Review of The Midas Paradox: Financial Markets, Government Policy Shocks, and the Great Depression, Scott Sumner (Independent Institute 2015), 560 pages, ISBN-13: 978-1598131505; $36.05 on Amazon.com
There have been many books written about the Great Depression, the longest and most devastating economic catastrophe in American history, but little consensus exists among scholars regarding what caused the depression, which started in 1929 and lasted until 1939.
Scott Sumner, director of the Mercatus Center at George Mason University’s Program on Monetary Policy and an Independent Institute research fellow, has spent more than two decades researching the Great Depression and its causes, the result of which is his new book: The Midas Paradox: Financial Markets, Government Policy Shocks, and the Great Depression.
Using a simple supply-and-demand model, Sumner states, “The demand shocks to the economy were triggered by gold hoarding or changes in the price of gold, and the supply shocks were caused by policy driven changes in hourly wage rates.”
Sumner shows stock prices, commodity prices, and economic output only began to rise when investors became confident enough to stop hoarding gold.
The corresponding increase in the value of gold and monetary scarcity caused a decline in the world’s economic health—an effect Sumner calls “the Midas Paradox.” As Sumner’s historical research shows, the world’s nations became impoverished because of economic and political scares. Governments and private citizens were spooked into significant gold-hoarding runs. These runs, delineated by Sumner into four key episodes, destabilized international asset and commodity markets. National economies became poorer as governments hoarded increasing amounts of gold.
Getting the Whole Story
One of Sumner’s most interesting conclusions, which he only reached after decades of research on the hundreds of pieces of literature written about the Great Depression, is his explanation of how prior post-mortems have failed to fully examine the root causes, which he says has led to correct-but-incomplete diagnoses of the symptoms presented.
Even esteemed economists such as Milton Friedman, Sumner says, did not fully examine the situation. Friedman and Anna Schwartz’s A Monetary History of the United States, 1867–1960 is among the definitive works that addresses the Great Depression, but even that book did not dig deep enough to determine just why government intervention made things worse.
Sumner’s research methods differ from past examinations of the Great Depression; he includes contemporaneous news reports of the events involved, in addition to historical financial data. Examining history, as recounted by those reporting on it as current events, enabled Sumner to provide context and background to the quantitative search for correlations and relationships.
“In one respect, the event study approach used in this book makes it more difficult to find statistical significance where none exists,” Sumner writes. “A researcher looking for market anomalies can use regression analysis to quickly examine thousands of different relationships over numerous time periods, and just as quickly discard those that don’t produce statistical significance. In contrast, I have only one Great Depression to examine.”
Countdown to the Crisis
Studying the events leading up to the Great Depression, Sumner concludes the past is indeed prologue.
“The post-October 1929 rise in the world gold reserve ratio provides an explanation for the onset of the Depression that is broadly consistent with the gold market approach to aggregate demand,” Sumner wrote.
Sumner’s “gold market approach” measures economic demand by comparing the raw quantity of monetary gold and the ratio of gold to fiat money reserves, instead of using banking interest rates and money supplies. This is done to avoid measurement flaws inherent in other studies.
“This increase [in the world gold reserve ratio] seems to have begun after the stock market crash of October 1929 … which was well after the cyclical peak in output was reached in August 1929. How then could it have triggered the Depression? To answer this question we first need to take a closer look at the events leading up to the 1929 crash.”
Instead of existing as a single incident in time, Sumner writes, the Great Depression was a complex, interconnected string of events, consisting of nearly a dozen ups and downs caused by government ineptitude, important actors’ responses to events in the gold market, and other causes.
The Great Depression is surely the biggest puzzle in the history of capitalism. Millions of people were prosperous one year and out of work the next. Whatever you know or think you know about the Great Depression, this book is bound to teach you more, though you will have to be committed to learning from this serious piece of economic research. Nonetheless, the basic message is easy enough for non-specialists to understand: Gold hoarding by governments led to deflation, economic contraction, and a long-term depression.
The lessons Sumner takes from his analysis of the Great Depression could have been used in managing the Great Recession of 2008, but they most certainly were not. Hopefully, such insights will come in handy when the government attempts to respond to the next economic crisis.