(June 11, 2008) California continues to underperform the rest of the United States by most economic indicators, largely as a consequence of its extensive housing-mortgage problems, according to the latest quarterly report of the California Chamber of Commerce Economic Advisory Council (EAC).
The economic statistics continued to deteriorate over the past three months. In particular, growth in U.S. gross domestic product (GDP) dragged on at an anemic 0.6 percent annual rate, the same pace as in the fourth quarter and well below the 4.9 percent pace of third quarter 2007.
In 2008, employment growth has slowed in other — presumably unaffected — industries as well, reflecting employers’ uncertainty and cautious attitudes. Meanwhile, the nation’s unemployment rate moved up from 4.6 percent in June to 5 percent in December and 5.1 percent in March.
Consumer sentiment has plunged to its lowest level since 1982. Sentiment usually reflects current labor market conditions and recent trends on the inflation front. Both are problematic at present.
Rising prices for food and energy threaten to eclipse the growth in disposable income (indeed, they did so in March) and limit consumers’ discretionary spending options. It’s no surprise then that household spending slowed sharply in the first quarter, especially for durable goods, placing the U.S. economy at real risk of recession.
Concerns about recession have grown as the incoming data worsened. Most economic forecasters have reduced their projections for 2008, with a significant proportion now expecting a shallow downturn (in GDP terms) early in the year.
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Interest Rates
The Fed has several concerns: an upsurge of extreme instability in global financial markets beginning around mid-year 2007 and fears that volatility and tight credit conditions could spread to the real economy, already struggling with a severe downturn in housing activity. Global credit markets, which “seized up” in August, are still far from normal despite vigorous actions by central banks to increase market liquidity and ease interest costs.
An upsurge in inflation pressures complicates matters for policymakers. Most energy, industrial and agricultural commodity prices are high and rising rapidly, boosting costs for manufacturers, farmers and all businesses that operate fleets of trucks, locomotives, aircraft or ships. Many of the affected firms are attempting to pass the higher costs onto their customers.
California
Employment actually declined over the last 12 months in the state’s construction, mortgage-related financial, manufacturing, retail trade, real estate and information sectors. Still, the state’s unemployment rate rose from 5 percent in March 2007 to 6.2 percent in March 2008. This was a bigger increase than experienced by the United States as a whole, so the margin between the state and the nation widened from 0.6 percent to 1.1 percent.
Exports of goods made in California are providing a much-needed boost to the state’s economy. The largest category of exports is high tech manufactures (computers, peripherals and so forth), which edged up by just 0.1 percent in dollar terms. However, exports of transportation equipment soared by 28.6 percent. Exports of other important California-made products also grew rapidly, like chemicals (up by 11.9 percent), miscellaneous manufactures (+19.8 percent), and agribusiness products (farm produce, livestock, fish, and processed food products), which increased by 24.5 percent.
California Department of Finance reports show that corporation and sales tax receipts both have been running below expectations. The state government will have to address a severe budget crunch in coming months.
Among the state’s major metro areas, regional economic performance is mixed.
The San Francisco and San Jose areas continue to outperform other regions of the state. In large part, this reflects the renewed strength of the Bay Area’s high tech sector, where employment is rising nicely. In Southern California, the motion picture industry hasn’t returned to normal even though the writers’ strike has ended. Elsewhere in Los Angeles, the strongest industries are tourism, technology, and professional business services. San Diego’s economy is moving sideways, with growth in tourism, education and healthcare.
Agriculture and Resources
California’s agriculture sector is holding up well. Prices are high for most products and exports are growing nicely. Also, the minimum wage was raised in January, so farms will experience higher labor costs in 2008. A number of farms in California will have to make hard decisions in 2008 about which products to produce and which to reduce or eliminate if severe water restrictions are implemented.
Water supply will be an important concern in 2008. It looks like the state’s water supply overall will be a little below normal this year. The major issue for 2008 is how much water will be permitted to transit the Delta. Allocations to parts of the Bay Area, Southern California and the San Joaquin Valley will be sharply reduced this year —perhaps by 30 percent or more — following several court decisions to curtail Delta pumping in order to protect the endangered Delta smelt and salmon.
Real Estate
The downturn in housing has worsened over the last three months. The declines in California’s home sales and prices are exacerbated by the scarcity of jumbo mortgages on the one hand and a large number of real-estate owned (REO) homes on the other.
Several areas in California have experienced high foreclosure rates, and lenders have been repossessing large numbers of homes. Bank-owned REO homes account for a significant fraction of for-sale homes in several markets (up to and above 50 percent in some cases) and are said to be pushing prices down.
As in the resale market, many new home builders have large inventories of mostly-completed-but-not-yet-sold homes. Construction of new homes is dropping fast and effective prices are falling, both of which will help to clear out the unsold inventories.
In contrast to residential, most of California’s commercial real estate markets have held up fairly well. Demand for office space has slackened, reflecting the mixed trends expected for employment growth in office-based industries. Financing has become much harder to obtain for most types of new commercial real estate projects. The construction pipeline will empty out gradually, limiting the amount of new supply coming into already slowing markets.
Risks
Risks are mostly to the downside in this environment. Troubles in the state’s housing markets could worsen further, especially if prices continue to decline.
Continued volatility in global capital markets could reduce the willingness of financial institutions to take on mortgage related debt and also to engage in ordinary business and consumer lending, thereby worsening the current credit crunch and slowing business and household spending.
Rising energy and food prices continue to be an important risk factor. Higher prices of gasoline and other energy-intensive products actually shrink the amount of consumers’ income available for other types of purchases.
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Staff Contact: Dave Kilby