Chapter 29
ARTHUR LAFFER
One of Time magazine’s “Greatest Minds of the 20th Century”
Member of President Reagan’s Economic Policy Advisory Board
Popularized the Laffer curve and supply-side economics
Arthur Laffer tends to stir things up wherever he goes—and he does it with a smile. When I spoke with him, he had just gotten off the air with MSNBC, talking about—what else?—economics and politics. When I saw him, he was grinning. “I don’t think I gave them exactly what they wanted,” he chuckled. “At one point they wanted me to bash Clinton, but I supported Clinton!”
Indeed he did, and that stirred up a lot of Republicans who always thought he was one of them. After all, didn’t he help write Proposition 13, the late-1970s populist voter initiative in California that limited how high property taxes could rise in the Golden State?
Didn’t he promote the so-called Laffer curve and supply-side economics, which held that reducing federal taxes spurs economic growth and increases federal revenues? Didn’t President Ronald Reagan’s belief in that theory give him a driving argument to drastically cut tax rates for most Americans and American businesses in the early 1980s? Wasn’t he literally a Reagan economic adviser, for goodness’ sake?
Yep. That’s the guy. Then how could he stand up for Clinton? “For one thing,” he says, “he cut a lot of government spending as a share of GDP and brought us into surplus. And he cut capital gains taxes.”
Of course, Laffer’s support of Clinton may have had something to do with Clinton’s opponent, George H.W. Bush. Let’s just say Bush 41 was not a Laffer fan. He once called supply-side theories “voodoo economics.” Do I have to tell you who Laffer voted for in 1992? He says he voted for Clinton again in 1996.
But Arthur Laffer hasn’t really gone too far off the conservative campus. He was an early and vociferous opponent of the public option proposal in the Obama health care plan. For instance, there was this comment on CNN: “If you like the post office and the Department of Motor Vehicles and you think they’re run well, just wait until you see Medicare, Medicaid, and health care done by the government.” That’s red meat for the red states, isn’t it?
Maybe so. But Arthur Laffer doesn’t toe a predictable party line. He may have had official roles in a Republican government, but he’s more economist than politician. His educational background in economics includes an undergraduate degree from Yale and a master’s and PhD from Stanford. And he’s been on the faculty at the University of Chicago, the University of Southern California, and Pepperdine University. He was called one of the twentieth century’s greatest minds by Time magazine for his formulation of supply-side economics in 1974. So he might be able to think for himself, especially when it comes to economics.
He now believes that the flat tax is the direction the country should be going. “I love the flat tax,” he says. He sees it somewhere around 13 percent, for individuals and businesses alike. And who is he working with to push this? California Attorney General Jerry Brown, who is running for governor.
That should stir things up again.
The one true irony of Arthur Laffer’s career is that someone so brilliant could do something, well, not so brilliant. He talks about something he and another great mind, Milton Friedman, did together early in their careers.
Arthur Laffer’s Best Mistake, in His Own Words
I joined the University of Chicago faculty in 1968. I came from Stanford. And I was the whiz kid, or so I thought.
There was a money workshop where Milton Friedman was complaining that he wanted to speculate against the dollar with the British pound. But at that time it was illegal to speculate against currencies in the United States.
International trade is my specialty, and I had read The New York Money Market by Margaret Meyers, which is a three-volume set on how the money markets and the forward markets (futures) were all developed from the currency markets and the commodities.
What I told Milton was if you’re trying to do a political point, that’s fine, but if you really want to speculate, you can do it through commodities.
You can buy sugar forward [buy a futures contract expecting the price of sugar to go up] in the currency you want to short [the currency you want to bet against], and sell sugar forward in the currency you want to go long. Therefore, you’ve got a contract that’s zero net in the commodity, and all you’ve done is shorted one currency and gone long the other.
[Note: You can bet on the price of sugar to go up or down, but it really doesn’t matter where the price goes in this case because you’re betting both sides of the transaction, so the contracts cancel each other out. If one sugar contract goes up, the other goes down the same amount.
But the currencies the contracts are bought and sold in will change. So you get rid of the currency you think is going to go down by buying the contract on sugar. (You’re taking that currency out of your pocket and paying for the contract in that currency.) And you take in more of the currency you want to own by selling the sugar contract. (When you sell the contract, you take in that currency and put it in your pocket.) After the contracts expire, you’re holding more of the currency you wanted in your pocket. Your belief is that the currency in your pocket will be worth more than the currency you took out of it to buy the contract.
All of this, of course, ignores any costs to own the contracts, or what it costs to borrow that money.]
So I’m into international trade—that’s my specialty—so I explained it to Milton. And Milton said, “No, no, Arthur, you’re wrong—it doesn’t work that way.”
So that night I get this phone call. “Hello, Arthur, Milton here. Could you go through that again?”
And I say, “Sure. If you want to go short the British pound and go long the German mark, what you do is buy sugar forward (futures) in pounds, because then you’re selling pounds and buying sugar, and sell sugar forward in marks. You’re going to give sugar up and get marks. So you’ve really shorted the pound and longed the mark. That’s how you do it.”
He thought that was great. And I set it up to do this.
Two things went wrong. The first thing was that Germany at that time did not have a sophisticated-enough currency market to have commodities like sugar traded in German marks. So I couldn’t do it in the German mark.
I had to do it in the pound, but not in the German mark. So I did it on the pound and the dollar.
