INDEPENDENT INSTITUTE THE conomic historians have made great progress in unraveling the causes of the Great Depression, but not until Scott Sumner came along has anyone explained the multitude of twists and turns the economy took In The Midas Paradox: Financial Markets, Government Policy Shocks, and the Great Depression, Sumner offers his magnum opus—the first book to comprehensively explain both monetary and non-monetary causes of that cataclysm Drawing on financial market data and contemporaneous news stories, Sumner shows that the Great Depression is ultimately a story of incredibly bad policymaking—by central bankers, legislators, and two presidents—especially mistakes related to monetary policy and wage rates He also shows that macroeconomic thought has long been captive to a false narrative, which continues to misguide policymakers in their quixotic quest to promote robust and sustainable economic growth The Midas Paradox is a landmark treatise that solves mysteries that have long perplexed economic historians and corrects misconceptions about the true causes, consequences, and cures of macroeconomic instability Like Milton Friedman and Anna J Schwartz’s A Monetary History of the United States, 1867–1960, it is one of those rare books destined to shape future research and debate on the subject E THE THE Financial Markets, Government Policy Shocks, and the Great Depression SCOTT SUMNER OAKL AND, CALIFORNIA Copyright © 2015 by the Independent Institute All Rights Reserved No part of this book may be reproduced or transmitted in any form by electronic or mechanical means now known or to be invented, including photocopying, recording, or information storage and retrieval systems, without permission in writing from the publisher, except by a reviewer who may quote brief passages in a review Nothing herein should be construed as necessarily reflecting the views of the Institute or as an attempt to aid or hinder the passage of any bill before Congress Independent Institute 100 Swan Way, Oakland, CA 94621-1428 Telephone: 510-632-1366 Fax: 510-568-6040 Email: info@independent.org Website: www.independent.org Cover Design: Denise Tsui Cover Image: © 1935 / AP Photo Library of Congress Cataloging-in-Publication Data Sumner, Scott The Midas paradox : financial markets, government policy shocks, and the Great Depression / Scott Sumner 528 pages cm Includes bibliographical references and index ISBN 978-1-59813-150-5 (hardcover : alk paper) ISBN 978-1-59813-151-2 (pbk : alk paper) Depressions 1929 United States Monetary policy United States History 20th century United States Economic policy 20th century I Title HB37171929 S86 2015 330.973’0917 dc23 2013043553 For my mother Contents Preface PART I Gold, Wages, and the Great Depression Introduction PART II The Great Contraction From the Wall Street Crash to the First Banking Panic The German Crisis of 1931 The Liquidity Trap of 1932 PART III Bold and Persistent Experimentation: Macroeconomic Policy during 1933 A Foolproof Plan for Reflation The NIRA and the Hidden Depression The Rubber Dollar PART IV Back on the Gold Standard The Demise of the Gold Bloc The Gold Panic of 1937 10 The Midas Curse and the Roosevelt Depression PART V Conclusion 11 The Impact of the Depression on Twentieth-Century Macroeconomics 12 What Caused the Great Depression? 13 Theoretical Issues in Modeling the Great Depression References Index About the Author Preface macroeconomics during the highly inflationary 1970s Like many students of that era, I was greatly influenced by monetarist ideas, particularly A Monetary History of the United States, written by Milton Friedman and Anna Schwartz By the mid 1980s, I began to discover a new approach to monetary history, one that focused on the constraints of the international gold standard, not the quantity of money in a particular country Because I had found the views of Friedman and Schwartz to be quite persuasive, but also saw merit in the new “gold standard view” of the Depression, I was forced to try to reconcile these two perspectives This book represents the fruits of two decades of research on the role of gold in the Great Depression I began by trying to think through the concept of monetary policy under a gold standard If interest rates and commodity prices were determined internationally via arbitrage, in what sense could a country be said to have an independent monetary policy? Ultimately, I decided that the gold reserve ratio was the most sensible way of thinking about the stance of monetary policy under a gold standard When I worked out the numbers, I was surprised to find that world monetary policy tightened sharply between October 