Tuesday, August 11, 2009

So Long, California

Dude, California is so doomed.

It pains me to write this, for I have a deep bond with both California and Hawaii, but California as it is currently composed is well and truly doomed.Beneath the phony bluster of its pathetically incompetent "leadership" here is the fundamental picture.

The California economy has depended on six industries to power growth since 1941:

1. aerospace/defense
2. tourism
3. agriculture
4. high-tech (R&D, computers, biotech)
5. Hollywood (film, TV, music)
6. construction/building

This diverse base has enabled the state to recover from past collapses in any one industry. Most notably, aerospace and defense plummeted into near-oblivion after the Soviet Union fell apart; defense spending shrank, bases were consolidated and the remaining firms moved to lower-cost (and more politicially adept) states.

So the state lost one key driver of jobs and growth in the 1990s, but compensated for that by being the birthplace of the Internet/dot-com/digital/computing explosion. Now building/construction has imploded:

Vacancies Supress California Recovery (WSJ.com)

Right now, vacancy rates show no signs of turning around. Office vacancies in San Bernardino and Riverside counties have more than tripled, to 24.6% from 8% in 2006, according to estimates by broker CB Richard Ellis. At the same time, the Inland Empire's retail vacancy rate shot up to 10.6% in the second quarter from about 5% in 2006, according to CB.

The housing industry contributed more than $24 billion in revenue to the Southern California economy in 2008, or more than double the U.S. gross revenue from Hollywood movies, according to the Building Industry Association of Southern California.

Meanwhile, the number of housing permits in the five-county greater Los Angeles region has dropped 85% from 88,187 in 2005 to a projected 12,990 this year, Mr. Kyser said. The fall has been even steeper in San Bernardino and Riverside counties, where housing permits have plunged 96% from 45,299 in 2005 to a projected 2,000 this year, said Mr. Husing.

Construction has fallen, and it will not be recovering for the foreseeable future. Strong job creation attracted millions of new residents in previous decades, legal and otherwise, and of course those 20 million people (yes, 20 million more residents from 1960 to 2009) needed housing, highways, malls, office towers, warehouses, and so on.

Now that the job base is irrevocably shrinking, so too will the population with money for new housing, retail, etc. The state is massively overbuilt in every category: residential, commercial, retail, office, warehousing, you name it.

OK, so now the state is down to 4 primary industries. Unfortunately, the driver of recent Silicon Valley growth--the Web--is eroding Hollywood and its related industries (entertainment, music, etc.). The proprietary, integrated-distribution model of films and TV is being undercut by free downloads and multiplying channels of free entertainment and content.

As media maven/Dangerous Minds proprietor Richard Metzger and I have discussed for months-- why pay for something you can get for free? And if money's getting tight, maybe that $10 movie ticket and $5 popcorn is out. You can buy legal DVDs at every dollar store and drugstore in the land for a few dollars, rent them from many libraries for free or borrow them from friends (never mind downloading them for free or burning a copy for free).

The music CD is in terminal decline, regardless of the industry's repeated attempts to revive it with a bizarre mix of PR and threats. Why pay for ten crappy songs just to get the two songs you actually like? Legally download those two for $2 or perhaps only $1.38--less than 10% of the revenue once generated by the sale of a CD.

Yes, Disney is still a powerhouse of straight-to-DVD kids' content, and blockbusters still dominate summer entertainment, but beneath this apparently placid facade the industry is being gutted.

Hollywood feels the pinch: Film production at standstill.

My own few contacts in Tinseltown are reporting more free-lancing gigs as studios and production companies shed costly staff in favor of temps.

Other states have poached much of the nation's film and TV production, and the reasons for producing anything in high-cost California are simply not that compelling. Hopes for a resurgence of big-bucks production are slim to zero. So scratch another major industry.

That leaves, tourism, agriculture and high-tech, but there are problems with each of these mainstays as well.

Tourism is holding up as middle-class households choose a cheaper domestic vacation rather than go overseas, but that's partly because "only" 6.7 million people have lost their jobs. As that number doubles in the years ahead, more families will have to forego the pricey Disneyland holiday entirely, or cut such trips from once or twice a year to once every few years.

