Welcome to Finance and Fury, the Furious Friday edition.

Last Friday, we went through theory versus practical reality of public infrastructure spending  – roads and railroads are needed.

In this episode – Look back at an economic crash – in relation to infrastructure – I Know there are differences – but illustration of when too much of a good thing can go bad – especially when economic or development policies create a reliance to the economy on economic growth – especially when there is speculation involved

What am I talking about? Crash of 1873 – What was it –

  1. To start – US coming out of their Civil War(1861-1865) – in an effort to deal with unemployment and economic fallout- infrastructure was proposed – The US has a long history of government job creation program –
  2. Job creation efforts were undertaken at the local level by cities or state by state –
    1. During the 1857, 1870s and the 1890s economic crisis and depressions going on
    2. New York, Boston, Phili – developed municipal programs to aid the poor or unemployed –
    3. But the administration and financing of these programs presented major problems for each city or state –
    4. Logistics was one but funding was another major one –
  3. Led to the proposal for statement government to take over for cities and for the federal government to take over from the states – assumed the responsibility for these work relief programs
  4. So a boom in railroad construction commences – 33,000 miles (53,000 km) of new track were laidacross the country between 1868 and 1873
    1. Back then – the railroad industry was the nation’s largest employer outside of agriculture due to the work programs –
    2. Most of the boom in railroad investment was being driven by government land grants and subsidies to the railroads – involved large amounts of money and but due to the size started becoming a ticking timebomb of financial risk
    3. a large infusion of cash from speculators caused spectacular growth in the industry as well as in construction of docks, factories and ancillary facilities that process the goods needed for construction – timber, etc –
    4. But how long does it take for infrastructure like railroads to make a return – years – so the capitalwas involved in projects offering no immediate returns
  5. Now enters the Coinage act 1873
    1. In 1871 – the German Empire ceased minting silver thaler coins in 1871 – most countries had gold and silver coins – similar to today but back then they were the actual metal, not just imitations
    2. But Germany doing this caused a drop in demand and downward pressure on the value of silver
      1. Less demand lower prices
    3. But this had affects in the United States
      1. One effect was in the mining industry – as the US was where much of the supply of silver was mined
      2. But also on their monetary system – United States Congress passed the Coinage Act of 1873 – changed the US silver policy
    4. Before this – backed its currency with both gold and silver – minted both types of coins
    5. This Act moved them to a de factogold standard – resulting in no longer buying silver at a statutory price or allowing for silver to be converted from the public into silver coins
      1. Statutory price used to be a monetary tool – set the price of metals like gold and silver based around the money supply –
    6. So the immediate effect of depressing silver prices and also changing the coinage law reduced the domestic money supply – this resulted in raising interest rates – hurting those who carried heavy debt loads
    7. This perception of instability in United States monetary policy caused investors to shy away from long-term obligations, particularly long-term bonds. The problem was compounded by the railroad boom, which was in its later stages at the time – started kicking off company failures
  6. One of the biggest failures – In September 1873, Jay Cooke & Company, a major component of the United States banking establishment, found itself unable to market several million dollars in Northern Pacific Railway bonds. Cooke’s firm, like many others, had invested heavily in the railroads on both sides – the ownership but also selling bonds (the debt) in the investment to investors
    1. Around this time investment banks were anxious for more capital for their enterprises in railroads – easy cash cow and could get government loans – but new monetary policy of contracting the money supply (again, also thereby raising interest rates) made matters worse for those in debt – those who speculated on infrastructure investments – that wouldn’t see returns for years – were no left holding the bag with higher interest repayments
    2. In addition – put a halt on more infrastructure spending – there were plans by Cooke and other entrepreneurs to build the second transcontinental railroad, called the Northern Pacific Railway.
      1. Cooke’s firm provided the financing – ground for the line was all ready to go – But just as he was about to swing a US$300 million government loan reports circulated that his firm’s credit had become nearly worthless – loan was ceased and in September 1873, the firm declared bankruptcy.
    3. Another flow on effect – was on the insurance industry – Many US insurance companies went out of business as deteriorating financial conditions created solvency problems for life insurers – they invest in a low of what is seen stable investments – like bonds
    4. Other effects- The failure of the Jay Cooke bank, followed quickly by that of Henry Clews – set off a chain reaction of bank failures
      1. Factories began to lay off workers as the United States slipped into depression. The effects of the panic were quickly felt in New York, and more slowly in Chicago, Virginia City, Nevada (where silver mining was active), and San Francisco.
    5. The New York Stock Exchange closed for ten days starting 20 September – first time in history that the market was closed
    6. By November 1873 some 55 of the nation’s railroads had failed, and another 60 went bankrupt by the first anniversary of the crisis.
      1. Construction of new rail lines plummeted from 7,500 miles (12,070 km) of track in 1872 to just 1,600 miles (2,575 km) in 1875 – remember that this had become one of the backbones of the economy
      2. 18,000 businesses failed between 1873 and 1875 – flow on effects of banks failing but also companies providing goods and services to the railroad industry
  • Unemployment peaked in 1878 at 8.25%.
  1. Building construction was halted, wages were cut, real estate values fell and corporate profits vanished
  2. Further flow on effects created a second business slump by 1877 – example – the market for lumber crashed, leading to several lumber companies going bankrupt
  1. With the depression, ambitious railroad building programs crashed across the South, leaving most states deep in debt and burdened with heavy taxes. Retrenchment was a common response of southern states to state debts during the depression.
  1. Social unrest and Rioting – In 1877, steep wage cuts led American railroad workers to launch the Great Railroad Strike. Initial protests broke out in Martinsburg, West Virginia when the Baltimore and Ohio Railroad (B&O) cut worker’s pay for the third time in a year.
    1. As the workers began rioting, with reports of looting and attacks on civilians and police – dispatched federal troops. Within the week, similar riots had erupted in Maryland, New York, Pennsylvania, Illinois, and Missouri.

