Dr. Arthur Laffer Presentation

After much delay, here it is. You won't find a summary of this presentation anywhere else, as there were one 130 people in the room, and none were part of the media (as far as I could tell). Anyhow, here it is!

Dr. Laffer and I, after his presentation on the state of the economy

I had the distinct honor of sitting in on one of Dr. Arthur Laffer's presentations about a week ago (credit to Mr. Devine for getting me in). I was, coincidentally, the only high school student in a room full of investment managers and corporate big wigs (I was sitting next to a financial adviser from JP Morgan). At any rate, suffice it to say that this was a very rare (and amazing) opportunity for your run-of-the-mill high school senior.

I will below outline the contents of his speech from the notes I took. There may be some holes, and I apologize if anything's missing (I know that for one segment I was so enraptured by Dr. Laffer's presentation that I forgot about notes), but I will attempt to recreate his presentation as accurately as possible, paraphrasing and quoting Dr. Laffer when necessary. But more than anything, please keep a keen eye on Dr. Laffer's distinct sense of humor, which I will let you draw your own conclusions about.

Dr. Laffer was supposed to arrive for the presentation at 12:00PM, but his flight was delayed. We ended up waiting for an hour, and his presentation started a bit past 1:00PM. As a result, his lecture was slightly shorter than it otherwise would have been. Anyways, at around 1:15PM, Dr. Laffer walks in with his signature smile apologizing that he was late but saying that it wasn't his fault.

Dr. Laffer began by asking the audience how we manage to survive with both Granholm AND Obama. Way to set the tone for a presentation, eh? He continues to point out that there can be "no economic growth with raising taxes, protectionist policies, and a federal reserve that is printing money like crazy." He acknowledges that we have been seeing "green shoots" in the economy, but then goes on to outline 3 reasons why these green shoots will not translate into sustainable growth.

Reason 1: The accelerator effect (Dr. Laffer calls it the "Free Fall Effect.")
I'll admit that I'm not too familiar with this. I'll do some more research later, but I'll summarize what Dr. Laffer said. The idea is that a small investment will lead to a larger increase in GDP. Therefore, a small population increase will lead to a large increase in construction (...somehow). At any rate, the point of this is that in the short term, GDP growth goes down sharp, and goes up sharp. Dr. Laffer described our situation as a "Dead cat bounce." He also stated that this signals that recent growth growth "won't be here in 2011."

Reason 2: The Fed's Expansionary Policies

Dr. Laffer noted that the Fed's balance sheet has surged from $840 billion to over $2.2 trillion. He also cited the fact that bank reserves have grown from $800 billion to over $1 trillion. The Fed has engaged in some risky policies such as quantitative easing. In every introductory economics course we learn that an excess supply of money leads to an increase in aggregate demand and inflated prices. This is why Dr. Laffer believes that oil prices are at $70 per barrel when they should be at around $40 per barrel.

However, Dr. Laffer believes that the Fed will be forced to reverse its expansionary policy soon, similar to what happened in 2000. Dr. Laffer said that in 2000, due to a fear of a run on banks from Y2K, the Fed expanded the money supply. However, once it realized that the world was not going to end and that there would be no run on banks, the Fed contracted its policy. They "took the punch bowl away and took back the punch from those who already got it." In Dr. Laffer's opinion, as soon as the Fed ends its expansionary policies, we will descend back into the depths of recession.

Reason 3: The Tax Boundary Effect
This effect was the focus of Dr. Laffer's presentation, and what I found the most interesting. Dr. Laffer noted that President Obama was purposely allowing the Bush Tax Cuts to expire rather than renewing them or raising taxes through a tax bill. The idea is that on January 1st 2011, we are going to have an across the board tax rate increase. The highest marginal personal income bracket, the capital gains tax, and business taxes will all increase significantly.

Keeping in mind that businesses "can change the location, volume, composition, and timing of their income," the logical conclusion is businesses will be incentivized move profit from 2011 into 2010. This creates temporary growth in 2010 while sacrificing growth in 2011. Dr. Laffer claimed that this would move 3-4% of 2011 GDP growth and move it into 2010.

