LAWRENCE KUDLOW Nasdaq 10000 by 2010 part1
In a 1998 front-page story, "From Addiction Back to Influence in Tax Cut Fray," the Washington Post reported that Larry Kudlow, "the reigning optimist on Wall Street," was forecasting budget surpluses "hundreds of billions beyond those predicted" by government officials and consensus-minded economists. His many detractors considered his forecast to be "wishful thinking," in defiance of "mainstream economic models."
But Kudlow--today the chief investment strategist and senior managing director of ING Barings--was right, just as he had been right in predicting the Dow at 10,000 five years before it happened, and in calling the timing of the 1990-1991 recession and its subsequent recovery.
Born in 1947, Kudlow grew up in New Jersey and studied politics and economics at the Woodrow Wilson School at Princeton, but cheerfully points out that he is burdened with no advanced degrees. When it comes to financial markets he regards himself as selftaught. He has worked at the New York Federal Reserve Bank, and at the Office of Management and Budget under Reagan.
In 1994, the New York Times published a full-page article, "A Wall Street Star's Agonizing Confession," about Kudlow's life and addiction to cocaine. He resigned from his $1 million a year job at Bear Stearns after missing a speaking engagement with some of the firm's best clients. In 1995 he entered a drug and alcohol treatment program in Minnesota, and two years later converted to Catholicism. Recently, he has been on the Bush-Cheney transition advisory committee.
In our interview, Kudlow talks about his experiences, economic prospects for the new administration, the economic indicators that get his attention, his forecasts for 2010, and his faith.
"You're going to see a massive recovery of the NASDAQ. The mix of companies will change, but the bandwidth revolution will come and lead the NASDAQ to 10,000..."
The American Spectator: What do you think of George W. Bush?
Lawrence Kudlow: You know, to meet him is reassuring. He's fascinating, because he's real smart, and yet he doesn't have to prove it to you.
TAS: Who does that remind us of?
Kudlow: Right. Reagan. Marty Anderson [assistant for domestic affairs in the Reagan Administration] told me there was a bit of Reagan in George W. I was still in my anti-Papa Bush mode, thinking one Bush was enough for any country. But W. wound up with the best of the Bush character and family values--which Papa Bush always had--without the squishy policy thinking. And I think I know why.
TAS: Why?
Kudlow: One of the things I learned from my own crash and burn is it's good to fail. You learn a lot when you fail. I don't think his father ever suffered. Losing an election is not suffering. It's not a real loss like losing your job, or your wife, or your money. Papa Bush had pretty smooth going, but W. had two big setbacks. He lost his business and was ashamed for years about that. He basically lost his shirt as oil prices collapsed in the 1980s. And from his bittersweet experiences in the Texas oil patch, I think he developed more of an entrepreneurial outlook.
TAS: The other setback?
Kudlow: His business failure was one of the reasons he drank so much. And then he came within an inch of losing his wife. Laura said, you know, "It's either me or the bottle." She basically was out of there. I am impressed with W.'s fortitude. The fashionable world is against him but he hangs tough. He goes to Washington after the election and he has a series of tension-filled photo-ops. Very clumsy looking. You can see it in the body language. He had to sit there with Clinton, sit there with Gore. But he steadfastly talked about two things. Lower tax rates and the slowdown of the economy, and the need for religious faith. He is showing Reagan-esque discipline.
TAS: Staying on message.
Kudlow: If Bush keeps this up he will gain the country's support. Most people in this country work in a business, and most are small businesses. They know there are really only two or three important things. So when they see a president who hammers away at two or three things, they like him. It reminds them of their own life.
TAS: You know him a bit, don't you?
