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From the Wikipedia article on the Panic of 1857:

Beginning in September 1857, the financial downturn did not last long; however, a proper recovery was not seen until the American Civil War.

Given the destructive nature of war and the way it diverts useful resources to destructive means, the economy should have crumbled further instead of recovering. This is particularly so in a civil war when casualties incurred on either side are a cost to the country. How could the U.S economy recover given the destructive effects of a civil war?

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    Correlation does not imply causation. The financial panic started in 1857 and "proper recovery" occurred after the Civil War, but that does not imply that the Civil War caused the recovery. – user21811 Aug 23 '17 at 16:47
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    After a war lots of stuff need to be fixed, repaired, rebuilt. If all is OK not much needs to be fixed - not as large demand for work. Assuming that work is what mostly displaces money in society (quite disputable in our modern days) - then demand for work is gonna boost the economy as more money circulates if more people are paid to do work. – mathreadler Aug 24 '17 at 15:50
  • I think they are referring to the North where the USA was spending and innovating like no tomorrow and then giving out crony contracts afterwards. The South was a money pit of despair for over a decade afterwards. Confederate money during the war was pretty much useless so inventions like the Hunley and USS Alabama came from a place of pure passion. That and the South built an entire economy on being a bunch of 'racist douchebags' via slavery (metalocalypse anyone) so the post war was pretty bad for them. – user3916597 Aug 24 '17 at 16:46
  • Some really cool facts about the South during and after the war which you may be interested in. First, Germany post WWI level inflation, inflationdata.com/articles/confederate-inflation . Finally, economic not so recovery (cotton exports hit a peak in 1860) and the way people mis-treated freed slaves digitalhistory.uh.edu/exhibits/reconstruction/section3/…. Cheers! – user3916597 Aug 24 '17 at 16:52
  • @GalacticCowboy: Actually, most wars greatly expand "GDP," that is, the sum total of military and civilian demand. You can argue that civilian consumption fails to rise, but that's a "distribution" issue. But a war does lift "raw" GDP numbers, which is how recoveries are measured. In this regard, a war is a "cure" for sluggish GDP. – Tom Au Aug 25 '17 at 5:06
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tl;dr Modern industrial warfare pushes the economy to 100% utilization; this cures the effect of an economic downturn (which is effectively suboptimal economic utilization).

Wars in general, and the civil war in particular create stimulus spending - governments buy bullets and boots. Governments drive the economy to 100% utilization. Unemployment vanishes as young men move from their traditional jobs to new jobs created just for the war. As @jwenting points out, mortality decreases the size of the labor pool, which affects the economic power of the remaining labor pool. Individuals not normally in the labor pool take up jobs to replace the young men.

Industry is pushed to 100% capacity - industry produces war goods on a priority footing, causing shortages of consumer goods, which drives up prices, drawing even more idle resources (e.g. labor, capital) into production.

Between government need for new weapons and technologies, and the retooling of production lines to produce more bullets and less butter, there are opportunities for innovation. Innovation makes more efficient uses of the available resources and deepens the capital pool dramatically. Furthermore, during wartime, innovation is easier. In normal conditions there are always opponents to innovation, because innovation is never Pareto Efficient. War lowers the commitment to Pareto Efficiency and makes innovation easier to implement. A full explanation of this phenomenon would probably require a small essay.

Wars act on financial markets - because wars are intrinsically an existential threat to governments, they borrow money heavily, which further increases the size of the economy and draws financial assets into the markets. There are additional effects of 100% utilization on capital markets, but I would need a lot more caffeine before I could address that question.

The civil war was arguably the first industrial war - although the war was fought with boots & bullets, the war was won with trains and industrial production. The North ultimately won because it could outproduce the South.

For sources, consult any book on macroeconomics, search on Keynes or Helicopter Ben Bernanke; you can also draw an analogy to quantitative easing.

It may also be useful to consult the Parable of the Broken Window; many people believe that the economy grows as the participants replace things that were broken. This is a fallacy. (I might argue edge cases of the fallacy, because there is some benefit from the increased efficiency of new infrastructure & the cost of brownfield vs greenfield development, but those are edge cases and would require a much longer essay. (and I'm probably not competent to write it; I'm only a hobby economist)).

