The Panic of 1907: How a California Earthquake Shook Global Finance

The Panic of 1907 is often remembered as the moment when Wall Street nearly collapsed under the weight of its own speculation – when trust companies failed, crowds lined up outside banks, and the great financier J.P. Morgan locked the nation’s leading bankers in his library to force a rescue plan.

But that dramatic picture, though accurate, tells only part of the story.

From an Austrian economics perspective, the deeper truth of 1907 is more complex, and in some ways, more reassuring. The panic did not arise from deep corruption or chronic mismanagement of money. It was not the inevitable consequence of a flawed system. In fact, by the early 20th century, the United States had one of the most dynamic and disciplined financial environments in the world; a gold-based currency, relatively low inflation, strong private banks, and a thriving industrial economy.

What brought the system down in 1907 was not primarily its own weakness, but the force of an external catastrophe i.e., the San Francisco earthquake of 1906, which rippled through the global monetary order. That disaster triggered massive insurance payouts from British and European firms to American claimants, draining gold reserves from London and forcing the Bank of England to raise interest rates, thereby tightening global credit.

It was a shockwave that began beneath the streets of San Francisco, traveled across the Atlantic through the balance sheets of insurers, and returned to New York in the form of a liquidity crisis.

And in an age of instant telegraphs, daily newspapers, and national news wires, the panic spread faster than ever before.

America’s Financial System Before the Panic: Stability, Growth, and Gold

At the dawn of the 20th century, the United States operated under what many economists, especially those of the Austrian tradition, regard as a sound monetary system. The dollar was tied to gold; paper currency could be exchanged for specie, and there was no central bank manipulating the money supply.

Between the end of the Civil War and the first decade of the 1900s, the U.S. enjoyed robust economic growth with remarkable price stability. The period sometimes called the ‘Classical Gold Standard Era’ (roughly 1879–1914) was one of unprecedented global prosperity, not just for the United States but for much of the industrialized world.

In this environment, private banks and trust companies thrived under a regime that combined competitive independence with disciplined prudence. There were periodic local bank runs and occasional credit crunches, natural features of a decentralized system, but overall, the ‘free banking’ model produced steady expansion, investment in industry, and rising living standards.

Unlike later centralized systems, credit in this period was grounded in real savings and gold reserves, not in fiat expansion. Interest rates reflected time-preference and the balance between savers and borrowers.

In short: the United States of 1906 was not a house of cards waiting to collapse. It was a strong, flexible system that had weathered many storms, and it would take an extraordinary external force to bring it to its knees.

The Earthquake That Shook the World

At 5:12 a.m. on April 18, 1906, the ground beneath San Francisco heaved violently. The quake, one of the most powerful in recorded U.S. history, and the fires that followed, destroyed nearly the entire city.

Estimates of total property loss reached $400 million (equivalent to over $12 billion today). Over 3,000 people lost their lives and tens of thousands were left homeless, but beyond the human tragedy lay a financial tsunami.

At the time, the vast majority of San Francisco’s property insurance was underwritten not by American firms, but by British and European insurers. Lloyd’s of London, along with a host of other firms, bore the brunt of the claims.

To settle these obligations, enormous sums had to be transferred from London to the United States – mostly in gold, since the world was still firmly on the gold standard. These transfers were so large that they showed up in international monetary statistics.

In the months after the quake, roughly $60-70 million in gold flowed across the Atlantic to pay American claims. For context, that was a large portion of Britain’s gold reserves at the time.

The Bank of England, guardian of the pound sterling (the world’s dominant reserve and trade currency) could not ignore such an outflow. In the classical gold-standard mechanism, gold outflows meant less domestic liquidity, which in turn required higher interest rates to defend the currency.

Accordingly, the Bank raised its discount rate in late 1906 to stem gold losses and attract inflows from the Continent. London’s higher rates tightened credit conditions globally.

This move had profound consequences for the United States. British investors, facing more attractive rates at home, began repatriating capital from New York and other markets. International lending slowed. The cost of borrowing rose.

The system had not been mismanaged, it was simply reacting to the automatic rules of the gold standard. But in practice, this global credit contraction landed hardest on the U.S. financial markets, which were accustomed to relying on short-term funds from abroad.

The Shockwaves Reach Wall Street

By 1907, liquidity in New York was tight. Seasonal demands for currency (to move crops and finance trade) coincided with rising international rates. Bank reserves were stretched thin, and trust companies, important intermediaries in the city’s financial ecosystem, were especially vulnerable.

In a sense, the American banking system was healthy but illiquid. It was like a sturdy ship caught in a sudden gale: the vessel was sound, but the waves were violent.

The Spark: The Heinze Brothers and the United Copper Corner

The immediate cause of the Panic began not with a major bank, but with a reckless gamble.