Kudlow: We were roommates for a few days in the mid-'80s. It was a golf outing at Pebble Beach, organized by Steve Dart, Justin Dart's son. I am not a bosom buddy, but you do get acquainted that way. But the last time we had spoken before the campaign was in 1992. He was furious at me, because I was criticizing his father on the air. He called and just reamed me out. I said, "Bushy, I'm sorry. You fire Nick Brady, Dick Darman, and Mike Boskin and I will support you. If you don't, the second term will be worse than the first. I am not for Clinton, but I am not for your dad." When I saw him seven years later, it was clear that he was going to stay tough. And he has. My basic political rule is tax cuts and pro-life. If someone stays sound on those issues, as he has, you can trust the rest will more than likely fall into place.
TAS: What about his advisers?
Kudlow: Some are going to be better than we think. Others I am less sure about.
TAS: Like?
Kudlow: Well, Marty Feldstein and Mike Boskin. They get involved in arguments about surpluses and deficits, government saving and paying down the debt: trying to "Japan-ize" the United States. The Japanese for years were obsessed with saving. They had the highest savings rate in the world, and now they have the lowest growth rate in the world.
TAS: What about Paul O'Neill at Treasury?
Kudlow: My first choice would have been Arthur Laffer, either for CEA [Council of Economic Advisers] chair or treasury secretary. He is a giant figure in economics. I might have said Robert Mundell but he is older and winding down. I thought Wayne Angell would have been excellent because of his understanding of tax-rate incentives and hard money. But O'Neill is an interesting guy even though a lot of people are writing him off as a Jerry Ford, root-canal budget-balancer.
TAS: He was in the Office of Management and Budget under Ford.
Kudlow: He was a deputy OMB director.
TAS: He probably wore his WIN button [Whip Inflation Now].
Kudlow: He probably wore his WIN button. The Ford people had few good economic ideas. They were not as bad as the Nixon Administration. On economics, Nixon was the second-worst twentieth century president. Hoover beats him. But O'Neill was only a deputy OMB director. Some supply-siders are not thrilled because he has never been part of our group. But I've known him for twenty years. He's more of a tax reformer than people think, and he's smart. True, he wanted to raise energy taxes ten years ago. But that was another time. He's not inherently high-tax. He has written and spoken for years about the need for tax reform.
TAS: So you believe a Ford OMB guy is going to lead a supply-side crusade.
Kudlow: I don't know if it's fair to call O'Neill a Ford guy, but most of them are more free-market oriented today than they were 25 years ago. They've changed because they've seen how it can work. I think it's true for Cheney, true for Rumsfeld, true for O'Neill. They are, pardon the phrase, more conservative now. Although you know the Laffer Curve was launched in the Ford White House.
TAS: I thought it was launched on a cocktail napkin.
Kudlow: Yeah, but it was a Ford Administration cocktail napkin. Arthur Laffer was in Rumsfeld's office with Cheney in 1975. Laffer was a paid consultant. At cocktails, he drew the curve for them to explain how dropping tax rates from the prohibitive range would expand revenues. They couldn't convince Alan Greenspan, who was chairman of the Council, or Bill Simon, who was treasury secretary. So Ford never went with it. He had a tax rebate instead, an anti-recessionary "stimulus" like Jimmy Carter's. It lasted two quarters, pumped up the economy and evaporated. The economy sagged right down again.
TAS: Still, the leading salesman of the tax cut is going to be a major old-economy Fortune 500 CEO...
Kudlow: Although he was on the board of Lucent.
TAS: Like I said, old economy. But why are tax cuts still controversial? After Reagan's tax cuts, revenues rose as predicted, national wealth soared, and in the long run we dissolved the deficit, though there was never any serious spending restraint, except later in defense. Yet in the last election, the Republican had a supply-side program and wouldn't admit it. Bush's argument was always: "We are giving you back the money you deserve." Positioning it as a payday for the rich dissolved the moral argument, left the growth issue untouched. And we leave unchallenged the absurd notion that Bush's tax cut is going to cost $1.6 trillion. What happened to the rising tide that lifts all boats? How could supply-siders be so right and yet surrender the war of ideas? Larry Lindsey, Bush's chief economic adviser--what happened to him? He literally wrote the book on the success of the Reagan tax cuts.
