Credit crisis of 1772

The peacetime Credit Crisis of 1772 originated in London and then spread to other parts of Europe, such as Scotland and Netherlands. On 8 June 1772, Alexander Fordyce, a partner in the banking house Neal, James, Fordyce and Down in London, fled to France to avoid debt repayment, and the resulting collapse of the firm stirred up panic in London. Economic growth at that period was highly dependent on the use of credit, which was largely based upon people’s confidence in the banks. As confidence started ebbing, paralysis of the credit system followed: crowds of people gathered at the banks and requested debt repayment in cash or attempted to withdraw their deposits. As a result, twenty important banking houses went bankrupt or stopped payment by the end of June, and many other firms endured hardships during the crisis. At that time, the Gentleman’s Magazine commented, "No event for 50 years past has been remembered to have given so fatal a blow both to trade and public credit".

Before the crisis

From the mid-1760s to the early 1770s, the credit boom, supported by merchants and bankers, facilitated the expansion of manufacturing, mining and internal improvements in both Britain and the thirteen colonies. Until the outbreak of the credit crisis, the period from 1770 to 1772 was considered prosperous and politically calm in both Britain and the American colonies. As the result of the Townshend Act and the breakdown of the Non-importation Act, the period was marked with a tremendous growth in exports from Britain to the American colonies. As shown in the graph (Fig. 1), exports to North America, represented by the red line, increased rapidly compared to imports to North America between 1750-72. These massive exports were supported by credit that British merchants granted to American planters.

Problems, however, lay behind the credit boom and the prosperity of both British and colonial economies: speculation and the establishment of dubious financial institutions. For example, in Scotland, bankers adopted "the notorious practice of drawing and redrawing fictitious bills of exchange…in an effort to expand credit". For the purpose of increasing the supply of money, the Ayr Bank was established in Ayr, Scotland in 1769; however, after the original capital was exhausted, the firm raised money by a chain of bills. Henry Hamilton has explained how a chain of bills works, "A, say in Edinburgh, drew a bill on his agent B in London, payable in two months. Before payment was due B redrew on A for the same sum plus interest and commission. Meantime A discounted his bill in Edinburgh and before the two months were up he drew another bill on B and so on". This method could only temporarily support economic development, yet it promoted false optimism in the market. The warning signals of the impending crisis, such as the overstocked shelves and warehouses in the colonies, were completely overlooked by British merchants and American planters.

Effects on Europe

After the crisis, a dramatic rise in the number of bankruptcies was observed: the average number of bankruptcies in London was 310 from 1764–71, but the number rose to 484 in 1772 and 556 in 1773. Banks that were deeply involved in speculation endured hard times during the crisis. For example, the partners of the Ayr Bank paid no less than ￡663,397 in order to fully repay their creditors. Owing to this process, only 112 out of 226 partners remained solvent by August 1775. In contrast, banks that had never engaged in speculation did not bear any losses and gained prestige for their outstanding performance despite the turbulence. The East India Company bore heavy losses and its stock price fell significantly. As Dutch banking houses had invested extensively in the stock of the East India Company, they suffered the loss along with the other shareholders. In this manner, the credit crisis spread from London to Amsterdam.

Effects on thirteen colonies

The credit crisis of 1772 greatly deteriorated debtor-creditor relations between the American colonies and Britain, especially in the South. The southern colonies, which produced tobacco, rice, and indigo and exported them to Britain, were granted higher credit than the northern colonies, where competitive commodities were produced. It was estimated that in 1776 the total amount of debt that British merchants claimed from the colonies equaled 2, 958,390; Southern colonies had claims of ￡2,482,763, nearly 85 per cent of the total amount. Before the crisis, the commission system of trading prevailed in the southern plantation colonies. The merchants in London helped the planters sell their crops and shipped what planters wanted to purchase in London as returns. The commission equaled the price of the British goods minus the revenue of the crops. The planters were usually granted credit for twelve months without interest and at five per cent on the unpaid balance after the deadline.

After the outbreak of the crisis, British merchants urgently called for debt repayment, and American planters faced the serious problem of how to pay the debt for several reasons. First, because of the economic boom before the crisis, planters were not prepared for large-scale debt liquidation. As the credit system broke down, bills of exchange were rejected and almost all heavy gold was sent to Britain. Second, without the support of credit, planters were unable to continue producing and selling their goods. Since the whole market became crippled, the fallen price of their goods also intensified the pressure on planters. Owing to the crisis, the colonies endured hard times to maintain the balance of payments.

The Crisis of 1772 also set off a chain of events related to the controversy over the colonial tea market. The East India Company was one of the firms that suffered the hardest hits in the crisis. Failing to pay or renew its loan from the Bank of England, the firm sought to sell its eighteen million pounds of tea from its British warehouses to the American colonies. Back then the firm had to market its tea to the colonies through middlemen, so the high price made its tea unfavorable compared to the tea that was smuggled to or was produced locally in the colonies. In May 1773, however, the Parliament imposed a three pence tax for each pound of tea sold, and allowed the firm to sell directly through its own agents. The Tea Act reduced the tea price and enabled the East India Company’s monopoly over the local tea business in the colonial tea market. Furious about how British government and the East India Company controlled the colonial tea trade, citizens in Charleston, Philadelphia, New York and Boston rejected the imported tea, and these protests eventually led to the Boston Tea Party in 1773. The crisis also worsened the relationship of the North American colonies and Britain, due to the fact that it affected all 13 of the colonies, and due to the fact that the British were forced to introduce contraversial legislation for the colonies in an attempt to remedy the crisis.

See also

• The Ayr Bank
• Neal, James, Fordyce and Down

References

• The British Credit Crisis of 1772 and The American Colonies