The financial crisis was due to a period of economic expansion from mid-1834 to mid-1836. The prices of land, cotton, and slaves rose sharply in these years. The origins of this boom had many causes, both domestic and international. Because of the peculiar factors of international trade at the time, abundant amounts of silver were coming into the United States from Mexico and China. Land sales and tariffs on imports were also generating substantial federal revenues. Through lucrative cotton exports and the marketing of state-backed bonds in British money markets, the United States acquired significant capital investment from Great Britain. These bonds financed transportation projects in the United States. Open British credit, through Anglo-American banking houses like Baring Brothers, fueled much of the United States's westward expansion, internal improvements, and industrial growth in the antebellum era.
In 1836, directors of the Bank of England noticed that the Bank's monetary reserves had declined precipitously in recent years, possibly because of poor wheat harvests that forced Great Britain to import much of its food. To compensate, the directors indicated that they would gradually raise interest rates from 3 to 5 percent. Conventional financial theory held that banks should raise interest rates and curb lending when faced with low monetary reserves. Raising interest rates, according to the laws of supply and demand, was supposed to attract specie since money generally flows where it will generate the greatest return. In an open economy with free trade and relatively weak trade barriers, the monetary policies of the hegemon – Great Britain – are transmitted to the rest of the world. This means that when Britain raised interest rates, major banks in the United States would be forced to do the same.
When New York banks raised interest rates and scaled back on lending, the effects were damaging. Since the price of a bond bears an inverse relationship to the yield (or interest rate), the increase in prevailing interest rates would have forced down the price of American securities. Importantly, demand for cotton plummeted. The price of cotton fell by 25% in February and March 1837. The United States economy, especially in the southern states, was heavily dependent on stable cotton prices. Receipts from cotton sales provided funding for some schools, balanced the nation's trade deficit, fortified the US dollar, and procured foreign exchange earnings in British pound sterling, the world's reserve currency at the time. Since the United States was still a predominantly agricultural economy centered on the export of staple crops and an incipient manufacturing sector, a collapse in cotton prices would have caused massive reverberations.
Stephen Arnold Douglas (April 23, 1813 – June 3, 1861) was an American politician from Illinois and the designer of the Kansas–Nebraska Act. He was a U.S.…