wall street and main street: the macroeconomic consequences of new york bank suspensions,...

ORI GIN AL PA PER

Wall Street and Main Street: the macroeconomicconsequences of New York bank suspensions,1866–1914

John A. James • James McAndrews •

David F. Weiman

Received: 17 May 2010 / Accepted: 16 August 2012 / Published online: 31 August 2012

� Springer-Verlag 2012

Abstract Before the formation of the Federal Reserve, banking panics were

routine events in the United States. During the most severe episodes, banks in cities

across the country would often suspend or restrict the par convertibility of their

demand deposit liabilities. In diagnosing the causes of the Great Depression,

Friedman and Schwartz famously regard these local initiatives as a second best

solution, which in the absence of an effective lender of last resort would have

prevented the rash of bank failures during the early 1930s and their dire monetary

and real impacts. Recent research in macroeconomics though has raised the pos-

sibility that banks’ suspension of payments might also have negative real effects

albeit through changes in aggregate supply such as the financing of working capital.

We would expect to observe these negative shocks during the pre-Fed era, because

the decentralized, private interbank payments network was especially vulnerable to

systemic disruptions such as suspensions by New York and other money center

banks. Reports in national trade periodicals and local newspapers during suspension

periods offer many accounts of factories closing because of the inability to obtain

currency for weekly payrolls and ‘‘domestic exchange’’ to finance internal trade. We

corroborate these observations with more systematic econometric evidence at the

national and regional levels. Our results show that controlling for the overall con-

traction and bank failures, suspension periods were associated with a statistically

significant and quantitatively large decline in real activity, on the order of 10–20 %.

J. A. James (&)

Department of Economics, University of Virginia, PO Box 400182,

Charlottesville, VA 22904, USA

e-mail: [email protected]

J. McAndrews

Federal Reserve Bank of New York, New York, NY, USA

D. F. Weiman

Department of Economics, Barnard College, New York, NY, USA

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Cliometrica (2013) 7:99–130

DOI 10.1007/s11698-012-0083-x

Keywords Financial crises � National banking system � Panics � Payments system �Suspension of payments

JEL Classification E32 � G01 � N11 � N21

1 Introduction

Under the National Banking System (1866–1914), the United States experienced

periodic financial crises, often severe enough to occasion collective action on the

part of the banking system. To relieve pressure on their reserves, in 1873, 1893, and

1907 banks in many or most cities agreed to temporarily suspend or restrict cash

payments at par. During these periods, they limited or denied altogether the par

convertibility of their deposit liabilities into cash, specie, or legal tender notes

(Calomiris and Gorton 1991, 96–100).1 Surveying the pre-1860 experience in his

masterful book on The Ways and Means of Payment, Stephen Colwell (1859, 487)

clearly viewed the ‘‘suspension of payments’’ as the preferred solution to bank

panics. The alternative, paying out specie during such a period, compelled banks

… like Samson in the temple of the Philistines, to pull down the whole fabric

of credit, public and private, about the ears of the people, to disturb and check

the progress of industry in all its departments, to make bankrupts of their

customers, and to sow pauperism broadcast in the field of labor… The triumph

of banks which pass through a season of panic and revulsion without

suspending [is] a triumph like the victory which leaves 100,000 dead bodies

on the field of battle, which makes 10,000 widows, 50,000 orphans, and

200,000 paupers!

More recently and famously, Friedman and Schwartz (1963, 163–168) contrasted

banks’ responses to panics during the national banking era and the Great Depression

under the Federal Reserve System. Like Colwell, they argued that by exercising the

suspension option banks in the earlier period could effectively stop bank runs in

their tracks. ‘‘Restriction of payments thus protected the banking system and gave

time for the immediate panic to wear off, as well as for additional currency to be

made available’’ (1963, 167). To be sure, there were some exceptions to their

generalization that in August 1893 ‘‘restriction of cash payments brought to an end

the stream of bank failures’’ (1963, 110), as some 101 banks closed their doors even

after this date (Wicker 2000, 78–80). Still, the contrast between bank failure rates

during earlier crises with restriction periods and the Great Depression before

Roosevelt’s bank holiday is stark prima facie evidence in favor of their position.

Notwithstanding Dewald’s (1972) attempt to revive traditional arguments against

suspensions (see also Wicker 2000), the tide over the last half-century has run

1 Friedman and Schwartz (1963) preferred the terminology of restrictions of cash payments instead of the

more common contemporary term of suspension to distinguish it from the temporary closure of particular

beleaguered banks. But since both terms are used interchangeably in the literature, we shall do so here as

well. Only remember that by ‘‘suspension’’ we always mean a temporary restriction on par cash

payments, not a complete deferral of bank operations.

100 J. A. James et al.

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strongly in favor of the Friedman and Schwartz view. Temporary restrictions of cash

payments are now generally regarded to have greatly reduced, if not completely

arrested, the rate of bank failures during banking panics and thereby to have

dampened the rate of monetary and real economic contraction. This argument also

has garnered theoretical support in several formal models such as Gorton (1985a)

based on imperfect information and various extensions of the Diamond and Dybvig

(1983) sequential server framework (Chari 1989; Wallace 1990; Selgin 1993).

Empirically, Dwyer and Hassan (2007) compare the effects of falling prices of

southern and border state bonds in 1861 on banks in Wisconsin and Illinois. In

Wisconsin, where there was suspension, they find failure rates (44 %) and

noteholder losses lower than in Illinois (failure rate of 87 %) where there was not.

While Friedman and Schwartz (1963, 698) considered the restriction period in

1907 as a ‘‘therapeutic measure,’’ they conceded that there were some costs—‘‘short

but brief difficulties’’—as the non-bank public adjusted to the ‘‘use of two only

partly convertible means of payment—currency and deposits.’’ Still, they (1963,

167) insisted that these seemingly dire measures ‘‘could have continued for a much

longer period, as in some earlier episodes, without producing an economic

breakdown and indeed could have continued in conjunction with economic revival.’’

We, by contrast, see a more serious downside effect of banks restrictions on

currency payments. Despite offering temporary relief to local banks, these payments

disruptions could potentially destabilize the entire interbank payments system

centered in New York and in turn temporarily derail the macroeconomy.

The payments system encompasses the complex of financial instruments and

relationships that transfer value (or good funds) between buyers and sellers to

complete their transactions. Cash is the simplest means of payment, as cash

payments directly transfer good funds from buyer to seller and so constitute final

settlement without mediation by a third party. In other words, they bundle in the

same transaction the payments order transmitting the instructions to transfer funds

from buyer to seller and the actual funds transfers themselves. The vast majority of

transactions, especially in developed economies, involve non-cash payments

instruments like checks or credit card receipts. Unlike cash, they represent payment

orders directing the transfer of good funds between intermediaries and ultimately

each party’s transactions account. Banks therefore play a vital role in mediating

payments in a world where most transactions are not based on cash on demand

(COD). Indeed, McAndrews and Roberds (1999, 32) view the linking of buyer and

seller as the ‘‘initial and key role of banks,’’ with their financial intermediation

function linking lender and borrower as a consequence of their payments system

origins. The character and reliability of the payments system therefore is clearly a

crucial support to a market economy, and even local disruptions can have

potentially severe systemic effects on economic transactions and activity.

Modern-day studies of the impacts of panics and financial crises have

concentrated on the transmission channels of changes in interest rates and/or credit

availability (e.g., Mishkin 1996). Recent research in macroeconomics though has

raised the possibility that monetary changes might affect the real economy through

changes in aggregate supply as well as changes in aggregate demand. Contemporary

studies have generally emphasized the impact on investment in working capital and

Wall Street and Main Street 101

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consequently on the firm’s short-run ability to produce (Barth and Ramey 2002;

Christiano et al. 1997; Christiano and Eichenbaum 1992).

Here, however, we identify two other primary channels that would have worked

through suspensions. First of all, restrictions of cash payments can cause local

‘‘currency famines,’’ as cash was the principal method of payment for wages and

most retail transactions during the pre-Fed period. Second, in non-local payments,

suspensions by banks in nodal locations can have potential network effects resulting

in coordination failures. If banks prefer to synchronize payments outflows with

payments inflows, thereby funding outlays with cash flow receipts (see McAndrews

and Rajan 2000), disruptions or delays in remittances can lead to gridlock in the

payments system.2 Whether through ‘‘currency famines’’ or the ‘‘hemorrhaging’’ of

long-distance payments flows, the resulting aggregate supply dislocations could

have had pronounced real effects.3

Shocks that disrupt payment networks moreover can affect broader measures of

financial liquidity, which today can be observed in bid-ask spreads in financial

markets for example. Empirical evidence shows that various measures of financial

market liquidity in the U.S. Treasury bond as well as in the stock market are reduced

during periods of crises. It also demonstrates that unexpected injections of money

can neutralize these shocks by enhancing liquidity in these markets (Fleming 2003;

Chordia et al. 2004).

