I.O.U.S.A. (59 page)

Q:
I haven ’ t heard that idea. Did you make that up?

Arthur Laffer:
That ’ s what I ’ ve been doing for 30 years. That ’ s the ultimate supply side. No other supply - side reform would be necessary if you did that one.

Q:
What ’ s the story about the Hôtel de Crillon?

Arthur Laffer:
Back in the 1970s, when we devaluing the dollar and doing the Smithsonian Accord and Camp David, our delegations would go to France and meet at the Hôtel de c17.indd 238

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Crillon. I took my wife - to - be at the time to Paris and I wanted to propose to her in Paris. Now, I ’ m a huge Francophile and I love the country. Hôtel de Crillon Hotel is
the
hotel in Paris. I went there and tried to get the room that I ’ d had during the olden days and I couldn ’ t remember what room number it was. They said,

“ Oh, don ’ t worry, Dr. Laffer, it ’ s room . . . , ” whatever it was. I said, “ Goodness, how do you remember that? ” He said, “ Because that ’ s the only room that was bugged. ” I think they may have been joking, but it was a riot. I did propose to my wife there and, unfortunately, she did not accept. She said she ’ d think about it. It took her six weeks to make the decision.

Q:
Yeah, the napkin, because I think that now has sort of stretched
into a story of its own.

Arthur Laffer:
My classmate at Yale, a good, good friend of mine, is Dick Cheney. He ’ s a spectacular person. He ’ s a fi ne, decent, wonderful guy and a great public servant, one of the greatest I know. I used to have dinner once a week with Don Rumsfeld when Nixon was having all of his problems. Spiro Agnew was gone, and Ford came in as vice president and I would have dinner, alone, with Don Rumsfeld. He was an ambassador to NATO and then he came over here as chief of staff for Ford and we ’ d have dinner. And every now and then, we ’ d invite someone to join us.

At the Two Continents Restaurant, right next to the Treasury, we invited a guy named Jude Wanniski who was writing for the
Wall Street Journal
at the time, and Dick Cheney, who was Don Rumsfeld ’ s deputy chief of staff. It was during the time that Ford had that silly, silly program called Whip Infl ation Now, the WIN

program. It was just an acronym for a 5 percent tax surcharge, which is just goofy, silly, sparkle - headed stuff, but they did it.

What I was trying to explain to him there at the restaurant was that a 5 percent tax surcharge will not lead to 5 percent more in revenues. It may lead to 4 percent more in revenues. It may lead to 3 percent, but it may also cost you revenues because there ’ s always the feedback effect. When you raise tax rates, you reduce the incentives for doing an activity and, therefore, you shrink the c17.indd 239

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tax base
.
How far that base shrinks given the tax rate increase is an empirical question and depends on how long you ’ re willing to wait.

I was explaining that, and I supposedly drew the curve on the restaurant napkin. Now, I can assure you it was not the Two Continents ’ Restaurant where I did that, no matter what Jude Wanniski wrote two years later, because my mom was a lovely, lovely lady and she taught me, “ Arthur, never, ever, ever draw on cloth napkins, ” and they had cloth napkins.

But the Laffer curve was what I always used in class to show students that there are two effects of tax rates. One is the arithmetic effect, which is the higher tax rate, the more revenue collected per dollar of tax base. But the other one is the economic effect: If you raise tax rates, you reduce the incentives for doing that activity and you contract the tax base. These two effects always work in opposite directions. Sometimes the arithmetic effect wins and sometimes the economic effect wins. It depends on where you are in the curve, how long you ’ re willing to wait, and how broad the tax is. But it was a fun story that Jude wrote about in the Two Continents Restaurant there at the Hotel Washington.

Q:
You mentioned you didn ’ t think Paul Volcker had raised
interest rates?