A full answer to the question would address the cause of the 1857 panic; unfortunately the 1857 panic was caused by shortfalls in the specie market and it is commonly known that I cannot discuss specie based currency without entering a irrational raging madness that causes me to froth at the mouth like a rabid dog and post page after page of furious invective of the quality usually found on conspiracy web sites. Today I've chosen to spare us that spectacle.

@jeff asks whether the results would have been different with fiat currency vs commodity (specie) currency. Not really; the chief difference is that fiat money facilitates a monetary policy, where commodity money restricts the ability of the government to employ a monetary policy. In either case war is an existential threat, (If the government doesn't address the war, the government ceases to exist). In either case, the government must shift the economy to a wartime footing, and in doing so demand more from the labor and capital markets. That increase government demand is what recovers the economy from the downturn. The mechanics are slightly different, but the effect is the same.

Wars may cause famines, and the government may choose to address those famines; if the government does, it will continue to stimulate the economy, but the ability of the government to make such choices are constrained by the deficit spending to fund the war. But now we're well outside the scope of OP's question.

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    normal forces opposing change -- can you elaborate who you mean? – MaxB Aug 23 '17 at 12:00
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    I was afraid someone would ask that. – Mark C. Wallace Aug 23 '17 at 12:05
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    @Munchkin - I was afraid that someone would ask that; updated my answer to address the broken window fallacy. – Mark C. Wallace Aug 23 '17 at 13:48
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    @MarkC.Wallace I think you probably want the Broken windows fallacy link (en.wikipedia.org/wiki/Parable_of_the_broken_window) instead; Wikipedia had that listed in the disambiguation page and it sounds about right :) – BalinKingOfMoria Aug 23 '17 at 13:52
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    And another reason you didn't mention is the loss of life. The war destroys a part of the labour pool (through conscription at first, as well as through the deaths of a lot of workers), reducing or eliminating unemployment. This has an effect on wages, increasing the buying power of the remaining population. – jwenting Aug 24 '17 at 6:55
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Many depressions are caused by "too little supply." But the ones that precede big wars, such as the American Revolution, the Civil War, and World War II are caused by too little demand. So the resulting wars are a "cure" insofar as they boost aggregate demand. A country's resources are fully mobilized, and thrown into the war, GDP expands as a result, and formerly unemployed people find employment as soldiers, or at least as civilian replacements for men who became soldiers. (Forget for a moment that civilians don't get to enjoy the part of the expanded GDP that is consumed by the war.

The Civil War spurred a lot of technological innovation. New inventions such as paper money, canned goods, sewing machines, interchangeable clothes and machine parts, created a lot of jobs during and after the war, while increasing overall productivity. Not to mention war-related devices such as the telegraph and railroads, which were invented earlier, but got a huge boost in use and efficiency from the Civil War.

And as J Wenting pointed out in a coment on another post, the war killed a lot of laborers, but that made the remaining ones scarcer, boosting their wages and aggregate demand. And while wars are extremely destructive, they lower the base on which growth is calculated immediately afterwards, thereby boosting the growth rate.

  • Since your post mentions paper money specifically, I sort of repeat my question to Mark Wallace's post: Was fiat a key factor in the recovery? – Jeff Aug 25 '17 at 5:01
  • I am no economist, but I thought that in any market, white, black or grey, prices rapidly equilibrate such that demand (at that price) will equal supply (at that price). How then does one distinguish too little supply from too little demand in the absence of a fiat currency, such that illiquidity is a constant problem? You seem to be stating that they are distinguished by the presence or absence of an imminent future war. – Pieter Geerkens Aug 25 '17 at 9:33
  • @PieterGeerkens: I think you are asking Tom but if you are questioning that wars cause demand, there is ample evidence that they do. WW2 certainly changed things for the USA. – Jeff Aug 25 '17 at 10:36
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    @PieterGeerkens: That was the old "theory" (Say's Law), but John Maynard Keynes demonstrated otherwise. investopedia.com/terms/k/keynesianeconomics.asp in "The General Theory of Employment, Interest and Money. " – Tom Au Aug 25 '17 at 12:47
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    @PieterGeerkens: The point I was trying to make was that demand led depressions are longer and more severe than the "other kind" and more likely to lead to war. At least that was the experience of the 1850s and the 1930s. Put another way, they last until a war provides the "cure." It is noteworthy that the German economy was the first major one to exit the 1930s Depression, because Hitler's rearmament program provided the necessary pump priming. Maybe the best "solution" is to prepare for war without actually fighting one. – Tom Au Aug 25 '17 at 22:57

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