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Stedman and Hutchinson, comps. A Library of American Literature:
An Anthology in Eleven Volumes. 1891.
Vols. IX–XI: Literature of the Republic, Part IV., 1861–1889

The Theory of Commercial Panics

By William Walter Phelps (1839–1894)

[Born in New York, N. Y., 1839. Died in Teaneck, N. J., 1894. From a Speech in the U. S. H. of R., 1 April, 1874.]

YES, I admit with it—even with an honest currency—we shall still have panics. A world which does its business on a credit basis cannot escape them; and this basis is one which grows wider as the world grows older.

The demands on credit must increase; for the world does not contain money enough to effect its business, and credit in one of its multiform shapes must continue to be the principal instrument of exchange. Only in rude barbarism does money discharge all the functions of exchange; and as civilization increases the business of the world, credit by bill, by note, by check, by book account, is forced into greater exercise.

To-day our people are carrying on all their business with promises to pay. If forced to pay money, they have only enough of it to pay for fifteen one-hundredths of their business. And yet this vast system of credit stands the strain, this complicate industry goes on for years, until its delicate support is broken. That support is trust: the trust my friend has that his bank will pay his check; the trust I have that my friends debited in my ledger for money loaned will pay when I ask them. This enables the bank-check and the book credit, or any currency, to take the place of money.

When this support is broken, when citizens begin to doubt the solvency of banks and bankers, and neighbors the solvency of each other, then comes a panic—the child of distrust—and all, refusing every form of credit, note, or draft, or bill, or check, demand money. Currency is valueless; the delicate machinery of credit which the ages have perfected ceases to work, and man, in the frenzy of distrust, remitted to his original barbarism, will take only gold. Until the panic is hopeless, if law interferes, they will obey it, and take the legal money, which the law enforces. If the panic is hopeless, the creditor, doubting the ultimate solvency even of the government, refuses its legal-tender, and peace comes only in the utter ruin of bankruptcy. The trouble is the people have asked fifteen millions of legalized money to do the work of one hundred millions, and it cannot.

This shows the cause of panics—the possibility in the human heart suddenly to lose its normal trust in its kind. And the human heart is the same and will act to the same causes, whether the legal money is gold or whether it is paper. We shall be liable to panics always; for we can never make the exchanges of our present civilization for money, but must always use credit mainly. And when we use credit, and the human heart remains as it is, we are always subject to the incursion of that distrust which will suddenly palsy the activity of currency, and panic will reign. All we claim is that the liability to this incursion of distrust, this panic, is naturally greater under an irredeemable currency. The evils of an irredeemable currency, to which I have already alluded, tend strongly to produce it, tend strongly to aggravate and perpetuate it when produced. The reign of paper money gives us speculation and extravagance. Both use up money rapidly, extravagance consumes, speculation wastes it, or buries it in unprofitable investment. This twofold drain is felt, and a people whose morale has been sapped by an artificial prosperity are forced to look about them. They recognize and exaggerate consequences which they have no courage to endure: and in speedy loss of hope and faith they rush to save all that to them has worth—money. And the loss of trust, which leads men temporarily to despise credit and seek only gold, is panic. Paper money has produced it; paper money will aggravate it. Had we a redeemable currency, a currency that the solvent world has, the insane want of money would be met. The gold of a thrifty population, ever looking for the most profitable market, would come to our relief. The profits offered would overcome all obstacles and drain the world, were it necessary. But it is not. It is an unreasoning panic. The arrival of a little gold, the news of it on a westering ship, breaks the spell, and confidence reigns again.