Memo To: Website Fans, Browsers, Clients
From: Jude Wanniski
Re: My 1999 Client Letter
With the Dow Jones Industrial Average now struggling to stay north of 9000, I thought it would be instructive to run a letter I sent to Polyconomics' clients on March 17, 1999, when the DJIA for the first time hit 10,000. This will help you better understand how much the level of the nominal market indices depend upon the dollar/gold price. In reading, remember that the dates mentioned in the piece all relate to 3/17/99 when it was published.
DOW AT 10,000: THE EASY PART
In a signed editorial-page commentary in Monday's NYTimes, the newspaper's chief economics editorial writer, Floyd Norris, noted that the current bull market began on December 6, 1974, with the Dow Jones Industrial Average hitting its low of 577.60. He said nobody then realized the Dow's bottom had been touched after "having plunged 45 percent in less than two years amid the worst economic news America had seen since the Great Depression." It is not a coincidence that on December 4, two days earlier, I had watched Art Laffer draw his famous curve on a cocktail napkin in the bar at the Hotel Washington, for Dick Cheney, then deputy White House chief of staff. I had arranged the meeting after talking to Don Rumsfeld, then chief of staff in President Gerald Ford's White House, right after the disastrous November elections.
My objective was to persuade the Ford administration to drop its plans to fight inflation by raising taxes but to cut them instead. I'd already done most of the job of persuading Rumsfeld, who had not yet joined the White House staff when the decision was made to go into the November 1974 elections promising an income-tax increase! The meeting with Cheney was to get them feeling comfortable that a real Ph.D. economist, who earlier had worked as chief economist at the Nixon budget office, believed tax cuts were the way to go. They had my assurance I would back them up at the WSJournal, which I did on December 11 with my famous interview with Robert Mundell, "It's Time to Cut Taxes." The Dow hit bottom as word seeped into the market that Rumsfeld had in fact begun the process of turning the administration around on December 5, when he got his report from Cheney and called Treasury Secretary William Simon to make the change. There never was any doubt in my mind that this is what turned the stock market around, as there was no doubt in my mind that Republicans lost four dozen seats in the November election not as punishment for Watergate, but for promising a tax increase.
This hardly marked the beginning of a bull market, though, or Jerry Ford would have been re-elected, there would have been no Jimmy Carter presidency, and Ronald Reagan would not have had to saddle up and ride into town in 1980. Simon's Treasury boys produced a Keynesian tax cut with no supply effects, a $50 cash tax rebate to put money into people's pockets. There was a nominal rise in the Dow during the Carter years that followed, but the price of gold rose still faster, which meant the capital stock declined in terms of gold. Looking at gold and equities in combination, I trace the beginning of the current bull market to the summer of 1980, when the gold/DJIA index stopped falling. This also was at the point where it began to look increasingly possible that Reagan would win in November on his tax agenda. The stock market did not do well in 1981 and early 1982, as the GOP austerity crowd -- led by Alan Greenspan, Pete Domenici, Bob Dole, and David Stockman -- talked Reagan into phasing in the tax cuts. As the cuts gradually began to take hold, the demand for dollar liquidity rose, and when not supplied by the Volcker Fed, the gold price fell by half, to $300 from $600. It was the worst monetary deflation in the history of the dollar, perhaps excepting the deflation of the 1870s when gold was also halved, to $20.67 from $40.
It only was when the deflation crisis forced Paul Volcker to flood the banking system with liquidity in the summer of 1982 that the bull market began in earnest. The sharp correction of 1987, when the Dow fell by a third, will be viewed by history as the combination of the 1986 tax act, which increased the capital gains tax, and the first of the two major Greenspan flubs of his 12-year tenure at the Fed. Treasury Secretary Jim Baker III had negotiated the Louvre Accord to stabilize exchange rates -- with gold as a reference point. But in October, a Greenspan interview in Fortune magazine appeared, indicating the new Fed chairman thought the dollar had to be devalued. Baker chipped in with an ill-timed criticism of the Bundesbank, and all the market could see was a new poisonous combination of inflation sending the effective capital gains tax close to 75% at the margin. The market gradually came back as Greenspan put himself under the care of fellow Fed Governor Wayne Angell and renewed appreciation of the gold signal.
In the Tuesday WSJournal, Larry Kudlow writes a decent review of the march toward 10,000 on the Dow, correctly giving Reagan the lion's share of the credit and awarding a gold star to Greenspan for getting inflation under control. Kudlow, who moves easily between the growth wing of the GOP and its austerity wing, still shies from criticizing Greenspan for overdoing the monetary austerity that gave us the collapse of commodity prices and the Asian crisis. He also errs in predicting a Dow of 50,000 by the year 2020. Sure, we could get to that number by boosting the gold price to $15,000 an ounce, or to a Dow of 500,000 with gold at $150,000. To get to 50,000 with gold at $300 is impossible to imagine. The only reason we got to 10,000 as easily as we have is that Presidents Johnson, Nixon, Ford and Carter followed the policies of demand-side Keynesians and monetarists, messed up the structure of our economy, sent it into massive underemployment, and reduced us to such a low base from which to rebound. The easiest part of getting the Dow at a higher level is to clean up the mess.
What we have today is an economy that has the same pricetag in terms of wealth as in 1966 -- today's Dow equating with when the Dow first touched 1000. But it has been twisted out of shape, top heavy with capital as evidenced by the lag in the Russell 2000. It still is burdened with the complexity of a tax system that permits capital to form through loopholes, including the marvelous Roth IRA. And we still have an uncertain money at the center of the economy. If we did everything perfectly in the next few years, in terms of tax simplification and a dollar as good as gold, we would be able to contemplate a Dow of perhaps 15,000 by 2010 -- assuming Y2K damage will not be excessive. But then it gets harder to advance, because an economy that has an optimum structure of government then only can improve with technological innovation. In a long run, this means a growth rate of 2.5% annually. Admittedly, the cutting edge of technology at times rushes ahead in great bursts, then slows to zero or negative rates, with 2.5% the average. But a broad index of equity prices that doubles from this point by 2020, at constant gold, would be plenty to cheer about. Corrected for gold, the Dow has compounded at 2.5% over the past 80 years, but the return is higher if dividends are added.
The great changes in equity indices during the next 20 years will be in the emerging markets, where asset values can easily quintuple without inflation. This is because their capital stock, physical and human, is so far behind ours, and in most cases, their structures of government impede economic advance. It does not help that they all live in a world of floating currencies, which makes them all vulnerable to errors by the major central banks. If we were to fix the dollar to gold, for example, Mexico could finally link to the dollar with confidence, and we could easily imagine the Bolsa at ten times its current value in 20 years. On February 19, 1997, we wrote: "The Dow at 7000: No Big Deal." It is a bigger deal to hit 10,000, but that still was the easiest part of getting it to where it should be, thanks to Laffer and his Curve.
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