Part 2
TAS: Who was behind the supply-side revival in Clinton's second term?
Kudlow: It's a very strange story. No one in the Clinton Administration talked in supply-side terms, but they did two very important things. Rubin and Greenspan worked for a stronger dollar, which neutralized the 1993 income tax hike by bringing inflation down. It effectively reduced the capital gains tax rate and restored the incentives to invest. Second, the statutory capital gains tax rate was also reduced, though not until 1997.
TAS: Saying Rubin and Greenspan "neutralized" the Clinton tax hike is a huge claim. Because supply-siders' biggest problem is that people see that the economy boomed under Clinton, who they know raised taxes.
Kudlow: Right, except that after the tax hike, the administration and the CBO were still predicting $200 billion deficits as far as the eye could see.
TAS: But can you support this incredibly important claim that the reduction of inflation actually "neutralized" the Clinton income tax rate increase?
Kudlow: Sure. Clinton raised the top income tax rate from 31 to 40 percent. But even with capital gains tax at 28 percent, where it was raised to in 1986, the reduction in inflation, from 5.4 percent in 1990 to essentially zero in recent years, increased the return on investment far more than the increase in income tax reduced wage and salary incentives. In a period of entrepreneurial creativity, the return on capital becomes more important than ordinary income.
TAS: And income flees massively toward various permutations of capital gains, like options.
Kudlow: That's exactly right. The options revolution in compensation was a largely successful attempt to avoid the statutory tax increase. And then, almost miraculously, came the lower statutory capital gains tax rate. So two important pillars of supply-side thinking were re-instituted under Clinton. Suddenly he was governing as a Reaganite. My take on the success of the 1990s is that between the night Newt Gingrich took the House of Representatives and the night the Monica Lewinsky scandal surfaced, Clinton governed as a supply-side Republican, and the economic results show. After Monica, Clinton moved left to secure his base. He became a big regulator for his last 18 months. And Al Gore ran as a business-bashing, left-wing populist, departing from Clintonomics. Gore should have won by eight points. It's an incredible story. The Democratic Party was on the verge of an historic policy realignment, but they frittered it away. Clinton was the most pro-growth Democrat since John F. Kennedy.
TAS: Well, Kennedy did it willingly. Clinton faced a Republican Congress. He started by raising taxes and trying to nationalize medicine.
Kudlow: But to his credit, he brought in the strong dollar.
TAS: But he appointed a Fed board that eventually undermined Greenspan.
Kudlow: Still, Clinton's shift is the mark of a talented politician. Clinton beat Bob Dole from the right, and he boosted the Dow about 6,000 points. The supply model was resuscitated by happenstance. Newt Gingrich didn't do it. The Contract with America didn't have lower tax rates. It had tax credits and balanced budgets. But it never had a growth component. tas: It was a focus-group document. Typical Gingrich. kudlow: One night, right before they announced the Contract, Steve Forbes, the Wall Street Journal's Bob Bartley, and I had a knock-down drag-out with Gingrich. That's the only time I have ever heard Bartley raise his voice. Newt said, "I hear you have a problem with our tax plan." Bob looked at me and said, "Go ahead, shoot down this thing." And I did. Gingrich got very angry. "How dare you lecture me on tax policy?" I said, "I'm not lecturing you. I'm giving you advice." Then Bartley raised hell. I'd never seen him like that before. In the early '80s, we always had trouble with Gingrich. He was not a supply-sider and was never reliable on economic policy.
TAS: Gingrich was the single most disappointing politician of recent times.
Kudlow: He was a guy with an ego, but not a real policy vision. In the early 1980s, he rode [Jack] Kemp's coattails when he saw how popular Kemp's ideas had become. When Reagan won there were times when we at OMB sat down with Gingrich, and it was hard to know what his position was. You knew where Jack was. He was arguing with Dave Stockman, who had already jumped ship on us. But you didn't know where Newt was. He had his finger in the wind.
TAS: As we speak, the Fed has finally cut rates, a full point this month. [January--TAS] Far enough?
