“Illustration shows Uncle Sam holding up a balance scale with “Labor” on the left and “Capital” on the right; when the two are balanced the scale points toward “Prosperity” and when uneven, the scale points toward ‘Depression’.” (Source)
(Source: Global Financial Data)
From the Archives
Benner’s Prophecies of Future Ups and Downs in Prices (1884)
There have been market predictions since markets first existed. Almost all predictions are wrong, but it is interesting to read those of a man named Samuel Benner, who authored books that sound more like a fortune tellers guide than an investment book. For example, the book linked this week is titled:
“Benner’s Prophecies of Future Ups and Downs in Prices: What Years to Make Money on Pig-Iron, Hogs, Corn, and Provisions”
(One note on today’s reads is that they will be a bit shorter than usual, as quarter-end is a busy period for me at work and I am still in the moving process so time for writing has been scarce. However, I can promise you that next week I will be back with the traditional long-form content you’ve all come to expect!)
Despite some volatility after President Trump tested positive for COVID-19, the stock market has been a little bit more rosy since I last posted on September 27th. The Russell 2000 is up 8.5%, the S&P 500 is up 3.8%, and the NASDAQ is up 3.2%. But, politics… amirite? Following the two debates it would be ridiculous to focus on anything other than the fast-approaching Presidential election on November 3rd. That said, today we will talk about elections, politics, and markets stretching back centuries.
The Compromise of 1877
Some of you may vaguely remember this story of the 1876 election from your high school AP US History class, but it feels particularly relevant as we face the reality of a potentially contested election in the very near term. The following description of this seminal moment in American history comes from New York Magazine:
“… if you want an example of a real nation-rending, Constitution-bending contested presidential election that might have conceivably led to a second Civil War, you have to go back to the U.S. Centennial Year of 1876, when Republican Rutherford B. Hayes defeated Democrat Samuel Tilden by a single electoral vote after a dispute that wasn’t resolved until the eve of Hayes’s inauguration in March of 1877.
The solid popular majority (including ex-slaves in the South protected by the actual or threatened presence of federal troops) that had reelected Civil War hero Ulysses S. Grant in 1872 had been weakened by a sustained economic depression, systemic corruption, and southern white resistance to (and northern white fatigue with) Reconstruction. The midterm elections of 1874 produced an epochal 94-seat swing in House seats (there were only 293 seats at the time) towards Democrats, who won the chamber, even as “redemption” movements aimed at restoring white political power (often behind ex-Confederate leaders) made big gains in the South.
By the time voters went to the polls to elect a successor to Grant, he had all but despaired of continuing Reconstruction, with federal courts undermining civil rights enforcement powers and Congress no longer interested in restoring them. Mississippi was “redeemed” for Democrats in 1875 amid widespread white terrorism, leaving just three southern states (Florida, Louisiana, and South Carolina) under Republican control, with another (North Carolina) closely contested.
When Ohio Governor Rutherford B. Hayes won the GOP nomination in 1876, he was mainly known as a hard-money champion and a mild supporter of civil service reform. Privately he had expressed a not-uncommon disinterest in using federal power to defend Black voting and other political rights, though Republicans did “wave the bloody shirt” by accusing his Democratic rival Samuel Tilden (a New Yorker mostly renowned for fighting Tammany Hall corruption) of being a puppet of ex-Confederates.
Much of the South was conceded to Tilden, though as Reconstruction historian Eric Foner has explained, in the four “unredeemed states,” local Republicans “waged a desperate struggle for survival” knowing that a restoration of Democratic control would lead to a restoration of white supremacy. Engagement was high everywhere in the country, as reflected in the 1876 election’s record-high voter turnout of 82 percent — a level which has never again been equaled.
The Hayes-Tilden Deadlock
With the economy being the main public preoccupation in the north, Tilden won the key swing states of Indiana, New Jersey, and his own New York, as well as a clear plurality of the national popular vote (at least as reported — widespread violent voter suppression in the South cast considerable doubt on Tilden’s margin). Late on Election Night, Tilden was one electoral vote short of a majority, with three of the “unredeemed” southern states (Florida, Louisiana, and South Carolina) plus Oregon still unresolved.