1929 and October 1930, a policy shift that had been missed by previous researchers Next, I discovered that the gold ratio wasn’t the only important way in which the gold standard impacted macroeconomic conditions during the 1930s Private gold hoarding increased sharply on four occasions; each of which was associated with falling output and falling asset prices in the U.S Changes in the price of gold were extremely important during 1933–34, as rising gold prices led to rising asset prices and economic recovery I also discovered interesting links between government policies that impacted the global gold market, asset market prices, and the broader macroeconomy In particular, markets seemed to anticipate the effects of policy shifts, and there were even cases where the effects of policy seemed to precede the causes Obviously, “effect” cannot precede “cause”; what was actually happening was that markets were anticipating that gold market disturbances would impact future monetary policy, and this caused asset prices to respond immediately to the expected change in policy Broader price indices and even industrial production also responded surprisingly quickly—not the long and variable lags often assumed by macroeconomists Much of this work was done in the 1980s and 1990s, and I was quite pleased that three of these papers were cited by Gauti Eggertsson in 2008, in an important article in the American Economic Review Eggertsson applied cutting edge “new Keynesian” models to the gold standard era, which suggested that anticipations of future monetary policy would often have a much more powerful impact on current conditions than the current stance of monetary policy I had stumbled on some ideas that had important implications for theoretical macroeconomics By the early 1990s, I was beginning to think in terms of a comprehensive narrative of the Great Depression The idea was to something roughly analogous to Friedman and Schwartz’s seminal work, but from a gold standard perspective Instead of focusing on the famous MV=PY equation as the organizing principle, I developed some identities relating the gold market to the macroeconomy, and then collected the relevant data When I reached the middle of 1933, however, I noticed that the monetary approach to the Great Depression seemed to suddenly break down That’s when I turned my attention to the role of wages, I FIRST STUDIED which were raised by over 20 percent in just two months, from July to September 1933 This would be the first of five “wage shocks,” each of which set back a promising recovery At that point, I did some research with Stephen Silver on the issue of wage cyclicality during the Great Depression When I combined the two approaches, a monetary approach based on the gold market, with a supply-side approach based on legislated wage shocks, I had a model that provided an excellent fit for the entire period from 1929 to 1940, indeed, in some respects, for the entire interwar period Unfortunately, the project kept getting delayed (once a year’s worth of work was simply lost), and hence this book is coming out many years after the original research was done However, this delay may have been a blessing in disguise, as the research turned out to have very important implications for the economic crisis of 2008 At that point, I began advocating a new monetary policy, as I concluded that most of the profession had misdiagnosed the crisis And more surprisingly, the profession misinterpreted the 2008 crisis in almost exactly the same way that the Great Depression was originally misdiagnosed See if any of the following sounds familiar: In the Depression most people assumed monetary policy was ineffective, as interest rates fell close to zero and the monetary base increased sharply (i.e., “QE.”) Most assumed the Depression was caused by financial distress, not tight money Most assumed that monetary policy was too expansionary during the 1920s, and that the Depression was a relapse from an overheated boom Sound familiar? In 1963 Friedman and Schwartz showed that those views were mistaken, yet economists made precisely the same errors this time around My hope is that by gaining a better understanding of what happened in the 1930s, we will be able to better understand our current policy dilemma, and develop more effective solutions My original manuscript included two theory chapters after the introduction, which would have proved intimidating for the average reader This material has been moved back to Chapter 13 Specialists should read Chapter 13 after the intro, and before the nine narrative chapters It will make it easier to follow the theory that is used to evaluate