The Wall Street Journal's March 3, 2009 article "The Obama Economy" claims the drop in the Dow Jones Industrial Average (the Dow) is evidence of the failure of the new president's economic policies:
As the Dow keeps dropping, the President is running out of people to blame.
As 2009 opened, three weeks before Barack Obama took office, the Dow Jones Industrial Average closed at 9034 on January 2, its highest level since the autumn panic. Yesterday the Dow fell another 4.24% to 6763, for an overall decline of 25% in two months and to its lowest level since 1997. The dismaying message here is that President Obama's policies have become part of the economy's problem.
Americans have welcomed the Obama era in the same spirit of hope the President campaigned on. But after five weeks in office, it's become clear that Mr. Obama's policies are slowing, if not stopping, what would otherwise be the normal process of economic recovery. From punishing business to squandering scarce national public resources, Team Obama is creating more uncertainty and less confidence -- and thus a longer period of recession or subpar growth.
The Democrats who now run Washington don't want to hear this, because they benefit from blaming all bad economic news on President Bush. And Mr. Obama has inherited an unusual recession deepened by credit problems, both of which will take time to climb out of. But it's also true that the economy has fallen far enough, and long enough, that much of the excess that led to recession is being worked off. Already 15 months old, the current recession will soon match the average length -- and average job loss -- of the last three postwar downturns. What goes down will come up -- unless destructive policies interfere with the sources of potential recovery.
And those sources have been forming for some time. The prices of oil and other commodities have fallen by two-thirds since their 2008 summer peak, which has the effect of a major tax cut. The world is awash in liquidity, thanks to monetary ease by the Federal Reserve and other central banks. Monetary policy operates with a lag, but last year's easing will eventually stir economic activity.
Housing prices have fallen 27% from their Case-Shiller peak, or some two-thirds of the way back to their historical trend. While still high, credit spreads are far from their peaks during the panic, and corporate borrowers are again able to tap the credit markets. As equities were signaling with their late 2008 rally and January top, growth should under normal circumstances begin to appear in the second half of this year.
So what has happened in the last two months? The economy has received no great new outside shock. Exchange rates and other prices have been stable, and there are no security crises of note. The reality of a sharp recession has been known and built into stock prices since last year's fourth quarter.
What is new is the unveiling of Mr. Obama's agenda and his approach to governance. Every new President has a finite stock of capital -- financial and political -- to deploy, and amid recession Mr. Obama has more than most. But one negative revelation has been the way he has chosen to spend his scarce resources on income transfers rather than growth promotion. Most of his "stimulus" spending was devoted to social programs, rather than public works, and nearly all of the tax cuts were devoted to income maintenance rather than to improving incentives to work or invest.
His Treasury has been making a similar mistake with its financial bailout plans. The banking system needs to work through its losses, and one necessary use of public capital is to assist in burning down those bad assets as fast as possible. Yet most of Team Obama's ministrations so far have gone toward triage and life support, rather than repair and recovery.
AIG yesterday received its fourth "rescue," including $70 billion in Troubled Asset Relief Program cash, without any clear business direction. (See here.) Citigroup's restructuring last week added not a dollar of new capital, and also no clear direction. Perhaps the imminent Treasury "stress tests" will clear the decks, but until they do the banks are all living in fear of becoming the next AIG. All of this squanders public money that could better go toward burning down bank debt.
The market has notably plunged since Mr. Obama introduced his budget last week, and that should be no surprise. The document was a declaration of hostility toward capitalists across the economy. Health-care stocks have dived on fears of new government mandates and price controls. Private lenders to students have been told they're no longer wanted. Anyone who uses carbon energy has been warned to expect a huge tax increase from cap and trade. And every risk-taker and investor now knows that another tax increase will slam the economy in 2011, unless Mr. Obama lets Speaker Nancy Pelosi impose one even earlier.
Meanwhile, Congress demands more bank lending even as it assails lenders and threatens to let judges rewrite mortgage contracts. The powers in Congress -- unrebuked by Mr. Obama -- are ridiculing and punishing the very capitalists who are essential to a sustainable recovery. The result has been a capital strike, and the return of the fear from last year that we could face a far deeper downturn. This is no way to nurture a wounded economy back to health.
Listening to Mr. Obama and his chief of staff, Rahm Emanuel, on the weekend, we couldn't help but wonder if they appreciate any of this. They seem preoccupied with going to the barricades against Republicans who wield little power, or picking a fight with Rush Limbaugh, as if this is the kind of economic leadership Americans want.
Perhaps they're reading the polls and figure they have two or three years before voters stop blaming Republicans and Mr. Bush for the economy. Even if that's right in the long run, in the meantime their assault on business and investors is delaying a recovery and ensuring that the expansion will be weaker than it should be when it finally does arrive.
There are two flaws in this critique of Obama, which is coming from someone whom I presume would be criticizing him regardless of the performance of the stock market or the economy. The editorial is yet another example of the post hoc ergo propter hoc flaw of logic that is all too common in political and economic discourse. For the sake of expedience, allow me to quote the Wikipedia entry:
Post hoc ergo propter hoc, Latin for "after this, therefore because (on account) of this", is a logical fallacy (of the questionable cause variety) which states, "Since that event followed this one, that event must have been caused by this one." It is often shortened to simply post hoc and is also sometimes referred to as false cause, coincidental correlation or correlation not causation. It is subtly different from the fallacy cum hoc ergo propter hoc, in which the chronological ordering of a correlation is insignificant.