In October 1907, two brothers from Montana, F. Augustus Heinze and Otto Heinze, attempted to ‘corner’ the stock of United Copper Company, a firm tied to their mining empire.

Augustus Heinze believed that many traders on Wall Street had already sold United Copper stock short. That is, they had borrowed shares to sell, hoping to buy them back later at a lower price. Heinze thought that he and his allies could squeeze these shorts by buying up all the freely available shares remaining on the market.

If successful, anyone who was short would then be forced to buy from the Heinze group at whatever price they demanded, in order to settle their short positions. In Heinze’s mind, this was not unlike the speculative plays common at the time – bold but not necessarily illegal. Heinze was convinced he could outmaneuver the market.

Heinze and his associates began aggressively buying United Copper stock, pushing the price up sharply over several days in mid-October 1907. At its peak, the stock surged from around $39 to $60 a share in just one day, seemingly validating Heinze’s strategy.

He then called in the shorted shares, meaning that anyone who had borrowed stock to sell would have to deliver it back to him. Heinze believed he controlled so much of the outstanding supply that short sellers would be unable to obtain the stock elsewhere, forcing them to buy it at ruinous prices from the Heinze group.

But Heinze had overestimated his control of the market.

There were more freely traded shares of United Copper than he realized, and many short sellers were able to find stock from other sources. When they delivered those shares instead of buying from Heinze, the ‘corner’ collapsed.

Once it became clear that Heinze’s gambit had failed, the stock price plummeted from $60 down to under $10 within 48 hours. Heinze and his backers were left financially ruined, unable to meet the loans and margin calls they had used to fund the speculation.

The damage extended far beyond their personal fortunes. F. Augustus Heinze was also the president of Mercantile National Bank in New York. When word spread of his speculative activities, depositors panicked, fearing that the bank’s funds had been used to support the copper corner.

Heinze was forced to resign, but by then the contagion had begun to spread. The public associated his network of associates, including several prominent trust companies, with reckless speculation. The most important of these was the Knickerbocker Trust Company, one of the largest trusts in the city.

The Knickerbocker Trust Collapse

The president of Knickerbocker Trust, Charles T. Barney, had quietly lent support to the Heinze brothers’ scheme. When this became known, other bankers, particularly J.P. Morgan’s circle, refused to assist Knickerbocker.

On October 21, 1907, the National Bank of Commerce announced it would no longer clear checks for Knickerbocker. In modern terms, that was a death sentence; clearing relationships were vital for daily transactions.

Within hours, panic erupted. Crowds of anxious depositors lined up outside Knickerbocker’s offices on Fifth Avenue. Police were called to control the throng. By the end of the day, over $8 million had been withdrawn. The next morning, Knickerbocker suspended operations.

That closure was the turning point.

Knickerbocker was not a small player, it was one of the top three trust companies in the country. Its failure shattered public confidence in the entire trust sector. Rumors spread, depositors rushed to withdraw cash, and soon other trusts faced the same fate.

By late October, the panic had spread through New York’s financial system. Trust companies and banks were hoarding cash, refusing to lend to one another. The call money market (where brokers borrowed short-term funds to finance stock purchases) froze up. Stock prices on the New York Stock Exchange plummeted by an estimated 40-50%, totaling around $10-12 billion in losses at the worst point of the crisis.

Panic in an Age of Telegraphs and Newspapers

One of the underappreciated features of the 1907 panic was the speed with which information, and rumor, traveled.

By the early 20th century, America had a national telegraph network, coast-to-coast news wires, and dozens of daily newspapers feeding each other’s headlines. The Associated Press and other wire services meant that news of a bank run in New York could appear in morning papers in Chicago, Denver, or San Francisco the very next day.

This was a revolution in communication.

In earlier decades, bank runs might be local, limited by the speed of the horse or the train. In 1907, fear itself had gone national.

Depositors across the country read alarming stories about failed trusts, vanished fortunes, and panic on Wall Street. The imagery was vivid; crowds shouting outside marble banks, policemen holding back anxious investors, brokers collapsing on the stock-exchange floor.

The spread of information had a democratizing effect; it empowered ordinary people to act immediately on what they heard. But it also amplified panic.

As telegraphs buzzed and headlines multiplied, the public demanded that something be done. For many Americans, this crisis, unfolding in real time before their eyes, was proof that the government needed to create stronger safeguards against financial contagion.

In that sense, the information revolution of the early 20th century helped transform public opinion: no longer content to leave finance entirely to private actors, the public now expected a measure of collective protection.

J.P. Morgan’s Intervention: Leadership in a Vacuum

In the absence of a national central bank, the responsibility for restoring confidence fell to the most powerful financier in the United States: J. Pierpont Morgan.

From his library on Madison Avenue, Morgan summoned the heads of New York’s major banks and trust companies. With calm authority, he examined balance sheets, decided which institutions were solvent, and demanded that his peers contribute funds to rescue those that could be saved.

