Intersections: A Monthly Go-To for Reliable Facts and Analysis About California's Debt, Investments and Economy

Vol. 1, No. 1, Published May 6, 2015

 

Connecting the Dots: Global and National Forces Impacting California
May 2015

By Lynn Reaser

Global Factors

stock market bull

If California were a separate nation, it would be among the top 10 economies in the world. Its scale and role mean that it is both large enough to have a significant effect on the rest of the world and to be significantly buffeted by global events. Developments on three fronts have been especially important for California so far in 2015: oil prices, Europe, and the dollar.

After peaking at around $107 a barrel in June 2014, oil prices in terms of the West Texas Intermediate (WTI) benchmark spent much of the first quarter at $50 a barrel or below before firming modestly to around $58 a barrel by the end of April. (See Figure 21.) With storage facilities full, prices are likely to stay depressed through the spring until summer driving demand begins to pick up. An acceleration in U.S. output, accompanying the explosion of hydraulic fracturing (“fracking”), combined with a slowing in worldwide economic growth and energy demand, has driven prices downward. OPEC (Organization of Petroleum Exporting Countries) has indicated that it is unwilling to cut production, but will essentially wage a “price war” with U.S. producers.

Signs have now emerged that companies are cutting back oil exploration and development budgets, especially for higher cost or riskier ventures. Downward adjustments of future supply forecasts may nudge oil prices toward around $65 a barrel by the end of the year. Gasoline prices in California have recently moved higher, although most of the rise has been due to seasonal refinery changes to summer fuel blends. Oil and gasoline prices remain sharply down from year-ago levels, and that trend is likely to persist through 2015.

Greece has moved once again onto center stage in Europe as the new leftist Syriza government has pushed back against the austerity demanded by the “troika” granting it emergency funds: the International Monetary Fund, the European Commission, and the European Central Bank. A virtual standoff has emerged between the Greeks and other European leaders, with neither side wishing to back off from their positions. In the end, a compromise is likely, extending limited lending from the Europeans in exchange for some commitment of financial and economic reform from the Greeks. While Europe is better prepared than five years ago to possibly endure a Greek exit from the Eurozone, no one is certain of the damaging ripple effects that might occur through the banks and the financial system. For California, European stability is important since the Eurozone is the state’s second largest trading partner, following only Mexico.

The U.S. dollar has soared as the American economy outperforms others. (See Figure 22.) The Federal Reserve appears likely to tighten monetary policy while most other central banks either ease further or maintain highly expansionary trends. Although recent softer U.S. data has brought the dollar down slightly, it is up 12 percent from a year ago versus currencies of America’s primary trading partners. The stronger dollar will make it more difficult to sell into many foreign markets, raise competition from imports, and hinder foreign tourism. At the same time, a stronger dollar will benefit many California companies dependent on imports for products, parts, and supplies.

National Drivers

California is responsible for more than 12 percent, or approximately one of every eight dollars, of the total value of output produced nationally. The state thus contributes to and is heavily influenced by national trends. While recent U.S. growth numbers have been erratic and inflation exceptionally low, national economic trends still appear favorable for the state.

U.S. real gross domestic product (GDP) increased at an annual rate of only 2.2 percent in the fourth quarter and came to a virtual halt in the first quarter of 2015. Growth in the prior two quarters had averaged close to 5.0 percent.

Harsh weather depressed economic activity, while the dollar’s strength weighed on exports and lower oil prices dampened capital spending. As the year progresses, energy savings and further job gains should boost household spending. Consumer spending should be joined by gains in business investment, homebuilding, and nonresidential construction, along with a modest pickup in government spending, to further lift economic growth. As a result, look for national real GDP growth to move above 3.0 percent by the second half of the year. (See Figure 23.)

Inflation, as seen in the rise in consumer prices, has fallen well shy of the Federal Reserve’s target of 2.0 percent for the last four years. (See Figure 24.) The plunge in oil prices pushed down the year-over-year change in consumer prices to -0.1 percent in March. Excluding food and energy, consumer prices were up 1.8 percent from a year earlier. While some of the drop in oil prices and the dollar’s upswing may feed through to the underlying inflation rate, the impact should be limited as both oil prices and the dollar eventually stabilize or reverse course. There are also few signs that either households or businesses believe that deflation will set in, which would cause them to defer spending and investment plans with adverse economic repercussions.

On balance, a backdrop of improving economic growth in the U.S. and abroad, along with modest but firming inflation, bode well for California’s economy in 2015. 

Figure 21: Oil Prices Plunge

WTI Crude Oil, Dollars Per Barrel, Quarterly Average

Oil prices in terms of the West Texas Intermediate (WTI) benchmark spent much of the first quarter at $50 a barrel or below before firming modestly to around $58 a barrel by the end of April.

Source: The Fermanian Business & Economic Institute

Figure 22: Greenback in Demand

Broad Trade-Weighted Index, Jan. 1997=100, Dec. Average

The U.S. dollar has soared as the American economy outperforms others.

Source: The Fermanian Business & Economic Institute

Figure 23: U.S. Real GDP to Gain Momentum

4th Quarter, Percent Change Over Prior Year

National real gross domestic product growth is gaining momentum.

Source: The Fermanian Business & Economic Institute

Figure 24: Consumer Prices Tepid

4th Quarter, Percent Change Over Prior Year

Inflation, as seen in the rise in consumer prices, has fallen well shy of the Federal Reserve’s target of 2.0 percent for the last four years.

Source: The Fermanian Business & Economic Institute

Lynn Reaser is chief of the Treasurer’s Council of Economic Advisors and chief economist at the Fermanian Business and Economic Institute for Point Loma Nazarene University. The opinions in this article are presented in the spirit of spurring discussion and reflect those of the author and not necessarily the Treasurer, his office or the State of California.