Subsequently, legal battles broke out in the three southern states over both the presidential contest and partisan control of state governments, with competing slates of electors being sent to Washington by all three. In Oregon, where Hayes’s popular vote win was not disputed, the Democratic governor claimed one of the three Republican electors was legally unqualified, and appointed a Democratic replacement. At this point, rarely-consulted and not terribly clear constitutional provisions governing congressional certification of electoral votes came into play. Republicans claimed the President of the Senate (a member of their party) had the power to determine which slates of electors to accept, and Democrats claimed the full Congress had to concur, which might mean the House (which it controlled) would resolve the election if no electoral college majority was recognized.
As the time neared in January 1877 for this fateful decision to be made, tensions rose around the country and in Washington. Democrats were particularly motivated given their candidate’s apparent popular vote margin (ultimately judged to be three percent) and threatened “Tilden or War.” Southern Blacks feared that a Democratic administration might reinstate slavery. As Ohio Republican congressman James Monroe recalled in 1893, there was no obvious scenario for resolving the crisis:
‘It was repeatedly stated on the floor of the House of Representatives, and apparently believed by the majority, that if the Republican party should proceed, through the President of the Senate, to count the, votes of the disputed States, and declare them for General Hayes, the House would then proceed to elect Mr. Tilden, or to count the vote and declare him elected by the nation. There would then have been a dual presidency, a divided army and navy, a divided people, and probably civil war. What plan could be devised to save the country from the evils that threatened it?’
The Electoral Commission of 1877
Eventually, President Grant and other Republicans proposed a special bipartisan commission to deal with the situation created by the ambiguous constitutional language on counting and certifying electoral votes, and after some hesitation Democrats accepted it. The commission would be composed of five U.S. Representatives (three Democrats and two Republicans), five U.S. Senators (three Republicans and two Democrats), and five Justices of the U.S. Supreme Court (two appointed by Republican presidents, two by Democratic presidents, and one — assumed to be Justice David Davis — reputed to be independent. But a ploy by Democrats to curry favor with David backfired horribly, as history professor Ari Hoogenboom explains:
‘[Davis] disqualified himself after a monumental miscalculation by Tilden’s corrupt nephew, Colonel William T. Pelton, who assumed that electing Davis as senator from Illinois with Democratic votes would purchase his support for Tilden on the Electoral Commission. Davis was replaced by a Republican, Joseph P. Bradley, giving Hayes’s party an 8:7 edge. Bradley did have an independent streak, but in strict party votes Hayes was awarded the disputed states.’
The Wormley Conference and The Compromise of 1877
The obvious partisanship of the commission vote and continuing sentiment among Democrats that Tilden had been robbed led to resistance, via a rare filibuster, in the Democratic-controlled House to a final certification of the electoral vote. This was the situation as the March 3 Inaugural Day approached. But in a series of very secret meetings in Washington, what was later known as the Compromise of 1877 was hammered out, as Nicholas E. Hollis later summarized:
‘After months of stalemate and rising tensions over the contested Election of 1876, emissaries from the Hayes-Tilden camps privately met several times at the Wormley Hotel and negotiated a settlement…arguably one of the most important in our Nation’s history which remains shrouded in denials to the present. The “secret deal” was formulated only days before the end of the Grant Administration under threat of filibuster and violence on Monday evening, February 26, 1877, chiefly, in the rooms of W.M. Evarts (a key Hayes backer who served as counsel to the Electoral Commission and later became as Secretary of State in the Hayes Administration).
The Wormley Agreement paved the way for the end of the Reconstruction Era, providing assurances for the early withdrawal of remaining Federal troops in three southern states (Louisiana, South Carolina and Florida) and the right of these states to “control their own affairs.” The written pledge provided by trusted Hayes’ aide (Charles Foster) to John Young Brown (D-KY) of the Tilden group cemented a strange alliance between Hayes’ Ohio Republicans and Tilden’s southern Democrats.’
Soon thereafter the House filibuster ended, Hayes’s electoral vote victory was certified, and he was peacefully inaugurated.”
Nuts, right? Well what about the stock market? How did it perform during this period of intense political uncertainty and divisiveness? Here’s what we can glean from the Global Financial Data database:
With that, let’s dive into the Sunday Reads!
