Posts filed under “Cycles”
Crisis Chronicles: The Man on the Twenty-Dollar Bill and the Panic of 1837
Thomas Klitgaard and James Narron
Liberty Street Economics, MAY 08, 2015
President Andrew Jackson was a “hard money” man. He saw specie—that is, gold and silver—as real money, and considered paper money a suspicious store of value fabricated by corrupt bankers. So Jackson issued a decree that purchases of government land could only be made with gold or silver. And just as much as Jackson loved hard money, he despised the elites running the banking system, so he embarked on a crusade to abolish the Second Bank of the United States (the Bank). Both of these efforts by Jackson boosted the demand for specie and revealed the soft spots in an economy based on hard money. In this edition of Crisis Chronicles, we show how the heightened demand for specie ultimately led to the Panic of 1837, resulting in a credit crunch that pushed the economy into a depression that lasted until 1843.
Jackson’s Stand “Against Any Prostitution of Our Government”
From the first day of his presidency, Jackson was committed to eliminating the Bank, which was a private bank with some shares owned by the federal government. The Bank was the sole fiscal agent for the U.S. Treasury and therefore could create credit across the country by pushing out or holding onto government specie. It also played a major role by issuing a national currency, backed by the Treasury’s deposits, that was more credible than the currency issued by the banks. In addition, the Bank could limit the creation of paper currency by requiring the banks that were over-issuing notes to hand over specie when their banknotes were used to pay taxes. The risk of having to give back specie limited the size of banks, so many agreed with Jackson that the economy would be better off without the Bank.
When he refused to extend the Bank’s charter in 1832, Jackson proclaimed that “We can at least take a stand against all new grants of monopolies and exclusive privileges, against any prostitution of our Government for the advancement of the few at the expense of the many.” Hammond, in Banks and Politics in America (1957, p 349), opined that “Jackson was extraordinarily effective in combat. He combined the simple agrarian principles of political economy absorbed at his mother’s knee with the most up-to-date doctrine of laissez faire.”
Extravagant Schemes and Fantastic Operations
In the run-up to the Panic, the banking system was busy financing the construction of railroads and canals, offering credit to those buying government lands and those expanding agricultural and manufacturing ventures. The government was making so much money from land sales and the Tariff of 1833 that its debt was paid off in 1835. In his re-election campaign, Jackson promised that additional revenues would be sent to the states, and the anticipation of such funds led many states to initiate big infrastructure investments that made their finances vulnerable when the 1837 crisis hit.
McGrane, in his book, The Panic of 1837 (1924, p. 42), wrote, “The questionable banking practices and extravagant internal improvement schemes of the East were duplicated by similar fantastic operations in the West and South. The universal prosperity of the nation led individuals and states to expand credit too rapidly, now that the restraining influence of the United States Bank had been removed.” The demise of the Bank required that all of the Bank’s specie be distributed around the country, further enabling banks to expand their lending, and ended any oversight of their banknote issuance. In early 1837, a prudent person might have thought that gold and silver looked like a wise portfolio choice.
Jackson further pushed up demand for specie with the Specie Circular, an executive order signed in 1836 that required that specie, and not banknotes, be used to buy government lands. He did this to limit the amount of paper money received by the government and because he thought there was a bubble in land prices. He reasoned that requiring payment in gold and silver would pop the bubble.
This aggressive push to wean the economy off of paper currency—and onto hard money—strained the banking system. Demand for specie by customers in New York City exceeded supply, and, on May 9, 1837, banks there responded by refusing specie withdrawal. The suspension of convertibility in the nation’s financial center caused panic that quickly spread to the rest of the country. Banks, looking to replenish the specie in their vaults, refused to make new loans and called in existing loans, triggering a collapse of credit and a severe and prolonged decline in production and employment across the country.
Post-Crisis: Two Tendencies in Banking
The crisis set the next stage for banking. Helderman, in National and State Banks (1931, p.9), wrote, “Under the lash of economic distress, two clear tendencies emerged: one, a reform movement; the other, a sharp anti-bank reaction. The reform movement first evolved into a program in New York where in 1838 the free-bank system was created . . . The other result was to intensify the hard-money ideas of the day, leading to a movement in the West to abolish banks of issue. Absurd as it may seem today, the movement was based on a theory shared by many sober men of the time.” Free banking allowed individuals to set up private banks without the approval of state legislators, although with the requirement that they hold state bonds. These efforts reflected a desire to increase the creation of credit and a dislike of governments granting special privileges.
Women on Currency
In a bit of modern irony, there is a movement today to replace Jackson’s portrait on the twenty-dollar bill. The WomenOn20s organization is hosting an online referendum to allow the public to vote for their favorite female candidate, and it plans to petition President Obama to direct the Secretary of the Treasury, who oversees currency design, to make the change. Images of women once dominated the design of bank-issued currency, as Stephen Mihm explains. Portraits ranged from ethereal representations of justice, goddesses, and mythology, to anonymous working women, to real women such as Pocahontas, Martha Washington, and Swedish opera star Jenny Lind, “the Beyoncé of her day,” according to Mimh.
One argument for removing Jackson that is made on the WomenOn20s website is that, because Jackson was a fierce opponent of the central banking system and favored hard money over paper currency, he’s an odd choice to be represented on Federal Reserve notes in the first place. So, should Jackson be replaced on the twenty-dollar bill? And if so, with whom? Tell us what you think.
