California's Best Days Are Ahead of It
The below article is a speech that will be given today before a continuing legal education seminar organized at the University of Southern California's Law School. The venue is the Jonathan Club in downtown Los Angeles.
Let me first off say how excited I am to be here today. Glenn Sonnenberg and the USC Law School have put on a great symposium about the future of the most important state in the United States. And then as someone who grew up not far from here in Pasadena, I'm flattered to be a part of the discussion inside of one of southern California's most impressive venues in the Jonathan Club.
About the Jonathan Club, I should say that the Club itself speaks to what I think is a very bright future for California overall. Though cities, states and countries are increasingly irrelevant in an economically interconnected world, it must be said that the Jonathan Club's beautiful physical plant and its thriving nature speak to a high level of talented human capital within the state of California that ensures its successful future.
But first up, it's probably worthwhile to consider all the negatives that restrain California's present growth. An overbearing political class on the state level that is unable to control spending comes up first. Though California's ascent was a function of self-reliant individuals who crossed a continent eager to seek their fortune, the very state that personifies individual initiative has morphed into a big-government, capital destroying Nanny State.
Calvin Coolidge once said that "if you see ten troubles coming down the road, relax, because 9 out of 10 will fall into the ditch", and he was right. Whether maladies are economic or physical, nearly always the best solution to them is to let them run their course. Economies, like the human body, are a collection of individuals, and recessions, though painful, are in fact a signal of an economy on the mend as all the bad ideas, all the malinvestment, and all the misuses of labor are cleansed from it.
Of course the big problem today is that rather than allow the individuals who comprise the California economy to succeed and fail on the way to way to economic harmony, the state's political class has created regulatory bodies meant to fix any and all problems, real and perceived. The result is an ever-growing regulatariate whose many rules put up needless barriers to the natural commercial drive for profit.
The most recent story supporting this claim is that of Carl's Jr., and the movement of its headquarters to Texas. Tired of the infinite rules that make opening a restaurant meant to give consumers what they want so difficult, Carl's has moved to Texas, a state where the politicians cheer commercial initiative. After that, I've certainly heard the story all the way in Washington, DC about the flow of U-Haul trucks between California and Texas; most of those U-Hauls heading east on I-10. Talent is flowing away from California, and as human talent is what drives advancement, California has a serious problem.
Another well known driver of California's depressed situation is the rate of taxation. Taxes are a price placed on work, and with a state income tax rate that seemingly leads the nation, another popular narrative concerning California's certain death is a price placed on success that is too burdensome.
So when you combine overbearing politicians and regulators, government spending that is siphoning capital away from the innovators, taxes that put way too high a price on success, and worst of all the resulting human capital outflow from the state, it's easy to conclude that California's glory days are in the rear-view mirror and that it's set to become - at best - a pretty place for the successful around the country to visit during vacations; essentially France on the west coast of the United States.
In light of the above, one could easily conclude that California's best days are behind it, but to do so would be for one to fall for a consensus that is surely wrong. Yes, California has gruesome burdens that are hampering entrepreneurs, but the simple truth is that all the negatives I've listed don't explain why California sags. Indeed, California's greatest barrier to economic growth is something I've not yet even mentioned, but that I will offer up out once I explain why California will soon enough be back on track.
To understand why California is set to thrive is for me as simple as uttering USC, UCLA, Cal Tech, UC Berkeley and Stanford. Most might assume I base this on the great educations offered by all five. But contrarian that I am, I won't.
My own view is that education is vastly overrated, and that college professors by definition teach yesterday's news. So it's not the education these world-leading universities provide that ensures California's future, but instead the simple reality that as great universities, they'll continue to attract some of the brightest minds from around the world.
College doesn't make the man, but students hard working and talented enough to be accepted to any of the universities mentioned signal the kind of individuals who all things being equal, will be excellent entrepreneurs in some instances, and top quality employees of California businesses in others. So while we hear regularly about talent outflows from California, what we don't hear about enough are the inflows to California universities.