Serious payments system disruptions are of course still possible in the modern

economy. For example, the September 11 attacks on the World Trade Center

critically impaired the Fedwire large-value funds transfer system, but gridlock was

averted only through swift and decisive intervention by the Federal Reserve

(McAndrews and Potter 2002). The analogous problem in pre-Federal Reserve

period was not so readily solved, as both local and non-local transactions were

cleared and settled through private payments networks. New York correspondent

banks were central in these networks. They constituted the ‘‘clearing house of the

country’’ in O. M. W. Sprague’s phrase (1910, 126), holding interior banks’ (excess)

clearing and secondary reserves. Consequently, payments restrictions, especially in

New York, could significantly reduce access to ‘‘good funds’’ for local and non-

local payments and thereby impede normal operations of production and exchange

(i.e., reducing the liquidity of banks’ clearing and secondary reserves).

2 This applied to intercity remittances. Within cities, interbank payments were generally accomplished

by net settlement at the end of the day at the clearinghouse. Recent theoretical work also suggests that

delayed settlement in the payment system can exacerbate the resolution of uncertainty and credit risks

which regular settlement is designed to achieve (Koeppl et al. 2005). These disruptions caused by the

banking crises we study delayed settlements for both financial and real transactions. If the counterparties

could not costlessly resort to alternative means of settlement, which we assert they could not do, then real

risks and uncertainty in the economy persisted longer than anticipated, reducing the ability of

counterparties to take on new transactions or to extend additional credit.3 Yet, another channel in modern monetary theory is based on the idea that credit instruments act as a

social memory device for economic transactions (Kocherlakota 2000). If there is a disruption in the

system by which agents in the economy make long-distance monetary transfers, as occurred during the

panics under review, they must turn to less well-suited instruments (such as cash transfers) to accomplish

the information-tracking task that the drafts and checks performed during normal times. This adjustment

constitutes a supply shock as well, because it increases producers’ information costs.


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Our argument is developed in six parts. In Sects. 2 and 3, we provide the

necessary background: a brief description of pre-Fed private payments networks and

chronology of the 1873, 1893, and 1907 panics. Section 4 details the varied impacts

of the 1893 and 1907 banking crises on the local and long-distance payments

systems, and Sects. 5 through 7 offer empirical support for this counterview,

graphically (in Sect. 5) and econometrically at the aggregate and regional levels

(Sects. 6 and 7 respectively). In the conclusion, we offer some thoughts on the

formation of the Fed and its interventions in the payments system.

2 Payments networks

After the demise of the Second Bank of the United States (in 1836), long-distance

payments posed a difficult problem in a country characterized predominately by

independent unit banks with no central monetary authority or integrated nationwide

banking system (see Knodell 1998). Buyers or their intermediaries could have

shipped specie to payees, but a system of intercity payments involving the physical

transfer of cash to settle every transaction would have been both costly and risky.

Due to the prohibition against branch banking, the clearing and collection of long-

distance financial obligations could not be internalized through the formation of

large-scale enterprises like in other key sectors of the economy (Chandler 1977).

Monetary integration, then, depended on the formation of a ‘‘national’’ banking

system to transfer deposits among independent banks without excessive cash

shipments. Instead, banks developed two types of private networks to facilitate

interbank transactions, local clearinghouses, and correspondent relationships.

In the 1850s, banks in New York, Boston, Philadelphia, and Baltimore formed

clearing associations for the collection and clearing of local checks (Cannon 1910;

Gorton and Mullineaux 1987). The spatial gap in the payments system between

local clearinghouses and between city and country banks was filled by correspon-

dent relationships. Earlier on, ‘‘country’’ banks routinely maintained reserve

balances in commercial centers, notably Boston and New York, for the redemption

of their banknote issues (see Myers 1931; Weber 2003), and by mid-century, a

‘‘system’’ of bank correspondents with New York as a national center mediating

interregional payments had begun to emerge (Bodenhorn 2000, 192–198). Based on

longer-term relationships between independent banks, correspondent networks

constituted a novel organizational form, something between tighter urban clearing-

house ‘‘clubs’’ that restricted membership and actively monitored member

operations and arms-length contractual relationships in a competitive market.

As the national ‘‘jobbing’’ center in the wholesale distribution trade, New York

became the national center for clearing and settling interregional payments.

‘‘Tradesmen everywhere have dealings with New York City. There is not a store in

the country which does not receive either directly or indirectly certain of its supplies

from that city’’ (Johnson 1905, 79). New York funds were readily acceptable means

of payment everywhere because so many agents made payments there. Drafts or

other credit instruments drawn on a local bank’s correspondent account and payable

in New York City consequently became the most common medium for settling


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debts not just between interior cities and New York, but even between agents in

different communities. With the diffusion of deposit banking toward the end of the

nineteenth century, checks drawn on individual accounts began to displace New

York drafts as the preferred payment instrument in intercity trade. Banks still relied

on correspondents to collect checks drawn on ‘‘foreign’’ banks and to settle their

balances. These interbank settlement payments, as before, were generally accom-

plished by the issue of a draft on a financial center, usually a New York bank.

In the course of providing routine payment services to business customers, banks

would deplete and replenish their correspondent accounts. In addition to buying New

York drafts to make long-distance payments, business customers sold exchange to

their banks by depositing drafts or check payments drawn on a New York (or other

money center) bank. Banks would remit these items to their correspondent for

collection and receive payment usually in the form of ledger entries to their

correspondent account, rather than shipments of cash. In turn, at any point in time,

they could find themselves with deficient or excess funds in their correspondent

accounts. To remedy these imbalances, banks could arrange to ship cash to or from

their correspondents, but would then incur significant transactions costs and risks.

As an often cheaper alternative way to manage their portfolio of clearing reserves,

local banks developed a ‘‘wholesale’’ or interbank market where they bought and sold

surplus correspondent balances. In normal times, they would, for example, purchase a

New York deposit with vault cash and simply convert one form of excess (or clearing)

reserve into another. The price of a New York deposit or the New York exchange rate

in terms of local money was in principle fixed at one, since both locations were on the

same (gold) dollar standard and New York banks pledged to redeem their deposits for

legal tender money at par on demand. Depending on local demand–supply conditions,

the spot price of New York exchange in, for example, Chicago could deviate from

mint parity but only within bounds set by the currency points, the cost of transferring

good funds from Chicago to New York or vice versa. Analogous to the operation of

the fixed exchange rate gold standard, any larger deviation in domestic exchange rates

would elicit interregional/intercity currency flows.

Continuing our analogy to the gold standard, banks’ restriction of payments in

panic periods represented a temporary suspension of the domestic monetary ‘‘rules

of the game’’ (Bordo and Kydland 1995). The New York exchange, now the price of

a New York deposit in terms of a Chicago deposit for example, could vary more

widely, as it depended as well on the currency premiums in the two locations—the

price of legal tender money in terms of a less liquid bank deposit. Consequently,

sharp deviations in New York exchange rates outside of the normal bounds

constitute prima facie evidence of an effective restriction period.

3 The panics of 1873, 1893, and 1907

We offer here the tersest chronologies of the panics and suspensions of 1873, 1893,

and 1907. More detailed accounts may be found in Sprague (1910), Kemmerer

(1911), and Wicker (2000). In 1873, the period of financial turbulence began with

the failure of the New York Warehouse and Security Company on September 8,


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which was ‘‘not regarded at the time as having any general significance’’

(Commercial and Financial Chronicle, September 20, 1873, 382). Conditions

thereafter deteriorated, leading to the hallmark collapse of the (until then) esteemed

private banking house of Jay Cooke & Co. on September 18. Plummeting stock

prices led to the closure of the New York Stock Exchange for 10 days. In response,

the New York Clearing House Association on September 20 authorized the issue of

clearinghouse loan certificates, which was accomplished on Monday, September 22.

Devised in the Panic of 1857, these loan certificates were issued in every

significant financial crisis thereafter (Dunbar 1906, 78–94; Cannon 1910, 75–136;

Myers 1931, 97–102; Timberlake 1984; Gorton 1985b; Roberds 1995).4 Application

was made to the Loan Committee with collateral offered in 1857 of New York state

bank notes, later of specified bank portfolio assets. If the security was deemed

acceptable, loan certificates were issued up to a percentage of the market value of

the securities. They typically carried a 6 % interest charge and could be used to

settle internal clearing balances within the clearinghouse, preventing currency

drains to other local clearinghouse banks. Banks could thereby be freed to pay out

currency to their depositors.5

The panic nevertheless spread quickly down the east coast and into the interior. New

York banks suspended cash payments several days later on Wednesday, September 24,

and they were soon followed by banks in cities across the country (Sprague 1910,

65–66). Typically, suspension was a last resort after loan certificates had already been

issued—only in 1907 did the issue of loan certificates and suspension coincide in New

York. The suspension period lasted just over a month. Particulars are displayed in

Table 1 (Sprague 1910, 35–71; Roberds 1995, 21–23; Wicker 2000, 16–26).