Kudlow: No. The Federal Funds rate should go to four and a half percent. Maybe four. Long-term interest rates have fallen. And we are seeing recession-like numbers--three straight declines of industrial production. But if the Fed gets its interest rate cuts finished, say by March, and in April tax rates are cut and made retroactive to January 1, Bush could be looking like a genius. He may be the guy with the best analytic handle on this.
TAS: He's had good luck.
Kudlow: He sure has. Economy declining and surplus rising! Better to be lucky than smart, they say. Better still to be lucky and smart.
TAS: We're all down on Greenspan these days. But you spent years promoting him for canonization.
Kudlow: Absolutely. I wanted sainthood. "He deserves a Nobel Prize," I said on the air. I said it because he acknowledged the impact of the new technology--that there was no need for the Fed to tighten automatically with four percent growth. He conceded that enhanced productivity was raising the "speed limits" of the economy.
TAS: Right.
Kudlow: Now, that wasn't exactly what I wanted to hear, because I don't believe "speed limits" are appropriate at all. Still, he was taking on an establishment that said that 2.5 percent is the most we can grow without inflation. So I gave him credit for that. Then, after the spring of 1999, he relapsed into the standard, People's-Republic-of-Cambridge Phillips Curve nonsense. That's all it is. That has been the most regrettable part of his tenure. He had a chance to provide breakthrough leadership that would have lasted beyond his time.
TAS: Do you know why he stumbled?
Kudlow: No, I don't. It was like somebody flipped a switch. The fact that the Fed has 500 Ph.D. economists, the vast majority of them from universities in the northeast, especially the Ivy League, doesn't help. Greenspan started playing down the role of money in inflation, which is the key. And we started getting all this fine-tuning nonsense: unemployment is this, wages are that, retail sales are this. Inflation is a monetary problem. If there is too much money out there, you'll know it. Because the gold price will go up $100, or the bond rate will go up 100 basis points. It has nothing to do with retail sales. But Greenspan obscured all that. His relapse means we have made no progress on the science of central banking.
TAS: Still, compared to previous chairmen, he was almost a miracle worker for years. And with Y2K there was an 18 percent jump in the money supply. Maybe he gave us one rate increase too many. Is that enough for excommunication?
Kudlow: No. But genuflection isn't good either. Greenspan rehabilitated a flawed theory. That destroyed trillions in national wealth, at least temporarily, and will now give us a few tough quarters. Worst of all, he kept alive this notion that growth and prosperity cause inflation. We need to get beyond that. We are fast approaching a time when the information economy can produce as much as six percent growth a year. That level should be the goal of fiscal policy. And it will actually suppress inflation.
TAS: There are two open chairs on the Fed Board, and Roger Ferguson's term expires soon. So Bush has three slots. What should he do? Who on the board should he re-appoint?
Kudlow: No one. The president can't fire board members, sadly. If he could, I would recommend he fire Lawrence Meyer, the principal Phillips Curve theorist on the Fed. He has been unrelenting in his mistakes. As far as I can determine Ferguson has just been a garden-variety Phillips Curve guy. I would not have reappointed Greenspan to a third, sorry, to a fourth term. As a general rule, I don't believe anybody should be appointed to more than two terms for anything. Four is off the charts. You get stale. And they're grinding jobs. Alan is 74 now. I don't mean to denigrate that, but it's a tough job, double-digit work hours every day, and Alan is a hard worker.
TAS: Do you have a replacement in mind?
Kudlow: Robert McTeer. He has been the president of the Dallas Fed for almost ten years. He is a free-market, new-economy, price-rule market watcher. He actually objected several times to Fed policies last year. He would make an excellent Fed chairman. He would also make an excellent Treasury official as perhaps a transition to the Fed. I'd love to see him as Paul O'Neill's deputy.
TAS: But is Greenspan still the best Fed chairman in history?