policy shocks Nonetheless, the basic message is easy enough for even non-specialists to follow Gold hoarding led to deflation and the Great Contraction of 1929–1933, and also the depression of 1937–1938, and five attempts to artificially raise wages during the New Deal slowed the recovery I have worked on this project for so long that I won’t be able to recall all of those who assisted me, but a few names stand out Stephen Silver coauthored the paper that provided the template for the analysis of interwar wage shocks Michael Bordo and George Selgin encouraged me to turn my academic papers into a unified narrative of the Depression years Tyler Cowen and Alex Tabarrok encouraged me to persevere after an initial setback Clark Johnson provided a great deal of useful feedback over the years, as did my colleagues at Bentley University A portion of the research was funded by the National Science Foundation And I’d like to thank my wife and daughter, who put up with huge stacks of paper swamping our home office currency tinkering proposals, 176 and Government Reorganization Bill, 334–35 and greenbacks, 186, 187, 243–44, 243n hearing with New York Fed President Harrison, 169–70 and minimum wage rate, 317–18, 326 and monetary policy coordination, 73 and price level stabilization policies, 236n and run on the dollar, 133–34, 136–37 Smoot-Hawley Tariff Act, 56–59, 63–66, 79n, 204, 467–68 spending initiatives, 288 and stock market crashes, 58–60, 64 and taxes, 129, 330 Wage-Hours Act, 299, 337 and war debt policies, 113–14, 125, 136, 144 See also Glass-Steagall Act U.S economy, late 1920s and late 1990s compared, 35n See also economic crisis of 2008 U.S GNP deflator, 75 U.S monetary gold stock, 53, 149, 181n, 240, 316, 316–17, 339–40 U.S Treasury bonds “Baby Bond” issues, 126, 126n declines in value, 108–9, 179, 180, 232, 255, 289 and dollar panic of 1932, 130 effect of government data announcements, 15–16 and Glass-Steagall, 126–27 increases in value, 111n, 279, 302, 336 and inflation, 249–50 prices, October 1933 to January 1934, 246, 246n and real interest rates, 438 VAR (vector autoregression), 16, 17n Vedder, Richard K., 226–27, 226n, 227n, 465–66 volatility analysis of stock prices, 7, 14–15, 15n Volcker disinflation, 374 Wage-Hours Act (1938), 299, 337 wages overview, xii–xiii aggregate wage level, 406, 462–63 artificially boosting above equilibrium, 406 countercyclicality during the Depression, 423–24 and depression of 1937–1938, 328–29, 340–41 and gold market shocks, 18 and monetary policy, 328–29, 332 and NIRA, 275–77, 277, 367 sticky-wage analysis, 1929–1933, 461–67 sticky-wage business cycle models, 422n sticky wages, 416, 461–67 sticky wage transmission channel, 158–59, 463, 465, 467 sticky-wage variant of AS/AD framework, 20–23, 21, 30, 419 and stock market, 339 and unemployment rate, 207, 222–23, 341, 411, 463 and U.S Congress, 317–18, 326, 337 wage and price cyclicality, 22–23, 207–9, 208, 209, 220, 418–19, 423–24, 466–67 wage data source, 83 WPI and wage cyclicality, 423–24 See also minimum wage rate; nominal wages; real wages wage shocks overview, xii–xiii, 3, 6, 219–20, 351–52, 389 and AS/AD framework, 18 and Blue Eagle program, 213–15, 220–21 and depression of 1937–1938, 320, 321 FDR’s boost of nominal wage rates, 8–9, 173 and gold bloc demise, 275–77, 277 and gold hoarding, xiii and New Deal, 466 and NIRA, 205–9, 208, 208–9, 209, 367 and price levels, 340–41 research on, 409 sticky-wage variant of AS/AD framework, 20–23, 21, 30, 419 and stock market, 212–13 and unemployment rate, 222–23 and Wagner Act, 351, 351–52, 389 Wagner Act (1935), 288–89, 298, 300, 311, 317, 351, 421–22 Wall Street See Dow Jones Industrial Average; stock market Wanniski, Jude, 56–58 war debts and BIS, 54 Hoover’s debt moratorium proposal, 68–69, 96–97, 97, 97n, 99–101, 115 moratorium announcement, 96 perception of U.S failure to cooperate, 56–58 Warren, George, 235–36, 243–44, 254, 256–58, 263–64, 360 wars and war scares Czech crisis, 337–38, 342–44 and Dow, 344–45 fighting in Austria, 286–87 German annexation of Austria, 332 Sino-Japanese War, 318 Spanish Civil War, 290 Sudeten situation, 343 wealth effect, 39–40, 39n Weidenmier, Marc D., 278n Weinstein, Michael M., 226–27 White, Eugene N., 40n wholesale price index (WPI) overview, 124, 174, 174–75, 175, 195–96, 277 biases, 22 and depression of 1937–1938, 318, 319 and dollar price of gold, 191, 191–95, 192, 193, 194 and Great Depression Model, 420 and industrial production, 205 and NIRA repeal, 286 as price index of the 1930s, 22 and real wages in AS/AD model, 20 response to FDR’s monetary policies, 298–99, 299 and wage cyclicality, 423–24 weekly indicators, April 1933 to