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All about California
Buffett worries that the Golden State could lead the U.S. back into recession. But is he wrong?
October 7, 2003: 12:27 PM EDT
By Mark Gongloff, CNN/Money Staff Writer

NEW YORK (CNN/Money) - As Californians go to the polls Tuesday to pick a governor, it might be easy to dismiss the entire process as a political sideshow with few implications for the national economy.

Warren Buffet, for one, would disagree.

"If California has troubles, the country has troubles," Buffett said in August. "If California prospers, the country prospers." The billionaire investor is acting as an economic adviser to the campaign of Republican candidate Arnold Schwarzenegger.

According to recent polls, current Governor Gray Davis, a Democrat, appears in danger of being recalled, and Schwarzenegger has a slim lead over the state's Democratic Lieutenant Governor, Cruz Bustamante, in the race to succeed Davis.

At first blush, Buffett's argument seems to make perfect sense. California, by some measures, has the world's fifth-largest economy and is responsible for more than 10 percent of the U.S. economy. Naturally, it would seem to have an overwhelming advantage over the other 49 states, all of which produce far less.

But the relationship may be more symbiotic than that, according to Sung Won Sohn, chief economist at Wells Fargo & Co., who publishes a report on California's economy.

"This is what economists call a simultaneous process, meaning that it works both ways," Sohn said.

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Sohn noted that while California consumers a lot of the stuff that the rest of the country produces -- such as automobiles and machinery -- it also produces a lot of the stuff the rest of the country eats -- including fruits and vegetables, computer hardware, movies and services like tourism.

In other words, even if Californians lose their appetite for services and consumer and capital goods, they're still going to have to keep producing them for the rest of the country. And with output of about $1.35 trillion in 2001, the latest data available, California's economy is smaller only than those of the United States, Japan, Germany and Britain.

On the other hand, if the rest of the country loses its demand for semiconductors and summer blockbusters such as "Gigli," they'll still have to keep making Hummers for Arnold.

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In fact, California's recent financial woes, including a whopping $38 billion budget deficit, look suspiciously like those of a number of other states -- states that got fat on higher tax revenues during the late-'90s boom, spent like crazy, and are now terribly hung over.

"As the national economy gets better, California will get better, and some of its problems will be less acute," said Joshua Feinman, chief economist at Deutsche Bank Asset Management.

The one wild card in the California deck is housing. The state has some of the hottest -- some would say over-inflated -- markets in the country, including Riverside-San Bernardino, Los Angeles, and Sacramento; in all three areas, home prices jumped more than 20 percent in the second quarter, according to the most recent data from the National Association of Realtors.

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CNNfn's Jen Rogers takes a look at how successful Arnold Schwarzenegger is in the business world and what investments he holds.

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It still seems unlikely to most economists that these markets are really in a bubble, which would mean prices there are due for a sudden, drastic fall-off that would slam the regional and state economies.

And those economists had better be right, since severe housing-market pain, in major cities in California or elsewhere, could put the rest of the economy at risk.

"If there were a bubble in California and if it were to burst, that would be a national economic catastrophe," said Wells Fargo's Sohn, who emphasized he didn't think there were any regional real estate bubbles.

But he added: "Clearly, California is very vulnerable on that score, along with some parts of the East Coast, from Boston to Washington, D.C."  Top of page

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