In 1893, the New York stock market collapsed in early May, with the failure of the

National Cordage Trust. Most of early financial disruptions, however, occurred in

interior cities rather than in New York, with panics and bank runs in several interior

cities. These continued through July in such cities as Portland, Kansas City, Denver,

and Louisville (Wicker 2000, 65–77). In view of the resultant cash drains to the interior,

the New York Clearing House on June 15 authorized the issuance of clearinghouse loan

certificates as a precautionary measure. But with continued external drains on reserves,

New York banks restricted cash payments on August 3, strongly limiting but not

completely prohibiting cash payments to liability holders. This decision was followed

immediately by banks throughout the country. The restriction in New York was not,

however, complete, and banks continued to ship cash to some degree to interior banks

4 Loan certificates were issued in 1860 through 1864 in New York; in 1873 in New York, Boston,

Philadelphia, Baltimore, Cincinnati, St. Louis, and New Orleans; in 1879 in New Orleans; in 1884 in New

York; in 1890 in New York, Boston, and Philadelphia; and in 1893 in New York, Boston, Philadelphia,

New Orleans, Buffalo, Pittsburgh, Detroit, Atlanta, and Birmingham (Cannon 1910, 75–116). In 1907,

according to Andrew (1908b), clearinghouses in 41 of the 145 cities surveyed issued these large-

denomination clearinghouse loan certificates.5 The decision to issue loan certificates involved significant conflicts of interest within the clearinghouse,

among other things between considerations of avoiding the effects of panics and resultant decreases in

profits on the one hand and giving aid to commercial rivals on the other (Goodhart 1988, 38–39; Roberds

1995, 19; James and Weiman 2005). In July 1893, for example, 78 % of interbank settlements in the New

York Clearing House were accomplished with loan certificates; in August, it was 95 % (Sprague 1910,

182).


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drawing down their bankers’ balances (Sprague 1910, 177–178, 182). The period of

restriction for New York banks lasted around 1 month with resumption there beginning

on September 2. Again, Table 1 summarizes the details.

The 1907 panic, in contrast to 1893, was more similar to those in 1873 and 1884

(though the latter did not result in general suspension and so is not discussed here). The

initial crisis occurred among New York banks and then radiated out to the interior.6 On

October 16 after the collapse of a copper corner by Augustus Heinze and of two of the

brokerage houses involved, runs developed on three banks associated with Heinze.

Assistance from the New York Clearing House preserved the Heinze banks, but the

financial disturbance began in earnest less than a week later with runs on New York

trust companies. While a money pool organized by J. P. Morgan fended off disaster for

the trust companies in the near term, interior bank withdrawals from national banks led

the New York Clearing House to issue clearinghouse loan certificates and suspend cash

payments on October 26. Virtually a nationwide restriction of payments followed the

New York banks’ decision (see Chicago Tribune, October 27, 1907, 1). They did not

resume cash payments until after the first of the year, a period of suspension more than

twice as long as in 1893. Yet again, the chronology appears in Table 1.

4 Payments disruptions

Decisions regarding when to restrict and resume cash payments were generally made

by local clearinghouses.7 In the great majority of cases (of which we know),

Table 1 Panics of 1873, 1893, and 1907

1873 1893 1907

Panic onset Sept 18 May 1 Oct 21

Issue of clearinghouse loan certificates in NYC Sept 22 June 21 Oct 26

Aggregate loan certificate issue, NYCH ($ million) 26.6 41.5 101.0

Maximum amount outstanding ($ million) 22.4 15.2 38.3

Bank reserves of NYCH members ($ million)a 57.1 95.6 121.0

Ratio of maximum certificates issued to reserves (%) 39.2 15.9 31.7

Loan certificate issue nationwide ($ million) – 69.1 238.1

Restriction of cash payments in NYC Sept 24 Aug 3 Oct 26

Resumption of cash payments in NYC Nov 1 Sept 2 Jan 1

Sources: Andrew (1908b, p. 507), Sprague (1910, pp. 34, 145, 163, 261–262, 432–433), Roberds (1995),

Wicker (2000, pp. 9, 121)a On May 6, 1893; Oct 19, 1907

6 Hanes and Rhode (2011) argue, however, that the fundamental roots of financial crises in the United

States under the gold standard lay in fluctuations in the cotton harvest.7 There are some exceptions, of course. In 1907, for example, the governors of Oklahoma, Nevada,

Washington, Oregon, and California declared legal holidays, allowing individual banks to choose whether

to restrict payments. In several mid-western states, bank commissioners and superintendents made it

known that they would not look askance if banks decided to restrict payments; some even suggested it as

an option (Andrew 1908b, 498–500).


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however, they followed the timing of the New York Clearing House. To be sure,

restriction in New York did not instantly result in uniform restriction of payments

across the country. Even in 1907, when restrictions were said to have been the most

widespread, there were pockets of cash payments. Among banks in financial centers,

only those in Washington, DC, did not restrict payments. And according to Andrew’s

survey of 145 independent cities with a population (in 1900) over 25,000, banks in

only 53 (or just over one-third) did not restrict cash payments (1908b, 438–446).8

Just as there was variation in the geographical extent and timing of cash

restrictions, so also did the restrictions practices differ across cities. In New York in

1907, as in earlier episodes, restrictions on cash withdrawals were ‘‘discretionary.’’9

This seems to have been the standard policy in major financial centers including

Boston, Chicago, Philadelphia, St. Louis, and San Francisco. In other cities, explicit

limits were often placed on the magnitude and frequency of cash withdrawals such

as $50 per day or $100 per week in Atlanta, $50 per day in New Orleans, and $200

per customer in Peoria (Andrew 1908b, 440–443).

Such constraints on deposit customers might have had relatively little effect on

local transactions, if agents were content simply to deposit check payments into

their account. During suspensions, banks remained open and performed regular

functions (except paying cash for bank liabilities at par on demand). Checks were

routinely stamped ‘‘payable through the clearing house’’ and credited to individual

accounts. But to the extent that checks were not readily acceptable everywhere and

that recipients were not content simply to deposit them into their accounts, such

limitations most probably had serious and immediate effects.10 Bank deposit

liabilities then did not fully fulfill their medium of exchange role. Rockoff (1993)

argued that this fact alone represented a decrease in the quality-adjusted money

supply and could have disrupted planned spending.

The impact of restrictions in paying out cash would of course have fallen most

heavily on deposit-holders who needed currency to meet obligations. Wages were

typically paid in cash. Indeed, most households at this time did not maintain

checking accounts. Business firms therefore, unable to procure cash to meet

payrolls, were forced to lay off workers and shut down plants. In July 1893,

newspapers published many accounts of factories closing due to failures, inability to

make collections or to obtain credits from banks, but by August, after restrictions

were imposed, the most frequently cited cause had become the inability to procure

8 In Andrew’s ‘‘roll of honor,’’ those with populations greater than 100,000 included Rochester (NY),

Toledo (OH), Worcester (MA), Patterson (NJ), and Scranton (PA). He found only six states (Maine,

Vermont, South Dakota, Montana, Idaho, and Wyoming) in which there was no record of restrictions of

payments, but in several of those, there was no city of greater than 25,000 population and hence no

information on doings there (p. 446).9 Refusals by New York banks to pay out cash for their interior correspondents in 1907 are described in

Senate Document No. 435 (U.S. Senate 1908). As for 1893, ‘‘the majority of New York institutions

continued to pay cash on demand to all depositors, and those which did refuse cash payments not only

offered to such depositors checks on other banks, but cashed small checks without inquiry,’’ but ‘‘the

banks which did shut down on cash payments to depositors included several of the soundest institutions in

the city’’ (Noyes 1894, 26–27).10 Kroszner (2000, 162), au contraire, argued ‘‘the temporary suspension of cash payments in late 1907,

while causing some inconveniences, allowed the banks to continue to provide payments functions….’’


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cash to make payrolls (Sprague 1910, 202–203; see also Bradstreet’s, August 12,

1893, 511; Stevens 1894, 137; and Noyes 1894, 28). Speaking of August 1893, the

Commercial and Financial Chronicle (September 16, 1893, 446) observed, ‘‘Never

before has there been such a sudden striking cessation of industrial activity. Nor was

any section of the country exempt from the paralysis: mills, factories, furnaces,

mines nearly everywhere shut down in large numbers, and commerce and enterprise

were arrested in an extraordinary and unprecedented degree.’’ Toward the end of the

month, however, some factories began to reopen and cash payments were restored

in September.

Difficulties in meeting cash payrolls, however, appeared to have been less

pronounced in 1907 than in 1893 (Sprague 1910, 290), even though Andrew judged

the 1907 panic as the more disruptive to local payments.11 ‘‘Probably the most

extensive and prolonged breakdown of the country’s credit mechanism which has

occurred since the establishment of the national banking system… Even during the

critical periods of 1873 and 1893 it is unlikely that as many banks limited the

payment of their obligations in cash’’ (Andrews 1908b, 497). The 1907 panic was

characterized by the extensive issue of local emergency currency or currency

substitutes.12 Banks in many localities issued small-denomination clearinghouse

certificates, obligations of the clearinghouse which could circulate from hand to hand

(as opposed to the traditional large-denomination ones used in interbank settlement);

clearinghouse checks, again typically in small denominations and payable through

the clearinghouse (i.e., not convertible into cash) but drawn on particular banks;

cashier’s checks in convenient denominations which were ‘‘practically circulating

notes’’; New York drafts in denominations of $1 up (in Birmingham); negotiable

certificates of deposit to be used in local payments; and finally, pay checks drawn by

bank customers upon their banks in small denominations and used for payments of

wages (widely used in Pittsburgh) (1908b, 506–512). These currency substitutes,

although of dubious legal status, were not just tolerated but widely embraced.