The weak dollar has given California tourism a big boost in the past few years as tourists from Asia and Europe have flocked in for shopping bargains and their version of a "cheap overseas adventure." But if the dollar were to strengthen--as impossible as it may seem, a strong case can be made for just this scenario--then the "cheap U.S. vacation" may become much less cheap for non-U.S. tourists.

And let's not forget that Asia and Europe have yet to feel the full impact of the global recession; their own stimulus borrowing and spending is keeping those economies afloat for the time being. But governments can't borrow $5 trillion to squander on stimulus every year--there simply isn't that much surplus capital sloshing around any more. So once global stimulus packages dry up due to rising interest rates, global tourism will take a huge hit. And states like California that depend heavily on free-spending tourists will be especially hard-hit.

As for agriculture, water is always a thorny problem in California, as much of the state is semi-arid and water must be channeled hundreds of miles to mega-cities on the coast and farmland in the interior Central Valley. A period of under-average rainfall--not quite a drought, but close--is putting pressure on all big water users, and agriculture is feeling the pinch. Short of a catastrophic multi-year severe drought, agriculture will remain a huge industry in California--but most of the jobs in the industry are not the kind which enable a McMansions/"shopping spree at the Mall" lifestyle.

As for high-tech/biotech--Silicon Valley has already lost its manufacturing, and many in the Valley are turning to "green tech"/alternative energy as the driver of future job growth. Perhaps, but that depends on how long the "oil head-fake" runs. If oil stays cheap then the financially compelling reason to fund alt energy diminishes.

And ironically, the Web itself is poaching jobs from its source: why hire someone in insanely pricey California when you can hire them somewhere much cheaper? Yes, the valley is still the nexus of venture capital, and the university/government/start-up magic is still in place, but it would be foolish in the extreme not to see that the model which built Hewlett Packard and Apple is gone.

Once upon a time in the 1980s, Macintosh computers were assembled in the S.F. Bay Area (Fremont) or in the Valley. No more. Now the "future" is a few guys and gals in a San Francisco loft coding some sort of Web 3.0 app which is ultimately supported by ad revenue--just like Web 1.0 and Web 2.0.

These businesses don't grow into enterprises with thousands of employees--even apparently huge sites like Facebook only require a modest number of employees--and that's at their peak, which is inevitably short-lived. Then they fade and vanish, as they really have no innovation or value in the sense that Hewlett Packard and Apple have value.

The stream of businesses leaving California has always been substantial, but start-ups created enough jobs to replace those lost. No more. Start-ups are smaller, leaner and more prone to be snapped up by larger competitors before they reach critical-mass and start expanding.

So the jury is still out on high-tech. It has enough strengths to sustain its current R&D model but that is not a job driver except at the highest level of skills and experience. Got a PhD in biochemistry and experience in stem-cell research? We have a job for you and a couple of lab techs, but forget anything lower on the food chain until you get to fruit picker.

Speaking of juries, the "growth industry" which is throttling the state is the legal sector. There are supposedly 500,000 attorneys in California but it feels like 5 million.

Then there's the famously dysfunctional political landscape in which Demo-Publicans have agreed to gerrymander districts so every partisan is protected from electoral competition. This is the acme of a simulacrum democracy in which a small elite runs the state to its own advantage, ignoring the feeble protests of disenfranchised voters and taxpayers.

Fraud, deception, pretense and obfuscation have reached new heights in the last State budget, a pathetic hash of lies and false hopes. Out of supposedly $24 billion in cuts, at least $10 billion was accounting trickery; and the 500,000 attorneys in the state (or maybe it'a a million now) are finding work by suing the state on behalf of the innumerable parasitic special interests and fiefdoms which depend on state largesse for their survival (see below).

Meanwhile, the State labors under two enormous burdens: a stupendously high level of taxes of every kind (not to mention skyrocketing fees for everything), and a "leadership" and punditry crying that taxes are too low.

The divide between the state's "leadership" and reality has widened to Grand Canyon dimensions, but thanks to gerrymandering the same cast of characters (or their clones) will return to the state capital in Sacramento next year for another session of pandering, posturing and providing a pretense of "solving" structural problems.