Feb 1934, 229–30 and world gold stock, 291–92, 292 wholesale price indices, 312, 460–61 Wicksellian monetary theory, 362 Wicksell, Knut, 377–78, 379 Wigmore, Barry on devaluation impact on policy expectations, 26–30 on dollar depreciation program, 198, 219, 225 on monetary policy, 111n on NIRA, 225–26 on stock market crash of 1929, 213 on stock market reaction to dollar depreciation, 193 Williams, Aneurin, 360 Woodford, Michael, 261n, 377–78 world gold market overview, 455 and depression of 1937–1938, 324 instability, 1936–1938, and price of gold, 26–30 role in world economy, 291–92, 292 world gold reserve ratio overview, 37, 440 and banking crises of late-1930, 86 and British monetary policy, 51–53, 52n, 449–50 and central banks, 440–42, 450–51, 456–57 declines suggesting expansionary monetary policies, 73–74, 84 and Federal Reserve policy, 85 Hoover’s failure to allow lowering of, 99–100 impact of changes in, 40–42, 41, 46, 83, 84, 89–91, 90, 388, 416, 427 increases between 1926–1932, 75, 159, 428–29, 432–33, 434–35, 451 and monetary policy, 410, 454–55 and NIRA, 224 and onset of Great Depression, 46 and U.S monetary policy, 52, 283, 293 world gold reserves, erratic growth in, 434–35 World Monetary Conference (WMC), 182, 189–91, 210 world monetary crises, 95, 98, 112, 292 world monetary gold stock overview, 30 annualized changes in, 107, 107–8, 107n bank closures, stock prices, and, 167, 167–68 and deflation, 27–28, 27n, 87–88 and French monetary policy, 53 and French policy, 42n, 83, 84 and world price level, 41, 41–42, 44n world monetary policy overview, 7, 46, 439–40 Bank of England raising interest rates, 61, 78 British–French monetary accord, 91–92 and cause of Great Depression, 77–78 and central banks, 444–45, 446, 447–51, 449n confidence in/hope for the system, 139, 163, 292 expectations of cooperation, 56–58 and gold flows, 105–7, 106, 107, 107n, 425 and gold supply, 429–30 GRatio as proxy for, 458–60 and international gold standard, 147, 148–56, 155, 161–63 See also Young Plan world price level, 86–87 WPI See wholesale price index Wright, Jonathan H., 402 Xia, Yihong, 196n Young Plan, 54–56, 95, 96 Young Plan bonds (YPBs) correlation with Dow, 68–69, 102, 112, 113–14, 118–21, 125 decline during British exchange crisis, 113 fall in price, 104 rumor-based movement, 125 and U.S stock market, 93–101, 94, 97 Zecher, J Richard on effect of dollar depreciation, 198 on gold stock and world money supply, 449n monetary policy endogeneity study, 5, 198, 210n, 409, 437 About the Author is a Research Fellow at the Independent Institute, Professor of Economics at Bentley University, and Director of the Program on Monetary Policy at the Mercatus Center He received his Ph.D in economics from the University of Chicago and he edits the influential blog “The Money Illusion.” In 2012, the Chronicle of Higher Education referred to Sumner as “among the most influential” economist bloggers, along with N Gregory Mankiw of Harvard University and Paul Krugman of Princeton University In 2012, Foreign Policy ranked Sumner jointly with Federal Reserve Chairman Ben Bernanke 15th on its list of “100 Top Global Thinkers.” SCOTT SUMNER Professor Sumner is a contributor to numerous scholarly volumes, and his articles and reviews have appeared in such journals as the Journal of Political Economy; Business and Society Review; Journal of Policy Modeling; Economic Inquiry; Contributions to Macroeconomics; Economic Letters; Journal of Macroeconomics; Journal of Money, Credit and Banking; and Bulletin of Economic Research Independent Studies in Political Economy THE ACADEMY IN CRISIS | Ed by John W Sommer AGAINST LEVIATHAN | Robert Higgs AMERICAN HEALTH CARE | Ed by Roger D Feldman ANARCHY AND THE LAW | Ed by Edward P Stringham ANTITRUST AND MONOPOLY | D T Armentano AQUANOMICS | Ed by B Delworth Gardner & Randy T Simmons ARMS, POLITICS, AND THE ECONOMY | Ed by Robert Higgs A BETTER CHOICE | John C Goodman BEYOND POLITICS | Randy T Simmons BOOM AND BUST BANKING | Ed by David Beckworth CALIFORNIA DREAMING | Lawrence J McQuillan CAN TEACHERS OWN THEIR OWN SCHOOLS? | Richard K Vedder THE CHALLENGE OF LIBERTY | Ed by Robert Higgs & Carl P Close THE CHE GUEVARA MYTH AND THE FUTURE OF LIBERTY | Alvaro Vargas Llosa CHOICE | Robert P Murphy THE CIVILIAN AND THE MILITARY | Arthur A Ekirch, Jr CRISIS AND LEVIATHAN, 25TH ANNIVERSARY EDITION | Robert Higgs CUTTING GREEN TAPE | Ed by Richard L Stroup & Roger E Meiners THE DECLINE OF AMERICAN LIBERALISM | Arthur A Ekirch, Jr DELUSIONS OF POWER | Robert Higgs DEPRESSION, WAR, AND COLD WAR | Robert Higgs THE DIVERSITY MYTH | David O Sacks & Peter A Thiel DRUG WAR CRIMES | Jeffrey A Miron ELECTRIC