Andrew (1908b, 516) concluded that they ‘‘worked effectively and doubtless

prevented multitudes of bankruptcies which otherwise would have occurred.’’

Such issues, designed to be held by the public, appeared first in 1893 and

flowered in 1907. They supplemented in local payments the large-value clearing-

house loan certificates described in the previous section, which provided liquidity

for settling internal interbank transactions. Andrew estimated the total volume of all

cash substitutes outstanding during the 1907 restrictions at over $500 million, as

11 Although the Chicago Tribune (November 23, 1907) noted that ‘‘some plants are idle because of the

difficulty experienced in obtaining cash with which to pay employees…’’ Sprague (1910, 71) also

suggested that payroll difficulties in 1873 were less pronounced than in later suspensions because wages

were typically paid monthly rather than weekly. Nevertheless, he cited a number of reports of plant

closures in 1873 as a consequence. In any case, they were relatively short-lived, however (as in 1893),

having essentially disappeared within a month, after mid-October. ‘‘Their place was taken by far more

serious causes of trouble, which were not, however, of a banking nature’’ (pp. 72–74).12 These instruments were employed in 1893 as well, although not to the extent as in 1907. Warner

claimed, for example, that clearinghouse certificates were frequently issued, particularly in the Southeast,

in towns where no clearinghouse existed—‘‘a travesty on the paper after which they were named’’ (1896,

71). He estimated ‘‘vaguely’’ around $80 million of emergency currency put in circulation (p. 73), or

about 8 % of the stock of high-powered money (Friedman and Schwartz 1970, 6).


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compared with a currency stock of $1,810 million in 1907 IV (Friedman and

Schwartz 1970, 65). ‘‘For 2 months or more these devices furnished the principal

means of payment for the greater part of the country, passing almost as freely as

greenbacks or bank-notes from hand to hand’’ (1908b, 515).13

During periods of cash restriction when the convertibility of bank balances into

currency at par could have been limited, a free market developed in New York

(most importantly) and other cities (such as Boston, Philadelphia, and Chicago)

where currency could be purchased with deposits (at a premium, needless to say).14

‘‘No civilized nation has ever experienced such a currency famine [in 1893]’’

(Warner 1896, 71). Demanders of cash included merchants, firms in order to meet

payrolls, and interior banks that needed to meet the withdrawal demands of their

country correspondents.15, 16 The daily currency premia in New York during the

suspensions of 1873, 1893, and 1907 against the number of days elapsed since the

onset of suspension are pictured in Fig. 1. The range between the high and low for

the day is shown for 1873 and 1907, while for 1893 it is the range between the

average daily buy and sell values.17 Although the premium reached 5 % in 1873, in

later suspensions it never rose above 4 %.18 One factor contributing to the day-to-

day variation in the premium was the timing of gold shipments from Europe.19 One

13 The largest component of this total, however, remained the traditional large-value clearinghouse loan

certificates ($238 million as compared with an issue of $69.1 million in 1893) (see Table 1).14 The currency premium apparently applied to all forms of currency, not just gold. The Commercial andFinancial Chronicle (5 August 1893, 196) noted the premium on small note currency, while a week later

it observed that ‘‘all kinds of currency’’ were in demand ‘‘even standard silver dollars’’ (12 August 1893,

232).15 In 1893, the early large purchasers were interior banks. ‘‘Then the premium declined, owing to a

smaller demand which was confined largely to those requiring money for pay-roll purposes,’’ with the

peak on August 19 resulting from the renewal of purchases by banks (Sprague 1910, 188). Andrew

(1908a, 291) similarly attributed the initial currency premium in New York at the end of October 1907 to

Western banks that paid ‘‘a bonus for large blocks of money.’’ These demands were supplemented by

‘‘orders from large mill-owners and manufacturers who were supplied with sufficient money to meet pay-

roll demands.’’16 Hoarding was stimulated by the incipient and actual currency premium. During the panic week in

October 1907 culminating in the declaration of suspension on Saturday, about six times the normal rate of

safe deposit boxes were rented. Similar surges in demand also occurred in Boston, Chicago, St. Louis, and

San Francisco. Interior country banks as well as individuals were enthusiastic hoarders. Their gain in cash

reserves was almost equal to the loss of cash by central reserve city banks over the same period. As

Andrew (1908a, 298) observed, ‘‘The most extraordinary aspect of the matter is that the hoarding of

reserves occurred for the greater part in places where cash payments were suspended by the banks and at a

time when the banks were inundating their respective communities with illegal money substitutes.’’17 Possibly, the reported low and high figures in 1873 and 1907 might have been prices paid by brokers

and retail prices paid by customers, respectively (as in 1893), so the daily bands measure the spread rather

than the range of intraday fluctuations (Sprague 1910, 57).18 However, Andrew (1908a, 290–291) noted that ‘‘even in the dire vicissitudes’’ in France in its war

with Prussia ‘‘the premium paid for coin rose only once to the level of 4 %, a surplus price which was

frequently paid for currency in New York during November, 1907.’’ On the other hand, Noyes (1894, 28)

attributed the fact that the premium never rose ‘‘exorbitantly high’’ to the expectation that early

resumption of cash payments by banks was ‘‘universally expected.’’19 Indeed during the month of suspension, August 1893, over $40 million in gold was imported from

Europe to New York, a sum greater than the cash sent from New York to the interior. At the same time,

European gold was also shipped directly to some other cities, such as Chicago (Sprague 1910, 190–195).


123

guess put the volume of transactions in 1893 at around $15 million (Noyes 1894,

29).

The issue of currency substitutes may well have mitigated the problems in making

local payments in many cities, but there was no such substitute available to offset the

dislocations of the non-local, interregional payments system.20 Network or coordi-

nation problems among intercity banks interfered with normal settlement procedures.

01

23

45

high

/low

high

/low

0 10 20 30

dayselapsed

perc

ent

perc

ent

perc

ent

1873

01

23

45

sell/

buy

0 10 20 30dayselapsed

1893

01

23

45

0 20 40 60

dayselapsed

1907

Fig. 1 Currency premiums in New York. Sources: Andrew (1908a), Sprague (1910, pp. 57, 187,280–282)

20 A resolution of the Merchants’ Association of New York passed on November 21, 1907, read in part:

‘‘Checks payable ‘through clearing-house only’ are useful for local settlements, but do not pay non-local

debts. The business of all large manufacturing and mercantile concerns is chiefly non-local, and cannot go

on if local funds are everywhere tied up. Interstate exchange is essential to the conduct of interstate

business, and this constitutes the greater part of our domestic exchanges. Provision for the settlement of

local indebtedness is helpful, but provision for the settlement of non-local indebtedness is essential, and,

therefore, still more helpful’’ (Bankers’ Magazine, December 1907, 970).


123

With the timeliness and predictability of intercity payments disrupted, the only

alternative was in many cases shipping currency (if available). Most basically, some

banks simply refused to accept or collect out-of-town checks. The New Orleans agent

of Bankers’ Magazine reported in 1873, for instance, the ‘‘refusal of the western and

other banks to receive checks on New York, as is the regular course in the settlement of

collections made here for their account’’ (November 1873, 385).21 Access to New

York balances, the fundamental interregional means of payment and settlement

medium, was similarly disrupted. The Comptroller of the Currency (1907, 70) noted

that ‘‘all domestic exchanges were at once thrown into disorder and the means of

remittance and collection were almost entirely suspended… This [derangement of the

machinery for making collections and remittances] has interfered with every kind and

class of business and led to great curtailment of business operations of every kind.’’22

Domestic exchange rates on New York, which in normal times were bounded by

the cost of shipping currency, rose or fell to dramatic levels, and on a number of

days, the market for New York exchange in interior cities simply dried up

altogether. In 1893, New York funds often sold at extraordinary discounts in mid-

western cities; in Chicago, for example, discounts reached $30 per $1,000 New

York as compared with normal levels of 50¢ or less.23 In 1907, these large discounts

gave way to substantial premiums, peaking at $2.50 per $1000 of New York funds

in the Chicago market. Moreover, the Chicago Tribune reported transactions on

only 1 day over the nearly two-week period from October 23 to November 4, 1907.

The reasons behind this dramatic shift from large discounts to premiums during

the 1893 and 1907 crises are discussed more fully in James et al. (2011). For our

purposes here, we emphasize two salient factors. On the demand side, banks after

the 1893 crisis depended increasingly on their New York correspondents and

exchange for settling customers’ long-distance check payments, but also for vital

securities and foreign exchange transactions (James and Weiman 2010). Their

responses to the 1907 crisis, individually and collectively through the clearinghouse,

disrupted the main sources of supply. Unlike under normal conditions, banks could

not rely on the regular channels of clearing and settlement to replenish their New

York balances. In local clearinghouses, deficit banks were more likely to settle their

accounts in loan certificates than in cash or with a New York draft.24 Without

21 Similarly, in 1893, Louisville banks were reported to have declined to receive country checks ‘‘even

for collection’’ and preferred not to ‘‘handle’’ New York exchange (Bradstreet’s, August 12, 1893, 511).

