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Once the Mecca of industrial America, Detroit is now the poster child for what can happen when it all goes wrong after years of bad decisions, mismanagement and politically influenced policy. In fact, the situation is to the point where the 11th largest city in the U.S. has a 22.8% unemployment rate and "30% of its citizens are on food stamps," according to a report in the Wall Street Journal.
Even as the U.S. government has "rescued" or in the eyes of some only prolonged the inevitable by bailing out Chrysler and General Motors, citizens of Detroit are facing the potential of living in a 21st Century ghost town as retailers are leaving the city in droves. According to The Wall Street Journal "Borders Inc. was founded 40 miles away, but the only one of the chain's bookstores here closed this month. And Starbucks Corp., famous for saturating U.S. cities with its storefronts, has only four left in this city of 900,000 after closures last summer."
The situation is to the point where citizens are having a hard time buying groceries or even buying a retail cup of coffee. According to the Journal: "No national grocery chain operates a store here. A lack of outlets that sell fresh produce and meat has led the United Food and Commercial Workers union and a community group to think about building a grocery store of its own." And even businesses that are relatively successful are having second thoughts. For example "One of the few remaining bookstores is the massive used-book outlet John K. King has operated out of an abandoned glove factory since 1983. But Mr. King is considering moving his operations to the suburbs."
Yet, this is not a new situation as it has been building up for some time. Aside from the auto industry's problems, Detroit's issues have been influenced by the flight of people to the suburbs, leaving the city without the base for commerce, middle to upper income people. According to The Journal "Hundreds of buildings were left vacant by the nearly one million residents who have left. Thousands of businesses have closed since the city's population peaked six decades ago," while "Navigating zoning rules and other red tape to develop land for big-box stores that might cater to a low-income clientele is daunting."
And it could well be a canary in a coal mine type situation for other cities where the business climate is souring.
California Concussion
Elsewhere, the state of California, often touted as the sixth largest economy in the world, is on the verge of bankruptcy, or some sort of state where it won't be able to function, due to its huge and seemingly irrepairable budget shortfall.
According to Dow Jones Newswires: "Standard & Poor's Ratings Services late Monday warned it may downgrade California's credit ratings, citing concern the U.S.'s most populous state may miss debt payments if it doesn't make a significant revision to its fiscal 2010 budget. In putting California's debt on credit watch with negative implications, S&P said its structural budget gap may lead to acute liquidity strain, payment delays, or issuance of instruments in lieu of cash payments, and warned it may lower California's ratings below the A category unless the state addresses the problem."
In other words, California is about to enter the fiscal "Twilight Zone," a dimension of sights, sounds, and things that could lead to a situation akin to a ride on Disney's "Tower of Terror" for the citizens of the state.
S & P, using California State Comptroller figures predicted that "the state will have insufficient cash to meet all of its payment obligations by July 28, 2009 and will have a cash deficit of $2.78 billion at July 31. By April 2010, the cash deficit is projected to grow to $25.3 billion," and that it may have to "defer cash payments for certain lower obligations such as vendors, student aid, and tax refunds in order to preserve cash for required payments for education and debt service. Another possibility is the issuance of warrants in place of cash payments."
Demographic Reversal
Just as Detroit's downtown population has dwindled, so are the descendants of those who fled Oklahoma's dust bowl days of the Great Depression coming back to the plains. According to a syndicated report from Mc Clatchy Newspapers: "As California housing prices went wild in the middle of this decade, hundreds of thousands of residents scratched their heads and moved to places where homes were still affordable, state and federal statistics show. When prices started falling and unemployment started rising, many continued to leave California for healthier job markets. The result was five consecutive years when California saw more residents going to other states than coming. Although many stayed closer to home - Nevada, Oregon, Arizona - the mid-South saw a large influx."
And the trend has become more accentuated as "From 2004 through 2007, about 275,000 Californians left the Golden State for the old Dust Bowl states of Oklahoma and Texas, twice the number that left those two states for California, recent Internal Revenue Service figures show. In fact, the mid-South gained more residents from California during those four years than either Oregon, Nevada or Arizona. The trend continued into 2008."
And the answer as to why they moved is pretty simple: "easier to find a job; cheaper to buy or rent a home; better place to make a fresh start. Ask them why they stay in Oklahoma and they'll add to that list a deep optimism that it's a place where things are about to take off."
Conclusion
Detroit and California were once at the top of the heap. Booming economies boosted by the automobile industry in the 1960s for the former, and the promise of fun in the sun and "California Girls" for the latter. Yet, something went wrong in both places.
And the something was that the social safety net expanded beyond what the taxpayers, in the case of California, and those buying the products, in the case of Detroit, could afford. Rising taxes in California, and housing prices that spiraled out of control and eventually crashed were also in the mix.
In other words, excess, and an insatiable desire to remain excessive finally took its toll on both places. Sure, there are nuances. Detroit had its union issues. And California has its education and welfare issues that are at the core, or at least significantly responsible for what is happening now. But the effect is the same, reverse migration, as people seek greener pastures.
From a business standpoint, there will be repercussions. California is a major agricultural state. Anything that threatens that sector of industry will bring higher prices for food and related products, such as wine.
The automobile industry has already moved elsewhere, with both domestic and foreign carmakers building plants in North Carolina, other areas of the South, and Texas. But, it's possible that we could see more of that as states vie for industries that could provide jobs.
What we're seeing is similar to what happened after the Great Depression. People have to make decisions, and those decisions are what will shape the next set of trends. As investors, realizing that we are in a period of significant transition is the first step toward making the long term decisions that will build wealth. At this stage of the game, the most important strategy is to remain patient.
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