The Political Consequences of Two Great Crises
“Economic crises have important political consequences. The Great Depression in the 1930s led to political realignments in Sweden and the United States and to the breakdown of democracy in Austria and Germany. More recently, the Great Inflation of the 1970s and 1980s and the economic downturns that occurred after the first and second oil shocks (in 1973 and 1979) marked the beginning of a long period of austerity in economic and social affairs, resulting in the secular decline of Europe’s social democratic parties.
During the most recent global crisis – the “Great Recession” – scholars and political commentators across the world argued that there was something surprising about the failure of center-left parties to benefit from the ongoing crisis of financial capitalism, particularly in Europe. For example, this was the view of the Economist, which noted in its coverage of the elections to the European Parliament in 2009 that the moderate left “failed to capitalise on an economic crisis tailor-made for critics of the free market” (The Economist 2009). It was also the view of left-wing academics such as Tony Judt, who considered it “striking” that “in a series of European elections following the financial meltdown, social democratic parties consistently did badly; notwithstanding the collapse of the market, they proved conspicuously unable to rise to the occasion” (Judt 2010).
If we take history as our guide, however, the failures of the political left in 2008–2011 were not all that surprising. Comparing the Great Recession to another deep global, financial, and economic crisis – the Great Depression – this paper analyzes the first post-crisis national elections in 1929–1933 and 2008–2011 in the twenty countries that were democracies at the time of the Great Wall Street Crash on October 24, 1929, and held at least one democratic election between the Wall Street Crash and the mid-1930s (Australia, Austria, Belgium, Canada, Costa Rica, Czechoslovakia, Denmark, Estonia, France, Germany, Greece, Ireland, Latvia, the Netherlands, New Zealand, Norway, Sweden, Switzerland, United Kingdom, and the United States). I will show that the political repercussions of the Great Depression and the Great Recession were remarkably similar: in both periods, right parties were more successful than left parties in elections held soon after the crash, but after a few years, left parties started to do better.”
The Panic of 1792
1792 was a congressional election year marred by a financial scandal that rocked the nation, but also saw the initiation of America’s first bull market.
“The first attempt at a stock corner in the United States came at the birth of the American stock market, occurring even before the New York Stock Exchange had been established. Instead, it occurred in trading at Philadelphia. In 1792, Philadelphia was both the capitol and the financial center of the United States. Consequently, it is not surprising that politics and finance intermixed to create the nation’s first financial panic and the first time the government stepped in to save the markets from themselves…
The Society for Establishing Useful Manufactures (SUM) was established in 1791 to promote industrial development along the Passaic River in New Jersey, founding the city of Patterson in the process. The goal was to use the Great Falls of the Passaic River as a power source for grist mills. The company was the idea of Assistant Secretary of the Treasury Tench Coxe, and was charted in New Jersey under Hamilton’s direction as a type of public-private partnership.
Hamilton asked William Duer, who had sided with Hamilton in The Federalist Papers, writing in support of the United States Constitution under the alias of “Philo-Publius,” to become governor and chief salesmen for the SUM. Duer was instrumental in helping to raise $500,000 in capital for the new company.
William Duer was not only a master salesman, but a speculator as well. When Hamilton discovered that Duer had been a driving force in the “scripomania” which had driven the Bank Scrip Bubble, he sent Duer a letter admonishing him for speculating in bank scrip. Like any plunger, his failure in the Bank Scipr Bubble only motivated him to invest on a larger scale and to try and have greater control over the market to insure success.
Duer organized a pool along with Alexander Macomb, a wealthy land speculator who had purchased the largest piece of property from the state of New York, and with other owners of shares in the Bank of the United States. They were known as “The Six Percent Club” since shares in the Bank of the United States paid a 6% dividend. Their goal was to try and corner the market before the next distribution of shares in July 1792 and sell the shares to European investors at a profit. Duer and the others bought the shares on time, in essence buying options, rather than buying full shares, so they could maximize their profit through leverage.
The Bank of the United States finally opened in December 1791, and made use of its capital by making loans and issuing banknotes. This increased the money supply and helped to feed new speculation in bank shares and U.S. 6% bonds. The wild ride in shares of the Bank of the United States continued. Shares rose in price from 524 to 680 on October 26, 1792, fell back to 528 on December 17, 1791 and rose to 712 on January 4, 1792. Since the U.S. Government Sixes could be used to buy shares, their price rose in sympathy with the increase in the price of the Bank of the United States, rising to 129 on March 5, 1792….
