Panic of 1825 facts for kids

Kids Encyclopedia Facts

The Panic of 1825 was a big stock market crash that started in England. It happened partly because people made risky investments, especially in places like Latin America. One of these risky investments was in a made-up country called Poyais!

The crisis hit Britain the hardest, causing twelve banks to close down. But its effects were also felt in Europe, Latin America, and the United States. To stop the crisis from getting worse, gold and silver were collected from people, and the French central bank, the Banque de France, sent gold to help save the Bank of England.

Many people call the Panic of 1825 the first modern economic crisis that wasn't caused by something outside the economy, like a war. This makes it seem like the start of modern economic cycles, where economies go through ups and downs. Before the crash, the Napoleonic Wars had made a lot of money for Britain's financial system. The government's actions to increase the money supply as the war ended led to a time of great wealth and many risky business ideas. The stock market grew too fast, like a bubble, and banks got caught up in the excitement, lending money for very risky projects.

Why Banks Struggled

About seventy banks failed during this time. Today, experts believe that a lot of the blame for the crash falls on the banks themselves. They didn't gather enough good information, didn't watch out for problems, and didn't do simple checks on the businesses they were lending to.

Here are some of the main reasons for the crisis:

Problems with loans given to countries in Latin America.
It was too easy for local banks to print their own banknotes. This led to dishonest people investing in very risky projects that promised huge returns.
The Bank of England quickly increased the amount of money available, then quickly pulled it back. This caused people to rush to banks to get their money out. The Bank of England also refused to help other banks by lending them money when they needed it most, until it was too late.

At the time, the Bank of England wasn't like a modern central bank. It was a private bank that wanted to make a profit. It had three main duties: to its owners (shareholders), to the British government, and to the other commercial banks it worked with. The Bank of England raised its lending rates to protect its own investors. This made things worse for other banks instead of helping them.

Even though a banker named Henry Thornton had explained in 1802 how a central bank should act in a crisis (by lending money to prevent widespread panic), the Bank of England didn't do this until much later, during the Overend Gurney crisis in 1866. The Bank of England's inaction in 1825 caused the banking system to almost stop working, leading to many businesses going bankrupt and lots of people losing their jobs.

What Led to the Panic?

Several things happened in Britain that led to the Panic of 1825. Along with the Industrial Revolution, there were fast changes in how money worked and how banks operated. Also, before the crisis, Britain was heavily involved in the very expensive French Revolutionary and Napoleonic Wars.

The crash happened after a time when Britain had stopped using the gold standard as a temporary war measure. This meant the government could print more money. This policy made the whole financial system very profitable. But when the war ended, and the government wanted to go back to using the gold standard, the economy slowed down.

To prepare for going back to the gold standard, the Bank of England raised interest rates. It also collected a lot of gold and took banknotes out of circulation. This caused prices to fall, but it allowed the Bank to fully return to the gold standard in 1821.

Experts generally agree on the events leading up to the crash. However, they have different ideas about which factors were the most important.

Different Ideas About the Causes

In 1925, William Ackworth suggested that the government and the Bank of England's strict policy of making prices fall made the problems worse. These problems were already happening as the country moved from a wartime economy to a peacetime one.

Economists like David Ricardo thought the Bank's actions were due to a lack of understanding.

However, later experts have argued that the Bank wasn't ignorant. Instead, they say the Bank was upset because the government tried to limit its power and control how much money it could create.

Other experts have focused on how British people were speculating (making risky investments) in Latin American markets. This happened because the government's money policy allowed for a lot of growth.

Alexander Dick points out that this crisis was special. It wasn't just caused by outside events like war or foreign speculation, though those played a part. He believes the crisis came from the financial economy becoming more varied and complex.

Larry Neal's important study of the crash argues that no single thing was to blame. He says it wasn't just speculation, or the Bank of England, or the local banks. Instead, he believes all the problems from moving from war to peace came from the growing "uncertainties" in how financial information was shared and understood.

Local Banks

One factor many experts mention is how quickly local banks, called "country banks," spread during the Industrial Revolution. From 1780 onwards, these banks grew fast across England and Wales. By 1810, there were over 800 licensed and unlicensed banks. They issued small banknotes and gave loans to new industries like workshops, mines, and factories. Some scholars believe that without these banks, the Industrial Revolution might not have even started because there wouldn't have been enough money to fund it.

