Interview with Arthur Laffer: The Inventor of the Laffer Curve Reveals His Economic Outlook
by Dr. Mark Skousen, Advisory Panelist, Investment U
Friday, January 19, 2007: Issue #629
Last week, I had the opportunity of a rare interview with one of the world’s most ingenious financial economists, Arthur Laffer, at his new office in Nashville.
A former professor at the famed University of Chicago, Art Laffer is the inventor of the “Laffer Curve,” found in all economics textbooks; it demonstrates that cutting taxes can stimulate productivity so that government revenues can actually increase. The Laffer Curve has been proven right, especially when it comes to cutting capital gains taxes
Every year after a capital gains tax cut, such as 1978, 1986, 1997, and 2001, revenues from capital gains have increased substantially.
Laffer is a sought-after expert. His offices are crowded with letters and photos of famous people – Alan Greenspan, Ronald Reagan, Jane Fonda, et al. While I was in his office, he got a phone call from former governor Mitt Romney, who is running for president, and Steve Moore from The Wall Street Journal.
But he’s also known as a brilliant money manager and economic forecaster, and since 2000, his Macro 100 stock portfolio is 48 percentage points ahead of the S&P 500 Index. Below is our interview, where we’ll take a look at his unique top-down approach to investing.
Is the Laffer Curve a Free Lunch in Economics?
Mark Skousen: I see your Laffer Curve is still in all the textbooks. How does it feel to be famous?
Art Laffer: I love it. It’s great. I was blessed with a name that is very entertaining [laughter].
Mark Skousen: Is the Laffer Curve alive and well?
Art Laffer: I brought it back in the 1980s under Reagan, but it’s been around for time immemorial in economics. And it’s true. How can you ever be worse off if you lower tax rates and you get more money?
Mark Skousen: So there is a free lunch in economics?
Art Laffer: Of course, there’s a free lunch!
Mark Skousen: Is there a free lunch in finance? Do investors get a free lunch taking advantage of Warren Buffett’s expertise in Berkshire Hathaway?
Art Laffer: Sure. When Buffett acquires a very large asset and gets it at a discount, because he sees things we don’t get to see as retail investors, it’s hard not to win. It’s a huge advantage over other investors.
Mark Skousen: Do you manage money?
Art Laffer: We have two firms: Laffer Associates is our research firm and boutique broker/dealer. We have close to 350 institutional clients. And we have a money management firm, co-owned by General Electric, again for institutional investors. We advise the Huntington Funds on the Macro 100 stocks, so individual investors can take advantage of our services through the Huntington funds. We’ve been in business for six years.
Arthur B. Laffer’s Top-Down Investing Style
Mark Skousen: Do you have a unique strategy?
Art Laffer: Our angle is unique. We look at the world from macroeconomics. For example, if oil goes from $10 to $70, you will do well no matter what oil companies you buy. So the key is to invest in sectors that are benefiting from changing macroeconomic policies. We look at trade, income and fiscal policies.
Mark Skousen: What’s your favorite sector right now?
Art Laffer: Growth stocks, both small- and large-cap. We think we’re in a “neutral interest rate” environment – we don’t think they are going up or down by much right now. We also invest in companies in individual states that are lowering taxes, and avoiding companies in states that are raising taxes.
Mark Skousen: Are there states that are lowering taxes?
Art Laffer: Oh, my, yes, over 40 right now. State governments are cutting taxes like mad, and adopting pro-growth strategies. It’s very exciting. This is one of the most overlooked pluses in the economy right now.
Mark Skousen: But aren’t most companies national or global these days?
Art Laffer: That’s true for McDonald’s and IBM, but many companies are concentrated in just one state, such as auto suppliers. We also do our stock analysis country by country.
Mark Skousen: Are you still bullish on China and India like most analysts?
Art Laffer: Yes, but not as much as I used to be. I was bullish on Japan a year ago, but not so much now. We look at every country’s monetary policy, tax policy, etc.
Mark Skousen: You’re not investing in Venezuela?
Art Laffer: No. I’d be out of Venezuela for a lot of reasons. Oil is going to come way down in price.
Mark Skousen: Oh, really? You sound like Steve Forbes, who predicted $35 a year ago in one of my Investment U interviews.
Art Laffer: Oh, yes, and easily lower than that, over the next two years.
Mark Skousen: Many of my gold bug friends, including Jim Rogers, see a 20-year bull market in commodities. What do you think?
Art Laffer: They are wrong, wrong, wrong! Oil, copper, gold they’re all coming down and will continue to fall in price. We’ve seen a huge bull market in commodities, and at the same time, we are now seeing the dollar at its lowest level in terms of its trading partners.
