Be Smart When You Compare Reagan’s Economy to Obama’s
Some partisans act as if we can run a controlled experiment to see which president’s policies were better. We can’t.
Bloomberg, April 21, 2017
If I were teaching a college-level course on political economy, my midterm exam would ask students to spot the errors in an op-ed with the headline, “Do You Want Reagan’s Economy or Obama’s? ”
Why? Because this particular article, by former Republican Senator Phil Gramm and Michael Solon, a GOP policy adviser, provides a perfect opportunity to show how partisan biases get in the way of clear analysis. And maybe, by showing the flaws in a poorly constructed argument, I can save you from making similar errors in your investment processes.
But first, since I mentioned bias, I want to disclose mine: Over the years, I have been a frequent critic of Gramm, mainly because his record of analysis and forecasting is so poor. He was a prime and unrepentant architect of the deregulatory regime that contributed so much to the financial crisis. In July 2008, he scolded Americans for being “a nation of whiners” and suffering from a “mental recession”: “Thank God the economy is not as bad as you read in the newspaper every day,” he wrote as the economy tumbled into a recession that was much worse than what you were reading in the paper every day.
With that out of the way, let’s take a look at Gramm’s recent commentary:
We begin with the simple observation about Gramm’s underlying premise: that presidents control the economy and by extension the stock market. As we have noted before, partisans give presidents too much credit when things go right and too much blame when things go wrong. This is a deeply flawed basis on which to analyze the complexities of economy, the limited power of presidents, the role of Congress, the impact of the Federal Reserve, overseas geopolitical events, the economic cycle and just plain old dumb luck.
Similar forces affect the stock market. It isn’t that a president has no impact on your investments; it is that we simply assign too much credit one way or the other for market performance.
So let’s consider a few of the areas that can have a major influence on the economy above and beyond anything a president might do:
No. 1. The Federal Reserve: Too many political pundits don’t pay enough heed to the power of the central bank. In the 1970s we had two oil-supply shocks, loose monetary policy and soaring inflation. Then the Fed’s new chairman, Paul Volcker, did the unthinkable, jacking up short-term rates to 20 percent with the goal of breaking the back of inflation. This caused two short, sharp recessions and set the stage for 30 years of falling rates and economic prosperity.
If you wanted to give credit to a single person for the economic prosperity of the 1980s — and as noted above, placing blame on or giving credit for the economy’s performance to any one person is a bad idea — my nominee would be Volcker.
Similarly, Volcker’s successor, Alan Greenspan, bears some of the blame for providing the tinder for the financial crisis by keeping rates too low for too long. Last, a lot of credit for the economic recovery under Barack Obama belongs to former Fed Chairman Ben Bernanke. Obama was hamstrung in his ability to get legislation passed after 2010; his fiscal stimulus was short-lived and inadequate, leaving the Fed’s monetary policy as the only game in town.
No. 2. Demographics: One can’t understand the economy of 1980s without acknowledging the tailwind that demographics provided. Members of the biggest population spurt in U.S. history — the baby boomers born in the two decades after World War II — were entering their 30s and 40s. These are prime earning and spending years. Money flowed into housing, automobiles, travel and all manner of consumer discretionary spending.
No. 3. The 1970s bear market ended: Another oft-overlooked factor was that 1982 marked the end of a 16-year bear market. On top of it, the slow growth of the 1970s and a pair of back-to-back recessions in the span of two years created lots of pent up demand that was waiting to be unleashed. I give Reagan credit for improving sentiment, reviving the animal spirits and ending the malaise of the Jimmy Carter presidency. However, studies of economic cycles suggest the country was ripe for a sea change regardless.
No. 4. The financial crisis: Notably omitted from the Gramm’s commentary is any mention of the financial crisis whatsoever. You can search the column for any of the following words: AIG, Lehman Brothers, subprime, mortgages, crisis, bailout — but you won’t find them. One can only ponder the reason he would leave out that Obama inherited a financial system on the verge of collapse, which then led to the worst recession in 75 years. This is a serious mistake in any assessment of the Obama recovery.
All of this is a roundabout way of saying that the U.S. economy can’t be thought of as a controlled experiment where we can test different policies to see which one works best. Reagan and Obama are not variables in some grand economic laboratory.