The divide between the politicos' perceptions and reality could not be wider than on small business. Politicos and other "leaders" miss no opportunity to proclaim California is "business-friendly" yet the reality is few states are more anti-business than California: few have more onerous taxes, junk fees and Kafka-esque overlapping regulatory jurisdictions. Few have a more dishonest method of telling would-be entrepreneurs, "we don't like your kind of business here, get lost." If it was really so business-friendly here, why is the exodus of businesses leaving the state gaining momentum?

A fraud-riddled workers compensation system was "reformed" a few years ago, providing some small relief, but basically you're insane to have employees in California unless you have a global corporate office with a deep, well-funded legal team to defend yourself from all the bogus lawsuits and claims you will face.

California has a deeply entrenched "entitlement mindset" which holds the state responsible for virtually everything: feeding your kids (yes, all public schoolkids get a free breakfast, even if their parents make $300K a year), teaching them in their native language (even if they're doomed to dead-end jobs if they don't master English), paying for delivery of your baby (never mind where you came from or if you're a citizen, we love kids!), providing care for your parents (again, never mind if you're a citizen or they're a citizen-- everyone's got "rights" here to everything), providing emergency care if something bad happens to you while you're sniffing glue/shooting smack/getting in gun battles, and of course providing you with free legal aid when you sue somebody or something for for not making your misadventures safe, warm and cuddly (aw, you harrassed a tiger, jumped in its cage and got mauled? Somebody with money must be liable for your suffering... let's look around for who has insurance.)

Since when did the state guarantee to provide everything for everyone who happens to live in the state? Is that reasonable? Regardless of how you answer, the fact is that is it no longer affordable.

Meanwhile, the only real engine for long-term innovation and growth, the University of California system, is in terminal decline because funds for various fiefdoms, prisons and social spending are deemed higher priorities: California's universities in trouble (The Economist)

Just like the leadership in Rome when the Empire was imploding around them, California's abjectly incompetent "leadership" depends on incantations ("we'll recover next year, we always have") and references to a mythic "Gold Rush pioneer spirit" which will magically transform millions of resentful entitlement-obsessed residents, millions of unemployed and and thousands of bankrupted small business owners into high-taxpaying souls who are delighted to pay 9.5% sales tax and 10.5% income tax, $55 for parking tickets, $20 to enter a state park, etc. etc.

With half its key industries gone and the last three challenged or in decline, its bloated multi-layers of government cantakerously demanding more taxes from a depleted private sector and its political class in various stages of terminal denial and moral corruption, the California we have known for the past 68 years is doomed to collapse.

Something will take its place, and what that is will be up to the citizenry. Either the entire status quo will be left in place to implode, or it will be tossed out by a voter rebellion. There really isn't much middle ground left.

Reader Deon N. sent in the following link and added this cogent commentary.

Lawsuits are the latest roadblock for California budget.

I am sorry to be of the opinion that the story provided at the link above is important on different levels: It is becoming increasingly clear that the only way for CA to realistically move forward is by filing for bankruptcy or some form of creditor protection. The rest of the stuff (proposed patchwork of solutions) is noise which will come back to haunt in a few months. The story below is a clear indicator that the BK path for CA should be considered in order to enable the state to now get creditors, lawyers and other vultures of it's back. Otherwise, the prior commitments made during economic boom times will be drag on the general path to healing.

GENERAL ECONOMY OBSERVATION/COMMENT:
It appears that we are just now starting to move from the CAPITAL DESTRUCTION phase and moving a little towards the DEBT DESTRUCTION phase. Believe or or not, this is a good thing since it allows roots to take place once debt is eliminated. It may take time and be painful, but in the next couple of years we may see a lot more of this. Expect mass amounts of personal, business, commercial/residential mortgage (more), and government filings for BK's/Insolvency or debtor inability to pay notices. My analogy is that you can't build a house on sand (debt), if it is to last standing. The sand (debt) should be cleared away and built on a solid foundation. Only then can we have a viable and sustainable "partial" recovery.

Thank you, Deon.

NOTE: I am pleased to announce that editor Michael Rainey at AOL's "Daily Finance" site has asked me to be a contributing blogger. My first story was posted Sunday, 8/9/09: Ten reasons to beware the Bear. I believe he was seeking a skeptic and I will try to deliver the goods.

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