Kudlow: I think Larry Lindsey is a good man. But when he was nominated for Fed governor, his nomination was held up for many months by George Mitchell and the Senate Democrats. They bitterly hated his book The Growth Experiment, a masterly defense of Reaganomics. I think he was seared by that experience, and he has become more cautious in marketing a pure supply-side tax-cut model. I don't believe he has lost his compass. Knowing that he had to deal with the Washington press corps, he made a decision to play down some of the rhetoric.
TAS: Supply-side arguments weren't heard at all.
Kudlow: Well, Bush's staff would not challenge the myth that Clinton's tax hike created the surplus. But I am not as hard on Bush as you. He made this case from time to time during the campaign, including a valuable interview he gave to CNBC when he absolutely defended supply-side economics and growth. I grant you that in the public forums he shied away from it.
TAS: The question remains, how did supply-siders win such a great victory in the 1980s, both theoretically and empirically, and yet a Republican president now has to deny it to gain "credibility," and a Republican Congress remains committed to "static analysis"--the theory that tax cuts are a dead revenue loss with no behavior change or growth effect?
Kudlow: Well, one big mistake had consequences for years. We missed a chance in 1995, after we took Congress, to appoint a supply-side director of the Congressional Budget Office. John Kasich and Pete Domenici blew it. Domenici never was a friend of the supply-side. Kasich was on again, off again. We missed that opportunity. They put in June O'Neill, a perfectly nice lady who was utterly baffled by supply-side theory. I remember in September 1998, I spoke to the CBO board, along with some other economists, and I gave a whole rap about capital gains. The 1997 reduction in the capital gains tax rate was already throwing off increased revenues. Even more important was the productivity revolution that was coming from technology investment. Yet the CBO was still predicting 2.5 percent yearly growth, subnormal productivity, and excessively high deficits.
TAS: So we "couldn't afford" tax cuts.
Kudlow: I told them there was this phenomenal wave of entrepreneurship and technological innovation. "The economy is going to grow at 4 or 5 percent for the next several years. That is going to give you a budget surplus next year, and bigger surpluses after that." I hauled out one of my charts, showing $500 billion budget surpluses by the late 1990s. O'Neill thought I was nuts.
TAS: Was anyone else predicting surpluses?
Kudlow: No. In this group of 20 academic economists, I got no support. I was not surprised that Bob Gordon of Northwestern didn't support me. Nor that William Nordhaus of Yale attacked me. I expected to get no support from Rudy Penner, an allegedly Republican economist who always sides with the establishment. But I was surprised to get no support from Republicans like Martin Feldstein of Harvard and John Taylor of Stanford, people who had worked for Reagan and Papa Bush.
TAS: So they missed the growth story.
Kudlow: Right. I got into a rather testy debate with June O'Neill, because I pointed out that the CBO was grossly underestimating tax revenues. "The system pushes people up the slope of a progressive tax code," I said. "It's obvious revenue will grow faster than personal income." She got very testy. Recently, CBO raised its baseline to 3.3 percent growth. So that's progress. It's still lower than the post-World War II historical rates, but it's better than they had.
TAS: How much does half a point matter?
Kudlow: Moving to 3.3 percent annual growth estimate is going to add another trillion or so to the surplus estimates for the next five years. [This has since happened--TAS] And that's not even counting the effect of improved supply-side incentives from a tax cut. At 3.3 percent they are just coming to grips with the historical reality that this country creates more growth than people say. All of those academics on the CBO board assume the horrible 1970s are the baseline. They also think we dodged a bullet in the 1980s. In their view, we had all this crazy tax cutting, Reagan almost destroyed the economy, but somehow the country managed to come through it thanks finally to Clinton and Papa Bush raising taxes.
TAS: So what really happened?
Kudlow: The truth is the opposite. The economy didn't grow worth a shake in the early '90s. Two tax hikes in 1990 and '93 kept growth down to barely three percent. Coming out of a recession, that is nothing. We should be seeing 5 or 6 percent growth early in a recovery. The economy did start growing after the Republicans took Congress in 1994, because that put an end to the threat of more tax hikes and over-regulation. Then in 1996 and '97, we had some supply-side legislation.
