The economy of California is a force to be reckoned with. Featuring a vast collection of households and businesses, the health of California’s economy is not only vital to the country as a whole, it also serves as an indicator of the strength of the national economy.
“If California is doing poorly because of the tech sector or the trade sector, you can be pretty sure that the whole economy at the nationl level is also going to be struggling,” says Comerica Chief Economist Dana Johnson. “Likewise, if those sectors are strong, the national economy is going to be strong. It really is a bellwether for the rest of the economy.”
Smart Business spoke with Johnson about business conditions for 2006, how the devastating hurricane season could affect the economy and the red-hot real estate market in California.
In 2006, do you think general business conditions will be better, about the same or worse?
I think business conditions will be about the same overall, but in the early part of the year, somewhat worse. We’re going to be going through a soft patch in the economy this winter as household spending growth slows quite perceptively.
This will be due to a combination of higher energy costs, higher interest rates and smaller increases in house prices. These three things together will cause most households to spend more cautiously.
We’re going to go through a period this winter, and maybe into the early spring, where household spending growth, which has been one of the main sources of support for the expansion, will grow more slowly before reaccelerating.
For the year as a whole, growth in 2006 will be similar to the growth we’re getting in 2005.
How will the hurricane season affect the economy in the upcoming year?
The aftereffects are of two sorts.
One, there is some ongoing upward pressure on energy prices, the most dramatic being the market for natural gas but also the market for gasoline. The knocking out of some refining capacity has definitely created a bigger increase in gasoline prices than you would have expected based on where crude oil prices have been trading.
That gap, however, is going to be relatively short-lived. We’re going to see most of the refining capacity restored by the end of the year, and we’ll get back into a more normal relationship between crude oil prices and gasoline prices.
The more lasting impact will be from the knocking out of natural gas production in a significant number of wells in the Gulf Coast region. There is not an ability to import natural gas in the quantity needed to make up for lost production there, so I think we’re going to see pretty painful natural gas prices all through the winter heating season.
What challenges will businesses face due to increased energy prices this winter?
A lot of businesses will have trouble passing on their higher energy costs to their customers. Particularly hard hit, of course, will be anybody that uses energy to provide transportation services or in their production processes.
The net effect will be that profit margins are squeezed, which will take some starch out of the economy.
Real estate prices have skyrocketed in California. Do you believe businesses that own real estate will continue to benefit from these evaluations or will demand for real estate cool off?
Demand is going to cool to a degree. I think we’re seeing the lag effect of higher short-term interest rates that the Fed has put in place and the impact of some guidance by the Fed to lenders to be careful in providing highly leveraged forms of financing for real estate acquisitions.
These factors will combine to cool off the housing markets, and as that happens, the commercial real estate markets will cool off as well.
How is California’s economy similar to other parts of the country and how does it differ?
California’s economy … accounts for about one-eighth of the national economy. At first approximation, it doesn’t have a strikingly different behavior than the country as a whole.
I think it’s fair to say, though, that California is more involved in foreign trade than many parts of the country and it’s more involved in the growth of the knowledge economy with the high number of tech ventures that are concentrated in the state. New trends emerge more quickly in California with regards to the globalization process and regards to high-tech enterprises.
But at the end of the day, the history of California’s economy is that it grows in line, or maybe just a touch faster, than the national economy.
Dana Johnson is chief economist for Comerica Bank. Reach him at (734) 930-2401 or through the bank’s Web site, www.comerica.com.
