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April 02, 2007

Two Agents that Made a Great Bull Market Risk-free
by Bob Hoye

A great bull market involving stocks, commodities, and low grade bonds ran for a number of years and completed in 1873. During the latter part of it, Europe suffered a war and, with the usual strains found in credit markets, the establishment found two features that would eliminate risk.

One was that Treasury Secretary Richardson had immense abilities and powers that would prevent anything going wrong. Then, backing this up, was that the undersea telegraph cables could render the immediate transfer of the precise amount of liquidity to extinguish a problem.

A recent article by a well known historian observed that today's instantaneous news transmission will be less forgiving than in the past. Also noted was that long-distance communications "were a bit patchy" as far back as 1914.

This seems to be a limited step towards fully appreciating the role of "instantaneous communications" and phases of great excitements in the financial markets. Indeed, long distance communication was virtually made instantaneous in the late 1860s with wire services provided by cross-channel and transatlantic cable systems.

This, as well as the speed of the "new" ticker tape machines were important parts of the bubble in stocks, corporate bonds, and commodities that blew out in September, 1873. Western Union Telegraph was the popular big-cap high-tech stock.

On the way up the boom, the enthusiasm went beyond individual high-tech favourites and formed a consensus that instantaneous communication would provide ready assistance in staving off a liquidity problem. This was reviewed in contemporary publications.

The initial whiff of panic arrived in late September with the failure of Jay Cooke and Co. The immediacy of transmission is best appreciated by quoting directly from the October 4, 1873 edition of The Economist:

"The failure ...was known in London to the most important American houses, we believe, the very evening of its occurrence, and to all the world next morning."

As Cooke was a huge underwriter and distributor of bonds, the failure was serious. The article mentioned "cable transfers", which The Economist pointed out was the same as if "an indefinite amount" of liquidity had actually arrived.

The article observed that without this assistance the distress would have been greater than at anytime in the past. The words almost glowed:

"The contrast between what has happened now and what has happened in 1857, when there was no telegraph, is sufficiently striking. The American crisis of that year broke out at the end of September, but news did not reach England till nearly the middle of October, and shipments of gold [liquidity] were then started, but could not reach America or be known there till the beginning of November."

The article concluded with:

"The power [of the cable] gives of using prompt remedies; and it seems hardly possible to over-estimate the value of the services which the Atlantic Cable has now rendered."

This was written only a month after the leading New York newspaper, the Herald, had editorialized that the power of central government could be used to avert panics. Secretary of the Treasury, Richardson's, esteem was considerable and most believed proof against liquidity problems. At the time, the U.S. was between experiments in central banking and absent such an agency with the hindrance of a gold-convertible currency, it was argued that the Treasury could issue any amount of liquidity to stave off any problem.

The ironies with and subsequent to the appearance of financial stringency in that fateful September of 1873 are worth reviewing. The stock market crashed through October such that Western Union plunged from $90 in mid-September to $46 at the end of October. The instruction is that even with instantaneous "cable transfers" a highly speculative financial market recorded yet another typical September to November catastrophe.

Then, despite more time for more assistance, the global bear market endured until 1878.

This was accompanied by a global business contraction that lasted to 1879, afflicting most standards of living.

In 1874, the New York Commercial Chronicle reviewed the damage and The Economist summarized the study, in part, with:

"The almost universal excitement of 1871-73 had thoroughly disorganized both labour and commerce. The working people became intoxicated and unrestrained under rapid advances of wages and rapid diminution of the hours of work [due to trade union power]; and the excessive profits of the coal, iron, shipping, and other trades introduced into ordinary business a degree of recklessness which can only end in mischief."

As with the previous great bubble that climaxed in 1825, the post-1873 contraction was lengthy. The U.K. was the senior economy and leading economists called the period from 1873 to 1895 as "The Great Depression".

The ultimate irony was that economists were still analyzing "The Great Depression" as to how it happened, or been ameliorated, or even avoided - well into the 1930s.

This review briefly covers a couple of reasons why the establishment stayed too long during the financial mania that climaxed in 1873, which was fourth in a series of new financial eras that began in the early 1700s.

From the peak of the last business cycle with the "old" and disturbing era of inflation, all six such eras ran for nine years. Then the data are available to the month, which is the case for the 1929 and 2000 examples - the duration was 116 months.

The other reasons for using the 1873 example is that the U.S. dollar was fiat and Europe suffered the Franco-Prussian War of 1870 - 1871. Within this, Paris suffered bombardment and siege that threatened starvation.

So there are some similarities to the recent financial mania as it is being played out in the U.S.

As to a couple of the reasons why the crowd partied too late in 1873, one was that the Secretary of the Treasury had immense powers to prevent contraction. At the height of the boom, the Herald editorialized:

"Power had been centralized in him to an extent not enjoyed by the Governor of the Bank of England. He can issue the paper representatives of a score or more of millions ... it is difficult to conceive of any condition or circumstances which he cannot control."

In so many words, risk had been eliminated. This was reinforced by the new instantaneous communications that would render immediate assistance, should any be needed.

Essentially, there are two ways of reviewing financial history - one, the more popular, is to rewrite with little use of quotation. The other, for full effect, directly employs rich and vivid quotation.

This brief review will close with another from the always positive Herald. This irony was in claiming that a panic was not possible. After the initial phase of the crash (on October 1) the cheerleading continued with:

"A crisis in our financial dealings has been met and passed without loss of confidence, without fear, largely without distrust. Here are growth, understanding, increased knowledge, firmer reliance. [We have] safe engineers in time of peril."

According to mainline economists, The Great Depression ran from 1873 to 1895. At the height of the 1929 mania, the popular consensus was that the old, destabilized, and discredited Treasury System had been replaced by the vastly superior Federal Reserve System - whereby nothing could go wrong.

Bob Hoye
Institutional Advisors

The opinions in this report are solely those of the author. The information herein was obtained from various sources; however we do not guarantee its accuracy or completeness. This research report is prepared for general circulation and is circulated for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investors should note that income from such securities, if any, may fluctuate and that each securitys price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not necessarily a guide to future performance.

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Copyright © 2003-2008 Bob Hoye

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