Kudlow: You know, in his own clumsy way Paul Volcker may be the best Fed chairman in history. He's an odd character--by no means a supply-sider. By and large he didn't like Reagan's tax cuts. But he took the inflation rate from fifteen and brought it down to two, roughly between 1980 and 1986. You have to say that was the most extraordinary achievement in the Fed's history. Alan took the inflation rate from four or five to two. That is a fine achievement, but not quite the same. I was on a panel with Volcker the other day. He's a very eccentric man, very dogmatic. But in his own way, brilliant. Remember, he was around when the dollar was linked to gold. He was in the Treasury Department in the '50s. He's a relic of the past. You know what? He gave us an antiquated monetary policy. And that's what was needed. He took the gold price down from $800 to $300 an ounce.
TAS: You are still largely a gold guy?
Kudlow: Yes. It provides important information about inflation.
TAS: But is gold really relevant, with all of these currencies trading against each other? We have wonderful barometers. Why still gold?
Kudlow: It has not failed me. When gold is low, inflation is low. In 1999 and 2000 when Greenspan was wrongly obsessing over inflation, I just kept saying wake me when gold hits $300. Sure, the gold bugs are gone, the investors. But I don't want gold to be a hot investment. The minute it is, I know the rest of the story is going to fall apart.
TAS: Gold bugs bring bears?
Kudlow: That's where I came in. As a young pup in the 1970s, it was precisely the fervor for gold that taught me how much trouble we were in. Because if you're buying gold, you're not investing in your brother-in-law's new wireless application to get on the Internet, right?
TAS: What about Walt Wriston's Information Standard? This notion that increasingly central banks or governments are not going to be able to misbehave because of the efficiency of price signals on instantaneous global trading networks?
Kudlow: There's a lot to that. The financial markets act as cops and flag bad policies. Global electronic financial markets were the first to embody the information age. They punish countries by withdrawing capital immediately. In that sense, Walt is right. But you still have to have a reference point. And there are few market indicators that will tell you whether you're winning or losing on inflation. One of them is gold. Another has to be interest rates. Particularly long-term rates. If your currency is collapsing, you must be doing something wrong. If your stock market is plunging, you are doing something wrong. Because hundreds of millions of people cannot be wrong. But a handful of Ph.D.s with their computer models can be wrong.
TAS: It has happened.
Kudlow: You're darned right it has. They lack humility. If I have a forecast and market events are proving me wrong, I need the humility to go back and ask myself something I don't want to ask: What did I do wrong? Now we have Greenspan sitting there with a board and 500 Ph.D.s from the best universities, God help us, all of whom, virtually, believe tax cuts will overstimulate the economy. They have no clue how the people who actually drive the economy behave. Nonprofessionals investing in the market have a better grasp of these principles than the experts.
TAS: Why this pessimism of the intelligentsia?
Kudlow: I had this wonderful experience at the Council on Foreign Relations a few months ago, debating Robert Schiller from Yale, the guy who wrote Irrational Exuberance. We're in front of 300 people--enemy territory. He is a total pessimist-- he thinks in ten years the Dow will be 6,000. I believe it will be 35,000. He believes that the U.S. is incapable of growing above 2 or 3 percent. I believe it can grow by five. He believes we're in tulip mania. This sort of pessimism comes from academic culture. People who aren't in the day-to-day commercial, entrepreneurial battle have no confidence in the people of this country. They believe that without the wisdom of the Ivy League, the markets will go haywire. And lacking faith in others, they oppose freedom for others.
TAS: That's why they oppose tax cuts?
Kudlow: Right. It's absolutely predictable that the one thing liberal economists are never for is tax cuts. They never favor moving money out of the government and back to individuals. Their big battle cry now is "Let the Fed take care of recovery." Tax cuts might jeopardize the budget surpluses, bring back inflation, "overheat" the economy. We can't have tax cuts, ever. Paul Krugman, Larry Summers, the New York Times editorial page: all on cue. Having the Fed engineer a recovery is exactly the policy mistake of the '70s. It shows just how retro the economics profession is. They've learned nothing. A warning here. I do believe the Fed should cut rates. But depending on the Fed to lead the economy by pushing out too much money raises the possibility that the Fed could flood the market with reserves for the next 12 months to stimulate the economy. Then by 2002 we'd have inflation of six or seven percent without lower tax rates to increase production and investment. Excess money will drive interest rates up, however big the budget surplus.
