PANIC. In the economic sense, panic has usually signified the existence among the public in general of an intense contagious fear that soon the banks would either be unable to repay their depositors on demand, or would not be in a position to lend money, with the result that the normal processes of the money market would be com pletely upset. The synonym for the first type of panic is the Run : of the second, the Financial Crisis. The first is marked by a demand by the public for legal tender, in extreme cases, by a demand for gold: the second is marked by a demand for bank balances, that is, loans which are hoarded by the borrowers for the same reason that notes or gold are hoarded by the depositor : not because the money is needed at once, but because it may not be available in case it is needed. Examples of the financial panic are the crises of 1847, 1857, and 1866 in Great Britain, each of which led to the suspension of the Bank Charter act : of the run, the state of affairs in New York in the autumn of 1907. Since the depositors do not know which banks really are weak, and since the run is based upon the instinct of self-preservation, it can best be countered by boldness. The claims of the depositors must be met without question because, at the height of the run, any attempt at expostulation will be interpreted as a sign that all is not well, and the run will thereby become intensified. During a run, the commercial banks cannot afford to see any really sound concern go to the ground.
It is therefore common practice for neighbouring banks to lend money to any sound bank afflicted by a run. This policy is, how ever, of no avail in those instances in which numerous bank fail ures have thoroughly frightened the depositors, for, in such cases, runs on several banks occur at the same time. To meet this sit uation, most leading nations have established central banks. These banks customarily exchange circulating notes of their own issues for sound negotiable paper held by the local bank. The local bank pays out to its depositors the central bank notes and thus satisfies their demands. It follows: when local banks really are in sound condition, it is usually easy for the central bank to stop runs.
When, however, the local banks hold a large mass of "frozen," or in other words uncollectible, loans, the situation is different. This was the state of affairs prevailing in March 1933, in the United States. On March 4, when President Franklin D. Roose velt took office, 420 banks had failed since January 1, and every bank was in danger. Therefore, he immediately closed all banks, and no bank was allowed to reopen until examiners had found it to be in sound condition. This procedure stopped the epidemic of
runs, for the public now had confidence in the ability of the re opened banks to pay depositors on demand. To prevent runs in the future, the U.S. Government enacted a law guaranteeing the safety of every national bank deposit of $5,000 or less. After the adoption of this law, runs disappeared.
The two rules by which a central bank ought to be guided in the event of a financial crisis were worked out empirically by the Bank of England between 1825 and 1866, and are set forth in Walter Bagehot's celebrated book, Lombard Street (1873).
The first rule is that loans ought to be made freely and on any sound security. The knowledge that loans are obtainable in spires confidence. The second rule is that the loans should be made at a price high enough to discourage borrowing, for other wise an amount may be demanded which exceeds the power even of a central bank to grant. British experience in the middle part of the igth century showed very conclusively that the mere ex istence of a central bank does not of itself allay a financial panic, so long as the ability of a central bank to lend freely is doubted. Owing to the provisions of the Bank Charter act of 1844, the ability of the Bank of England to lend was doubted, and confidence was not restored until the issue of the so-called "Government Letter," advising the bank that, in the event of its breaking the law by issuing a volume of notes in excess of the statutory amount, the Government would seek to obtain an Act of Indem nity from Parliament. The modern central bank, which is given power to issue notes in excess of any statutory reserve percentage, provided that it is prepared to pay a tax upon the amount so is sued in excess, is in a very much stronger position. This valuable element of elasticity was provided in Great Britain by the terms of the Currency and Bank Notes acts of 1914-15, by which the Bank could increase its fiduciary circulation with the consent of the Treasury : an element of safety which is perpetuated by the Currency and Bank Notes act of 1928. In Great Britain, the se verity of financial crises and the frequency of runs has diminished very greatly. The Baring crisis of 1890 was successfully sur mounted without the necessity of having recourse to a suspension of the Bank act of 1844. From that time until the outbreak of the World War, while there were isolated cases of runs against par ticular banks, there was no general crisis involving even the dis cussion of the expediency of suspending the act of