CHOICES | Ed by Andrew N Kleit THE EMPIRE HAS NO CLOTHES | Ivan Eland THE ENTERPRISE OF LAW | Bruce L Benson ENTREPRENEURIAL ECONOMICS | Ed by Alexander Tabarrok FINANCING FAILURE | Vern McKinley THE FOUNDERS’ SECOND AMENDMENT | Stephen P Halbrook GLOBAL CROSSINGS | Alvaro Vargas Llosa GOOD MONEY | George Selgin GUN CONTROL IN THE THIRD REICH | Stephen P Halbrook HAZARDOUS TO OUR HEALTH? | Ed by Robert Higgs HOT TALK, COLD SCIENCE | S Fred Singer HOUSING AMERICA | Ed by Randall G Holcombe & Benjamin Powell JUDGE AND JURY | Eric Helland & Alexender Tabarrok LESSONS FROM THE POOR | Ed by Alvaro Vargas Llosa LIBERTY FOR LATIN AMERICA | Alvaro Vargas Llosa LIBERTY FOR WOMEN | Ed by Wendy McElroy LIVING ECONOMICS | Peter J Boettke MAKING POOR NATIONS RICH | Ed by Benjamin Powell MARKET FAILURE OR SUCCESS | Ed by Tyler Cowen & Eric Crampton THE MIDAS PARADOX | Scott Sumner MONEY AND THE NATION STATE | Ed by Kevin Dowd & Richard H Timberlake, Jr NEITHER LIBERTY NOR SAFETY | Robert Higgs THE NEW HOLY WARS | Robert H Nelson NO WAR FOR OIL | Ivan Eland OPPOSING THE CRUSADER STATE | Ed by Robert Higgs & Carl P Close OUT OF WORK | Richard K Vedder & Lowell E Gallaway PARTITIONING FOR PEACE | Ivan Eland PATENT TROLLS | William J Watkins, Jr PLOWSHARES AND PORK BARRELS | E C Pasour, Jr & Randal R Rucker A POVERTY OF REASON | Wilfred Beckerman THE POWER OF HABEAS CORPUS IN AMERICA | Anthony Gregory PRICELESS | John C Goodman PROPERTY RIGHTS | Ed by Bruce L Benson THE PURSUIT OF JUSTICE | Ed by Edward J López RACE & LIBERTY IN AMERICA | Ed by Jonathan Bean RECARVING RUSHMORE | Ivan Eland RECLAIMING THE AMERICAN REVOLUTION | William J Watkins, Jr REGULATION AND THE REAGAN ERA | Ed by Roger E Meiners & Bruce Yandle RESTORING FREE SPEECH AND LIBERTY ON CAMPUS | Donald A Downs RESURGENCE OF THE WARFARE STATE | Robert Higgs RE-THINKING GREEN | Ed by Robert Higgs & Carl P Close RISKY BUSINESS | Ed by Lawrence S Powell SECURING CIVIL RIGHTS | Stephen P Halbrook STRANGE BREW | Douglas Glen Whitman STREET SMART | Ed by Gabriel Roth TAKING A STAND | Robert Higgs TAXING CHOICE | Ed by William F Shughart, II THE TERRIBLE 10 | Burton A Abrams THAT EVERY MAN BE ARMED | Stephen P Halbrook TO SERVE AND PROTECT | Bruce L Benson VIETNAM RISING | William Ratliff THE VOLUNTARY CITY | Ed by David T Beito, Peter Gordon, & Alexander Tabarrok WINNERS, LOSERS & MICROSOFT | Stan J Liebowitz & Stephen E Margolis WRITING OFF IDEAS | Randall G Holcombe For further information: 510-632-1366 • orders@independent.org • http://www.independent.org/publications/books/ Praise for The Midas Paradox “Scott Sumner is one of the most original economists around Having been a pioneer in making the case for nominal GDP targeting, he has now turned his insightful talents to economic history, providing an important and fresh reexamination of the causes of the Great Depression and the halting recovery thereafter Provocative, well argued and well written, The Midas Paradox is an important contribution to our understanding of the roots of the worst economic period in the nation’s history.” —Robert E Litan, former Senior Fellow and Vice President for Economic Studies, The Brookings Institution “The Midas Paradox is a must read to understand the complexities of monetary management under the international gold standards of the 1930s Scott Sumner importantly focuses his research on the critical role of market expectations and labor policy failures that compounded central bank mistakes and led to tragic consequences for the global economy.” —Manuel H Johnson II, former Vice Chairman, Federal Reserve System “Scott Sumner is one of the preeminent monetary thinkers today The Midas Paradox represents his twenty years’ study of the Great Depression, one of the most important economic events of the twentieth century Highly recommended.” —Tyler Cowen, Holbert C Harris Chair of Economics and Director of the Mercatus Center, George Mason University “In The Midas Paradox, Scott Sumner provides a fascinating account of how monetary policy under the gold standard got us into the Great Depression and how wage policies under the New Deal slowed the subsequent recovery The book is deep and rich and has important lessons for today—a must-read for anyone interested in monetary policy and history and the errors of government policy.” —Douglas A Irwin, Robert E Maxwell ’23 Professor of Arts and Sciences, Department of Economics, Dartmouth College “Explaining the Great Depression is the ‘holy grail’ of macroeconomics, in the words of none other than Ben Bernanke By combining economic theory with economic history and the history of economic thought, Scott Sumner shows how it is possible to make