Where the Golden State Still Shines


By Michael Wallace Now that Arnold Schwarzenegger has prevailed in the Oct. 7 California gubernatorial recall election, what sort of economy will he inherit from ousted Governor Gray Davis? Based on an anecdotal sampling of news headlines and preelection rhetoric, you might think the Golden State has reached an advanced state of decay (see BW Online, "A New Governor Won't Fix What Ails California").

Certainly, it faces some intractable political and fiscal problems. But economic decay isn't one of them. Partisan politics and late-night talk show gags aside, the California economy has weathered remarkably well one of the worst economic storms to pound its shores since World War II.

"As California goes, so goes the nation" is a saying that has some currency, given the size of this Pacific giant. According to data provided by the World Bank and UCLA, California ranks fifth in the world in economic size, with a gross product of $1.39 trillion in 2001 -- behind only the U.S., Japan, Germany, and Britain. So the rest of the U.S. has a large stake in the future success of California's economy.

MORE JOBS. It's a diverse blend of low- and high-tech industries that spans the manufacturing and service sectors, giving the Golden State breadth, depth, and resilience. According to the Bureau of Labor Statistics, the top California employer is the trade, transport, and utilities sector, followed closely by the government, professional and business services, manufacturing, and education.

For all the gloom and doom about its economy, the state's unemployment rate has already fallen from a peak of 6.8% in June to 6.6% in August -- similar to the improved tone in national labor data in September. In regional and national terms, the jobless rate likely peaked four months ago.

California may also be benefiting from several distinct spending trends in the wake of the September 11 terrorist attacks. According to the San Francisco Federal Reserve's September edition of Western Economic Developments, U.S. Defense Dept. spending has increased dramatically in the land of sequoias, sandy beaches, and superhighways over the past several years. In fact, California's share of the U.S. defense budget was $36 billion in 2002 -- roughly the size of its much-maligned budget deficit. Another vital industry, travel and tourism, has also bounced back strongly following the depressing triple whammy of September 11, the Iraq war, and the SARS outbreak.

SOLID FOUNDATIONS. An additional key support for California's economy -- housing -- has shown surprising strength. Unlike the early 1990s, the state's housing market has remained robust, thanks to record low interest rates and chronic supply shortages. According the California Realtors Assn., median home prices are expected to increase by 13% in 2004, though sales may cool by 5.4% after a record run in 2003.

Signals from the bond market also are encouraging. After ballooning some 80 basis points due to the uncertainty engendered by the "total recall" election, the yield spread on the state's general obligation bonds, vs. a benchmark muni index compiled by Bloomberg, has now narrowed to a half-percent. Indeed, Moody's, Standard & Poor's, and others may be inclined to take a fresh look at the state's credit rating -- which was downgraded by both major agencies this summer -- if Arnold can deliver a sound budget.

California's new chief executive could also benefit from a new "rise of the machines." California's defense industry is dandy, but Silicon Valley is sublime. And the leading technology sector has clearly begun to rebound, though the San Francisco Fed notes that "semiconductor firms have yet to increase their orders for new equipment" -- backing up the Fed's assertion that some slack remains in the economy.

Business investment in technology is trending up sharply, PC shipments are growing, and semiconductor sales are expanding. Even shipments from the beleaguered communication-equipment industry are rounding toward positive territory, though high-tech job growth is still lagging.

A DIVIDEND FOR BUSH? As for the state's crucial chip sector, the Semiconductor Industry Assn. confirmed that global chip sales surged 4%, to $13.4 billion, in August for a 12.5% increase year-over-year. The SIA noted that "stronger than normal" seasonal gains were led by the consumer, PC, and wireless sectors for the largest monthly increase since 1990 (with the exception of the peak year of 2000). Another sign of strength for the group: The Philex Semiconductor index (SOX) at 450 is also hovering just below its September high, which was the highest level in a year and a half.

All in all, the Governator may be inheriting a more golden economy than widely perceived, which could help trim the state's yawning deficit and bolster his popularity. Indeed, a boffo performance by the Last Action Hero in Sacramento could even presage a shift in momentum in next year's Presidential election (in which direction, however, is an open question: See BW Online, 10/8/03, "California's Message for George Bush"). And with a tough contest looming in 2004, the national GOP wouldn't mind having a little star power at its disposal. Wallace is a senior market strategist for MMS International


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