Or else, it became very expensive to use such payments instruments. In 1893, Sprague (1910, 206)

claimed that ‘‘drafts were often of little or no utility to the holder because the banks refused to take them

except at a ruinous discount or for collection.’’22 Just as was suggested with regard to payroll difficulties, Sprague (1910, 75–77) argued that the

‘‘dislocation’’ of the domestic exchanges had less serious consequences in 1873 than later because

markets had been less integrated geographically. Moreover, the exchanges then while ‘‘deranged for a

time… were never completely blocked [except in Chicago].’’23 The large relative premia of local funds relative to those in New York were not simply the result of the

interior origins of the Panic of 1893. In the Panic of 1873, which did originate in New York rather than in

the interior, domestic exchange rates in Chicago also fell dramatically, reaching levels of -$35.24 As striking evidence of this trend, the Independent Treasury withdrew from the Boston clearinghouse

on 30 October, precisely because it could not accept bank liabilities in the form of loan certificates in

settling its accounts (Boston Globe, 31 October 1907, 7).


123

recourse to an emergency currency in long-distance payments, banks resorted

to even more dire measures; they effectively ignored collection notices and

either delayed payment or just refused to settle in New York funds (Sprague

1910, 296–298).25 On the flip side, if banks in, for example, Chicago could not

expect distant counterparties to settle their payments obligations promptly, then

they would likely respond in kind and transmit the liquidity shortage to other

centers.

Facing these supply uncertainties, banks were reluctant to sell their excess New

York funds in local markets even at a premium and to run the risk of future costly

shortfalls. Their hoarding of New York exchange, of course, only reinforced this

classic coordination failure by diminishing the liquidity of domestic exchange

markets—the marginal source of New York funds in commercial centers. While

Sprague (1910, 294–296) blamed banks for their short-sighted reactions, he did not

fully appreciate their dilemma. Without more systemic interventions in this case by

the U.S. Treasury, they had little recourse other than ‘‘to strengthen themselves

regardless of the consequences.’’26

Such interferences with long-distance payments and hence with the smooth

functioning of the payments system should have had an adverse effect on internal

trade. Bradstreet’s in 1893 noted ‘‘the clog to trade shown by prohibitive rates for

New York exchange at centers east, west, and northwest’’ (August 5, 1893, 495).

The Commercial and Financial Chronicle (September 16, 1893, 446) seconded that

observation:

the derangement of our financial machinery, which made it almost impossible

to obtain loans or sell domestic exchange, and which put money to a premium

over checks, had the effect of stopping the wheels of industry and of

contracting production and consumption within the narrowest limits, so that

our internal trade was reduced to very small proportions—in fact was brought

almost to a standstill—and hundreds of thousands of men thrown out of

employment.

Similarly, the Wall Street Journal observed in 1907 the ‘‘disorganization of

domestic exchanges … prevents the free movement of commodities for export’’

(December 2, 1907, 8).

25 According to Sprague (1910, 297–298), banks also refused to grant customers immediate credit for the

deposit of ‘‘foreign,’’ that is non-local, checks and instead made them wait for the funds until the items

were cleared and settled.26 An agent reported to Bradstreet’s from Philadelphia: ‘‘The scarcity and high rate of exchange on New

York has no doubt militated against the customary prompt settlements with that city, the banks for the

reason named being unwilling to part with their currency’’ (29 July 1893, 480). Similarly, Noyes (1894,

26) observed that in 1893 even before formal cash restrictions ‘‘country banks were charged with refusing

to remit their cash collections… The express companies did a very large business, during the panic, in

presenting out-of-town checks at the banks on which they were drawn, and bringing the money to the city

bank whence the check was remitted. The out-of-town banks frequently resisted this by paying in silver

dollars or fractional coin. Domestic exchange between two great Eastern cities was at one time fixed by

the express charges for transporting silver dollars.’’ And as well ‘‘banks in some larger cities were next

accused of withholding similar remittances.’’


123

The grain trade seemed to have been particularly affected. ‘‘Naturally, there has

been some dislocation of the nation’s business, notably in domestic exchanges,

which has reacted on the collecting and forwarding forces by a time stopping the

buying of wheat in the Northwest and of cotton at the South’’ (Bradstreet’s,

November 2, 1907, 698). By mid-month, ‘‘one especially hopeful sign has been

renewal of grain purchases in the Northwest, exchange checks on larger interior

markets being the medium of exchange, thus allowing of the resumption of grain

forwarding…’’ (November 16, 1907, 730).27 In the flour trade, ‘‘shipments [were]

falling off by reason of difficulty in financing drafts, and the wheat price is now

secondary to the question of finance’’ (Bradstreet’s, November 23, 1907, 747).

5 Graphical analysis

It is, of course, impossible to isolate precisely the real impact of payments

disruptions from the concurrent effects of the credit contraction during panic and

cash restriction periods.28 But we shall try. In this section, we present some

graphical evidence; in the next two, more systematic econometric results at the

national and regional levels. In 1893 panic, payments disruptions preceded general

cash restrictions in several interior cities; in 1907 panic, cash restrictions were only

days apart (October 21 and 26, respectively). That said, the economy did seem to go

into a tailspin during periods of restrictions of cash payments. These episodes are

quite clear in the data.

Figure 2 presents monthly figures for three measures of trade and economic

activity before, during, and after the 1893 and 1907 crises—railroad freight ton-

miles, pig iron production, and the Babson (physical quantity) index of business

activity (U.S. Bureau of the Census 1949, 332–334; Moore 1961, 130). The Miron–

Romer index of industrial production (1990) is shown in Fig. 3. The NBER-dated

business cycle peaks came in January 1893 and May 1907 (Burns and Mitchell

1946, 78). Clearly the graphs show little indication of a serious downturn in either

case until the onset of the financial panics in May and particularly June 1893 and

October 1907, after which time the indicators fall sharply. The months bracketing

the restriction periods—July and September in 1893, October and January (1908)

for 1907—are marked by vertical lines.

The pronounced declines in the series during the cash restrictions period in 1907

are evident. In 1893, the sharp decline begins in June but accelerates with cash

restrictions after July, although this is less evident to the untrained eye. Moreover,

rather dramatically in virtually every case, the decline stops and/or the series turn up

with the resumption of cash payments in September 1893 and January 1908. Sprague

(1910, 201–202) observed for the 1893 crisis: ‘‘Much of the decline in August, with

27 Disruptions in the foreign exchange market had similar effects. In 1873, the Chicago Tribune reported

that ‘‘the shipping movement was partially paralyzed by the news from New York that sterling exchange

was unnegotiable.’’ Shipments of wheat to Atlantic ports were interrupted and grain elevators became

‘‘crowded to their utmost capacity’’ (September 20 and September 25, 1873).28 Between the May 4 and October 4 call dates in 1893, loans of national banks fell by almost 15 %

(Sprague 1910, 208).


123

freighttonmiles billions ofton-miles, seasonally adjusted

Fre

ight

ton-

mile

s, 1

893

date

01/9

305

/93

07/9

308

/93

09/9

312

/93

7

7.58

8.5

pigironproductiondaily average in thousands of gross

Pig

iron

pro

duct

ion,

189

3da

te01

/93

05/9

307

/93

08/9

309

/93

12/9

3

10152025

babsonindex1923-27=100

babsonindex1923-27=100

Bab

son

inde

x of

bus

ines

s ac

tivity

, 189

3da

te

01/9

305

/93

07/9

308

/93

09/9

312

/93

202530

freighttonmiles billions ofton-miles, seasonally adjusted

Fre

ight

ton-

mile

s, 1

907

date

01/0

705

/07

10/0

701

/08

16182022

Pig

iron

pro

duct

ion,

190

7da

te01

/07

05/0

710

/07

01/0

8

304050607080

Bab

son

inde

x of

bus

ines

s ac

tivity

, 190

7da

te01

/07

05/0

710

/07

01/0

8

405060

tons, seasonally adjusted

pigironproductiondaily average in thousands of gross

tons,seasonally adjuste

Fig

.2

Mo

nth

lyin

dic

ato

rso

fec

on

om

icac

tiv

ity

in1

89

3an

d1

90

7.

So

urc

es:

See

tex

t


123

the subsequent partial recovery, can only be ascribed to the trade paralysis produced

by the financial situation at that time.’’ Of course, the economy only stabilized rather

than bouncing back after resumption, but ‘‘after the beginning of September the

course of the crisis of 1893 was no longer a banking affair’’ (p. 209).

For most of the data series, the declines over the periods of cash restrictions in

1893 and 1907 are quite comparable. The Miron–Romer industrial production

index, for example, fell by 16.7 % between July and September in 1893 and by

21.7 % between October 1907 and January 1908.29 The period of cash restriction

was twice as long in 1907 as in 1893, so if one thinks of the effects of restriction as

being a continuing process—the difficulty of obtaining cash to meet local payrolls

or of making payments at a distance—then the per month real effects of restriction

in 1907 were less severe than in 1893, even though the cash restrictions in 1907

have been characterized as both more widespread and more severe than in 1893

miro

nrom

erip

inde

x19

09 =

100

miro

nrom

erip

inde

x19

09 =

100

Miron-Romer Industrial Production lndex, 1893

Miron-Romer Industrial Production lndex,1907

date01/93 07/93 08/93 09/93 12/93

40

45

50

55

60

date01/07 05/07 10/07 01/08

70

80

90

100

110

Fig. 3 Miron–Romer index of industrial production in 1893 and 1907. Source: Miron and Romer (1990)

29 Freight ton-miles fell by 10.8 % between July and September 1893 and by 10.4 % between October

1907 and January 1908. The declines in pig iron production were 42.2 and 52.8 %, respectively, while in

the Babson index, they were 12 and 18 %.


