The Republicans responded to Cleveland's challenge. Nominating Senator Benjamin Harrison of Indiana for president and Levi P. Morton of New York as his running mate, they waged an aggressive campaign in which they boldly defended the principle of protective tariffs. Whereas Cleveland considered it beneath his dignity to campaign actively, Harrison made nearly a hundred speeches covering every subject from the tariff and veterans' pensions to the sterling character of Abraham Lincoln and his own fondness for small children. Much money was spent on the campaign, and there was perhaps more than the usual amount of corruption and trickery. A clever Republican wrote a letter to the British minister in Washington, Sir Lionel Sackville-West, in which he pretended to be a naturalized citizen of British birth named Murchison. In it he asked the minister if he thought Cleveland would pursue a pro-British policy if reelected. Sir Lionel incautiously responded, his letter (released to the press by the gleeful Republicans) indicating a preference for Cleveland. This "Murchison letter" was thought to cost the Democrats heavily among Irish-American voters. But the tariff was clearly the main issue on which the election was contested.
The outcome was monumentally frustrating for Cleveland and for his party. By carrying both New York and Indiana by narrow margins, Harrison obtained a majority in the Electoral College (233–168) and thus the presidency. But Cleveland won the states of the Deep South by exceptionally large margins. This gave him about 100,000 more popular votes than his opponent.
Some Democratic observers thought that Cleveland would have won if he had waited until after the election to bring forth the tariff issue. He responded to this argument in typical fashion. "I did not wish to be reelected without having the people understand just where I stood," he said. "Perhaps I made a mistake from the party standpoint; but damn it, it was right." After leaving office he settled his growing family in New York City, where he joined a prominent law firm. He made occasional innocuous speeches and maintained his contacts with prominent politicians, mostly through correspondence.
Under Harrison, the Republicans proceeded to raise the tariff and to deal with the surplus by appropriating large sums for pensions and for public works of various sorts and other pork-barrel projects. They also put through the Sherman Silver Purchase Act of 1890, which committed the government to buying 4.5 million ounces of silver a month. Altogether, Congress spent over $1 billion in 1890, by far the largest one-year outlay in the nation's history up to that time.
Public reaction to the work of the "Billion-Dollar Congress"—especially to the new McKinley Tariff, which appeared to raise the cost of many goods—was profound. In the 1890 congressional elections the Democrats swept the House of Representatives and made large gains in the Senate. It seemed likely that they would win back the presidency in 1892.
The McKinley Tariff and the free-spending legislation of the "Billion-Dollar Congress" made Cleveland eager for another term. His identification with tariff reduction and economy in government gave him made-to-order issues. But when large numbers of Democrats voted for a bill providing for the unlimited coinage of silver in 1891, he spoke out strongly against the measure, despite warnings that he would alienate southern and western members of the party. Once again, his frankness in tackling a controversial issue head-on probably helped more than it damaged his chances. In any case, the 1892 Democratic convention nominated him on the first ballot. Adlai E. Stevenson of Illinois was its vice presidential choice.
The campaign of 1892 was a three-cornered contest, for the new Peoples, or Populist, party had entered the race. The Populists nominated James B. Weaver of Iowa and came out for a long list of reforms ranging from the direct election of United States senators and a federal income tax to government ownership of the railroads. The Populist plank that attracted the most attention called for the unlimited coinage of silver.
As was his fashion, Cleveland did not campaign actively. He mended his fences with most of the important Democratic politicians and on election day won a sweeping victory. The electoral vote was 277 to 145, and he polled nearly 400,000 more popular votes than Harrison, the largest plurality in a presidential election since Grant defeated Greeley in 1872—this despite the fact that Weaver received over a million popular votes on the Populist ticket. The Democrats also won control of both houses of Congress.
Cleveland named Walter Q. Gresham of Indiana as his secretary of state. The rest of his second-term cabinet consisted of John G. Carlisle as secretary of the treasury, Daniel S. Lamont as secretary of war, Hilary A. Herbert as secretary of the navy, Wilson S. Bissel as postmaster general, Hoke Smith as secretary of the interior, and J. Sterling Morton as secretary of the new Department of Agriculture.