An Investigation into Great Britain's Commercial Crisis of 1857 and the Preceding Business Cycle

0:00I'm going to be talking about Great Britain's commercial crisis of 1857. Now, by 1857, the crises were really nothing new to the British economy. They seemed to recur about every 10 years or so. There had been a crisis in 1825, 36, 47, and then another crisis in 1857. But what was new and unique about the crisis of 57 was that it seemed to really come out of nowhere. It really caught the contemporaries at the time completely off guard. In previous crises, there had always been some conspicuous, outsized disturbance that attended the crisis, like a mania or a bubble. But in 1857, by and large, there was really no such thing.

0:47So they were justifiably confounded. In fact, according to one economist of the period, he wrote, quote, it was considered a marvel by most people that the approach of the usual 10 years had not been accompanied by some of those premonitory symptoms which indicated the presence of an unhealthy state of things. So eventually, most of the contemporaries just chalk this up to excessive speculation and fraudulent activity. So what I try to demonstrate is that the primary cause of the crisis had been interest rates or had been a very accommodating banking system that lowered interest rates well below the natural level so that interest rates no longer accurately reflected the availability of capital, the availability of labor, land, raw materials.

1:43And an investment boom, really a system-wide investment boom took place for which the availability of, or for which the necessary capital to see these investment projects through did not exist. So therefore, costs begin to rise. Profit margins begin to shrink. And there are other discoordinating effects of this. And ultimately, the boom proves unsustainable, and it requires a correction. Now, my approach in doing this was really a microeconomic approach. I tried to sort of recreate from the ground level up the entrepreneur's experience through the course of this 10-year business cycle.

2:31Now I focus primarily on the textile industries. So there is some room for further research. Now I do touch tangentially on other industries like the iron industry, agriculture, coal, et cetera. And I'll talk about them very briefly today. But as I said, my primary focus was on the textile industries. What I want to do now for the remainder of the talk is we're just going to move chronologically through this business cycle, focusing on the entrepreneur's experience, as I said, primarily in the textile industries, but I'll also talk about some other industries as well. I've broken this 10-year period down into three periods. The first one is 1848 through 1851, and the first industries we're going to look at are the woolen and the worsted industries.

3:20Now worsteds, for those of you who don't know, they're basically a woolen product, but they incorporate some other materials like cotton or silk into their cloth. Some of your jackets actually could be a worsted if you don't even know it. So both the woolens and the worsteds experience a very large extension of capital in this period here. Following the crisis The fact that it had taken place in 1847, commodity prices had dropped very precipitously, wool was no exception, wool had fallen in price by 33% and with cheap raw material, relatively cheap labor, low interest rates, all of the factors to warrant a boom in investments were in place and a very large boom is undertaken, particularly in the worsted According to the Chief Factory Inspector of Yorkshire, which is the hub of the worsted and woolen trades, he estimated that the output in the worsted department had increased by 40% in 1849 and in 1850 he said that they were increasing at the same rate.

4:31So this really is a very large extension of capital, very large boom. So through the course of this boom period, cost of production start to rise. The cost of wool increases by 35% by 1851. Wages are also on the increase. And really, by the end of 1851, both industries are amid a depression. And according to one report talking about the worsted trade at the end of 1851, it reads, quote, new mills had sprung up in abundance. And for the next three years, the manufacturers paid the penalty of overproducing. At no time, even in the worst periods of 1847, had the difference been wider between the cost of wool added to the price of labor and the prices realized for the manufactured article.

5:23And as I said, both industries are in a relatively depressed state by the end of 1851. Now, it should be noted, and I just want to be clear that I'm not saying that artificially reduced interest rates are the cause of everything that goes wrong in an economy. I mean, for example, had the British economy been on a, say, 100% reserve standard, no central bank, it's still entirely possible that these industries could have been overdone. I mean, markets and investors are very myopic, you know, investments have a tendency of being overdone. But the point is that had the economy, you know, not had fractional reserve banking, no central bank, we would have seen upward pressure on interest rates. This is what Friedrich Hayek refers to as the interest rate break, or interest break, he calls it, which is just sort of a salutary check on an economy, as interest rates rise to more accurately reflect the scarcity of capital.

6:23But we don't see this. In fact, interest rates continue to fall through this period, and they fall into 1853 before they start to rise. So our other industries, the cotton and the silk industry, there are no significant investments taking place in these industries, cost of production were just too high, there were raw material shortages or cotton failures in America, silk failures in cotton in Europe, so cost of production were just too high to warrant any significant extension of capital. But in our next period, 1852 through 1855, both of these industries undergo very large increase in output. The cotton industry, we'll start off by looking at the cotton industry.

