My Review of Scott Sumner’s The Midas Paradox

Posted on by

The book offers a historical interpretation of the Great Depression as a monetary phenomenon. My review is here. This paragraph may be a bit terse:

The price index that Sumner uses is the Wholesale Price Index. This is a volatile index that largely excludes finished goods and instead tracks goods that are intermediate inputs to other producers. From the standpoint of those final-goods producers, an increase in the WPI indicates not a positive demand shock but an adverse supply shock. Sumner did not succeed in convincing me that the causality runs from increases (decreases) in the WPI to increases (decreases) in output, rather than the other way around.

Suppose that the idea is that when monetary policy is expansionary, prices for finished goods go up and nominal wages remain sticky. Then producers will increase output, and this will raise the demand for goods that are intermediate inputs. The price of intermediate goods could rise by a much higher percentage than the price of finished goods, provided that intermediate goods are not a large share of the cost of producing finished goods and provided that the supply of intermediate goods is somewhat inelastic.

Using this story, the Wholesale Price Index is not really the “P” that goes into the real wage rate, W/P. Instead, it is an indicator that production is rising (or is expected to rise). We still have to take in on faith that a decrease in W/P is what caused the rise (or expected rise) in production.

3 thoughts on “My Review of Scott Sumner’s The Midas Paradox”

  1. 1929-1930 Government Gold Grab. Central banks that gained gold, particularly France and the United States, should have expanded currency in compliance with the gold standard, but failed to do so.

    Does Sumner (I haven’t read his book yet) mention that the US central bank (the Fed) had already violated the gold standard by issuing far more notes than it could redeem at par, so when it faced perfectly proper demands for specie after Black Tuesday it began to “hoard gold” in an attempt to meet its legal obligations?

    As Joseph Salerno explained, Murray Rothbard (and others) documented the Fed’s inflationary (“expansionary”) policy during the latter half of the 1920’s and pointed out that it continued to inflate even after 1929. Of perhaps greater interest is the subsequent effect of Roosevelt’s devaluation:

    It is important to recognize that this influx of gold was not a result of the “uncontrolled” operation of the gold standard, which had been abolished in 1933. Rather, it was the result of the deliberate and steady increase in the price at which gold was purchased by the U.S. Treasury and the Reconstruction Finance Corporation. By January 1934, the price of gold had risen from $20.67 to $35.00 per ounce, or by almost 70 percent, where it was officially pegged by the Gold Reserve Act of 1934. The Treasury was now legally mandated to maintain this devalued exchange rate between gold and the dollar by freely purchasing all the gold offered to it at this price. In effect, then, Treasury gold purchases were now economically identical to inflationary Fed open market purchases, substituting demonetized gold for government securities. Consequently, in response to this unilateral increase in the price of gold above its world price, there occurred a prodigious influx of gold into the United States—a “golden avalanche” it was called at the time—which vastly increased bank reserves. The result was an unprecedented inflation of the money supply (M2) during 1934, 1935, and 1936 at annual rates of 14 percent, 14.8 percent, and 11.4 percent, respectively.

    Creditors all around the world had gold on their books at $20.67/ounce (or various equivalents in local currency). When they had dollar-denominated obligations they used that gold to purchase newly-devalued dollars, enabling them to pay off their obligations at a steep discound.

    American citizens had their gold confiscated, redeemed at $20.67/ounce. So Roosevelt’s devaluation directly transferred some of the savings of Americans to foreign debtors.

    Of course Americans hoarded money– many of them feared more devaluations! Similar things occurred in other countries.

    Before I write any more, what is your reaction to Sumner’s thesis when you reconsider his story in the light of the Fed’s documented inflationary policies and the rational reactions of various groups of gold and currency owners?

    You quote Sumner speaking of the gold reserve ratio (which was distorted by inflationary finance)

  2. So I’m actually going to be foolhardy enough to post a comment on this without having read the book.

    As I vaguely understand it, Sumner’s main argument is that he can show a detailed correlation between the ups and downs of the explanatory factors he favors (first gold hoarding, then artificially high wages) and the ups and downs of output and employment. You do not seem to dispute these alleged correlations. Are you saying they’re just a coincidence?

    I considered the general point that correlations can continue to hold if someone has the direction of causation backwards, but I couldn’t understand its application in this case. If output varies with the severity of adjustment problems, why would there be a correlation between output and artificially high wages? (If you say “Interfering with the market causes adjustment problems”, do the two of you really disagree? And what about gold hoarding?)

  3. “This program was unique in U.S. history and was the primary factor behind both the 57 percent surge in industrial production between March and July 1933 and the 22 percent rise in the wholesale price level in the twelve months after March 1933. The initial recovery was triggered not by a preceding monetary expansion, but rather by expectations of future monetary expansion.”

    “[o]n five different occasions, the aggregate nominal wage rate rose significantly, each time in response to policies enacted by the Roosevelt administration. And each of these five wage shocks aborted promising recoveries that were underway.”

    Sumner tells a story of monetary expectations in which the market functionally changes 180 degrees in terms of expectations from late 1932 to early 1933 without definitive concrete action by the government. Then he tells a tale of other government programs choking the economy at certain points, which are eventually absorbed by the market and recovery restarts.

    Here is my question- how is it that the market makes this sudden turn in expectations on monetary policy and begins to act in a way (according to Sumner) that implies belief in long term expectations of monetary expansion in such a short time, but after 4 years of aborted recoveries and actual major events (5 of them by Sumner’s count) they had not developed expectations that FDR would continue increasing wages at every opportunity? Why start a recovery only to see it aborted immediately? Compounding this fact is that Hoover also was pursuing policies of inflating wages during his presidency.

    It takes a strange model of psychology to have markets fail to learn in one instance while being repeatedly bashed over the head by actual policy initiatives and to suddenly change their expectations in another area (and maintain them even through the face of a reversal in 1937!) with no actual actions being preformed.

Comments are closed.