substantial progress on this ambitious project Sumner may not explain everything, but he explains a lot The Midas Paradox deserves a place on that short shelf of essential books on the Depression.” —Barry Eichengreen, George C Pardee and Helen N Pardee Professor of Economics and Political Science, University of California, Berkeley “Having done some recent research myself on the causes of the Great Depression, I have found Scott Sumner’s book The Midas Paradox a source of new insights on that subject In particular, he sheds light on why deflation proved to be such an important factor in disrupting economic activity after the 1929 Crash He makes a properly global appraisal of monetary policy and concludes that central banks, on balance, were actually tightening the money supply when they should have been easing to offset the loss of liquidity in the financial sector from the 1929 crash The Midas Paradox is an important contribution to the study of the Great Depression, because it adds another explanation to such known factors as ill-timed protectionism or why producer prices dropped so sharply from 1929 to 1933, causing much distress in a heavily agrarian economy.” —George Melloan, former Deputy Editor, The Wall Street Journal; author, The Great Money Binge: Spending Our Way to Socialism “In The Midas Paradox, Scott Sumner adopts an ideal method (for my taste) of writing economic history He presents plenty of details on episodes, including pending and enacted legislation, and on contemporary consensus or disagreement on explanations and recommendations Sumner also presents judicious amounts of statistical and econometric evidence I find all this a gripping story.” —Leland B Yeager, Ludwig von Mises Professor of Economics, Emeritus, Auburn University “The Midas Paradox fills a gap in our understanding of the Great Depression The author continues the work of a long and distinguished line of scholarship that goes back to Rueff and Mundell in pinpointing the role of the gold market and the price of gold as a key factor in some of the salient episodes of the period.” —Michael D Bordo, Professor of Economics and Director of the Center for Monetary and Financial History, Rutgers University “With special attention to gold and labor market legislation, Sumner’s book The Midas Paradox provides an enlightening blend of detailed, warm-bodied financial and economic history of the 1930s with its broad-based statistical counterpart, using both national income accounts and financial data His perspective will be seen as a unique contribution to the large and still growing literature on the Great Depression.” —Roger W Garrison, Professor Emeritus of Economics, Auburn University “Scott Sumner’s wonderful book The Midas Paradox provides a thought-provoking reinterpretation of the Great Depression: it combines a monetary approach based on shocks to the gold market with a supply-side approach based on legislated real-wage shocks that fits the evidence for the entire interwar period Sumner’s insights into the Great Depression are also highly relevant to the global financial crisis The Midas Paradox is a major contribution both to economic history and to contemporary economic policy issues.” —Kevin Dowd, Professor of Finance and Economics at Durham University and Professor Emeritus of Financial Risk Management at the University of Nottingham, England “Scott Sumner offers a unified view of the Great Depression as seen through the lens of how financial markets’ expectations of future monetary policy appeared in the price of gold especially but also in other asset markets like the stock market In addition, the detailed, rich, historical narrative is full of insights about the causal nature of policy (monetary, fiscal, and regulatory) not captured in a single, abstract model Unlike the gold standard at the time, The Midas Paradox is not orthodox, but it certainly forces the reader to examine critically his or her prior views about the Depression.” —Robert L Hetzel, Senior Economist and Research Advisor, Research Department, Federal Reserve Bank of Richmond “The Midas Paradox is a fascinating, very clearly written and very important book It sheds a new light on the root causes of the Great Depression And, it encourages the rethinking of the fundamentals of the macroeconomic theory and policy.” —Leszek Balcerowicz, Professor of Economics, Department of International Comparative Studies, Warsaw School of Economics; former President, National Bank of Poland; and Former Deputy Prime Minister and Finance Minister, Republic of Poland “The Great Depression is the biggest puzzle in the history of modern capitalism How could millions of