Wars and Money

Europe was caught up in the huge French Revolution and Napoleonic Wars from 1789 to 1815. Britain got involved in early 1793. Even though there was a short peace in 1802, fighting started again when Napoleon returned to power in 1803. Great Britain stayed involved until its victory at the Battle of Waterloo in 1815.

Napoleon, who would soon become emperor, made it clear he planned to invade Britain. He gathered troops near Calais, which made Britain spend a lot of money to increase its army and navy. The British government built new defenses along England's southern coast and strengthened old ones. These military investments were very expensive.

Paying for War

Britain did add some new taxes during the war, but they weren't popular. They also didn't raise as much money as hoped. People thought they weren't even needed because Britain had good credit and could borrow money to pay for the war. Also, Britain had stopped using the gold standard in 1797, which allowed it to print more money without needing gold to back it up.

Borrowing Money

Britain usually paid for its wars by borrowing money rather than raising taxes. This was a strategy Britain had used since the early 1700s. Britain paid for its war spending by borrowing money for both short and long periods. Short-term loans were more expensive for the government to pay back. Long-term loans, which involved regular interest payments, were mainly used to pay off the more expensive short-term loans. This helped spread out the debt and lower the government's payments.

The country could do this because lenders trusted Britain's stable government. This allowed Britain to borrow a lot of money. Britain followed this traditional way of funding wars, borrowing 90% of its spending, until 1798. But as the Napoleonic Wars went on, Britain's massive spending reached record levels. Britain had to find other ways to get money.

Taxes During War

To help with war costs, William Pitt the Younger introduced Britain's first Progressive income tax in 1798. This was meant to be a temporary tax. It stayed in place until 1802 but was brought back in 1803 when fighting resumed. After Britain's victory at the Battle of Waterloo in 1815, the government wanted to keep some form of the tax. They feared that without the money, the government would struggle to pay its debts. But there was strong public opposition, and in 1816, the income tax was removed again.

More Money in Circulation

In February 1797, Britain passed a law called the Bank Restriction Act 1797. This law stopped people from exchanging gold for banknotes. It was seen as a necessary step during wartime. In March of the same year, the Bank of England also allowed small banknotes to be issued, which helped put more money into the economy.

Risky Foreign Investments

Even though banks no longer had to follow the gold standard, some economists say they were still quite careful. However, record exports to the Americas between 1808 and 1810, along with easy credit, led to more risky investments in foreign markets. This boom ended with a crash in the summer of 1810. Many businesses failed, and merchants went bankrupt. This business crisis quickly spread to the financial world, as merchants pulled down the bankers who had lent them money.

Currency Value Drops

During this time, the policy of putting more money into the economy and making credit easy also caused Britain's currency to lose value. Its exchange rate fell. Concerned by this, the government set up a committee to decide if they should go back to the gold standard soon, even if the war was still going on. This "Bullion Report of 1810" became very important for understanding how bank policies affect exchange rates.

The Bullion Report of 1810

This important report argued that the central bank's lending policies affected prices and exchange rates. It suggested that the central bank's power to control lending should be limited by a gold standard. This caused a lot of debate between 1810 and 1811 about the link between money policy and exchange rates. It also made people question how profitable the Bank of England was and challenged the power of its directors. In reality, though, the Bank's power stayed strong as long as the government relied on it to manage money transfers and issue debt during the war. The government defended the Bank, saying that war naturally caused exchange rates to fall.

Good Times During War

Thanks to these wartime money policies – which focused on putting more money into the economy and issuing debt rather than just relying on taxes – the entire British financial system did very well while the wars continued.

The government benefited from increased taxes, the income tax, and a bigger market for selling debt.

While the gold standard was paused, the Bank of England, acting as a public bank (not a central bank), made money by printing banknotes that weren't backed by gold. The Bank also profited from its role as a go-between during the wars. It worked with the government to manage money transfers both at home and abroad during one of history's most expensive wars up to that point.

London's private banks and foreign merchants who were escaping unfair demands expanded their businesses within the city.

Local banks grew rapidly across Britain between 1780 and 1810. After the Bank of England stopped exchanging gold for banknotes and allowed small notes to be issued in 1797, these small local banks could make money by printing small banknotes to replace coins.

From War to Peace

Government Spending

Coming out of the war and without the income from wartime taxes, the government struggled to pay off the huge national debt built up during the war.