Summary of events – Why did it go bad

  1. The Panic of 1873 arose from investments in railroads. Railroads had expanded rapidly in the nineteenth century
    1. Eventually – as investment in railroads continued, new projects outpaced demand for new capacity – returns on railroad investments declined – remember they were already delayed in nature –
    2. You had a share market crash in most major financial centres -USA, EU with Vienna – investors divested their holdings of American securities, particularly railroad bonds
    3. This mass selling depressed the market, lowered prices on shares and bonds, and impeded financing for railroad firms – Without cash to finance operations and refinance debts that came due, many railroad firms failed
      1. others defaulted on payments due to banks
      2. Large banks then failing changed investors expectations. Creditors lost confidence in railroads and in the banks that financed them. Stock markets further collapsed.
  • The panic spread to financial institutions in Washington, DC, Pennsylvania, New York, Virginia, and Georgia, as well as to banks in the Midwest, including Indiana, Illinois, and Ohio. Nationwide, at least one-hundred banks failed.

What is happening today?

  1. There is a Push for large infrastructure spending – a lot of speculation surrounding this –
    1. Push for spending to help boost economic growth and to provide employment
    2. Investment speculation – from Super funds involvements – Government policy as well
    3. Also have large investment funds that are looking at this – if you cant beat them join them
  2. Not on railroads – but Mostly on the same thing – green infrastructure
    1. ROE – is it low or high? ROE is relatively low – it is high cost but thanks to Gov subsidies it can provide a profit – but what if these go away?
    2. Or – what if supply outstrips demand? If most of the projects over time have little demand – lower ROE – similar to the railroads – diminishing marginal returns on everything
    3. Interest rates are low – so the borrowing costs of any infrastructure will be low for some time
    4. and lots of funds will come from Governments or Super funds – so it isn’t their money
      1. Either invest the money in the project – or buy bonds in the project (capital notes) to finance them