I don't have a statistic here to support my claim, but the certain truth is that many, having spent four glorious years at school here, will decide to pursue their post-collegiate careers in a state that is blessed with more physical beauty and cultural variety than any in the United States; New York the possible exception.
In short, California will thrive because it still has the best people within its borders.
The logical answer to my basic thesis is that California's excellent universities will house the world's talented for four years, but then they'll move out of the state to avoid the onerous regulations and taxes. That would be an interesting point, but a false one nonetheless.
That's the case because while California's taxes and regulations are an abomination, let's face it, it's long been this way. Indeed, was California that much different in the ‘80s or ‘90s? Surely it was, but not that much different.
Yet despite California being long overregulated and overtaxed, it's for most of its modern history attracted the best, most talented people. If this is doubted, I'll casually mention San Diego, Newport Beach, Los Angeles, and San Francisco. Talent and beauty often go together, and that's certainly long been the case with California. To provide some color to my statement, I'll engage in the anecdotal.
In the late ‘90s I attended Vanderbilt University's Owen Graduate School of Business, and early in the school year the then-CEO of Morgan Stanley came in to speak. With Wall Street booming at the time, and Morgan Stanley one of Wall Street's foremost investment banks, the speech was very well attended.
In giving his talk, Richard Fischer observed that the vast majority of Morgan Stanley applicants desired the San Francisco office. He said that was fine, but that he only wanted interested individuals to come talk to him if they desired more far flung locales like India.
Of course the broader point I'm trying to make here is that while regulations and taxes have surely grown worse in California, they were hardly easy in the late ‘90s, yet the best and brightest from the world's best business and law schools were vying for San Francisco.
No doubt some of this had to do with the city's beauty, but to be realistic San Francisco was the desired locale given all the money that was being made in the Internet boom. And what drove the Internet boom was investment.
The question then is why the investment, and that gets to the heart of California's problems today. Though the state is once again experiencing somewhat of a boom in its northern parts thanks to the rise of Facebook, the reason so many brilliant companies bubbled up in the ‘80s and ‘90s in California has to do with the policies concerning the dollar that prevailed then.
To put it simply, capital flowed in heavy amounts to California in the ‘80s and ‘90s because periods of a strong dollar drive capital into the concepts of the mind. Though California somewhat began as a commodity economy owing to the gold rush, its modern ascent has been rather metaphysical, intellectual, or one of the mind.
To see why this is so important, we must remember the broad implications of dollar policy. When the dollar is weak, meaning we're experiencing inflation, investment on the margin flows into the hard, prosaic assets of yesterday that already exist, and that are most impervious to the dollar's decline. Those assets tend to be rare art, stamps, land, and most notably oil and gold.
To put it very simply, Texas, North Dakota, Oklahoma, Australia, Canada, Brazil and numerous African countries are booming today because commodity economies to varying high degrees, during periods of dollar devaluation as we've experienced over the last 10 years, and as evidenced by the near sevenfold rise of gold, investment flows into hard commoditized assets least vulnerable to the devaluation. To put it even more simply, investment once again flows into wealth that already exists.
California has suffered mightily amid this inflation because quite happily its most talented citizens have migrated to the intellectual economy and into the creation of wealth that doesn't yet exist. Though the countries and states mentioned are most known for their mineral wealth, California is known for its intellectual wealth - think Intel, Cisco, Google, Facebook - the list is long.
The problem, and this is something completely lost on the political class inside and outside California, is that intellectual concepts suffer capital shortfalls during periods of currency devaluation. The answer for why is very basic: investment on its very best day is a very risky concept. Basically investors are committing capital to ideas the returns from which are at best, a very distant object.
To make it very simple, investors commit dollars in hopes of getting many multiples of dollars back. But when governments such as ours devalue, the incentive to commit capital to long-term business concepts is greatly reduced. Indeed, why commit dollars to something that, if you're lucky enough to get a return, they'll come back greatly reduced in value?