The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.
Thomas Klitgaard is a vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.
James Narron is a senior vice president in the Federal Reserve Bank of San Francisco’s Cash Product Office.
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NASDAQ 5000 – Crash? Bubble? Fair Value?
March 4, 2015
Almost fifteen years ago, on April 1, 2000, we wrote and published a piece entitled “Will the NASDAQ sell-off become a crash?” We have now retrieved that piece from our archives and posted it on our website.
In preparing that piece we evaluated the stock market and made a theoretical calculation in which we merged two companies, Cisco and Microsoft. We assumed that their reported earnings were accurate. We found that the two companies merged together had earnings of $10 billion and their merged theoretical market valuation amounted to $1 trillion. Our conclusion at the time was fairly straightforward. There was nothing wrong with either company. Both Cisco and Microsoft were fine, large, developing, worldwide leaders in the Technology sector. The stock price, however, was wrong. At 100 times earnings, the price of the theoretically merged company’s shares was not justified by any valuation technique. The combined GDP of all countries in the world was estimated at $30 trillion.
We concluded in our piece that the NASDAQ at 5000 was setting up for a crash. The fourth page measures the value of Cisco against a list of companies (that list included Apple). 15 years ago, we forecast that NASDAQ 5000 would lose over two-thirds of its value before the crash and sell-off ran their full course. Never did we think that the result would be a loss of 80% of its value.
This week, Convergex published a piece including their discussions of NASDAQ 5000. Author Nicholas Cola titled the piece “NASDAQ 5000 – Don’t Call it a Comeback” (March 3, 2015).
(See below for full report)
Here is the summary, which tells most of the story:
With the NASDAQ Composite back to the magic 5,000 level, today we look at the “heavy hitters” in the index. The companies with the top 10 weightings comprise some 32% of the entire index, led by Apple (9.9%), Microsoft (4.8%) the two flavors of Google (4.6%). So where do NASDAQ Comp valuation levels sit at 5,000, and what do you get for your money? Forward P/E multiples based on analyst expectations are 19x earnings, a noticeable premium to the S&P 500 at 17x. In return for that markup, those top 10 names in the NASDAQ offer the promise of real revenue and earnings growth. Analyst estimates for top line growth in 2015 for the top 10 names average out at 13.7% and the 3-year CAGR through 2017 is 11.2%. That translates into 9.4% earnings growth for this year and 11.7% compounded growth through 2017. The real question behind NASDAQ 5,000 Version 2.0 is simple: what price do you pay for growth stocks versus the broader index.
Let’s take a look at the issue now compared with conditions when our NASDAQ 5000 piece was written 15 years ago. Microsoft is now 4.8% of the index, Cisco is 2%, and Apple is approximately 10% of the index and the largest weight. The Convergex research piece provides the remaining information in detail. For information about Convergex, visit www.convergex.com. If you want to send them a reply on their commentary or obtain a copy of Nicholas Colas’s March 3, 2015, piece, we suggest sending an email to Convergex at firstname.lastname@example.org. Note: Cumberland is a user of Convergex’s services and receives their research missive daily.
So what does it mean that the price/earnings ratio is no longer 100:1? It is now in the mid-teens. The stocks currently represented in the NASDAQ are still heavily focused within the Technology sector. Some of the companies, whose market prices may be high relative to past references, are supported by profits and robust estimates of future growth. What is the condition of those companies? Do they have large reserves of cash, or are they involved in heavily leveraged debt structures? Cash seems to be the answer in most cases.
What is the basic condition of the Technology industry? In the dot.com era 15 years ago, as the NASDAQ steamed toward 5000, there were many companies that had no product or earnings. They had only future prospects. Companies formed in garages and found themselves with overnight capitalizations in the billions. Technology sector fever gripped the stock market as a whole, with the Tech sector priced at nearly one-third of total market value at its peak. The price of stocks relative to America’s gross domestic product (GDP) reached all-time highs, based upon trillions of dollars in market value for companies that were little more than concepts. By some estimates, the US market cap was $7 trillion in excess at the top of the tech bubble.
Is the picture the same today with the NASDAQ at 5000? We think not. Could the NASDAQ go through a correction? Yes. We have had an extended bull market of six years’ duration. Corrections have been elusive but are inevitable. That includes the NASDAQ.
We wrote about the NASDAQ 5000 15 years ago as a bubble, the forerunner of a crash, and a valuation supported without earnings or momentum other than prices set by speculative fever. Now, 15 years later, the NASDAQ represents companies that have worldwide growth potential and are revealing once again the remarkable robustness of technology advancement as a business model. These companies are very American. Look at the NASDAQ list and note the nature and structure of these success stories that are rooted in the United States.
Is the NASDAQ 5000 a crash in the making? Fifteen years ago the answer was, without equivocation, yes. Today, the answer is no. It is 15 years later.
We are overweight the Technology sector in our US exchange-traded fund (ETF) managed accounts. Those ETFs contain the stocks mentioned in the Convergex report along with many others. We think the outlook for this sector’s evolution is strong and strategically long-term, with higher earnings, profits, dividends, and stock prices ahead.
We put together a short video on this NASDAQ 5000 phenomenon and how it figured into the creation of our ETF separate account management structure back in 1999. You can view the video here.
David R. Kotok, Chairman and Chief Investment Officer