INVESTORS OUGHT TO
remember President Gerald Ford, who passed away last week at 93, for a key decision he made in December 1974. That decision ended America's worst economic downturn since the Great Depression, and marked the historic bottom from which was launched the great bull market in stocks that has endured to the present day.
The U.S. economy fell into recession in November 1973, shortly after OPEC imposed an oil embargo that created the first "energy crisis." This worsened an already critical inflation problem, which neither the Federal Reserve nor President Nixon's imposition of wage and price controls had been able to tame.
Ford took office in August 1974, when the Dow Jones Industrial Average had already lost more than a quarter of its value, having fallen to 777 from its December 1972 highs above 1000.
His famous speech in October announcing "Whip Inflation Now" buttons didn't help matters. In fact, by December, the Dow had lost more than a quarter of its value again falling as low as 570. The Dow hadn't been that low for more than a dozen years.
The reason wasn't just Ford's ineffectual attempt to deal with inflation. It was that Ford had convened a summit conference of America's economic leaders, and it looked like he was going to take the conference's horrible advice to deal with the recession by cutting spending and raising taxes with a 5% surtax on personal income.
Yes, tax hikes and spending cuts in a recession make about as much sense as putting a starving man on a diet, especially considering the astronomical tax rates that were already in effect then the top personal tax rate on earned income was 50%. And inflation was pushing more and more Americans into higher and higher brackets.
But that's what America's best economic minds were recommending and the stock market knew it would only worsen the recession.
Then in December 1974, everything changed. In a restaurant in Washington, D.C., a young economist named Arthur Laffer was having dinner with a young White House aide named Richard Cheney. Laffer explained to Cheney that if you raise taxes, you diminish the incentives to work, and the economy slows down (and tax revenues for the government fall, despite the higher tax rate). If you lower taxes, the opposite happens. Incentives to work are increased. The economy grows faster (and tax revenues increase, despite the lower tax rate).
Laffer illustrated this principle by sketching a diagram on a cocktail napkin. His diagram has since been immortalized as "The Laffer Curve."
Cheney told his boss, White House Chief of Staff Donald Rumsfeld, about the Laffer Curve. And the rest, as they say, is history.
Soon Ford stopped talking about raising taxes, and instead started talking about lowering them. That's when the stock market stopped going down.
In March 1975, it was official: Ford signed the tax cuts into law. That month marked the bottom of the recession.
And armed with the logic of the Laffer Curve, Ford decided not to veto a federal spending bill designed by the Democratic Congress to stimulate the economy. Ford made the bet that lower taxes would generate enough new growth to create the revenues necessary to pay for the spending.
The tax cuts weren't much. And most of that government spending was probably wasted. But every little bit of stimulus helps when you're in a recession. Small tax cuts were far better than the 5% tax hike that the stock market had been afraid of, and a little new government spending was better than slamming on the brakes.
Ford's legacy for investors was that by the time he left office, the Dow had rallied back to within a few percentage points of its 1972 peak above 1000. The market was back from the brink.
But most important, a powerful new economic principle was abroad in the land the idea that you could grow the economy by reducing the tax rates that hold back economic incentives.
Jimmy Carter, who followed Ford as president, did nothing with the new idea that Ford had fostered. (And, when Carter left office, the Dow was lower than when he arrived.) The next president, Ronald Reagan, grabbed that idea with both hands in the 1980s, with massive tax cuts that kicked Ford's bull market into high orbit. The Dow blasted through 1000 and never looked back.
Similarly, the massive growth spurt of the late 1990s began when President Bill Clinton reduced the tax rate on capital gains. And the economic expansion we're in right now kicked into gear in earnest in 2003 when President Bush cut tax rates on income, dividends and capital gains.
So don't belittle the memory of Gerald Ford as the hapless figure with a WIN button in his lapel. Take a look at the Dow Jones Industrial Average, now more than 20 times higher than what it was in that bleak December in 1974 when Ford made the right decision, and changed the course of economic history.
Thank you, President Ford.
Donald Luskin is chief investment officer of Trend Macrolytics, an economics consulting firm serving institutional investors. You may contact him email@example.com