TAS: Given the size of world financial markets, how much impact can the U.S. deficit, or debt, have?
Kudlow: You're talking about a fifteen or twenty trillion dollar daily trading day in the world financial markets. A $50 billion buy-back of Treasury Bonds has virtually no meaning. I'll grant you if the Treasury goes out and buys back 30-year bonds, the price will go up that afternoon. You'll see market dislocation for a few days, but it will settle quite quickly.
TAS: Is the center of gravity of American politics shifting?
Kudlow: The center is moving toward free enterprise, ownership, investment. The primacy of markets over governments as organizing and growth tools is accepted. A hundred million Americans are invested in the stock market. Bush can get these tax cuts through because free enterprise is the center in American politics today. That's a major change. Clinton in many ways acknowledged it.
TAS: And it looks like Bush will get his tax cut...
Kudlow: And turn out to be an excellent president. The force is with him. The political culture is with him. That's really the message of this election. Al Gore should have run as a Clinton Republican. It wasn't about his personality. It was about his message.
TAS: So I take it you don't think Bush's tax cut is going to cost us $1.6 trillion over ten years, right?
Kudlow: Of course not, that is absurd. You can only believe that if you believe the 1980s never happened, tax cuts have no effect on the economy, and that even if you pay people more after tax to work, save, and invest they won't do it because they don't care about the money. You have to ignore not only the Clinton boom after 1997, but the fact that personal income tax receipts rose more than a third in the wake of the Reagan tax cuts. Plus decades of global evidence that GDP rises in the wake of tax cuts and falls after tax increases. The truth is--on a strictly back-of-the-envelope basis--tax revenues will probably rise by $300-$500 billion over ten years as a result of Bush's tax cut. A tax cut of these dimensions will boost GDP growth about half a point a year, to about four percent rather than three or three and a half. The growth is cumulative, of course, you know, compound interest, man's best friend. In a decade in which we start with a $10 trillion a year economy, and end with a $15 trillion a year economy that means hundreds of billions of extra revenue. Of course these models going out a decade tend to be nonsense anyway, another reason their $1.6 trillion number is ridiculous. The real point is that if you strengthen incentives to work and invest, the economy will grow, and growth trumps everything. We should target four percent annual growth minimum because that's what we have done except when we have depressed incentive with high taxes and inflation. If you add the effect of new technology on productivity you are looking at five percent. That is where I think this is going. With five percent you're going to see a massive recovery of the NASDAQ. The mix of companies will change. But the bandwidth revolution will come and the Internet will take over economic life. The companies that lead that change will lead the NASDAQ to 10,000.
TAS: In this decade?
Kudlow: By 2010 it should reach 10,000. The Dow Jones--which is really an old-economy value index--should keep rising, because the old dogs are learning new tricks.
TAS: The NASDAQ at 10,000 will please my wife. But what about my mother? Where do you expect the Dow to be at the end of the decade?
Kudlow: I've been on the record for 35,000 for awhile.
TAS: The world has changed.
Kudlow: And it is not going back. That's not the way history works. Voters in free countries will keep driving their politicians toward a prosperity model. You're seeing it in Germany, England, Italy, South America. Once you get a taste you want more. They're getting a taste of freedom in China. They'll never go back. We're unwinding the -isms of the twentieth century, which blocked progress in major parts of the world. Fascism, communism, socialism: it's all unraveling. Through much pain in the twentieth century, we have learned what works. The human expense was staggering. But we learned and history will keep pushing us in the right direction.
TAS: Can we talk about some personal things? You may be the only Wall Street economist who ends his commentaries with a call to faith. How did you become a Catholic?