Bank of England's Role

To make up for losing its profitable wartime income, the Bank of England had to find new ways to earn money.

New Investments

London's financial markets reacted to the government paying off its high-interest war bonds by creating a "bewildering array" (a confusing variety) of new financial products.

Private Banks and Customers

Private London banks, their local partner banks, and their customers in industries like farming, trade, and manufacturing, found it hard to understand these new financial products. This led to a lot of confusion.

Fast Growth of Finance

Britain's financial system grew very quickly between 1770 and the end of the Napoleonic Wars. This happened at the same time as the country's industrialization. In 1770, there were only five types of stocks available on the London Exchange. But by 1824, investors could choose from 624 different companies to invest in.

What Happened After the Crisis?

Businesses Affected

Going back to the gold standard meant there was less money circulating and banks lent less. This made it hard for merchants to get money. Bankruptcies (when businesses fail) increased a lot in the rest of 1825 and almost doubled in 1826.

Publishing Industry Changes

The crisis also directly affected the publishing industry. While the number of publishers in Britain didn't go down between 1825 and 1827, the crisis completely changed how the industry worked. Publishers who followed older traditions of giving authors large payments in advance often owed money to banks. This made them very vulnerable during the crisis. Like many businesses, several major publishing houses had to declare bankruptcy. Older publishers like John Murray, Constable and Ballantyne, Hurst and Robinson, and Taylor and Hessey suffered, and some even completely collapsed.

The struggles of the established publishing houses allowed newer, less famous publishers to change the market. Expensive books were less in demand, but the market for cheaper books, pamphlets, and children's books grew quickly. Smaller publishers bought the leftover books from their failed competitors at a discount and sold cheap versions. This led to a demand for cheap stories and started the trend of publishing stories in parts, like a TV series.

New Rules and Regulations

The crisis of 1825, even though it shook public trust, didn't destroy the market. Instead, it ended up making it stronger and more centralized.

Many people at the time believed the crash, along with other smaller crises that followed, showed a need for better rules. Laws like the Limited Liability Act of 1855 and the Companies Acts of 1856 and 1862 tried to regulate the market better. This made it easier for individuals to invest.

The crash caused such a panic that London bankers and their customers asked the government to protect their credit by stopping the exchange of gold for banknotes, just like they did in 1797. But the government, worried about falling exchange rates and wanting to keep its good reputation, refused to do this. However, to help calm the public, the government put in place several changes to deal with the crisis as they understood it then.

Small banks would be replaced by branches of the Bank of England.
London banks would be allowed to compete for government contracts and business. This ended the special position the Bank of England had enjoyed during the Napoleonic Wars.
The gold standard would be extended to Scotland to help control the use of paper money not backed by gold.

These changes helped to bring the financial industry together and changed how people understood money, the economy, and society. While writers at the time first thought the problems came from unwisely abandoning the gold standard, their views later shifted. By the time James McCulloch published "The Late Crisis in the Money Market Impartially Considered," he began to think the crash wasn't just caused by greedy bankers but by a financial system that had become very complex.

Public View

While experts now believe the crisis was caused by the shift from a wartime to a peacetime economy, at the time, people mostly blamed weak local bankers who made unwise investments.

Christian Economics

The crash caused many families great hardship and left them confused about what had happened. Their feelings led to the growth of "Christian economics," which became a popular economic idea in the 1830s. This theory suggested that human actions, driven by individual desires, would always lead to some suffering.

The Business Cycle Idea

This idea of "atonement" (making up for mistakes) led to the concept of the business cycle. It was believed that producing too much would eventually lead to higher prices and, finally, an economic downturn.

In Books

Harriet Martineau's Illustrations of Political Economy suggests there's no perfect solution to financial ups and downs. Her work, along with many others from that time, seems to say that people should prepare themselves for inevitable confusion and collapses.

Thomas Babington Macaulay mentions the country's on-and-off gold standard in his "Review of Southey's Colloquies." He talks about the currency being "unwisely made less valuable, and unwisely brought back."

In Fiction

A historical novel by Stanley J. Weyman, Ovington's Bank, published almost a century later (1922), is about the Panic of 1825.

George Eliot's novel Middlemarch, written in 1870 but set in 1830, also mentions the crisis and how it affected the lives of people in Victorian England.