At the same time, these tax hikes don't generate the intended effects, as America's richest people know how to evade these high taxes. Dr. Laffer cited Warren Buffet and Bill Gates, who have most of their wealth in unrealized capital gains, for which the tax rate is 0%.

Dr. Laffer then proceeded to talk about the 1981 Tax Bill that he himself wrote, which progressively lowered taxes over the course of a few years. The measure evidently led to four consecutive quarters of positive GDP growth following a recession and led to a two year upward trend in GPD growth.

At any rate, the end result is the same. Come 2011, the tax increases will take effect, and businesses will be disincentivized to make profit. As a result, the economy will spiral back into recession, and President Obama will have to face the wrath of an unhappy public opinion. In his words, "we will have an economic collapse similar to the 2008 collapse. The train will go off the tracks."

He then proceeds to bash President Obama a bit, beginning by calling President Reagan the "Real President." He talks a bit about the recent extension of unemployment benefits ("If you pay people to not work, do I need to finish the sentence?"). He mentions how unnecessary the bailout of GM was, saying that "bankruptcy only reorganizes." He then proceeded to talk about the stimulus package, saying that "there is no stimulus in the stimulus package," due to the fact that stimulus for one person means a tax for another. He then comments on the midterm elections, saying that he hopes that republicans don't make any headway so that the Obama administration will take full responsibility for his failures. Indeed, Dr. Laffer joked, "It took Carter to produce Regan. Just imagine the great president that will come after Obama."

That, for the most part, was Dr. Laffer's presentation. He then proceeded to take a few questions. I'll summarize his thoughts about those too. He fielded a question about unrealized gains in social security and medicare (or something to that effect), but a lot of that blew over my head (there was a lot of jargon involved), so I won't include that question here.

1. Do you believe that government can create a "green economy"?
Dr. Laffer's answer, unsurprisingly, is no. He thinks that the whole concept of "energy independence" is ridiculous. He says that the idea of energy protectionism doesn't make any sense. "The logic that we can punish terrorists by not trading with them is crazy; otherwise North Korea would be a bustling capitalistic nation." Besides, the notion that we will stop trading with a nation because we are afraid that that nation will stop trading with us doesn't make much sense from a logical standpoint either. Dr. Laffer did not mention anything about the legitimacy of a carbon tax or a carbon credit system.

2. Where do you see Fed policy in the next year?
To sum up Dr. Laffer's beliefs in a sentence, Dr. Laffer basically said that the Fed is stuck somewhere between a rock and a hard spot. "I don't know why Ben Bernake would want to run for reelection. The guy's a great economist and a great professor, but I don't think they can pull it off. If I were him, I would go to the administration and say 'I'm very honored that you chose to renominate me, but I can't see myself getting the economy out of this recession.'" His view is that if the Fed keeps going with its expansionary policy, we'll see high inflation and unchecked growth. If the fed pulls back, we'll settle back into the depths of recession. It's a lose-lose situation.

3. What would you do if you were in charge of the economy?
Dr. Laffer's answer to this question was very interesting. His answered was two pronged. If given the choice, he said, he would simple "do nothing." "These guys don't get it," he said, "I've learned that panicked and drunk people lead to bad outcomes. The bottom line is that panicked politicians make stupid decisions." However, he said, if he DID have to do something, he would take the $3.6 trillion dollar yearly budget (with tax revenues of $2.2 trillion) and have a one and a half year federal tax holiday. The bottom line, Dr. Laffer said, is that there's "no alternative to economic growth."

My overall reactions to the presentation were very positive. His economic analysis was solid, and made a lot of sense even to a high school economics student. I would, however, have liked to see a few more numbers, or at least support for how he made his predictions (Moving 3-4% of 2011 GDP into 2010? Who came up with those numbers?). I also thought the presentation was a bit too politically charged, too much focused on bashing the current administration.

But then again, It's Arthur Laffer.