CAT 2016 GD/PI Preparation | Economics #6

By N Shiva Guru|Updated : December 30th, 2016

CAT 2016 results are being awaited for in the month of January; till then, it always helps to know a few things about one's own economy or the Economics about the country that is currently ruling the roost, USA! Today's post on GD/PI preparation for Economics deals with a crisis in the USA that happened in 1907. 

Today's Piece on Economics: Panic in 1907 by Balaji Vishwanathan

'Those who cannot remember the past are condemned to repeat it'

-- George Santayana

The Panic of 1907 was a great showcase of why an adequate level of government and regulations were needed for the smooth functioning of Capitalism. Iconic names like Lord Rothschild, John D. Rockefeller and JP Morgan found it hard to put down a massive "fire" in the financial system, eventually leading up the creation of Federal Reserve & many other protections for the investors.

Terminology
Until about 1930s, there was no single term for recession/financial crisis. Thus, they used terms like Panic, Depression etc for what is essentially called a recession these days. In 1907 there was a big crash in the markets due to the problems in the financial sector. In some sense, it looked very similar to the crisis that would occur 100 years since then. [Yet again, someone at JP Morgan stepped up, although Jamie Dimon was no JP Morgan.]

Here is how things looked like:

  1. There was no FDIC back then. Thus, there was no guarantee that the money you put in bank will not evaporate. These days we put money in our checking/savings account at the bank without thinking twice about whether the bank will survive tomorrow. Thus, people were always on the edge & would withdraw all the money from the banks the moment they are worried.
  2. There was no Federal Reserve back then to manage money supply. Thus, when money had to be moved to one part of the system, there was a significant strain on the other part. [Federal Reserve was eventually created due to this Panic].
  3. In 1906 there was a major earthquake in San Francisco that devastated the city. 1906 San Francisco earthquake. The city needed to be rebuilt and a lot of money was needed.
  4. Insurance companies are usually the biggest investors in financial markets [mostly bonds]. Many insurers lost a lot of money in the earthquake and they made money flow hard. Again, there was not as many regulations to run insurance companies & they were often run without much money in the bank.
  5. In parallel, major companies were embroiled in various troubles. Standard Oil (the mother of world's major oil companies now) was caught in a massive anti-trust problem [they were too big and were too manipulative]. Major railroads were caught in a fare manipulation system. These stocks were getting significantly hit. Theodore Roosevelt was especially brutal against major monopolies like the Sherman Antitrust Act - the breakup of whom led to a healthier US economy in the long term.
  6. There was no SEC back then and thus a few investors started a massive stock manipulation scheme in a copper company. The manipulation was assisted by a big financial company named Knickerbocker Trust Company that was like the Lehmann Brothers of that era.
  7. Without the government, investors often ran like headless chicken & things fell like dominoes. Someone had to take the job of fire control and only JP Morgan had any credibility in the system.
     

byjusexamprep


Exactly 100 years later, the very same mistakes would be repeated. Once again, financial companies started excessively gambling in the system and once again the regulators were weak and powerless.

(The author of this piece is Mr.Balaji Vishwanathan, a Top Writer on Quora)

Comments

write a comment

Follow us for latest updates