time was different and the market for railroads had no limit. It allowed for both a revolution in commerce as well as a social revolution. By 1880, you could travel from New York to San Francisco in less time than it took to go from New York to Washington, D.C., 50 years earlier.
With innovation came the need for financing the next project, and who was better suited for that than Wall Street? By 1890, there was more than $12 billion (nearly $300 billion in 2014 dollars) invested in the industry. As with any successful product, competition came into play. Within 10 years of Leland Stanford driving the “golden spike” that completed the transcontinental railroad on May 10, 1869, at Promontory Summit in the Utah Territory, there were four competing railroads carrying passengers and goods across the country. Revenues began to shrink, but the cost of infrastructure continued to climb, latecomers started to have troubles, and some smaller railroads went under.
On February 23, 1893, a major carrier, the Philadelphia and Reading Railroad, declared bankruptcy. This created a crisis of confidence (Lehman Brothers?), and investors began to panic and withdraw their money from the banking system. The federal government sought to stop the run by repealing legislation that tied the price of silver to the dollar, but that effort failed when more major railroads ceased to do business.
The final result was that hundreds of railroads went broke; over 500 banks, the majority of them in the West, closed; and 15,000 other businesses went under. Unemployment in major manufacturing cities moved above 18 percent at the peak of the depression in 1894 and remained in double digits until the recovery began in 1897 with the Klondike Gold Rush.
September 11, 2001: Price Can Never Go Up Again
Although the three bubbles that we have observed were from different times and different places, they all had a common origin: speculation fueled the bubble. In each case, the perceived opportunity overcame rational thought. Even one of the most brilliant men in recorded history fell victim to the mass hysteria. So now the question must be asked: Is it possible to have a deflationary bubble?
Could the price of an asset class be deflated with the same logic that causes the inflationary bubble?
Consider Tuesday, September 11, 2001.
I doubt that any living American will ever forget that morning. The impossible had happened; terrorists were able to take down American financial icons, the World Trade Centers in New York City. The markets reacted swiftly and viciously. If you were not lucky enough to close your positions, there was no way to reach financial safety.
Within minutes of the second tower being hit, the exchanges were forced to close. The infrastructure damage was immense, and it would take a full week before they could reopen. Although authorities pleaded for calm, as a professional trader you sensed the result before the markets reopened: panic.
When the markets resumed trading on Monday, September 17, the financial devastation of the attack was immediately apparent. The DJIA plummeted more than 4 percent on the opening bell. When the carnage stopped at 4:00, the Dow was down more than 7 percent.
Rumors on the street flourished. Bin Laden was not only the mastermind of the attack but he had purchased millions of dollars of puts on the OEX. New attacks were on the way. The economies of the Western Allies had lost hundreds of billions, and it would take decades to recover. The rest of week was even worse. Every day, the decline accelerated. Investors refused buy any US asset. Treasury Bonds, which had been used as a “flight to quality” for more than 80 years, joined the rout.
Friday morning, September 21, the economic news was horrible. There was no tomorrow; in a single stroke of violence, Bin Laden had realized his dream to bring the decadent Western world to its knees. The market opened down almost 5 percent from Thursday's close. The worst week in over 140 years was in the making. The futures markets were locked limit down. Economic Armageddon had arrived, and this time there was no bottom!
And then it stopped.
Some anonymous investor stepped up to the plate and bought. The market rallied the rest of the day to finish marginally lower; by December 31, 2001, it had rallied 23 percent from the bottom. Bin Laden did not accomplish his goal.
The United States not only survived but continues to flourish. The masterminds of the plot are either dead or in captivity.
The Commodity Bubble of 2008: Price Can Never Go Down Again
The housing bubble has gotten extensive coverage in all forms of media, so it will not be discussed here. But one of the largest meltdowns in world