Post hoc is a particularly tempting error because temporal sequence appears to be integral to causality. The fallacy lies in coming to a conclusion based solely on the order of events, rather than taking into account other factors that might rule out the connection. Most familiarly, many superstitious beliefs and magical thinking arise from this fallacy.
The form of the post hoc fallacy can be expressed as follows:
A occurred, then B occurred.
Therefore, A caused B.
When B is undesirable, this pattern is often extended in reverse: Avoiding A will prevent B.
From Attacking Faulty Reasoning by T. Edward Damer:
I can't help but think that you are the cause of this problem; we never had any problem with the furnace until you moved into the apartment." The manager of the apartment house, on no stated grounds other than the temporal priority of the new tenant's occupancy, has assumed that the tenant's presence has some causal relationship to the furnace's becoming faulty.
From With Good Reason by S. Morris Engel:
More and more young people are attending high schools and colleges today than ever before. Yet there is more juvenile delinquency and more alienation among the young. This makes it clear that these young people are being corrupted by their education.
The decline of stock markets since Obama took office is not proof that his policies caused the decline nor that his policies are not the appropriate ones to improve the economy. The Dow Jones Industrial Average (DJIA) closed at 14,164.53 on October 9, 2007. On Election Day, November 4, 2008, the DJIA closed at 9,625.28. On January 20, 2009, the day of President Obama’s inauguration, the DJIA closed at 7,949.09. The stock markets were in decline long before Obama was elected or took office. The decline in the Dow since Obama became President is (7949 – 6763)/7949 = 0.149 or about 15%. The author picked an arbitrary date in January to imply a bigger decline. The decline in the Dow before Obama became President was (14164 – 7949)/14164 = .438 or about 44%. So if one wanted to use post hoc ergo propter hoc (and remember one shouldn’t), a more reasonable conclusion is that the last 15 months of President Bush’s policies were much more damaging to Wall Street than Obama’s leadership has been.
Another flaw in this editorial is the presumption that whatever is good for stock markets is good for the economy. I agree that health-care stocks have declined because of Obama’s plans to save taxpayers money by reining in rapidly rising medical costs. But that does not prove that Obama’s policies are detrimental to the economy as a whole. Consider the opposite. If Obama announced that he would give trillion dollar gifts to all the corporations in the Dow Jones Industrial Average for no use other than to make them more profitable, the stocks of the benefitting companies would undoubtedly rise. But such a policy would add tremendously to the public debt burden of future generations without doing anything to increase the productivity of the economy or improve its long-term health. It is a mistake to assume that anything that benefits the wealthy or business interests (such as tax cuts and deregulation) is necessarily good for the economy. Some increases or decreases in taxes and government regulation of business may be beneficial to society as a whole. Others are not.
The author is critical of the income transfers in the stimulus package, preferring spending on public works. But the fundamental cause of this recession is insufficient overall spending on newly produced goods and services. The logic behind the income transfers is that they are a quick way to inject purchasing power into the hands of those most likely to spend. The biggest downside of income transfers is that the money might not be spent on newly made U.S. products. It could be used to pay down credit card debt or to buy foreign-made products, such as the many Chinese goods at Wal-Mart. If the government spends the money directly, such as on infrastructure projects, it can ensure the money goes to U.S. companies with American workers. And there is a lasting benefit from public works spending because the new highways, repaired bridges, and more energy efficient government buildings will continue to provide benefits for many years to come. The largest downside of public works spending is that these projects can take a long time to complete and the economy needs the increased spending immediately. Indeed, the best criticism of the stimulus package is that by the time some of its spending occurs, the recession might be over. (Then again, it might not.)
The criticism that the tax cuts are “devoted to income maintenance rather than to improving incentives to work or invest,” is a gilded way to assert that they should have been given to rich people and wealthy corporations rather than to low and middle-income Americans. By preserving incomes with tax reductions, the government is trying to maintain the purchasing power of the overall economy and prevent the recession from worsening. Tax policy can be used to alter society’s behavior, such as to encourage research and development or investment in physical capital. But those effects kick in much later than the immediate impact of income maintenance. And many of the tax cuts advocated by the rich are not structured to have targeted benefits to the economy. And I have always had difficulty with the theoretical argument that tax cuts increase the incentive to work. Everyone I know with a 9 to 5 job works 40 hours per week regardless of which tax bracket they are in. I have never had anyone tell me he or she works more or less because of changes in tax rates.
Anyone who has taken a class from me should know I am a huge advocate of markets and capitalism. But it is not a blind or ideological devotion. Capitalism and the markets it creates have a potentially destructive aspect. Unregulated markets can cause massive damage to society. (In the absence of government regulation, the market system allowed so much pollution into the environment that in 1969 the Cuyahoga River in Cleveland, Ohio literally caught on fire.) The important question is the appropriate degree of regulation. In a capitalist system, banks, like other profit-seeking businesses, should be allowed to fail. Yet, banks play a much different role in our economy than other businesses. The ability to borrow money does facilitate the overall spending that maintains our economy. And it is the inability to borrow and a lack of confidence in the financial sector that are critical components of our current economic troubles. Most financial experts believe failing to prop up these financial institutions would be devastating to our economy. Indeed, a common criticism of the handling of the financial crisis by President George W. Bush’s Secretary of the Treasury, Hank Paulson, is that he allowed the Lehman Brothers financial services company to go bankrupt, worsening the meltdown. In the absence of sufficient government regulation, banks became too large, too intertwined, and were allowed to engage in activities with too much risk. I believe the biggest mistake was to allow individual banks to become “too big to fail.” If government regulation had prevented much of the consolidation in the banking industry and had maintained a financial system with numerous smaller banks, it would be much easier to forego bailouts and let the worst ones fail.