TAS: From Clinton?
Kudlow: He became an inadvertent supply-sider. We had a capital gains rate reduction in 1997, from 28 percent back to 20. We also passed welfare reform. This was crucial because it reduced disincentives to work. It was like a tax cut for welfare recipients. We talk so much about reducing the welfare rolls we almost forget we are increasing the work rolls. We also expanded IRA Super Saver accounts, which has capital formation effects. Those are major items; Reagan would have supported them. All of a sudden you see the animal spirits of the economy revive. You could see the numbers literally jumping off the page after 1996. Suddenly the 2 percent and 3 percent quarters become four, five, six percent. Inflation declined--registering less than two percent. And given the poor way those indexes are constructed, that means zero. Maybe even deflation. So the resurgent Phillips Curvers at the Fed, whom Greenspan had joined by then, were proved wrong once again.
TAS: But now the Phillips Curve--this strange idea that economic growth above a certain level causes inflation--is back, along with the even more bizarre idea that to save the economy we have to destroy it.
Kudlow: Craig Roberts says the Phillips Curve survives because it affords planners a role in the political economy. They need a rationale for control. Since all the other manifestations of socialism have failed they are left with fine-tuning growth, as if they could. It's the last vestige of Keynesianism, although I'm not sure Keynes would have agreed with it. The great disappointment is that Greenspan signed on.
TAS: What happened to him?
Kudlow: He will tell you that he believes in a short-run Phillips Curve. In the short run, there is a trade-off between low unemployment and an "overheated economy." In fact, growth is the solution to inflation, not the cause of it.
TAS: Could you expand on that?
Kudlow: Show me a period of high growth, and I'll show you a period of low inflation. Inflation is caused by too many dollars chasing too few goods. More growth and more goods will absorb more money. During the heyday of the Reagan period, growth was almost five percent and inflation dropped to two percent. Under Bush and Clinton I, those numbers reversed. Growth solves a lot of problems, including inflation. And growth is principally a function of incentives, the after-tax return on investment, work, and especially entrepreneurship. So you have two separate levers. If it's inflation you're worried about, use the monetary lever. If it's growth, watch your incentives. If you want less inflation, take liquidity out of the economy through open market operations. That is, reduce the money supply. But boosting growth through improved incentives--tax cuts--will also help. The Phillips Curvers think of tax cuts as increasing the supply of money and thus consider them inflationary. But tax cuts that boost incentives and productivity increase the demand for money and actually restrain inflation.
TAS: Wasn't Greenspan an Ayn Rand fan? He should grasp incentives.
Kudlow: Yes, but he always had a conservative Keynesian streak, so he accepts the limits to growth idea. This is why he can believe the economy gets "overheated" and inflation looms, even when every price indicator indicates the dollar is sound. He believes in bubbles: Too much wealth creation will spur too much spending and economic activity, and that will spur inflation. He absolutely believes that. One of the reasons Greenspan has been easing up on rates is because the NASDAQ has corrected over 40 percent. That was in Bob Woodward's book. I underlined it. "Once the bubble bursts, the stock market bubble comes down by 40 percent, then we're okay." And he did it. What a way to run an economy.
TAS: But you yourself are an inflation hawk. You point out that the collapse of inflation was the biggest tax cut in the 1990s.
Kudlow: Right. James Baker undermined the dollar in 1987, and then Nick Brady and Lloyd Bentsen followed suit. But the Federal Reserve promoted a good monetary policy for most of the 1990s. Reviving the dollar was in my opinion the unheralded achievement of the Clinton Administration. The basic tenet of supply-side thinking is that working and taking risks has to pay. Crucially, it has to pay after tax, adjusted for inflation. So cutting taxes and reducing inflation are not contradictory as the Phillips Curvers think, but complementary.
TAS: This begins to make sense of the economy from the late '80s to the mid-'90s.