Kudlow: I had a problem with alcohol and cocaine. In the winter of 1993 I had spent a month in a treatment center here in New York. It taught the twelve-step program. God plays a role, but it's more the spiritual God of your choice. But at least there's something. I was not raised religious but I was searching for help. I remember that in this little prep school that I went to, the Dwight Englewood School in New Jersey, we had to say the Lord's Prayer in homeroom. Every morning at your desk you put your head down and say the Lord's Prayer. I was there grade seven through twelve, so it's something you remember. When I was going into this dark abyss with alcohol and cocaine, after some terrible binge, I can remember lying in bed desperate and I started saying the Lord's Prayer. What made me do that? Just--I was desperate, I was trying to ask for help. You know, who was going to get me out of this? I started searching for God.
TAS: So then what happened?
Kudlow: It was Jeff Bell, an old supply-side ally, who actually got me started with the Church. That same winter I was in the treatment center I bumped into Jeff on the street. I was still at Bear Stearns so it was 45th and Park. Now I knew that somewhere along the line he had converted to Catholicism. We started talking, and I told him--I don't know why because not many people knew about my problem yet--I told him that I was taking some steps that had recreated my faith in God. I didn't really tell him much. Then one day Father C. John McCloskey appeared at Bear Stearns. My secretary said, "This priest is here to see you." No appointment, but a lot of the partners donated to various charities. So I was ready to pull out my checkbook and write a thousand dollars to whatever. But this guy didn't want any money. He was a friend of Jeff Bell's and he wanted to talk to me. And he was a very engaging man.
TAS: Wasn't he a gold trader before becoming a priest?
Kudlow: Right. At Merrill. But that day he said he had been watching me on TV on the financial shows. "You've changed," he said. He was right. I was trying to be more restrained, calmer, things they taught me in treatment. So then he asked me, "Do you believe in the hereafter?" My answer was yes, because that's what you're taught in the Jewish faith, though I had not been raised very religious and I hadn't been in a temple since I was fifteen. Then, "Do you believe in Jesus Christ?" And I said I didn't know. But I didn't say no. He gave me a book or two to read and then said: "Why don't you try going to Mass?" I told him I had never been. "Do you have any opposition to it?" I said no. But, I would feel a little odd just walking into a Catholic Church. He said, well, lots of people do it. Then he introduced me to a friend who went to St. Thomas More on 89th and Madison, near where I lived. And I loved it. I loved the Mass.
TAS: Why?
Kudlow: If done right it has a certain mystical quality, and it appealed to me. It was different from anything I had been exposed to. I went to a retreat and I didn't like it because I didn't understand it, mostly. But it wasn't church. The church part is what I liked, the actual Mass. I liked the robes, the smoke. I loved it. All these rituals and rules. I began to realize that for the past eight or ten years I had been living without them. I was the rule. I was so self-centered. I'd just do whatever I felt like. I was in my master-of-the-universe period. You can't live that way. Nobody can. I knew it wasn't good and the drugs and the booze were part of it.
TAS: How are drugs part of that?
Kudlow: You become so self-centered and self-willed that you decide you can do anything, without regard for others. I wasn't showing up for events, for friends, for my wife. I'd go missing in action for days. I've made amends to people directly, but still, I'm ashamed about that period. But the church offered me a regulated regime for life, as did my twelve-step program. The two are similar because Bill Wilson, the founder of A.A., had been part of the Oxford Group, and a Catholic priest from St. Louis was his mentor. Anyhow, I knew this was something I should be doing, just from a selfish standpoint. I needed regulation. I needed to be taught rules of the road. It took me awhile to get my arms around it. But as I hit bottom, Ilost jobs, lost all income, lost friends, and very nearly lost my wife. I was willing to surrender and take it on faith that I had to change my life.
TAS: But you became a Catholic. So you had to stand up and say I believe some very specific things.
Kudlow: I was going to Mass on Sundays. And we recite the Nicene Creed, the church's statement of beliefs. There came this one day when I stopped just mouthing it and read it in an intellectual, cognitive way, and realized there's a whole story here. If you read the eucharistic part of the Mass, there's a whole story there and it's a fabulous story.
