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

Vol. 1, No. 3, Published July 6, 2015

Connecting the Dots: Global and National Forces Impacting California

By Lynn Reaser

Global Factors

stock market bull

Developments in both the rest of the world and the United States continue to critically impact California because of the state's deep and complex linkages involving trade, finance, travel, supply chains, and knowledge. These outside forces can either boost or restrain California's prospects.

Anxiety regarding Greece remained high in early July after voters rejected creditors’ demands for pension cuts and higher excise taxes. Hopefully new negotiations will produce a new compromise allowing Greece to remain in the Eurozone. If not, Greek banks could soon run out of euros and be forced to issue their own currency, ending their membership in the monetary and economic union. While financial markets could initially react significantly to a Greek exit, the improvements that have been achieved in countries such as Ireland, Portugal, and Spain should limit concerns about the integrity of the Eurozone.

Despite the turbulence sweeping the globe, 2015 actually looks like it will be the first year since 2010 that all three developed economic powers will achieve positive growth. The U.S., Japan, and the Eurozone are all on schedule to post gains in real gross domestic product (GDP).

China’s stock market experienced a sharp correction in June after a spectacular run-up during the past year, which has exhibited many characteristics of a classic bubble. Although the government had taken steps to “prick the bubble,” the Chinese government has moved quickly to limit the decline.  Brokerage firms, mutual-fund managers and an investment arm of the government have pledged to buy stocks. New share offerings have been suspended, quotas for foreigners to buy stocks increased and the Bank of China will provide funds to help investors borrow to purchase shares on margin. As a result, any damage to the broader Chinese economy should be limited.

Puerto Rico has surfaced as a third area of significant worry in recent weeks as it increasingly appears that the U.S. commonwealth will have difficulty meeting the requirements of its $72 billion of outstanding debt. Negotiations with creditors on stretching out payments or reducing interest rates could be protracted. Although a default on any payments would be disruptive, Puerto Rico�s total debt represents less than 2.0 percent of the total $3.7 trillion municipal bond market.

Oil prices have firmed in response to large cutbacks in exploration and development of new energy supplies. After plunging from more than $100 a barrel last summer to less than $50 a barrel early this year, the price of the West Texas Intermediate benchmark has settled at around $60 a barrel. (See Figure 21.) This development should help stabilize drilling activity while still giving a boost to net energy consuming countries, including the U.S., Japan, and India.

The value of the dollar also appears to have leveled off after its steep 12-percent climb over the past year. (See Figure 22.) Investors have now largely priced in expectations that the U.S. economy will outperform other major developed countries and that the Federal Reserve will lead other Central Banks in exiting from a period of extraordinary monetary ease. A respite from further steep declines in the dollar should bring some relief to exporters, U.S. companies with large overseas operations, and firms facing import competition from abroad.

National Drivers

The U.S. economy failed to post much of a spring bounce from a brutal winter that slammed New England.  First half real GDP growth looks to have reached only about 1.3% at an annualized rate.  Stronger numbers on retail sales, housing, and manufacturing activity have recently surfaced, suggesting that the economy will improve in the second half of 2015.

The fundamentals support the case of stronger growth averaging close to 3 percent both in the next six months and first half of 2016. (See Figure 23.) Households have reduced their debt burdens, while rising stock and home values have also helped to enhance net worth. Employment continues to expand substantially, while wage gains, although still limited, have been well ahead of inflation. (See Figure 24.) Home sales and building are positioned to see a lift as potential buyers move �off the fence� to buy before mortgage rates and home prices move higher. Businesses can be expected to invest more to bolster productivity, while improving revenues should give a lift to state and local government spending.

Inflation remains well below the Federal Reserve�s 2 percent target due primarily to the plunge in energy prices. Consumer prices in May were flat compared with a year ago. Excluding food and energy, �core� consumer prices were 1.7 percent higher than their year-earlier level. With an ending of the downward pressure from oil prices, inflation should start to edge higher in coming months. Further tightening of the labor market, which should lead to large wage gains, should further drive inflation toward the goal of monetary policymakers.

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.

Figure 21: Oil Prices Firm

West Texas Intermediate Dollar Per Barrel, Monthly Averages

After plunging from more than $100 a barrel last summer to less than $50 a barrel early this year, the price of the West Texas Intermediate benchmark has settled at around $60 a barrel.

Source: Haver Analytics; Fermanian Business and Economic Institute

Figure 22: Dollar Stabilizes

Trade-Weighted Index, Jan 1997=100

The value of the dollar appears to have leveled off after its steep 12-percent climb over the past year.

Source: Haver Analytics; Fermanian Business and Economic Institute

Figure 23: Stronger Growth Ahead

U.S. Real GDP, Average Annualized Percent Changes*

The fundamentals support the case of stronger growth averaging close to 3 percent both in the next six months and first half of 2016.

*H1 and H2= first and second half growth rates, respectively

Source: Haver Analytics; Fermanian Business and Economic Institute

Figure 24: Wage Increases Muted, But Beat Inflation

Percent Change Over Year Ago

Wage gains, although still limited, have been well ahead of inflation.

Source: Haver Analytics; Fermanian Business and Economic Institute