Arthur Laffer:
Paul Volcker is a hard money guy. He controlled the monetary base, and Paul Volcker understood that the Fed doesn ’ t control interest rates. They set the discount rate back then, but the discount rate followed the market; it didn ’ t lead the market. That was not a proactive policy in the Fed. It was a reactive policy of the markets. Volcker didn ’ t do anything to cause the 1981 – 1982

recession. It wasn ’ t tight money that caused high interest rates. It was the deferral of the tax cuts. We, unfortunately, made the huge mistake of deferring those tax cuts, which postponed income, and we caused a deep recession/depression in 1981 – 1982. Almost everyone blames Paul Volcker for that, but that is an incorrect accusation. What Volcker did during this period was reestablish credibility in the U.S. dollar by following a price rule. He brought c17.indd 240

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infl ation down and interest rates down, ultimately, in the U.S.

economy. He was just spectacular in monetary policy. To blame Paul Volcker for the recession of ‘ 81 –’ 82 is really incorrect.

Q:
Even at the time, he was hung in effi gy. There were people
committing suicide in the heartland.

Arthur Laffer:
Oh, I know. It was just terrible. It ’ s true that, when we took offi ce, the prime interest rate was 21.5 percent. But Volcker didn ’ t cause the infl ation. For goodness sakes, he came in in ’ 79 and, when he came in, he didn ’ t have total control of the Fed. He was the new guy. It took him quite a while to get control of the Fed. By ’ 80– ’ 81, by the time we were in, he then had control of the Fed and he did a spectacular job. You can ’ t do more than you can do. He ’ s just the chairman — he wasn ’ t the boss of everyone there. But as he gained control, he was able to effectuate really great policies. He did not cause the recession of ‘ 81 – ’ 82, and anyone who tells you that he did, doesn ’ t understand the basics of supply - side economics. Period.

Q:
I think you ’ re clear. You were friends with him at that time.

What was he going through when he was being blamed for it?

Arthur Laffer:
I like Paul Volcker a lot personally. I think he ’ s a neat, neat guy. I never was a
friend
of Volcker ’ s. I was a huge fan of Paul Volcker ’ s, but we never went out to dinner together. He and I felt very similarly about monetary policy and making sure to establish credibility in the U.S. dollar. Guaranteeing the value of the dollar was what the gold standard did. We were unwilling to go off gold and were the last ones pushed off, because we both understood the role of guaranteeing the value of the U.S. currency.

What Volcker came in and did in ‘ 79, and really much more in ’ 80

and onward, was establish a price rule for the U.S. dollar. He was able to really bring infl ation down dramatically by making sure that that price rule operates with respect to the monetary base.

Volcker did not control interest rates. The discount rate followed the 91 - day table. He didn ’ t lead it, but Volcker did control the growth rate of the monetary base. He used open market operations perfectly, and you can see exactly the consequences of c17.indd 241

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his policies almost 30 years later. You can see what has happened to infl ation and what ’ s happened to interest rates. We are in great shape because of Paul Volcker ’ s revolutionary change of monetary policy.

Q:
In 1971, just after the Wood Accord fell apart, the Fed enacted
its dollar index?

Arthur Laffer:
Yes.

Q:
That, just this fall, has fallen to historic lows. It ’ s never been as
low — is that right?

Arthur Laffer:
I don ’ t think that ’ s true.

Q:
Can you characterize the value of the dollar and the foreign
exchanges?

Arthur Laffer:
You can look at the worth of a dollar in terms of current goods and services and see the CPI or the producer ’ s price. That ’ s the correct measure. You can look at the value of the dollar in terms of future dollars. There, you ’ re looking at interest rates. That ’ s the way of looking at the current dollar versus future dollars. Or you can look at the value of the current dollar versus foreign currencies.

Today, the value of the U.S. dollar is extraordinarily low. It ’ s not the lowest it ’ s ever been, but it ’ s in the very low range. This is not a purchasing power parity problem where we are having hyper infl ation. We aren ’ t. The U.S. ’ s relative attractiveness versus foreign countries since 2002 has declined dramatically, but not because the U.S. has done something wrong. It ’ s because everyone else in the rest of the world is fi nally copycatting supply side economics. Seventeen or 18 countries now have low rate fl at taxes? They have emulated our supply side policies, and they ’ ve become far more attractive to investments. The U.S. had been the capital magnate of the world since Reagan ’ s tax policies and Volcker ’ s monetary policies. We had a huge capital surplus as everyone tried to invest in the United States. Warren Buffet would call that a trade defi cit, but he ’ s wrong. It ’ s a capital surplus. Since 2002, with the improvement abroad, people have tried to move their net investments from the U.S. and more toward foreign c17.indd 242

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countries. The fi rst impact of that is that the value of the dollar falls. It ’ s done it many times in the past, and it ’ s happening now.

