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The Price of Recovery
High-end retailers are finally acting like true capitalist retailers.


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Larry Kudlow

At the big Ralph Lauren Polo store on 72nd and Madison, my favorite salesman recently offered me a spiffy Purple Label sports jacket (double vents, slash pockets, brown tweed) for the modest sum of $2,600. How much? Respectfully, I told him to call me when the sale starts. A week later he offered me the jacket for $1,200. I hit the bid, and even felt good about it.

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This week, a very strong October retail sales report arrived, and Wall Street was shocked. Weekly chain-store sales have been gradually recovering from 9/11, hinting not only that the wartime economy has bottomed, but that it may actually be on the mend. So what’s selling? Well, in addition to brown-tweed jackets, auto and apparel sales are surging, which surely reflects an onslaught of big price discounts. We all know about the zero-financing rate being offered by carmakers. Undoubtedly, higher-end retailers are also slashing prices.

Some might argue that the price drops reduce the significance of the sales surge. But this is not the case. Price-cutting is the American way. It’s the free-market capitalist way. It’s the supply- and demand-side way. If something’s not selling, cut the price. Would you rather have higher prices with no sales, or lower prices with high sales?

Of course, discount stores have been doing this for quite a while. That’s why Wal-Mart’s sales and profits are doing so well. It’s good to see now that high-end retailers are finally acting like true capitalist retailers. They’re slashing prices to increase sales, and it’s working.

Not only does this development mean that more cars and apparel will be sold, it will also aid in the transition from an economic downturn to an economic recovery. Prices play a huge role in this adjustment. Price-cutting forces cost-cutting which leads to a rise in productivity. Lean and mean is back.

It’s important to make the distinction that price-cutting is disinflationary, and not deflationary. In the commodities area (gold, coffee, wheat, etc.) prices have been deflating. But in the goods and services area, it’s disinflation. This is a good thing. When prices drop, they act like like tax cuts, and disinflation is an economy-wide tax cut. Energy-price drops are tax cuts. Interest declines on mortgages are tax
cuts. If the consumer price index eases to 1.5% from 4%, the inflation drop reduces the effective capital-gains tax rate to 28% from 43%. This provides a 26% incentive reward for new risk-capital investment. Everybody wins.

Will the consumer price index drop to 1.5%? You can bet on it. Actually, a journalist friend who used to work in the commodity markets just gave me a whole new approach to inflation forecasting. His experience taught that sugar — that’s right, sugar — is a highly inflation-sensitive commodity. Well, over the past year the sugar price has dropped 35%. We’re disinflating, and the rebounding economy will reap the rewards. Next year, near-zero inflation will help generate economic growth in the 3%-or-better range. This is the tax-cut effect of lower inflation in action, and it’s an underrated recovery factor.

The underlying and time-tested rule here is that if you tax something less, you get more of it. Capital, production, consumption, whatever. The rising stock market tells us that investing America understands this. If we could only get Congress to get with the program and pass President Bush’s tax-cut plan, then we’d really be on our way.

Indeed, the plan’s cash bonus for more rapid write-offs on business equipment depreciation would slash the tax price for purchases of new equipment by roughly one-third. This would allow businesses to go shopping again. They would be freed to upgrade their Internet-related appliance and software packages, which, in turn, would generate even greater productivity when the business upswing gathers force.

During the 1970s, when wage and price controls were all the rage, our economy was far less resilient and productive. Today, as prices are free to move, we are a buoyant, free-market economy, where downward price adjustments become a vital recession-corrective. Retailers should keep up the good work. And Congress should get moving.



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