people be prospering one year, then out of work the next? Building on the work of previous scholars and adding fresh insights, Scott Sumner’s book The Midas Paradox offers perhaps the most ambitious analysis of the Depression yet, which seeks to explain its major ups and downs as well as how it got started Sumner’s book has important (and worrying) implications for today He argues that the Great Recession of 2008–09 was so severe because economists and central banks still have not fully learned the lessons of the Depression.” —Kurt Schuler, Senior Fellow, Center for Financial Stability; Economist, Office of International Affairs, US Department of the Treasury “Think you know what caused the Great Depression? If so, be prepared to think again: The Midas Paradox bristles with well-mounted challenges to orthodox—and to many unorthodox—accounts of history’s most notorious economic crisis Whether it manages to change your most confidently held beliefs or not, Scott Sumner’s painstaking book is bound to improve your understanding of the deepest and longest-lasting business downturn of them all.” — George A Selgin, Senior Fellow and Director, Center for Monetary and Financial Alternatives, Cato Institute; Professor Emeritus of Economics at the University of Georgia “The Midas Paradox succeeds in shedding new light on the Great Depression, and the gold market approach provides an effective unifying thread as the author navigates through the many shocks and policy shifts occurring over this key period The integration of international events over this period is also the best I have seen, and the connection between the 1930s policy dilemmas and those of today could not be more relevant.” —Richard C K Burdekin, Jonathan B Lovelace Professor of Economics, Claremont McKenna College “Scott Sumner provides a very thought-provoking and unique perspective on the causes of the Great Depression and the implications for current monetary and fiscal policy Whether or not you agree with Sumner’s analysis, The Midas Paradox will challenge some of your beliefs and make you think.” —John A Allison IV, Retired President and CEO, Cato Institute; Retired Chairman and CEO, BB&T Corporation “Just over 50 years ago the publication of A Monetary History of the United States, by Milton Friedman and Anna Schwartz, was a crucial episode in the monetarist counterrevolution that overturned the Keynesian dominance over postwar macroeconomics, gradually persuading most of the economics profession that the Great Depression was largely caused by the monumental ineptitude of the Federal Reserve However, the account of the Great Depression provided by A Monetary History, its many virtues notwithstanding, was defective in a number of respects, the most important of which being that its strictly quantity-theoretic focus on the behavior of the monetary aggregates was inconsistent with the workings of the international gold standard that was in operation for much of the Great Depression A number of subsequent researchers have since pointed out that the gold standard was a critical factor in causing and propagating the Great Depression Now in The Midas Paradox, Scott Sumner has, with great theoretical and empirical insight and ingenuity, provided a masterly narrative account of the onset and propagation of the Great Depression and of its decadelong duration, buttressed by striking quantitative and statistical evidence of the pivotal role played by the international gold standard in the Great Depression It is no exaggeration to say that The Midas Paradox has completely eclipsed all previous accounts of the Great Depression, and I have little doubt that a half century from now The Midas Paradox will remain the definitive account of that catastrophe.” —David Glasner, author, Free Banking and Monetary Reform “Scott Sumner offers readers of The Midas Paradox a bountiful harvest of new nuggets about the ‘gold standard view’ of the Great Depression This rewarding read begins with Sumner’s excellent preface—an important element that allows the author to review his own book, a privilege usually denied by journals.” —Steve H Hanke, Professor of Applied Economics and Co-Director of the Institute for Applied Economics, Global Health, and the Study of Business Enterprise, Johns Hopkins University “Whatever you know, or think you know, about the Great Depression, The Midas Paradox will teach you something new And as Scott Sumner points out, properly understanding what happened in the 1930s matters a great deal for getting policy right in our own time.” —Ramesh Ponnuru, Senior Editor, National Review “Scott Sumner has provided a tour de force of the Great Depression