When he locked the doors and refused to let anyone leave until they had agreed to provide support, it became the stuff of legend.

Morgan’s efforts, along with those of George Cortelyou (U.S. Treasury Secretary), James Stillman (National City Bank), and George F. Baker (First National Bank), succeeded in stemming the panic. Liquidity was restored through clearing-house certificates and emergency lending.

From an Austrian point of view, Morgan’s actions represent the self-correcting capacity of a decentralized system. There was no need for an all-powerful central bank; the market, through leadership and cooperation, managed its own crisis.

The recovery that followed was remarkably swift. By 1908, the U.S. economy was growing again.

The Aftermath: From Panic to Policy

Despite the recovery, the public was shaken. For the first time, many Americans saw the financial system as a single, interdependent organism, and one that could collapse overnight.

The speed of the panic’s spread through telegraphs and the press convinced many that old assumptions about ‘local containment’ no longer applied.

In 1908, Congress passed the Aldrich-Vreeland Act, establishing the National Monetary Commission to study the causes of the panic and propose reforms.

Out of this process came the eventual creation of the Federal Reserve System in 1913, a centralized institution designed to provide elastic currency, coordinate liquidity, and prevent future panics.

Austrian economists tend to see the Panic of 1907 not as a failure of the gold standard or of decentralized banking, but as proof that even sound systems can be destabilized by exogenous shocks and human panic.

In this reading, the 1906 earthquake was the initiating event, the external disturbance that rippled through an otherwise stable system. The ensuing panic was a reminder of the limits of knowledge and coordination, not of the inherent failure of gold or free banking.

Lessons from a Shaken but Resilient System

• Even good systems can be overwhelmed by catastrophe – The 1907 episode demonstrates that no monetary or financial system, no matter how well grounded in sound money, can be completely immune to massive external shocks. The San Francisco earthquake disrupted international settlements on a scale no model could predict. But the very fact that the system survived the blow, without hyperinflation, without default, and with a full recovery within a year, shows its resilience.
• The gold standard worked as designed – The Bank of England’s tightening, while painful, was the correct and automatic adjustment mechanism of the gold standard. Gold outflows signaled a need to raise rates and restore equilibrium. The process was not a failure, it was the global market at work. The fact that such an adjustment transmitted pain to New York was not proof of weakness, but of interdependence.
• Information technology accelerates both panic and reform – The telegraph and the modern press made the panic of 1907 a national psychological event. For the first time, ordinary Americans could follow a financial crisis almost in real time. This immediacy fueled fear, but also democratic oversight. It helped create political pressure for a new system of stability, culminating in the Federal Reserve.
• Leadership matters – In an era before formal central banking, individual leadership played a vital role. J.P. Morgan’s actions exemplified the strengths of private initiative in a decentralized order. His temporary assumption of quasi-central-bank duties was an emergency measure, not a sign that such authority should always be centralized.

A World Transformed

When the panic subsided, the U.S. had learned both humility and confidence: humility in recognizing that even sound systems can face crisis, and confidence in knowing that a market-based order could still recover without state control.

In the long run, the Panic of 1907 marked the end of one era, the last great financial crisis of the ‘free-banking’ age, and the beginning of another: the age of managed money.

But even as the Federal Reserve was created, many economists and historians have looked back at the pre-1913 era with admiration. It was an age when gold, prudence, and enterprise coexisted. A time when, even in the face of disaster, markets found ways to heal themselves.

FAQs

Conclusion: Earthquake Economics and the Lessons of 1907

The Panic of 1907 was not the product of reckless speculation or systemic rot. It was, in essence, a natural catastrophe transmitted through a tightly linked global financial network.

The San Francisco earthquake drained Britain’s gold, tightened international credit, and exposed the limits of even a sound, decentralized banking system in the face of global shocks and instantaneous communication.

Yet, the system endured. Prices remained stable. The dollar stayed tied to gold. The economy rebounded from a mild recession within a year.

If anything, the story of 1907 reminds us that no monetary arrangement can eliminate uncertainty, but that sound money, market discipline, and leadership grounded in responsibility give society the best chance of surviving it.

The quake shook the foundations, but the edifice held.

Related Pages:

• Fractional Reserve Banking - Trust companies and banks operated under different reserve structures—key to understanding their vulnerability.
• Representative Money - The gold standard is a textbook example; gold flows drove international adjustments during the crisis.
• Loanable Funds Theory - Explains why seasonal demands and international capital movements created credit strain.
• Money Multiplier - Gold outflows and trust-company failures constrained deposit expansion throughout the system.
• Business Cycle - The panic sits within broader boom-bust dynamics of early 20th-century industrial economies.
• Velocity of Money - Panic behavior sharply reduces velocity; 1907 is a clear historic example.

ShareFacebookXPinterestTumblrRedditWhatsApp