Kudlow: What you had in Reagan's first term was lower tax rates and a strong dollar. That was the purest manifestation of what used to be called the "classical model." And the economy responded brilliantly. In Reagan's second term, that started to break down. Probably most decisive, politically, was Reagan's decision to put James Baker, a great chief of staff, into the Treasury Department, and take Donald Regan, a good Treasury secretary, and put him in the White House. He turned out to be a bad White House chief of staff, and Baker was a bad Treasury secretary.
TAS: What did Baker do at Treasury?
Kudlow: First, the tax reform of 1986. He made a deal with Dan Rostenkowski to use static analysis on the bill. In order to "pay for" cutting the top rate from 50 to 28 percent they raised the capital gains tax from 20 to 30. Raising capital gains was a big mistake, because the stock market was valued on the lower rate. It was built into a number of investment decisions, as were valuations of assets owned by banks and savings and loans. Then Baker got into a spider web of negotiations with Germany and Japan over the trade deficit. He agreed that the dollar was too high, and he ensnared Fed Chairman Paul Volcker, up for re-appointment in 1987, into pursuing a loose monetary policy. They killed the dollar. The gold price went up from about $300 to $500 an ounce.
TAS: What was the effect of all that?
Kudlow: The stock market broke down in 1987. And the economy sputtered. Then bad tax and regulatory policy brought on the savings and loan crisis. It wasn't until Greenspan and Robert Rubin resurrected the strong dollar in 1995 that the Reagan model was resumed.
TAS: So the real story of the 20-year boom is Reagan's giving us what Bob Bartley called the "seven fat years," followed by seven years of Bush-Clinton drift, then a resurgence of incentives and growth in Clinton's second term.
Kudlow: Right. From about '88 to '95, the U.S. economy slowed to less than three percent growth, having been almost five percent during the fat years.
TAS: In 1986 it seemed the rise in the capital gains rate would be a small price to pay for that big income-tax rate cut.
Kudlow: No, because they weakened the dollar and inflation came back. The statutory capital gains rate can be dwarfed by inflation. The inflation rate fell from about 12 percent in 1980 to 2 percent in 1986. That was a major economy-wide tax cut. At a 12 percent inflation rate, a 45 percent capital gains rate, which is where we were before 1978, is effectively a tax rate of over 200 percent. By getting the inflation rate down and cutting the capital gains tax rate, under Reagan we reduced the real effective capital gains tax rate to about 35 percent. Down from 200 percent. That's a huge increase in the incentives on investment. That's when the first big wave of high-tech investment came, and the power of that is still with us. But that investment boom only made sense with a high rate of return, after taxes. In the late '80s, when we devalued the dollar, the effective marginal tax rate on capital zoomed up again and the economy slowed and the rate of advance of the stock market slowed a lot. Remember the Reagan stock market advanced more rapidly in percentage terms than the Clinton stock market, especially during Clinton I. Under Reagan, from a base of about 800, the Dow went up to around 2600, 2700. But after 1986 the market, which I believe is the best economic barometer, meanders. It drifts really from the summer of 1987 to say 1995. If I'm not mistaken, by election day in 1994, it was 3,800, a relatively tiny increase over eight years compared to Reagan.
TAS: Even that drift up was driven by buybacks, companies repurchasing their own shares. And tax-free institutions making mostly conservative investments.
Kudlow: Right. Another measure of this meandering period is that value stocks out-performed growth stocks. Periods of relatively sluggish growth move investors toward a more defensive position. They would rather buy Gillette, Coca-Cola, and Philip Morris than Microsoft or Intel, much less the risky tech companies. Growth stocks don't start beating value stocks until 1995, '96. Then they just kick ass for the next five years.
TAS: That's where the new revenues came from. Growth companies balanced the budget.
Kudlow: Totally. The expansion of these growth companies was phenomenal. These guys were building sales revenues, you know, 35, 40, 50 percent a year, and their capital gains were just unbelievable. |