Can the same thing happen as the crash –

  1. Not likely – there is a safety net now in the financial system and Central banks –
    1. Liquidity issues? More QE or bailouts –
    2. Super funds can put a lot of their money into this and have the guarantees of the debt not being too risky
    3. Especially in low interest rate world – but if we go through a new monetary system – if it creates higher interest rates then the amount of debt around would create massive issues
    4. But is it a good idea? Well time will tell – the debt on the infrastructure projects will be around for a while
  2. But may be a similar thing to Chinas WMPs – a shadow banking rolling ponzi scheme –
  3. Takes long time to get a return on infrastructure projects from implementation to be in working order –
  4. A lot can change in economic conditions over the 5-10 years it may take to see ROE on these projects
  5. Taking more debt out and if it isn’t quality investments – where supply outstrips demand – the infrastructure policy could be another trap in the future for another bubble and collapse

Thank you for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

Links –

https://resources.saylor.org/wwwresources/archived/site/wp-content/uploads/2011/08/HIST312-10.1.2-Panic-of-1893.pdf

https://www.federalreservehistory.org/essays/banking_panics_of_the_gilded_age

https://books.google.com.au/books?id=u_6uDAAAQBAJ&pg=PA170&lpg=PA170&dq=infrastructure+crash+1894&source=bl&ots=_OzgH-SsIv&sig=ACfU3U29tw7Dw11WpH2TKUM_HtYmjgBUlg&hl=en&sa=X&ved=2ahUKEwi55uymnPnpAhUZA3IKHWy3C1wQ6AEwEXoECAgQAQ#v=onepage&q=infrastructure%20crash%201894&f=false

How to avoid getting further into debt and get spending habits back in line

Welcome to Finance and Fury. Credit cards and pay day lenders are on the rise, as some of those out of work are becoming strapped for cash. Today, we look at this further but also look at some alternative strategies to avoid the debt traps. We’ll also look at how to...

What allocation has the most consistent returns?

Welcome to Finance and Fury. Sorry for the sporadic episodes – flat out with EOFY - In this episode we look at different asset allocations and how they have performed over time in relation to their returns as well as their risk – with a final focus on their risk...

The circular economy – The greatest barrier to competition and choice, or the saving grace for our futures?

Welcome to Finance and Fury, the Furious Friday edition Last week - went over partnership programs and potentials for coercive monopolies – today – implementation of policies in the circular economy – SDG12 Today’s ep – go through google and the largest companies on...

Are the risks from investments in structured products worth their potential returns?

Welcome to Finance and Fury, the Say What Wednesday edition. This week the question comes from Mina. “I would love to get your view on Structured products like the ones being offered by sequoia. Is the risk worth the return?” Great question – thanks Mina - this...

Buying Property inside an SMSF: Tips and traps, what works and what doesn’t

Say What Wednesday Buying Property inside an SMSF: Tips and traps, what works and what doesn't Welcome to Finance and Fury, 'Say What Wednesdays' where each week we answer your questions. This week's question is from Sandeep: “Hi, Can you please talk about how to...

When to refinance and negotiate value

Welcome to Finance and Fury. Today we have Jayden with us, and we will be talking about negotiating with banks and refinancing. Refinancing: Pros and Cons and how to negotiate Bank Valuations Interest rates might go up or might go down.so this is all about asking, is...

The future of property supply in Australia

Welcome to Finance and Fury. In this episode we look at the future of the supply of property in Australia. We will talk about the availability of land in Australia, look at the population density and supply of developments, as well as what the future supply has in...

Furious Fridays: The Death of Stalin

Furious Fridays The Death of Stalin Last episode we ended with Lenin’s death. The roll out of Communism was well underway and it was time for new leadership. One his last policies before he died in 1924 was the New Economic Policy (NEP) in 1922… A mixed economy put in...

Can a Central Bank go bankrupt and collapse the economy?

Welcome to Finance and Fury. Today we explore whether a Central Bank can go bankrupt and collapse the economy? In the modern state of the economy, if fiat money fails due to central banking errors, what does this mean for the global financial system and central banks?...

What is considered poor in Australia and how to become truly rich?

Welcome to Finance and Fury. I recently was reading an ABC article about the latest earnings reports from the Australian Bureau of Statistics (ABS) – revealing the average income in Australia – now this average is probably a little higher than what most people would...

Pin It on Pinterest

Share This