Mark Skousen: Do you envision the dollar crashing?
Art Laffer: No! It’s going to rise. When oil prices decline, the trade deficit – what I call the capital surplus – is going to come way down. These are all cases of a reversal to the mean.
Positive Outlook for U.S. Stocks
Mark Skousen: What about the U.S. stock market?
Art Laffer: I’ve never seen the U.S. stock market so well positioned as it is now. They’re really cheap right now. According to my own method of valuing stocks – taking into account profits in relation to interest rates and tax rates, which I call “capitalized economic profits,” the stock market has never been lower in relative terms. I don’t see a recession coming, I don’t see interest rates going up. Tell me, what tax increases do you see coming down the road?
Mark Skousen: Well, the Democrats are now in charge of Congress, and they could raise taxes.
Art Laffer: I was more worried about the Republicans raising taxes! I love gridlock on Capitol Hill. I don’t see a big tax increase right now. Have you noticed that the Federal deficit has fallen dramatically? The Laffer Curve works!
Mark Skousen: What’s your opinion of the new Fed chairman?
Art Laffer: Ben Bernanke, an orthodox Jew from South Carolina, is terrific. He may be boring, but he’s sound. The Fed has been leaning against inflation, and the monetary base is hardly growing at all, just what you want. The price of gold is going to come down, and the dollar is going to strengthen in 2007. This isn’t the 1970s. Compared to those days, today we have wonderful fiscal policy, and wonderful monetary policy. Who would have thought that since the 1970s, the highest Federal income tax rate and capital gains rate have fallen from 70%, to 35%? We don’t have 21% interest rates, we have 4% rates today.
Mark Skousen: Aren’t you worried by the regulatory stranglehold of Sarbanes Oxley?
Art Laffer: I think Sarbanes Oxley is great! Yeah, it’s added a layer of regulation that has hurt small business, but I’m on a lot of company boards, and a lot of companies have found Sarbox to be highly beneficial because they’ve learned a lot more about their companies, the good and the bad.
Mark Skousen: Isn’t it true that you are always optimistic about the stock market and the economy?
Art Laffer: No, not at all. In the 1960s and 1970s, I was a big pessimist.
Mark Skousen: Did you anticipate the Nasdaq collapse in the early 2000s?
Art Laffer: Yes, sir! I warned investors to “take warning” in late 1999, and in 2000, when inflation and interest rates were rising sharply, I told investors to go to the basement and hide and wait until its over. [Laffer showed me copies of papers he had written confirming his bearish views in the early 2000s.]
The War on Terror
Mark Skousen: Are you concerned at all about worldwide terrorism and the war in the Middle East?
Art Laffer: I really don’t see much of a problem. I think the Middle East is terrible, but it’s always been terrible. Iran and Iraq need the oil money badly, but when the oil price drops sharply, as it will, it will be the best foreign policy we ever had, and we’ll get rid of those tyrants in Iran and Venezuela. Sure, terrorism is a problem, but I lived through an era in the 1950s and 1960s under the fear of Soviet attack, and that was much more scary.
Art Laffer’s Most Important Lesson in Life
Mark Skousen: Final question that I ask all my experts: You’ve lived a long life, you’ve met a lot of famous people. What’s the most important lesson in life?
Art Laffer: Never lose sight of the fact that you are part of a family. You know, Mark, that I have six children and ten grandchildren. When I saw my first child, I knew that I was living for eternity. My dad was my best friend. I was married twice; my dad was my best man at my first wedding, my son at my second. There’s nothing – nothing – nothing that comes close to working as a team with my family. Many of my family members work here. It’s beautiful. I loved going to Washington, being an advisor to Reagan, being a professor, creating the Laffer Curve, but none of that comes close to the pleasure knowing that I have the greatest family in the world.
Mark Skousen: Thank you, Dr. Laffer.
Art Laffer and Chairman Mark Skousen in front of the Big Three Totem Pole of Economics.
Good trading, AEIOU,
Today’s Investment U Crib Sheet
- The Laffer-curve was reportedly coined by a Wall Street Journal writer in 1974. Jude Wanniski was meeting with Laffer and Dick Cheney when Laffer sketched the curve on a napkin to illustrate the concept – that there is an optimal tax rate for maximizing government revenues; a tax rate too low will clearly decrease revenues, but a tax rate too high will have the same effect.
- Crude oil prices have now hit a fresh 20-month low Saudi Arabia recently said that OPEC output cuts are working, and that an “emergency meeting” of the oil producer group’s members was no longer needed. Oil is trading close to $50 per barrel, and has dropped 18% this month.