Rumors of California's Death Are Greatly Exaggerated

In business school in the late ‘90s, like just about everyone else in my class I attended a speech given by Morgan Stanley's then CEO. Thanks to a strong dollar and relatively low taxes at the time, Wall Street was booming and Morgan Stanley was seen by most as one of the premiere jobs for an MBA student to secure.

Of note, the Morgan Stanley head stressed that as seemingly everyone desired San Francisco as a place to work, that better hiring options existed in other locales. In particular, so desperate was Morgan Stanley for India hires that he told anyone interested to approach him after his presentation.

The latter anecdote is notable considering all the talk within the commentariat - including articles written for RealClearMarkets - about California's certain decline. Supposedly high taxes, claustrophobic regulations and nosebleed spending are authoring its imminent demise; one that began with great speed several years ago.

About today's conventional wisdom, it should be said by me up front that taxes are a price, and the higher the levy, the greater the cost of success. Government spending is similarly a tax that siphons capital away from otherwise productive private sector endeavors, and then regulations inhibit the profit motive as precious resources are wasted complying with rules rather than directed toward profitable ideas.

That Californians suffer hideous economic policies can't be denied, and in a perfect world they'd be reversed. The individuals populating America's most innovative state shouldn't be penalized for their productivity, but what's not acknowledged enough is that at least in modern times, it's always been this way. Certainly it was this way in the late ‘90s when so much of the U.S.'s intellectual talent rushed to the Golden State in order to join a party that was all about wealth creation.

So while California's taxes, spending and regulation are definitely problems that need to be addressed, they don't explain why the state suffers economically at the moment. To see the real source of its agony, one must look north, all the way to North Dakota.

As a recent Wall Street Journal editorial noted, "The oil and gas rush has led to a jobs boom. North Dakota has the nation's lowest jobless rate, at 3.5%, and the state now has some 200 rigs pumping 440,000 barrels of oil a day, four times the amount in 2006. The state reports more than 16,000 current job openings, and places like Williston have become meccas for workers seeking jobs that often pay more than $100,000 a year."

What the editorial didn't mention is how very much the "money illusion" wrought by a severely debased dollar animates this rush to North Dakota. Indeed, South Dakota's historical economic outperformance versus North Dakota was long explained by supply-siders (I consider myself one - incentives matter, and barriers to production are just that) as a function of the northern Dakota having a state income tax, while South Dakota doesn't have one at all.  Yet the north outperforms the south at present despite the tax differential.  North Dakota is also rich in oil, the price of which is very much inflated by a limping dollar.  One wonders.... 

The Journal editorial in a more broad sense pointed to an 80% increase in oil and gas sector jobs (200,000) since 2003. While not begrudging productivity or job creation for one second, that there's been a jobs boom in the oil patch since 2003 should surprise no one who witnessed the 1970s. With the dollar's collapse then predictably coinciding with a major rise in oil prices, investment rushed to the energy sector.

Importantly then just as now, the price of oil didn't change. An ounce of gold bought the same amount of oil in 1971 as it did in 1981, and looking at the present, oil's rush upward since the beginning of the new millennium doesn't point to expensive oil as much as it does a very cheap dollar.

Considering North Dakota, that there are so many $100,000 jobs available in a state not known for innovation or the existence of major human talent should strike most anyone as an oddity that won't last. If it's too good to be true it likely is, and just as California's late ‘90s Internet boom was to some degree a function of an overly strong dollar driving investment away from the real (how was North Dakota doing then?) and into the metaphysical, what ails California today is a severely depressed dollar that has caused an investment outflow back into the prosaic, easily taxable, mineral-based ideas of yesterday. It's the ‘70s all over again.

Where it gets interesting is that history points to periods of dollar devaluation which tautologically result in higher gold and oil prices that are followed by periods of dollar strength. North Dakota is booming right now while California sags, but assuming the historical reversion to a strong dollar that will lead to much lower gold and oil prices, does anyone want to make a long-term bet on North Dakota versus a state still in possession of more intellectual talent than any in the nation? North Dakota thrives with gold at $1700 and oil at $100, but how economic will this rush to energy be if and when the dollar soars and gold plummets, along with the price of oil?

Looking at California today, though rich in oil, the state's economic success in modern times has been driven by intellectual pursuits of the technological variety. Its problem is that when investors seek places to allocate their capital, they're by definition purchasing future income streams. But with the dollar still very weak, what investor in his right mind would make the risky bet on technologies of the future if, assuming a return, the latter will come back in cheapened greenbacks? Not a good bet, which explains why commodity locales such as North Dakota presently thrive. With the nominal price of oil largely driven by the value of the dollar (oil once again rises when the dollar weakens), it's less risky for investors to plow into the tangible concepts of yesteryear.

So yes, California suffers at the moment, while commodity states and countries boom. But history is history, and it points to an eventual retreat from the recessionary policies of dollar weakness.

The greatest weight on California right now is a weak dollar that is siphoning investment away from its innovators, but with a policy change in favor of dollar strength, investment will return, and when it does all the exaggerated rumors of the state's demise will be exposed as faulty, along with $100,000 jobs in North Dakota.