123

(Andrew 1908b, 497). There are a couple of reasons why this may have been so.

First, of course, as has been noted, the issue and use of local cash substitutes was

much more extensive in 1907. Second, by around the turn of the century, checks had

become standard payments instruments in interregional transactions (Kinley 1910).

To the extent that recipients were willing simply to deposit checks received in their

accounts, rather than attempting to cash them, and in turn use the proceeds to issue

checks of their own, there would not have been a total collapse of the payments

system, although collections may have been slower.

6 Econometric analysis I: monthly aggregate data

Consider a standard aggregate demand function (in Eq. 1) in which real output

growth is a function of lagged real output growth (two lags), growth in real high-

powered money (lagged once), and bank failures. The variables y, p, and h are

logarithms of the output measure, the price level (measured by the Warren–Pearson

wholesale price index), and the stock of high-powered money (total currency

outside the Treasury—NBER series 14135).30 Bank failures might have affected

aggregate demand through several channels. In addition to effects on money

demand and supply, there may have been non-monetary effects through increased

costs of credit intermediation (Bernanke 1983). We measure bank failures as the

number of national banks placed in the hands of receivers (e.g., U. S. Comptroller of

the Currency 1894, 266–285). To be sure, this is an imperfect measure. For one

thing, it might include a few banks that were originally placed in receivership but

later restored to solvency. It does not include, however, banks that only temporarily

suspended cash payments. More importantly, from early on in the postbellum

period, the number of non-national bank failures substantially exceeded those of

national banks, but those figures are not available at a monthly frequency. However,

the correlation between annual national bank failures and those of state and private

banks is 0.958 (U.S. Comptroller of the Currency 1931, 3–8). Since national and

other bank failures moved so closely together at an annual frequency, monthly

national bank failures would seem a reasonable proxy for total bank failures.31

Finally, we follow Grossman (1993, 309–310) in allowing for a nonlinear influence

of bank failures. The square of bank failures is included as well as the level to

capture a ‘‘panic effect’’ in which ‘‘some critical mass of failures must be attained

before producing monetary effects.’’

Dyt ¼ a1Dyt�1 þ a2Dyt�2 þ a3ðDht � DptÞ þ a4ðDht�1 � Dpt�1Þ þ a5 failurest

þ a6 failures2t þ a0 þ et ð1Þ

30 All cited NBER series were retrieved from the MacroHistory database at http://data.

nber.org/databases/macrohistory/contents.31 Wicker (2000, 3) distinguished between bank suspensions, a closure that might have been temporary

or permanent, and failure that was permanent. Here we focus on the latter.


123

The aggregate supply function (in Eq. 2) is a standard Phillips curve relation in terms

of rates of change. Such a specification is consistent with an expectations-augmented

Phillips curve of either the old or new Keynesian flavor when expected inflation is

usually stable as under a gold-standard regime (Hanes and Rhode 2011, 21; Hanes

1999). A dummy variable for the periods of restrictions of cash payments in New York

is also included to capture the negative supply shock effects as per the discussion in the

introduction. Even though decisions of whether to and when to restrict and resume cash

payments were generally made independently by local clearinghouses, in the great

majority of cases (of which we know) they followed the timing of the New York

Clearing House. Similarly, just as there was significant variation in the geographical

extent and timing of cash restrictions, the scope of restrictions and the issue of cash

substitutes also differed markedly across cities. Such variation in the extent, scope, and

timing of cash restrictions across cities make a binary variable necessarily an imperfect

measure of their overall nationwide implementation. But New York banks clearly

called the tune, and a focus on the timing of events there seems most reasonable. We

assign a value of one to the suspension dummy variable if there is a period of suspension

in New York within the given month.

Dpt � Dpt�1 ¼ b1Dyt þ b2 suspensiont þ b0 þ gt ð2Þ

Solving for the change in output, we may write:

Dyt ¼ c1Dyt�1 þ c2Dyt�2 þ c3 failurest þ c4 failures2t þ c5 suspensiont þ c6Dht

þ c7Dht�1 þ c8Dpt þ c9Dpt�1 þ c0 þ mt

ð3Þ

In the econometric specification, we also include eleven monthly dummies (the

estimated coefficients of which we do not present here for compactness) and also a

variable, month of down turn, which measures the number of elapsed months since

the NBER peak to capture any systematic influence on output growth of the stage of

the downturn. Adding additional lags, say to failures, or changes in high-powered

money or prices, resulted in no notable changes to the tenor of results reported

below. The estimated coefficients of the additional lagged variables were not sta-

tistically significant themselves and had little effect on the estimated magnitude and

significance of the suspension variable, so we do not report them here. Similarly

adding real federal government expenditures as an exogenous variable had little

effect, and so those results are not presented here either.

The equation is estimated by instrumental variables. The basic instruments are

two lags of the following variables: Dy, Dp, suspension, failures, failures2, monthly

dummies, month of down turn. From January 1, 1879, the United States was on a de

facto gold-standard regime (but not de jure until 1900). So in column 1 of Tables 2,

3, and 4, Dh is taken as endogenous. Additional instruments used in those cases

include two lags of Dh, contemporaneous values and two lags of changes in British

price level (Craighead 2010; Klovland 1993; NBER series m4053) and of the

British open-market discount rate (NBER series 13016). Alternatively, following

Grossman (1993), in columns 2 we take Dh as exogenous. Instruments there would

also include contemporaneous and two lagged values of Dh.


123

We use three alternative proxies for the change in real output. The first is the

Miron–Romer index of industrial production (1990), which begins in 1884. Those

results are shown in Table 2. Second is the series on railroad freight ton-miles,

which starts in August 1866 and is the closest direct measure of the effects of

suspensions on internal trade (U.S. Bureau of the Census 1949, 334).32 Those results

Table 2 Instrumental variables regressions, Miron–Romer IP index (p values in brackets)

Right-side variables (1) (2)

h endogenous h exogenous

1884 II–1914 XII 1884 II–1914 XII

Dyt-1 -0.34779

[0.000]

-0.35163

[0.000]

Dyt-2 -0.05797

[0.313]

-0.06435

[0.299]

Failures—national banks 0.00937

[0.424]

0.00914

[0.515]

Failures2 -0.00065

[0.529]

-0.00045

[0.714]

Suspension -0.20488

[0.046]

-0.22851

[0.087]

Month of downturn -0.00008

[0.899]

-0.00002

[0.982]

Dpt -0.41791

[0.535]

-0.20335

[0.917]

Dpt-1 -0.02507

[0.936]

-0.02134

[0.942]

Dht 1.10204

[0.517]

0.54803

[0.492]

Dht-1 -1.28317

[0.038]

-1.14609

[0.088]

Constant -0.02448

[0.243]

-0.02655

[0.290]

R2 0.2438 0.2428

Wald v2 97.43

[0.000]

99.14

[0.000]

NOBS 303 303

Instruments: (1) Dyt-1, Dyt-2, failurest-1, failurest-2, failurest-12 , failurest-2

2 , suspensiont-1, suspen-

siont-2, rgbt, rgbt-1, rgbt-2, Dpt-1, Dpt-2, Dpgbt, Dpgbt-1, Dpgbt-2, Dht-1, Dht-2, month of downturnt,

month1t - month11t

(2) Dyt-1, Dyt-2, failurest-1, failurest-2, failurest-12 , failurest-2

2 , suspensiont-1, suspensiont-2, Dpt-1,

Dpt-2, Dht, Dht-1, Dht-2, month of downturnt, month1t - month11t

32 The series is constructed from data on monthly gross real earnings. From 1879 to 1890, it is based on

24–27 railroads accounting for about 50 % of total traffic drawn from Poor’s Manual of Railroads. After

1890, similar techniques were applied to ICC data for all railroads. The data are seasonally adjusted. A

detailed description may be found in U.S. Bureau of the Census (1949, 323–324).


123

appear in Table 3. Third is pig iron production beginning in 1877 (U.S. Bureau of

the Census 1949, 332–333),33 used by Grossman (1993) and by Calomiris and

Hubbard (1989). Results are presented in Table 4. The frequency of the data in the

regressions is monthly. Given that periods of cash restrictions were matters of just

Table 3 Instrumental variables regressions, railroad freight ton-miles (p values in brackets)



1879 II–1914 XII 1879 II–1914 XII

Dyt-1 0.28235

[0.000]

0.28868

[0.000]

Dyt-2 -0.30375

[0.000]

-0.29993

[0.000]

Failures—national banks -0.001761

[0.515]

-0.00212

[0.412]

Failures2 0.00019

[0.438]

0.00022

[0.342]

Suspension -0.08219

[0.006]

-0.07148

[0.001]

Month of down turn -0.00018

[0.118]

-0.00017

[0.133]

Dpt 0.17852

[0.304]

0.22905

[0.109]

Dpt-1 -0.08207

[0.300]

-0.06253

[0.366]

Dht 0.27546

[0.641]

-0.02555

[0.861]

Dht-1 0.02209

[0.890]

0.07410

[0.549]

Constant 0.00609

[0.218]

0.00715

[0.278]

R2 0.1712 0.1903

Wald v2 104.13

[0.000]

107.02

[0.000]

NOBS 370 370




month1t - month11t



Dpt-2, Dht, Dht-1, Dht-2, month of down turnt, month1t - month11t

33 These data are daily averages in gross tons constructed by dividing figures based on the weekly

capacity of furnaces in blast by the number of calendar days in the month. They are not seasonally

adjusted (U.S. Bureau of the Census 1949, 323). The original data are found in Macaulay (1938, A252–

A270).