in The Midas Paradox He convincingly shows in this accessible but thorough retelling of the Great Depression that policy errors were behind the long economic slump In particular, Sumner demonstrates that the combination of contractionary monetary policy working through the gold market and supply-side disruptions arising from New Deal policies created a large drag on economic activity This is a must read for anyone wanting to better understand the Great Depression and its implications for policy today.” —David Beckworth, Assistant Professor of Economics, Western Kentucky University; Editor, Boom and Bust Banking: The Causes and Consequences of the Great Recession “Where Scott Sumner’s The Midas Paradox is most useful is in its short-interval narrative of monetary, labor market, and sometimes political factors that drove U.S financial markets from the 1929 stock market crash through the 1937–1938 depression His view of the impact of many New Deal initiatives is controversial, and often harsh, but well-documented His discussion of the role of non-official hoarding and dis-hoarding of gold as a driver of liquidity conditions is original The book will be an indispensable source for anyone on the economic dynamics of the period.” —H Clark Johnson, author, Gold, France, and the Great Depression, 1919–1932; former Senior Economist, U.S Department of Defense INDEPENDENT INSTITUTE is a non-profit, non-partisan, public-policy research and educational organization that shapes ideas into profound and lasting impact The mission of Independent is to boldly advance peaceful, prosperous, and free societies grounded in a commitment to human worth and dignity Applying independent thinking to issues that matter, we create transformational ideas for today’s most pressing social and economic challenges The results of this work are published as books, our quarterly journal, The Independent Review, and other publications and form the basis for numerous conference and media programs By connecting these ideas with organizations and networks, we seek to inspire action that can unleash an era of unparalleled human flourishing at home and around the globe FOUNDER & PRESIDENT David J Theroux RESEARCH DIRECTOR William F Shughart II SENIOR FELLOWS Bruce L Benson Ivan Eland John C Goodman John R Graham Robert Higgs Lawrence J McQuillan Robert H Nelson Charles V Peña Benjamin Powell William F Shughart II Randy T Simmons Alexander Tabarrok Alvaro Vargas Llosa Richard K Vedder ACADEMIC ADVISORS Leszek Balcerowicz WARSAW SCHOOL OF ECONOMICS Herman Belz UNIVERSITY OF MARYLAND Thomas E Borcherding CLAREMONT GRADUATE SCHOOL Boudewijn Bouckaert UNIVERSITY OF GHENT, BELGIUM Allan C Carlson HOWARD CENTER Robert D Cooter UNIVERSITY OF CALIFORNIA, BERKELEY Robert W Crandall BROOKINGS INSTITUTION Richard A Epstein NEW YORK UNIVERSITY B Delworth Gardner BRIGHAM YOUNG UNIVERSITY George Gilder DISCOVERY INSTITUTE Nathan Glazer HARVARD UNIVERSITY Steve H Hanke JOHNS HOPKINS UNIVERSITY James J Heckman UNIVERSITY OF CHICAGO H Robert Heller SONIC AUTOMOTIVE Deirdre N McCloskey UNIVERSITY OF ILLINOIS, CHICAGO J Huston McCulloch OHIO STATE UNIVERSITY Forrest McDonald UNIVERSITY OF ALABAMA Thomas Gale Moore HOOVER INSTITUTION Charles Murray AMERICAN ENTERPRISE INSTITUTE Michael J Novak, Jr AMERICAN ENTERPRISE INSTITUTE June E O’Neill BARUCH COLLEGE Charles E Phelps UNIVERSITY OF ROCHESTER Nathan Rosenberg STANFORD UNIVERSITY Paul H Rubin EMORY UNIVERSITY Bruce M Russett YALE UNIVERSITY Pascal Salin UNIVERSITY OF PARIS, FRANCE Vernon L Smith CHAPMAN UNIVERSITY Pablo T Spiller UNIVERSITY OF CALIFORNIA, BERKELEY Joel H Spring STATE UNIVERSITY OF NEW YORK, OLD WESTBURY Richard L Stroup NORTH CAROLINA STATE UNIVERSITY Robert D Tollison CLEMSON UNIVERSITY Arnold S Trebach AMERICAN UNIVERSITY Richard E Wagner GEORGE MASON UNIVERSITY Walter E Williams GEORGE MASON UNIVERSITY Charles Wolf, Jr RAND CORPORATION 100 Swan Way, Oakland, California 94621-1428, U.S.A Telephone: 510-632-1366 • Facsimile: 510-568-6040 • Email: info@independent.org • www.independent.org ... future research and debate on the subject E THE THE Financial Markets, Government Policy Shocks, and the Great Depression SCOTT SUMNER OAKL AND, CALIFORNIA Copyright © 2015 by the Independent... multitude of twists and turns the economy took In The Midas Paradox: Financial Markets, Government Policy Shocks, and the Great Depression, Sumner offers his magnum opus the first book to comprehensively... Cataloging-in-Publication Data Sumner, Scott The Midas paradox : financial markets, government policy shocks, and the Great Depression / Scott Sumner 528 pages cm Includes bibliographical references and index ISBN