Historically, global recessions have originated in one of three ways: 1) external shocks (oil embargos, wars, etc.), 2) excessive government intervention (monetary and/or fiscal), or 3) a financial crisis. While there is overlap between the three, economists parse out the implied causes of a recession to understand the appropriate government response and the import upon private enterprises and households. The consensus indicates the current recession is a financial crisis that has a particular set of implications nationally and for the Central Valley.
The current financial crisis and global recession is worse than the average of the previous five U.S. recessions dating back to the Great Depression in 1929. The current trend is that it will be the worst financial crisis the world has ever seen. Table 1 highlights how the current financial crisis compares to the average economic performance of the last five recessions at the same stage of the recession cycle.
Over the last ten years, the Central Valley economy has been dependent on residential construction, rising commodity and food prices, and expanding state government expenditures. All three pillars of the 18 county Central Valley regional economies have unraveled with the following anecdotal evidence:
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Four Central Valley cities are among the top ten U.S. cities experiencing the worst decline in home prices
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Almond production (California produces 80% of the world output) increased by 16% while demand only increased 5% - prices have reached a 10 year low
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Dairy producers have seen a 50% drop in fluid milk prices (California produces about 25% of the country's milk). This will cause 200,000 cows of the state's herd population to be culled over the next 12 months
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California state employees are seeing net decreases in wages as the legislature and the Governor have imposed furloughs and pay freezes, recently announcing 10,000 layoffs.
The previous data forces Central Valley entrepreneurs to evaluate their relative level of vulnerability to the weakening economy and limited access to capital. The cyclical trend in the U.S. is that credit will grow seven quarters after economic output or GDP grows. So if GDP growth resumes in Q3-09 then credit would begin to grow again in Q1-11.
Thus, a firm's level of credit dependency will determine how it will grow and defend its business model in the next 2-3 years. The chart below illustrates the level of decrease in earnings growth a firm with credit dependency will experience compared to a firm with no credit dependency (i.e. the ability to finance through retained earnings instead of borrowings).
Chart 1
Impact of Debt Dependency on Strength of Recovery
The most vulnerable firms will be those with low product tradability where they have little or no ability to sell their products overseas and are limited to local markets. Conversely, the firms best positioned would be those that have high product tradability and high asset tangibility.
The core Central Valley business segments (Agribusiness, Construction, and Gov't Services) mentioned previously all have relatively moderate levels of product tradability and a mixed level of asset tangibility. This suggests that until credit growth resumes, the Central Valley business sector will lag national trends to recover as economic conditions improve.
The wiser and more forward-thinking operators will seek alternatives sources of capital to stay apace of the economic recovery and defend their core business value over the next 2-3 years. Our previous newsletter,
Vol. 2 No. 1, and the supplemental article in this edition, entitled "Meeting Capital and Operational Needs," highlight the role private capital can play in financing business growth both nationally and here locally in the Central Valley.