123

weeks or a couple of months at most, the use of high-frequency data in order to

capture their effects is essential. The downside, however, is that this limits the range

of observations because monthly high-powered money data begin only in 1879.

Consequently, the time period covered for the railroad freight ton-mile regressions

(Table 3) and pig iron production (Table 4) runs from February 1879 to the end of

1914. The Miron–Romer regressions (Table 2) run from February 1884 to the end

of 1914. In all of the alternative specifications, suspension is taken as an endogenous

variable.

Table 4 Instrumental variables regressions, pig iron production (p values in brackets)



1879 II–1914 XII 1879 II–1914 XII

Dyt-1 -0.57801

[0.000]

-0.57545

[0.000]

Dyt-2 -0.26107

[0.000]

-0.26388

[0.000]


[0.125]

-0.06990

[0.095]

Failures2 0.00573

[0.152]

0.00601

[0.118]

Suspension -0.76515

[0.105]

-0.68616

[0.051]

Month of down turn -0.00169

[0.365]

-0.00159

[0.381]

Dpt -2.10334

[0.456]

-1.70560

[0.465]

Dpt-1 -0.36044

[0.780]

-0.20390

[0.857]

Dht 2.18010

[0.817]

-0.12553

[0.958]

Dht-1 -1.39483

[0.589]

-0.99294

[0.624]

Constant 0.06607

[0.425]

0.07565

[0.303]

R2 0.1993 0.2037

Wald v2 136.93

[0.000]

137.68

[0.000]

NOBS 370 370




month1t - month11t



Dpt-2, Dht, Dht-1, Dht-2, month of downturnt, month1t - month11t


123

In the Tables 2, 3, and 4 results, we see first of all that whether the change in

high-powered money is taken as endogenous (column 1) or as exogenous (column

2) has little effect on the magnitudes or significance levels of other estimated

coefficients. There is a general consistency as well in the pattern of results across

choice of output variable. The lagged output variable is always highly significant,

although the signs differ—negative for the Miron–Romer IP index (Table 2) and pig

iron production (Table 4) but positive for railroad freight ton-miles (Table 3). The

effects of bank failures on the contemporaneous change in output is not significant

for the Miron–Romer IP index and railroad freight ton-miles, but is somewhat so for

pig iron production.34

More importantly here, regardless of the output measure and of the endogeneity/

exogeneity specification of high-powered money, the estimated suspension coef-

ficients are substantial in magnitude and highly significant. Other things equal,

Miron–Romer industrial production is estimated to have fallen about a third during

suspension months; freight ton-miles, a bit less than 10 %; and pig iron production,

a remarkable two-thirds to three-quarters. The real effects of suspension show up

strongly and consistently.

These equations encompass two periods of suspension—1893 and 1907. It

would be nice to go back a bit further, to include 1873 as well, but, as noted,

there are no monthly data on high-powered money available for the earlier

period. In view of the general insensitivity of the other coefficient estimates to

the specification of the high-powered money variable and the low significance

levels of the high-powered money coefficients themselves, we may take a leap of

faith and do without the Dh variable. Table 5 shows the estimation results again

using instrumental variables with railroad freight ton-miles as the dependent

variable over the period from September 1866 to December 1914 (adding twelve

more years to the range). Here, contemporaneous and lagged values of British

price change and interest rates (see above) are explicitly included in the equation

in lieu of Dh. Unlike in Table 3, the bank failures coefficient is statistically

significant and of the expected sign. But similar to those estimates in Table 3,

the estimated coefficient of suspension is of comparable magnitude and strongly

statistically significant.35 Expanding the sample does not weaken the earlier

results.

34 Also using pig iron production as the output measure over this period, Grossman (1993) found aucontraire a strong and statistically significant influence of bank failures. Perhaps this might have been due

to the fact that result is based on quarterly data that might conflate the effects of bank failures and

suspensions (suspensions do not appear explicitly in his specification).

In any case, the message in these results accord with Wicker (2000, 2) who argued that bank failures in

the interior (although qualified by excepting 1893) ‘‘were generally few in number, region-specific, and

too localized geographically to have exerted economy-wide effects… It was the suspension of cash

payments and not bank runs nor bank failures through which the public in the rest of the country

experienced the effects of banking panics.’’35 And this notwithstanding the real effects of suspension in 1873 may have been weaker than in 1893

and 1907. Indeed, Sprague (1910, 77) argued that it ‘‘had relatively little influence on the course of

trade.’’


123

7 Econometric analysis II: daily regional data

To corroborate the results in the preceding section, we analyze here the real impacts of

New York banks’ convertibility restrictions at the regional level during the 1893 and

1907 crises. To measure real activity, we follow an earlier literature and track the trends

in ‘‘outside’’ bank clearings, that is, the value of checks and related payment

instruments exchanged through clearinghouses in regional centers.36 Because

individual checks and bank drafts were the predominant payments instruments in

wholesale trade during these episodes, their clearing and settlement reflect the current

Table 5 Instrumental variables

regression, railroad freight ton-

miles (p values in brackets)

Right-side variables 1866 IX–1914 XII

Dyt-1 0.16413

[0.006]

Dyt-2 -0.35821

[0.000]


[0.101]

Failures2 0.00052

[0.165]

Suspension -0.10083

[0.011]

Month of downturn -0.00009

[0.563]

Dpt -0.87155

[0.306]

Dpt-1 0.00685

[0.938]

Dpgbt 0.64490

[0.124]

Dpgbt-1 0.20751

[0.473]

Drgbt 0.00235

[[0.343]

Drgbt-1 -0.00225

[0.344]

Constant 0.01497

[0.088]

R2

Wald v2 78.3

[0.000]

NOBS 516

36 See Persons (1919), Frickey (1925, 1930), and Garvy (1959). They exclude New York bank clearings,

which are skewed by the large value of financial (or ‘‘speculative’’) transactions.


123

flows of ‘‘business activity’’ (U.S. Comptroller of the Currency 1894, 1896; Kinley

1895, 1897). Moreover, unlike the aggregate indices, bank clearings were reported at

daily and weekly frequencies, and so can detect more precisely the impacts of the onset

and end of banks’ cash payments restrictions.

At the same time we recognize the limitations in using clearings as a barometer

of real activity. Perhaps most important, they omit on-us check and cash

transactions that bypassed the clearinghouse entirely. Conversely, they could

partially double-count the value of check transactions, as banks often used drafts to

settle their clearinghouse balances.37 These factors would only bias our results if

their share of total clearinghouse transactions changed dramatically over the time

periods covered here. The short durations—3 months for the 1893 and 6 months for

the 1907 case—make this outcome unlikely.

A more serious bias is the possible negative impacts of convertibility

restrictions on the use of bank payments instruments in wholesale trade and

hence on total bank clearings. For example, local clearings, but not real activity,

would drop precipitously if banks’ deposit customers substituted cash or cash

‘‘substitutes’’ for checks in conducting routine business activities during crises

(Andrew 1908b). Businesses might resort to cash on the margins but not for their

large-value transactions that dominate the total value of bank clearings. Not only

would they incur significant transactions and information costs in shifting into a

cash economy, but they also would deplete their cash reserves at the very moment

of a ‘‘currency famine.’’ If anything, bank customers would tend to hoard their

cash withdrawals, which would reinforce the decline caused by banks’ hoarding of

currency reserves (Warner 1896; Andrew 1908a; Sprague 1910). Additionally, as

has been noted, most workers could not afford a deposit account and so were paid

on a cash basis.

Finally, we observe that businesses actually had an incentive to shift their

demand for means of payment from currency to deposits. After all, convertibility

restrictions had no impact on, for example, check transactions that were settled via

ledger entries to banks’ clearinghouse and their customers’ deposit accounts. In fact,

for these payments, banks could use clearinghouse loan certificates to economize on

their scarce currency reserves. Moreover, the proliferation of cash substitutes tended

to funnel payments through clearinghouses. For example, bank customers were

urged to conduct local transactions in conveniently denominated certified checks or

script issues but only if noted ‘‘payable… through the clearing house’’ (quoted in

Andrew 1908b, 501). During restriction periods, in other words, we would expect to

see clearings biased in the opposite direction, that is, against our hypothesis, as

banks and their customers routed normal currency transactions through the banking

system.

Our empirical perspective is decidedly partial, focused on the brief period

embracing the restriction of cash payments. For both 1893 and 1907, there are fairly

consistent daily reports of bank clearings in the largest regional centers—Baltimore,

37 These are the main factors that differentiate bank clearings from the more economically pertinent

variable, debits to deposit accounts (Garvy 1959, 46–55). Still, as Garvy (pp. 69–70) showed, during the

postbellum period, annual ‘‘outside’’ bank clearings and GNP were highly correlated.