TAS: What is that?
Kudlow: It's--we are partaking of the body and blood of Christ. That's what I understand the Eucharist to be. We are pledging our faith in him and what he taught and all of a sudden it clicked, that Jesus Christ does not want me to touch alcohol or drugs because I wreck my body and I wreck his body and I wreck my life. Jesus died for me, too. And that is my redemption. I'm not a Catholic intellectual. I will never be one. I'm not interested in that. I'm interested in how I live my life each day. How I conduct my relationships with people. My view of Lord Jesus is very basic in that sense, though I have read some books that are interesting to me, including Fr. Richard John Neuhaus's recent book, Death on a Friday Afternoon.
TAS: He's a priest in New York, edits First Things.
Kudlow: The basic thought in the book is that even we optimistic Americans mustn't ever forget that Jesus spent that time on the cross, painfully. His crown of thorns was sticking into his skull, he was nailed to the cross, and it was horrible. The book had an impact on me, because in my own mundane, low-level way, I was on the cross. I don't know if I've had salvation, but I have had a change. Sobriety is one of the keys to my faith. And that's good because for me to destroy my life is a rejection of Jesus. In my worst moments--and I still get a few--the reason I don't go out and do something crazy is because I don't want to break my bond with God.
TAS: Sometimes people forget how tough addictions can be.
Kudlow: You see, what this journey is really about is changing along Christian principles. I still do stupid things, but I also go to confession. One of the things I like about Mass is that you go on your knees for part of the time. It is a wonderful thing to learn some humility. I was at Mass the other day and I was having some trouble, and I prayed. I didn't ask for an outcome, just help. Please show me some clarity, some calmness, give me a sign, and it worked. Took about a day, but it worked. I don't pray for stuff that I want. I ask help for stuff that I believe I need.
TAS: The Pope would say that the original reason God gave us liberty was to complete his creation. And that does take us back to economics and politics. It's no accident that your favorite dead economist, Joseph Schumpeter, focused on creativity.
Kudlow: That's why "supply side" doesn't really capture it. The reason we have the best economic and stock market record in the world is we are the freest country in the world. We call it supply-side economics, but what we're really fighting for is more freedom. Not unlimited freedom, and that's where faith comes in. Since God granted us our liberty, for which we are eternally grateful, we must reflect that by abiding by his rules. It's the rule part that I've come to acknowledge and frankly love. This is part of that mystery of faith, but I believe Jesus is with me. He enters my body and mind as long as I'm open to him and prevents me from doing something really stupid or from misbehaving. I believe that. Last Saturday, when I was at sixes and sevens in my own head, which is a risky real-estate section to be in, I believe Jesus came to me. I believe he somehow entered into my head for the next 48 hours and helped me get through this little patch. People brought Jesus to me: Fr. McCloskey, Jeff Bell, my mentor Sim Johnston. And He helps keep me sober every day and helps me to discharge my responsibilities.
TAS: Do you think you will write more about this?
Kudlow: I believe it is possible that the Holy Spirit can bring a certain ability to explain my faith. But not in an intellectual way. I don't possess those tools. Just in a personal way: Here's why I go to Mass, here's what it's done for me. Some people want me to carry the sword of Catholicism the way I carry the sword of free-market economics. It's not my goal and if it does happen, it will not be by my design. It's very personal. Jesus is my Father. He's also my Supreme Court because the court has rules and if you break them you get into trouble. In my twelve-step program there's all these young kids who went to Catholic school and rebelled. And they always get up and say how they rebelled against the Church and its rules. I just nod my head and kid them. I say, well, you don't understand how wonderful those rules are. Take it from me. I came to it late in life, but that's exactly the way it was supposed to be. I wrecked my life. It was literally destroyed. My old life was taken and a new life has been born. I understand now that all that had to happen. There's a script here. It's just that I didn't write it.
The American Spectator, March 2001 |