7:08Imports for cotton in 1852 had increased by 23% and the cotton price falls by 27%. And just as we saw in the woolen and the worsteds, with cheap raw material, cheap labor, low interest rates, rates, all the factors are in place to warrant an extension of capital, a large extension of capital. And that's exactly what we see. According to the Chief Factory Inspector of Lancashire, which is the center of the cotton trade, he writes, quote, at no period during the last 17 years that I have been officially acquainted with the manufacturing district in Lancashire have I known such general prosperity. The activity in every branch is extraordinary, for new mills are going up everywhere. And as a result, costs of production begin to rise.

7:55The cost of cotton between 1852 and 1855 increases by 15%, whereas the price of cloth actually falls by 5%. Wages during this period increase by 12.5%. And by the end of 1853, the cotton industry is in a relatively depressed state. And the same factory inspector who I just quoted, he writes at the end of 1853, quote, I observe a growing impression among the occupiers of cotton mills that the fall of prices and the diminished sales are to be accounted for in no small degree by the very great increase in the number of mills. It is self-evident that so great an increase must on the one hand tend to keep up or enhance the price of the raw material and of machinery and to to raise wages unless there be a proportionate increase of cotton, of machinery, and of laborers, and thus increases the cost of production.

8:53While on the other hand, the competition to affect sales must still further tend to lower profits. And so the cotton industry just remains in a depressed state through the end of 1855. Silk industry, supplies of silk in 1852 increased by 26%. And again, just as we've seen before, with low cost of raw material, cheap labor, low interest rates, a very large boom ensues. And again, by the end of 1854, the silk industry has emitted depression. Things have gotten so bad that according to a report by the Times newspaper, quote, none of our manufacturers can be induced to review with us the operations of the past year. The crisis comes in November of 1857. The last period that we're going to look at is 1856 and 1857. Now the British economy is thrown very active actually in 1856. There had been a war fought, the Crimean War, over 1854, 1855, and it comes to a close in 1857.

9:49The crisis comes in November of 1857. The crisis comes in November of 1857. The crisis comes in November of 1857. The crisis comes in November of 1857. The crisis comes in November of 1857. and War over 1854, 1855, and it comes to a close in 1856. So as markets open up, an export boom ensues, and the economy is thrown very active. But while the economy is very active, really the underlying economy grows increasingly ill. And through 1857, most of the major industries are in a depressed state. The iron trade, for example, in some districts was very depressed. In Glasgow, according to one report in July of 1857, quote, the district has not been so dull for many years. Wages of miners had increased 100%.

10:38Many blast furnaces were brought into operation, according to the government's mining expert Robert Hunt. He writes, quote, of the months leading up to the crisis, quote, at that time, the effects of over-manufacturing were producing unhealthy symptoms in all branches of trade. Construction industry was also depressed. They were struggling under high wages, according to one report by the Times newspaper. Quote, the labor is so costly that it keeps up the price of production above the market value, so that builders, if they yield to these large wages, can make no profit for their heavy outlay on labor. Railroad industry, similarly, they're struggling to pay high wages. According to a former parliament member named Sir Morton Peter Pepto, in a letter to the Times, he writes, quote, The prices of harvest labor has risen until the farmers outbid railway contractors.

11:31And we find ourselves compelled to suspend for the present the execution of all but very pressing public works. Textile industries, they participate in the general export boom, but they grow increasingly unprofitable, just as these other industries. Cotton had increased by 59 percent. The price of cotton increases by 59 percent between 55 and 57. And in May of 1857, according to one report, for some months there is hardly past a week in which failures of more or less consequence have not occurred. Wool in the worst industry is the same thing. Wool increases by 51 percent between 55 and 57. And their finished goods actually fall in price. silk industry, silk increases by fifty percent between fifty five and fifty seven their finished goods fall in price so just to conclude here and just to sort of tie this back in with what we're trying to explain which is the cause of the crisis of fifty seven we see that most of the major industries in Great Britain

12:31are in a depressed state leading up to the crisis this results in reduced output, reduced production this puts downward pressure on commodity prices and puts a tremendous amount of pressure on the mercantile community. And the 1857 crisis was marked chiefly by mercantile failures. In fact, some of the contemporaries even referred to it as a mercantile crisis. So I find it convincing, I find the evidence convincing that the primary cause of this crisis had been the slow, embrittling effects of interest rates that were pushed are pushed down by a very accommodating banking system, well below their natural rates, so that interest rates no longer accurately reflected the scarcity of real capital, labor, land, raw materials, so that competition to acquire that capital pushed their prices up, we saw profit margins shrink, there are other discoordinations in the economy that were brought about by this that I didn't have time to talk about, but I just want to thank you all very much.

13:43Thank you all very much for your time. I really appreciate it.