Winged Wheeler

After the War of 1812, New York state began construction of a canal connecting the Hudson River with the Great Lakes. The Erie Canal, completed in 1825, was one of those rare and curious instances where a socialist enterprise actually made a good profit, and it encouraged other states to emulate New York. An orgy of canal building resulted. Usually, state governments owned and operated these new canals. In those few instances where the canals were privately owned, the states contributed the largest share of the financing. By 1840, the canal boom had blessed the United States with 3,326 miles of mostly economically unjustified canals at an expense to the states of $125 million, a large sum in those days. Virtually all the new canals were a waste of resources and did not deliver the hoped-for monetary returns. Instead, the heavy state investments, when added to budget growth stimulated by the War of 1812, led to massive borrowing.1
Then, in May of 1837, a major financial panic engulfed the country’s 800 banks, forcing all but six to cease redeeming their banknotes and deposits for gold or silver coins. The panic brought on a sharp depression that was quickly over.2 Amazingly, after the recovery, the outstanding indebtedness of states nearly doubled, with a third of that invested in state-chartered banks in the Midwest and South.3 By the end of 1839, a second bank suspension spread to half the country’s banks. Over the next four years, nearly a quarter of state banks failed, the country’s total money stock (M2) declined by one-third, and prices plummeted by 42 percent.4 Needless to say, the state governments faced financial stringency, and during the deflation of 1839-1843, many became desperate. By 1844, $60 million worth of state improvement bonds were in default. Four states—Louisiana, Arkansas, Michigan, and Mississippi—as well as the territory of Florida eventually repudiated debts outright, while four others—Maryland, Illinois, Pennsylvania, and Indiana—defaulted temporarily. New York and Ohio escaped similar straits only by taking extraordinary measures.5

The Upside of Government Default — The American Magazine