It ’ s exactly the way markets should work, because the rest of the world is doing a lot better job of being attractive to output employment production and investments. Now, as you can see, the U.S. trade defi cit is starting to fall like a stone. It ’ s gone from 6.1 percent of GDP down to 4.8 percent, and it ’ s going to fall a lot further. Once it ’ s gone its route, you ’ ll see the dollar coming back in strength. There is nothing fundamentally wrong with the dollar.

It ’ s not like it was in the ‘ 70s. Far from it. That was a purchasing power parity infl ation problem. This one is a relative capital attractiveness issue and it ’ s not a problem. Foreigners are doing a great job, and we want them to do a great job.

Let me talk about the trade defi cit and the capital surplus a little bit. After we took offi ce in 1981 and cut taxes, brought infl ation under control, deregulated the economy, free trade — after we did all of that, there was a huge increase in the after - tax rate of return on U.S. - located assets. Everyone wanted to invest in the United States. How do foreigners generate the dollar cash fl ow to buy U.S. - located assets? There are only two ways they can do it. They have to sell more goods to us and buy fewer goods from us. The U.S. trade defi cit is one and the same as the U.S. capital surplus. Ask yourself the question, which would you rather have?

Capital lined up on U.S. borders trying to get into our country, or trying to get out of our country? Obviously, you ’ d rather have it coming in.

The trade defi cit is not a problem. The trade defi cit is the capital surplus. It shows the relative strength of the U.S. in attracting capital. Growth companies don ’ t lend money, they borrow money. They attract capital. The U.S. is the capital magnet of the world and there ’ s nothing wrong with that. We are not squandering our kids ’ or our grandkids ’ futures with credit card consumption and engorgement. That ’ s silly. The capital surplus is a sign of strength, not of weakness.

Let me give you an example. In Japan, because of their awful policies and their huge unfunded liabilities, you have a machine c17.indd 243

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that ’ s got a negative rate of return. You take that machine by truck down to Tokyo Harbor. You load that machine onto a ship in Tokyo Harbor. You send it over to the United States. You offl oad that machine in the United States. You put it on a lorry and you ship it to its location. The rate of return on that machine has gone from a negative in Japan to a positive in the U.S. By putting that machine on a ship in Japan, that ’ s a Japanese export and a Japanese trade surplus. By offl oading that machine in the U.S., that ’ s a U.S. import and a U.S. trade defi cit. The capital movement is the U.S. trade defi cit and the Japanese trade surplus. That ’ s the only way you can move capital across countries, and there ’ s nothing wrong with moving that machine from Japan to the U.S.

In fact, it ’ s good for everyone.

Q:
What about moving those machines to China? Lower wage
areas?

Arthur Laffer:
Nothing ’ s wrong with moving them to China. We need to have capital allocated on a worldwide basis based upon the after - tax return to the shareholders. And if countries change their policies, become more or less attractive, people are going to move capital. That ’ s why you have to be really competitive in the U.S.

That ’ s why I ’ m so terrifi ed about these anti - rich people and these politicians who are talking about raising taxes on the rich. Do you realize how uncompetitive that would make America? In the 1980s, when we cut tax rates, it was great, because everyone else was a Fabian socialist with massively high tax rates. It was a win/

win. Now that the rest of the world ’ s got lower tax rates than we have, if these yahoos go and raise the tax rates, it ’ s going to destroy the U.S. economy. Everyone ’ s going to want to pull their capital out of the U.S. and put it in other places like China and that low -

wage, low - tax - rate country, France. It ’ s scary to me when I see the Obamas, I see the Hillarys, I see the John Edwards speaking nonsense. If they have their way, we ’ re going to have one heck of a problem here in the United States.

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