February 4, 2001

It happened in California, and it could happen here

Posted in Sunday Business Post ·

Imagine a country where electricity blackouts are increasingly frequent, where traffic is at a standstill and property prices are sky-rocketing. Imagine a country that has experienced a surge in immigration and the population has grown 13 per cent in the past eight years.

Yet the government has been extremely slow to invest. Roads, railways, sewerage and other basics of infrastructure have not kept pace with growth and, now that things might be getting a bit sour, the government blames others, accusing erstwhile friends of failing to understand it.

Sound familiar? For many, California may symbolise the land of milk and honey — a type of American El Dorado. When we mention California, we think Hollywood, Silicon Valley, Easy Rider and the great American dream. Investors are also enthralled by high-tech booms, hugely successful media companies and the eighth largest economy in the world.

However, California is recently displaying signs of frailty. Up until a couple of weeks ago, California symbolised everything that was possible in the new paradigm economy. It was, and still is, the epicentre of the technological revolution, but something very disturbing has happened.

Confidence is evaporating like air out of a tyre and the Sunshine State is displaying all the problems of rapid growth and prospective slowdown more typical of an Asian Tiger economy than the high-tech home of Cisco, Intel and the like. California’s emerging woes, exacerbated by the dotcom collapse, should be a cautionary lesson to all booming economies with a weakness for their own propaganda.

These problems should also remind us in Ireland that even developed countries within a large monetary union can have the same economic dilemmas as emerging, formerly second world, economies. The speed at which confidence evaporates in a truly globalised economy is remarkable.

From being the darling of the investing community not so long ago, commentators are comparing California to a boom/bust Asian economy, with many predicting a severe recession, rising unemployment and falling property prices. But is this comparison valid? And are there any lessons for us?

Typically, the term “tiger economy” is used to describe an economy that pins its prosperity on a combination of rapid exports, strong growth rates and new technology. In this regard, California fits the bill. In fact, the Bloomberg financial wire service went so far as to suggest that California is the mirror image of the volatile Asian Tigers. This might be stretching the point somewhat, but the similarities are striking.

Certainly, the US’s most populous state has been growing like an emerging country over the past five years, notching up a growth rate of 8.5 per cent last year. For a state already ranked as one of the richest places on the planet, such growth rates are truly remarkable. However, in recent weeks many Californians could be forgiven for thinking that they were living in Manila.

Almost half of California was plunged into darkness and now the state is faced with escalating power bills and the prospect of having to import electricity. We expect this type of carry-on in Africa or Asia, not in the state with the highest proportion of millionaires anywhere on earth.

Like the typical Tiger economy, California also displays a weakness for property price bubbles. As dotcom money poured in, prices rose. Last year, Californians financed anything. Ideas scratched on the back of a beer mat and put forward by people with no business acumen were being floated for millions of dollars. This cash went directly into two pockets.

First, huge amounts were given to advertising agencies. In fact, an ad man suggested to me that the dotcom mania was a simple transfer of wealth from investors to advertising agencies via the conduit of internet start-ups. A touch dramatic, but the point is valid.

The second recipients of the dotcom cash were estate agents, who happily flogged overpriced houses to “entrepreneurs” who themselves borrowed against hyper-inflated, and subsequently worthless, share options.

Now the flight from these companies is in full swing and global investors see the retreat from dotcom land as being strikingly similar to the capital flight out of the Asian Tigers in 1997. Californian optimists (and estate agents) point to the four million rise in the population since 1992 to validate the property bubble. However, those with slightly longer memories remember that we have been here before.

In the mid-1980s, the Californian aerospace and defence industries expanded rapidly, fuelled by then-president Ronald Reagan’s Star Wars project. Unemployment fell and immigration rose. Money poured into the state. Banks and savings and loans institutions fell over themselves to lend to property investors (even Michael Milken, the king of the junk bond borrowers, set up in Los Angeles rather than on Wall Street).

When the Soviet Union imploded, so too did these industries, resulting in thousands of redundancies and lenders calling in loans. Property prices collapsed throughout the late 1980s and early 1990s. Pessimists argue that when the fallout from dotcom mania really begins to be felt, property will be (as always) one of the biggest casualties.

The ups and downs of property values in Los Angeles and San Francisco during the early 1990s and the internet start-up euphoria of the late 1990s brings to mind similar cycles in property markets in Hong Kong, Bangkok, Seoul and Tokyo.

And then there is the endemic short-termism in planning displayed in the Californian and Asian booms. For example, there was the half-baked privatisation of the electricity service, which saw companies bidding for ever-increasing electricity but prevented them from selling on to customers above a minimum, fixed price. This approach, together with the rising population, almost guaranteed power problems.

California’s freeways are congested as never before and the rising cost of land and labour has militated against serious public investment. Sounds rather familiar, does it not?

Finally, Californian politicians, when faced with these problems, have been very quick to blame outsiders. Last week, state Governor Gray Davis blamed “out-of-state” interests for the energy crisis. Blaming foreigners and outsiders was precisely the reaction of many of the Asian leaders when things started to go pear-shaped.

Dr Mahathir Mohammed of Malaysia railed against speculators, George Soros in particular, for precipitating Malaysia’s woes rather than taking a hard look in the mirror at himself and his policies. When all the rhetoric is stripped back, we see that the economic cycle doesn’t discriminate between language or culture.

What appears to be happening in California is like what happened in Asia and Japan in the past decade. When confidence — that effervescent and crucial factor — disappears, all we are left with is a mountain of debt. And if it can happen in California — the home of the American dream — it can happen anywhere.