By March, the banks started to face a credit crunch. Clinton and his clique began to withdraw large amounts of money from the city’s banks to create a credit shortage. Moreover, it was springtime when farmers began withdrawing money from the banks to pay for the crops they were planting.
Oliver Wolcott, the comptroller of the currency, had discovered the deficiency of $292,000 at the SUM, which Duer acknowledged, and demanded repayment. Wolcott called upon the U.S. attorney in New York to sue Duer for the long overdue debt. Duer appealed to Alexander Hamilton to intercede on his behalf, but Hamilton refused, and on March 9, 1792, Duer failed to meet payments on some of his loans and Duer’s paper pyramid collapsed.
With Duer and his pool no longer able to buy shares in the Bank of the United States, the price of the stock began a precipitous decline. On March 23, Duer took refuge in the New York city jail. Duer was soon joined in jail by two other members of the “Six Percent Club,” Walter Livingston (who is buried at Trinity Churchyard near Wall Street), who had cosigned over $200,000 of notes signed by Duer, and Alexander Macomb, who defaulted on $500,000 in stock he had purchased from the bears.
By mid-April, with the Six Percent Club defaulting and the price of Bank of the United States stock collapsing, the country suffered its first financial panic. This delighted Secretary of State Jefferson, Governor Clinton and his allies, who were opposed to Hamilton’s attempt to centralize the finances of the United States. They would turn the Panic into political capital which they would use to undercut Alexander Hamilton.
In response to the crisis, many banks tightened their credit, and in March and April, money began flowing to farmers to provide funding for their crops. From December 29 to March 9, cash reserves for the Bank of the United States decreased by 34%, prompting the bank to not renew nearly 25% of its outstanding 30-day loans. In order to pay off these loans, many borrowers were forced to sell securities they had purchased, which caused the price of stocks to fall sharply. The price of Bank of the United States half shares collapsed from 203 on March 3 to 146 on March 21 while the price of U.S. Sixes fell from 129 to 95. The price of stock in the Society for the Establishment of Useful Manufactures fell from 136.5 on February 8 to 30 on March 13, 1792.
Duer had perpetrated the young nation’s first financial Panic and stock market crash, and he paid the price. Duer spent the rest of his life in debtor’s prison where he died on May 7, 1799…
Nevertheless, in the elections in the congressional elections of 1792, Jefferson and his allies benefitted as voters expressed their disgust with Duer and his financial shenanigans. After the collapse was over, the United States began its first bull market, with stock rising in price until 1802.”
History as a Compass – Coronavirus, Financial Crashes, and Lessons from the Past
It is interesting to look back at what the world looked like even just a few months ago as COVID-19 was beginning to pose a serious threat to countries around the globe. Back in April I hosted this Real Vision special on financial history that featured three interviews with Scott Nations, Jim Grant, and Jim Chanos on what lessons investors could draw from the past for navigating markets today.
While I am obviously biased to think that the whole special is worth watching, I believe that my conversation with Jim Grant is the most relevant for today’s post focused on the relationship between politics and finance. In particular, Jim provides some fascinating insights and history on the political aspects of the Federal Reserve, and other lessons from economic history. (The conversation begins at 29:03)
Liberty Bonds and Republican Electoral Success in the 1920s
The NYT previously reported:
‘Fed relief for states and cities had also been highly anticipated because Congress provided only limited aid to those governments in its recent legislation. The markets that local governments use to issue bonds and finance themselves have been in turmoil, which threatened to make it difficult for officials to fund operations just as revenues dried up and the need for cash skyrocketed.’
It does not require much imagination to envision a scenario where certain towns or cities endure financial hardship while others in similar positions succeeded after perhaps receiving more favorable conditions from the Fed. With the outcomes of presidential elections strongly correlated with the strength of the economy, the so-called ‘winners & losers’ that the Fed ‘picks’ could potentially influence the ballots of voters in key swing states. Just look at how similar the two examples below are despite occurring in elections 100 years apart:
If this seems like a stretch, this article might change your mind.