So I sold sugar forward in pounds, and I bought sugar forward in dollars. [Note: This would be a position to bet the British pound would go up and the dollar down.]
The broker thought I was stupid. He said, “Let me see if I’ve got this right. You’re selling sugar forward and you’re buying sugar forward—is that right?” I said, “That’s exactly right.” He thought this was the dumbest thing he’d ever heard.
And I had done this with Milton. Milton put in his money, and so did I.
Then the second thing went wrong. The German mark revalued, so there was no effect on the pound and the dollar. So we missed it. But hey, that happens. At least we didn’t lose any money, because we were evenly balanced.
But all of a sudden, I started getting margin calls. Why? I had matched the same number of tons with the same number of tons, so it shouldn’t be a problem. But the broker came to me and said, “We’re getting margin calls and I can’t figure out why.” And I couldn’t figure out why, either.
Just so you know, this is a really stupid business mistake: The British contracts, the pound contracts, are done in British tons, and the U.S. contracts are done in U.S. tons.
Two thousand pounds is a U.S. ton, and 2,240 pounds is a British ton. And I had this enormous net position in sugar because I had it highly leveraged. And I lost my shirt and Milton’s shirt at the same time!
Now, it wasn’t a lot of money, because I was just an assistant professor, but can you imagine my embarrassment going to Milton Friedman explaining to him the mistake I made?
Q. What was the lesson?
Two things. Number one, to be a little bit more careful and actually work through examples. But number two, to have a little bit more humility—and find a broker who really knows what he’s doing! Ha!
About Arthur Laffer
Arthur B. Laffer is the founder and chairman of Laffer Associates, an institutional economic research and consulting firm, as well as Laffer Investments, an institutional investment management firm utilizing diverse investment strategies. Laffer Associates’ research focuses on the interconnecting macroeconomic, political, and demographic changes affecting global financial markets. Laffer Investments’ investment management strategies utilize some of the economic principles and models pioneered by Dr. Laffer as well as other unique offerings managed by the firm’s portfolio management group. The firms provide research and investment management services to a diverse group of clients, including institutions, pension funds, corporations, endowments, foundations, individuals, and others.
Dr. Laffer’s economic acumen and influence in triggering a worldwide tax-cutting movement in the 1980s have earned him the distinction in many publications as “the father of supply-side economics.” One of his earliest successes in shaping public policy was his involvement in Proposition 13, the groundbreaking California initiative that drastically cut property taxes in the state in 1978.
Years of experience and success in advising on a governmental level have distinguished Dr. Laffer in the business community as well. He currently sits on the board of directors of several public companies, which include: MPS Group Inc. (MPS) and Oxigene Inc. (OXGN). He also sits on the board of directors or board of advisers of a number of private companies, including Alpha Theory, Atrevida Partners, BAP Power, BridgeHealth Medical, F-Squared Investments, HealthEdge Partners, LifePics, Nicholas Applegate Institutional Funds, Pillar Data Systems, and Retirement Capital Group.
Dr. Laffer was a member of President Reagan’s Economic Policy Advisory Board for both of his two terms (1981-1989). He was a member of the executive committee of the Reagan/Bush Finance Committee in 1984 and was a founding member of the Reagan Executive Advisory Committee for the presidential race of 1980. He also advised Prime Minister Margaret Thatcher on fiscal policy in the United Kingdom during the 1980s.
He was formerly the Distinguished University Professor at Pepperdine University and a member of the Pepperdine board of directors. He also held the position as the Charles B. Thornton Professor of Business Economics at the University of Southern California from 1976 to 1984. He was an associate professor of business economics at the University of Chicago from 1970 to 1976 and a member of the Chicago faculty from 1967 through 1976.
During the years 1972 to 1977, Dr. Laffer was a consultant to Secretary of the Treasury William Simon, Secretary of Defense Donald Rumsfeld, and Secretary of the Treasury George Shultz. He was the first to hold the title of chief economist at the Office of Management and Budget (OMB) under Mr. Shultz from October 1970 to July 1972.
Dr. Laffer has been widely acknowledged for his economic achievements. Recently he was noted in Time magazine’s March 29, 1999, cover story, “The Century’s Greatest Minds” for inventing the Laffer curve, which it deemed one of “a few of the advances that powered this extraordinary century.” He was listed in “A Dozen Who Shaped the ’80s,” in the Los Angeles Times on January 1, 1990, and in “A Gallery of the Greatest People Who Influenced Our Daily Business,” in the Wall Street Journal on June 23, 1989. His creation of the Laffer curve was deemed a “memorable event” in financial history by Institutional Investor in its July 1992 Silver Anniversary issue, “The Heroes, Villains, Triumphs, Failures and Other Memorable Events.”
The awards that Dr. Laffer has received for his economic work include two Graham and Dodd Awards from the Financial Analysts Federation for outstanding feature articles published in the Financial Analysts Journal; the Distinguished Service Award by the National Association of Investment Clubs; the Adam Smith Award for his insights and contributions to the perpetuation of the ideals of a free market economy as first laid out in The Wealth of Nations; and the Daniel Webster Award for public speaking by the International Platform Association. Dr. Laffer also earned the Father of the Year award from the West Coast Father’s Day Committee in 1983.
Dr. Laffer received a BA in economics from Yale University in 1963. He received a MBA and a PhD in economics from Stanford University in 1965 and 1972, respectively.