123

Boston, Chicago, New Orleans, Philadelphia, and St. Louis.38 In each case, we

collected data over the restriction episode and equal duration (roughly 1 month in

1893 and 2 months in 1907) prior to and following it. Such a snapshot enables us to

capture the overall trend in clearings during the crisis and the impact, if any, of banks’

decision to restrict deposit convertibility. We also collected daily clearing data for the

same time period in 1892 and 1906, periods of relative normalcy, to test for any

seasonal impacts that could routinely deflate clearings during the restriction months.

The graphs in Figs. 4 and 5 trace out daily clearings in Boston, Chicago, and St.

Louis during the 1893 and 1907 crises. The vertical lines in the middle of each

graph demarcate the restriction period in New York. In both instances, daily

clearings follow a similar trend, declining heading into the restriction period and

then recovering afterward. The recovery is more pronounced in 1893, as shown by

the U-shaped overall trend for all three cities. In the 1907 crisis, by contrast, the

macroeconomy did not fully recover until April 1908, as evidenced by overall

downward trend in clearings from the end of August 1907 to the end of February

1908. Despite differences in the overall trends, clearings in both periods dropped

sharply during the restriction months. To be more precise, we characterize the

impact of the convertibility restrictions in terms of a downward parallel shift in the

overall trend line, that is, a decrease in the vertical intercept.

Fig. 4 Daily bank clearings in Boston, Chicago, and St. Louis, June 29 to September 28, 1893. Sources:See text

38 The figures for 1892 and 1893 come from the local money-securities markets reports in the ChicagoDaily Tribune. For the later years, the data are taken from the ‘‘Bank Clearings’’ section of the Wall StreetJournal and exclude New Orleans.


123

To test this generalization, we estimated simple linear regression equations on the

panel of daily bank clearings for the six cities in 1893 and five in 1907.39 The

dependent variable is the logarithm of bank clearings, and the independent variables

specify the overall trend (whether quadratic or linear) and a dummy variable for the

convertibility restriction period. To capture the large differences in clearings across

cities, we also included dummy variables for each location and so effectively

estimated a fixed-effect model (for the quadratic version):

ln(clearingsitÞ ¼ d1 timeþ d2 time2 þ d3 suspensiont þ d4i cityi þ eit ð4ÞBecause clearings were subject both to common national and also more

idiosyncratic regional shocks, we tested and corrected for heteroskedasticity and

cross-equation correlation in the error terms.40

The results presented in Table 6 support our empirical generalization as well as the

results from the aggregate analyses in the preceding section. In 1893, clearings closely

follow the flat U-shaped trend evident in Fig. 4, but drop markedly by an estimated

12.7 % during the suspension period. The regression estimates for 1907 yield similar

results, although the magnitude of the suspension effect depends on the specification

of the overall trend. To bias the case against our hypothesis, we focus on the results

derived from linear trend line specification (equation 1907.2), which downplay the

Fig. 5 Daily bank clearings in Boston, Chicago, and St. Louis, August 31, 1907, to February 28, 1908.Sources: See text

39 The panels for each year cover the same time period, but are unbalanced because of inconsistencies in

data reporting and collection. For this reason, we applied the panel-corrected standard error and not

generalized least squares estimation procedure.40 We also tested for but found no evidence of serial correlation in the error terms for each city.


123

impact of the surge in clearings immediately preceding the suspension. As is evident

from the graph, clearings tended to fall (by 4.8 % per month) over the entire period, but

dropped by an additional 9.3 % during the suspension period.41

The relevant coefficients in the estimated equations are statistically significant at

the 1 % confidence level. More importantly, they are economically relevant, vividly

capturing the suspension impact on economic activity. To show this, each figure

also includes a graph of the Chicago trend line excluding the restriction effect

(which is set to zero). Ironing out the seasonal and idiosyncratic fluctuations in

clearings, the trend line shows the overall ups and downs of the regional economy

during the crisis, but also the substantial gap in activity caused by the diminished

liquidity of bank deposits. To affirm our interpretation of the suspension coefficient,

we also estimated regressions on the same panel of cities over the same time frame

in 1892 and 1906.42 During those relatively normal times, there was no notable

Table 6 Panel regressions of daily bank clearings during the 1893 and 1907 crises (p values in brackets)

Right-side variables 1893 1907.1 1907.2

June 29 to September 28, 1893 August 31, 1907, to February 28, 1908

Time -0.0139

[0.000]

0.0030

[0.003]

-0.0016

[0.000]

Time2 0.000137

[0.002]

-0.000029

[0.000]

Suspension -0.1355

[0.000]

-0.1710

[0.000]

-0.0978

[0.000]

Baltimore 7.9741

[0.000]

8.4822

[0.000]

8.5882

[0.000]

Boston 9.7246

[0.000]

10.1251

[0.000]

10.2236

[0.000]

Chicago 9.7479

[0.000]

10.5879

[0.000]

10.5796

[0.000]

New Orleans 7.12567

[0.000]

Philadelphia 9.4633

[0.000]

10.0304

[0.000]

10.0232

[0.000]

St. Louis 8.2764

[0.000]

9.2959

[0.000]

9.2887

[0.000]

R2 0.9705 0.9561 0.9539

Wald v2 31844.68

[0.000]

22972.77

[0.000]

22500.91

[0.000]

NOBS 427 683 683

41 Regression estimates based on the quadratic specification yield an inverted-U trend line and imply a

much larger suspension impact of 15.7 %. Strikingly, the range parallels the results from the aggregate

analysis in the preceding section.42 The results are available from the authors upon request.


123

seasonal decline in clearings during the suspension period; in other words, we could

not reject the hypothesis that the suspension coefficient was equal to zero.

8 Conclusion

Most contemporary writers (e.g., Noyes 1894; Sprague 1910; and also Walter

Bagehot in Wicker 2000, 130–131), Colwell excepted, thought restrictions of cash

payments were economic disasters. Taking a more nuanced view in his analysis of

the 1893 crisis, Sprague (1910, 200) recognized that suspension ‘‘may have enabled

some banks which might have failed or suspended completely to escape those

misfortunes’’ and that it was ‘‘also possible that more drastic loan contraction would

have been enforced by the banks if they had been exerting every effort to maintain

cash payments.’’ Still, he insisted that suspension was a ‘‘potent factor accentuating

the depression in trade which characterized the month of August’’ because of

difficulties in meeting pay rolls which led to the ‘‘temporary shutting down of many

factories’’ and the ‘‘derangement’’ of the domestic exchanges, which caused ‘‘a

slackening in the movement of commodities and needless delays in collections.’’

Moreover, he concluded, it ‘‘increased the general feeling of distrust which, as

always in a crisis, does so much to bring about greater inactivity than the actual

condition of affairs warrants.’’

While the more recent literature downplays or neglects the effects of these

restrictions, our evidence provides support for the original position. Monthly and

daily data on economic activity in 1893 and 1907 clearly suggest that contractions

intensified during suspension periods. More systematic regression analysis affirms

this impression and quantifies the output loss during restriction periods. We cannot

judge the macroeconomic costs of banks’ restriction on cash payments versus the

alternative, a rash of bank failures. Like Sprague and his contemporaries, though,

our results recommend a search for reforms to the banking system that would

minimize the risks of both.

In fact, the prevention of widespread and severe disruptions of the payments

system in the wake of financial crises was a, if not the, fundamental financial reform

issue to many or most contemporaries and led directly to the establishment of the

Federal Reserve System. A principal feature of the new central bank was the

nationalization of the interbank settlement network. Fed institutions such as the gold

settlement fund and Fedwire (for telegraphic transfers of reserves) replaced their

private analogues, New York correspondent balances, and the Clearing House

Association on the one hand and domestic exchange markets on the other.

The Fed’s takeover of the interbank settlement system was not peculiar to the

U.S. payments system. According to the most recent survey of payments systems by

the Bank for International Settlements (2012), central banks own and operate the

main large-value (interbank) payments network in virtually all developed econo-

mies, either outright or in a partnership arrangement. What distinguishes the U.S.

payments system from those of other countries and remains controversial to this day

was the Fed’s entry into the check clearing system and the relative efficiency of

public and private clearing systems (Stevens 1996; Lacker et al. 1999; Gilbert


123

2000). However, even today in the face of the increased privatization of the

payments system spurred in large part by the Monetary Control Act of 1980, the

Federal Reserve still plays a potentially crucial role as the clearinghouse of last

resort in financial crises (Summers and Gilbert 1996; James and Weiman 2005).

Acknowledgments The views expressed in the paper are those of the authors and do not necessarily

represent the views of the Federal Reserve Bank of New York or of the Federal Reserve System. Earlier

versions of this paper were presented at the Institute for Monetary and Economic Studies, Bank of Japan,

London School of Economics, Rutgers University, 7th BETA Workshop in Historical Economics. We

thank the participants and Richard Grossman and Christopher Hanes for comments and suggestions but

alas must still accept responsibility for any errors. Weiman acknowledges the financial support of Barnard

College, and research assistance from Keren Baruch, Olivia Benjamin, and Nancy Greenewalt.

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wall street and main street: the macroeconomic consequences of new york bank suspensions,...

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