In this fascinating piece, the authors argue that the performance of Liberty Bonds partially influenced the outcome of the 1920 election, as those holding depreciated bonds blamed the Democratic party for their poor performance. As the Harding advertisement demonstrates above, the Republicans took full advantage of this situation.
“We find that counties with higher liberty bond ownership rates turned against the Democratic Party in the presidential elections of 1920 and 1924. This was a reaction to the depreciation of the bonds prior to the 1920 election (when the Democrats held the presidency), and the appreciation of the bonds in the early 1920s (under a Republican president), as the Fed raised and then subsequently lowered interest rates.”
In fact, the ramifications of these seemingly innocuous Liberty Bonds shaped the modern Federal Reserve. As it turns out, President Harry Truman was one of the Liberty Bond holders negatively affected by their declining prices:
‘After returning from World War I, Truman had to sell his family’s liberty bonds at severely depreciated prices to raise money, an experience that apparently infuriated him and made him suspicious of the motives behind Fed policy.”
When Truman became president in 1945, the Federal Reserve supported the ‘prices of government securities by purchasing large quantities of them’ (sound familiar?) under a wartime policy. However, after World War II the Fed wanted to end this operation, but President Truman and his Treasury department were ‘vigorously opposed’. As the United States became increasingly involved in the Korean War, and there was ‘very high inflation’ in the economy, the ‘the conflict between the Fed and Truman intensified.’ So much so, in fact, that
‘In 1951… Truman took the extraordinary step of asking the entire Federal Open Market Committee to meet with him in the Oval Office. In that meeting, Truman stated that he did not want “the people who hold our bonds now to have done to them what was done to him.”
Eventually, the conflict intensified to the point that it was ‘resolved through the negotiation of the Treasury-Fed Accord, which established the foundations of the Fed’s modern independence.’ As the authors of this article put it, ‘in more ways than one, liberty bonds shaped the evolution of American monetary and fiscal institutions.’ As the Federal Reserve is now being forced into a more ‘political dimension’ by participating in the municipal market, it will be interesting what the future second-order effects of this action will be. For example, studious Sunday Reads subscribers will remember the importance of this 1951 Treasury-Fed Accord from last week’s article on the relationship between presidential elections and the U.S. economy. In that article, the authors described the shift in this dynamic due to the 1951 accord:
‘The concomitant transformation of the position of the federal government in the national economy and the increase in the independence of the Federal Reserve suggests the following hypotheses related to the role of economic circumstances in presidential elections:
- Prior to 1952, price stability was positively associated with the share of the vote received by the incumbent president (or his fellow partisan).
- From 1952 to the present, income growth was positively associated with the share of the vote received by the incumbent president (or his fellow partisan).’
Victory or Repudiation? The Probability of the Southern Confederacy Winning the Civil War
I always find it interesting when a certain asset or instrument can be used as a gauge for predicting the outcome of a certain event like elections, wars, etc. For example, this chart from Bloomberg is just one of thousands on this topic:
If there was ever an event to dictate the future direction of the United States, it was the Civil War. In 2020 it is hard to fathom the level of uncertainty and conflict that existed at that time, and exactly what was at stake. In such periods of uncertainty speculators abound with bets on what they believe will unfold. This brilliant article takes a look at the markets behind the U.S. Civil War in the 19th century:
“Historians have long wondered whether the Southern Confederacy had a realistic chance at winning the American Civil War. We provide some quantitative evidence on this question by introducing a new methodology for estimating the probability of winning a civil war or revolution based on decisions in financial markets. Using a unique dataset of Confederate gold bonds in Amsterdam, we apply this methodology to estimate the probability of a Southern victory from the summer of 1863 until the end of the war. Our results suggest that European investors gave the Confederacy approximately a 42 percent chance of victory prior to the battle of Gettysburg/Vicksburg. News of the severity of the two rebel defeats led to a sell-off in Confederate bonds. By the end of 1863, the probability of a Southern victory fell to about 15 percent. Confederate victory prospects generally decreased for the remainder of the war. The analysis also suggests that McClellan’s possible election as U.S. President on a peace party platform as well as Confederate military victories in 1864 did little to reverse the market’s assessment that the South would probably lose the Civil War.”
MISS LAST WEEK’S SUNDAY READS? CATCH UP HERE