High PPI reduces the ability of the Fed to cut rates.
>> California Could Sink The Whole Country
By Steve Cochrane
02/15/01 12:00 PM ET
The newspapers are deluged
with stories about the
California energy crisis. It is
creating hardships for
households trying to pay their
utility bills and is disrupting
industrial production. The
uncertainty it generates is
causing delays in private
investment, and farmers are
wondering how they are going
to pay for their lifeblood--irrigation. Even the Dismal Scientist has
devoted nine recent articles to this topic. Now, make that ten.
So what? Who cares? If you are reading this anywhere outside of
California, including the nation's capital, you may be asking these
questions. After all, it's California's problem. They are the ones that
saddled themselves with a risky power deregulation plan. They are
the ones that said, "Don't build any new power plants in my back
yard." They are the ones that have grown wealthy on power-hungry
tech industries.
First, let's dispel one myth. California is not a power hungry
economy. Yes, it is big. Yes, its has grown rapidly in recent years.
However, when measured by the total volume of electric power
consumed per dollar of output, California is nearly the most energy
efficient state in the Union. Only New York is more efficient.
OK, but still, why care? Well, the state's sheer size, roughly 14% of
U.S. GDP, means that the performance of the U.S. economy is
determined in large part by that of California. Between 1995 and
2000, California accounted for nearly 20% of GDP growth, and this is
a conservative estimate since it accounts only for direct production in
California and not for goods produced elsewhere in the nation and
consumed in California. So, if California slows, the nation will
unavoidably feel it.
California accounts for slightly over 12% of U.S. population, but it
receives nearly 30% of all international migrants. It takes an
expanding economy to accommodate these migrants with jobs,
housing, schooling and other services. Moreover, the flow of migrants
into the U.S. tends to remain constant through good times and bad,
and if the California economy slows, immigrants landing in California
will move elsewhere looking for work, shifting the burden to other
states.
Additionally, California helps to keep the trade deficit from becoming
worse than it is. While the state accounts for nearly 14% of the U.S.
economy, it accounts for over 16% of total U.S. commodity exports,
nearly 25% of industrial equipment and computers, electronics, and
instruments exports, and over 15% of farm commodity and food
products exports.
The so-called new economy depends upon California. It employs
18% of all workers in high-tech industries and produces
approximately 25% of all value added created by high-tech industries.
With uncertain power supplies and rising electricity costs, however,
the tech industries have already begun to balk at further expansions
and hiring, and costs for production and R&D activity will rise. This
reduces productivity and could lead to higher prices for technology
goods and services produced in California. Higher prices for
productivity-enhancing technology would certainly slow growth
elsewhere in the nation's new economy.
California's electricity crisis is already costing neighboring states,
and the impact is spreading. In the Pacific Northwest, utilities are
beginning to raise rates in anticipation of short power supplies this
summer. Northwestern reservoirs are now so drained from supplying
California's unbalanced power market that it is certain they will need
to buy additional power on the spot market this summer, just when
peak demand in California will drive wholesale prices even higher.
Indirectly, the rest of the nation will also feel the impact of higher
prices, and it will not just relate to technology. Food prices will likely
rise as farmers struggle to pay the bills to pump water. Prices will
rise for the salad you pick up for lunch, for the orange slices and
raisins you snack on later, for the rice and vegetables on the side of
your dinner plate, for the wine you serve with it, and for the nuts you
bake into your dessert. The cost of that video rental after dinner will
rise as production costs rise. More than that, your imported car and
electronic gear will cost more since they may well pass through one
of California's ports that now pay higher costs to operate their
equipment and the related warehousing nearby.
Consumer price inflation in the West is at 3.9% year over year (see
chart). In San Francisco, inflation is over 5%. In Seattle it is over 4%.
Now this can't be blamed on power costs yet; rising house prices are
also a factor. However, rising power costs will only continue to add to
other imbalances already impacting prices in western markets.
Eventually, as power prices filter through the many production
processes in California, higher prices will be felt throughout the
country.
This could then tie the hands of the Federal Reserve in managing
monetary policy in a slower economic environment. The Fed has
made it perfectly clear that the current lack of any inflation threat is
what allows it to lower interest rates. That could all come to a halt if
inflation spreads eastward from California.
So we all have a stake in finding a solution to the power crisis in
California, as it relates to both the near-term issue of supply and the
longer-term issue of price and distribution. It is a national, as well as
a local, concern. <<
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