Damage from the San Francisco earthquake and fire of April 1906 was estimated to be between $350- $500 million, or 1.3 to 1.8 percent of U. S. GNP in 1906;³ large amounts of relief flowed into the city in the weeks immediately following the disaster. Because British companies underwrote the majority of the city's fire insurance policies -- an estimated £23 million (or $108 million at the time -- millions of pounds worth of insurance claims were soon presented in London. The magnitude of the resulting capital outflows in late summer and early autumn 1906 forced the Bank of England to undertake defensive measures to maintain a fixed sterling/dollar exchange rate. The central bank responded by raising its discount rate two hundred-fifty basis points between September and November 1906 and by pressuring British joint-stock companies to stop discounting American finance bills for the next year. (Economist, October 20, 1906, p. 1694).

Actions by the Bank of England attracted gold imports and sharply reduced the flow of gold to the United States. By May 1907, the United States had fallen into one of the shortest, but most severe recessions in American history (Friedman and Schwartz, [1963]). Thus primed for a financial crisis, already-weakened world markets crashed in October 1907 with the collapse of the Knickerbocker Trust Company in New York. Ultimately, the Panic of 1907 led to one of the most important institutional changes in American history: the creation of the Federal Reserve System designed to provide for an elastic currency and to act as a lender-of-last resort.