My friend the great economic historian Clark Johnson has written a review of Scott Sumner’s new book The Midas Paradox.
I am very happy that Clark has given me the possibility to publish the review on my blog as a guest post.
If you are interested in the causes of the Great Depression you should certainly read Scott’s new book, but you should not miss Clark’s own book on the Great Depression Gold, France, and the Great Depression, 1919-1932.
Here is Clark’s review…
Tight Money, High Wages: a review of Scott Sumner’s The Midas Paradox: Financial Markets, Government Policy Shocks, and the Great Depression (Independent Institute, 2015)
By Clark Johnson
Scott Sumner’s new book, The Midas Paradox, uses a “gold market approach” to understand the causes and persistence of the depression of the 1930s. By wide agreement, the roots of the 1929-1932 depression lay in a shortfall of aggregate demand – which was a consequence of systemic monetary constraint. Sumner uses the world’s quantity of monetary gold and the ratio of gold-to-money to determine the stance of monetary policy and to identify lost opportunities. The more usual indicators of interest rates and the quantity of money turn out to be misleading under a gold standard.
He then moves beyond the roots of the downturn to the reasons for persistence of weak economic conditions for years after the underlying monetary problem was solved. He develops the unexpected view that the US in particular saw a supply-side depression that began in 1933, one driven in large part by New-Deal-driven interferences in labor markets.
Monetary Origins of Depression
Sumner credits what he calls the Mundell-Johnson hypothesis, according to which the roots of the depression were in the post-WWI undervaluation of gold, as a precursor to his study. As the junior placeholder on that hypothesis, I recap my understanding of it here. The purchasing power of an ounce of gold changed little from the middle of the seventeenth century to the middle of the twentieth. Gold constraints were typically relaxed during wars to facilitate official spending and borrowing – and allowing price inflation. But English deflation restored prewar price levels in the years after the Puritan wars of the seventeenth century and the Napoleonic wars of the nineteenth.
A similar deflation was likely to occur after the First World War as major economies of Germany, Britain, and France would return to gold convertibility at the prewar value of $20.67/ ounce during the 1920s. The low postwar gold value affected monetary reserves in two ways: 1) it depressed the value of outstanding stocks; and 2) it reduced the price incentive for new gold production. In France, the US, and Germany, which had traditionally had large gold coin circulations, gold was mostly taken out of circulation during and after the war, which lessened confidence in convertible paper money. Economist Gustav Cassel drew attention to the “gold standard paradox,” by which a gold-based monetary system would require ever-increasing gold production to accommodate economic growth while maintaining reserve ratios.
Yet world gold production during the 1920s was below what it had beezn in the decade before the war; and given the postwar decline in gold’s purchasing power, the real value of new gold produced in the mid-1920s was just over 50 percent of what it had been in 1914.
Read the rest of the review here.