Moving into specifics, while $13 billion was spent in 2000 on drilling and completing U.S. oil wells, in 2012 the amount invested is expected to rise to $145 billion. This has been a major negative for California.
Though it's rich in oil and commodities, the greatest source of Californian wealth today is once again the pursuit of the innovative business ideas of tomorrow that require a great deal of investment. But with the dollar having been in freefall over the last 11 years, investment that would have funded more of tomorrow's Googles has migrated out of California in search of commodity-style investments; commodities priced in dollar invulnerable to the devaluation of the dollar.
To understand why this is true, we must consider oil. Most politicians, economists and economic commentators today suffer under the absurd illusion that oil is in fact expensive. Nothing could be further from the truth.
Oil is only expensive insofar as the dollar is cheap, and to prove my point, consider the price of oil in terms of gold; gold the greatest and most constant measure of value known to mankind. In 1971, before President Nixon took us off of the gold standard, an ounce of gold at $35/ounce bought 15 barrels of oil at roughly $2.50/bbl. In 1981, an ounce of gold at $480/ounce bought 15 barrels of oil at roughly $35/bbl. Last April an ounce of gold at $1500 bought 15 barrels of oil at roughly $100/bbl, and today an ounce at $1700, buys just under 16 barrels.
What these numbers make clear is that oil has never become expensive, but in cheapened dollars it's become a lot more expensive. More clearly, there's no supply shock at work, rather there's a dollar shock driving up commodities such as oil, and investors, seeking to protect their wealth from inflation, are chasing what is the most monetary of illusions.
The good news is that history tells us the U.S. Treasury's policy of a weak dollar - one that's prevailed under George W. Bush and Barack Obama both - will not last forever. Much as the Nixon and Carter administrations pursued a cheap dollar in the ‘70s on the way to oil shocks that made Texas a booming state in the ‘70s, the Bush and Obama administrations have done the same.
Just as Americans flocked to Texas in the ‘70s, they're doing so once again to California's detriment. Of course what's left out is that with the election of Ronald Reagan in the ‘80s, and then Bill Clinton's election in the ‘90s, is that both Presidents pursued a strong dollar on the way to collapsing gold and oil prices. And amid the dollar's surge, Texas suffered unemployment in the ‘80s 2 percentage points above the national average, while California boomed in the ‘80s and ‘90s.
California did well because as an intellectual economy full of visionaries pursuing tomorrow's engines of wealth, the state was a magnet for investment. Investors are tautologically buying future dollar income streams, and with the dollar strong, investors felt safe once again committing capital to the concepts of the future.
California would still be booming today, but for the Bush and Obama administration's clear policies of dollar weakness. With both favoring a debased greenback, investment has once again flowed back into the wealth concepts of yesterday; wealth concepts that are least vulnerable to inflation.
History says this will be reversed, note how many Republican presidential candidates are talking about dollar policy, and when the reversal occurs, gold and oil will plummet and investment will return to California and its intellectual concepts in short order.
So to conclude, while I won't excuse the State of California's ridiculous taxes and regulations for one minute, the greatest burden by far at the moment that is holding back California's growth is the weak dollar pursued by the U.S. Treasury. The latter has forced investors away from the most talented state in the world, and into wealth hedges of yesterday.
The good news is that this can and will be fixed. Inflation eventually burdens everyone whether they're in commodities or computers, and because that's the case, it's inevitable that future presidents will return us to a sound money path. When they do, California, for having the greatest collection of innovative and intellectual talent in the world will be a major recipient of massive capital inflows from around the world.
When this occurs the talent outflow from California will morph into an inflow, and unemployment will fall in concert with greatly increased investment. Happily for the world, the reorientation of investment driven by a strong dollar ensures major new advances in areas ranging from medicine to aviation to computers and technology.
California will boom, unemployment will plummet, and all this nonsensical talk about California's best days being behind it will cease. But for this to occur, monetary policy must be righted. The question now is which politicians are listening, and if so, when will they get control to fix the monetary error that is crushing the most innovative state the world has ever known?
Thank you very much.