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When
an earthquake rumpled the earth’s crust off the coast
of Sumatra
last December, it took hours for the shock wave, in the
form of a tsunami, to reach the shores of Thailand,
India
and Ceylon. If
only an advance warning system had existed, thousands of
lives could have been saved.
We’re
living through a financial tsunami right now: the
collapse of the U.S. dollar in foreign exchange markets.
The shock waves are radiating across the globe. They
haven’t reached Virginia
yet,
but they will. We don’t need an early warning
system--we all know what is happening. If we just pay
attention, we can survive the cataclysm. But if we
ignore the signs, we’ll be caught like the bathers on
Phuket beach.
The
falling dollar will have several predictable
consequences on governance and economics in Virginia. On
the negative side, a weaker dollar will drive up the
cost of imported goods, which in turn will push up
inflation. Federal Reserve Board chairman Alan Greenspan
has made it as clear as spring water that he will
respond to the inflationary threat by hiking interest
rates. Higher interest rates will make it more expensive
for consumers, businesses and governments to borrow.
That’s Economics 101. You can take it to the bank.
Fortunately,
a weaker dollar has its compensations. Because foreign
products and services will cost more, U.S. companies will find it easier to under-price their
competitors, both here at home and in foreign markets.
The manufacturing sector, which has suffered hideously
from the super-strong dollar of the past decade, should
experience a welcome respite. Meanwhile, foreign corporations,
benefiting from their newly muscular currencies, will
find it more affordable to invest here. We can
anticipate an up-tick both in the number of facility
expansions and corporate takeovers in the U.S. Those investments
will help offset the pain of higher interest rates.
Economics 102. Like night follows day.
To
commentators focused on state and local governance,
that’s all terribly abstract. The study of currency
fluctuations is best left to the policy wonks in the
Fed, the World Bank and the finance pages of the Wall
Street Journal. You don't often hear the power
brokers in Richmond discussing the exchange rate of dollars with Euros and yuan.
But
perhaps we should.
The
real estate bubble and tax revenues.
For starters, higher interest rates will prick the real
estate bubble. Under the most benign scenario,
residential property values will level off. Under the
pessimistic scenario, they will collapse in the very
markets--we're talking Northern Virginia here--that have
shown the greatest gains over the past several years.
I
fully expect regional boosters to make the case for Northern
Virginia
exceptionalism. The blast-off in property values, they
will say, is underpinned by a dynamic technology
sector and record job creation. Of course, that’s what
Northern
Virginians
said
in the 1980s just before the commercial real estate
crash… and what they said in the 1990s before the
bursting of the Internet bubble. It's undeniable that Northern
Virginia
has
the strongest economy in the Commonwealth--by a long
shot--but it’s also prone to speculative excess. In my
previous incarnation as editor of Virginia Business magazine, I called the last two big market
corrections in Northern Virginia. Both times, the bubbles lasted far longer than I ever
imagined. But, in the end, events proved me right.
Now
I’m calling for a major correction in the
Northern Virginia
residential real estate market, and lesser setbacks in
downstate markets. I may be wrong this time, but our political
and community leaders would be fools not to recognize the
possibility that a traumatic slump could occur.
Let’s
assume, just for purposes of argument, that I’m right.
What are the ramifications? Once a bubble bursts,
property values won’t just return to reasonable
levels. They’ll plummet to unreasonable discounts as
fear sets in, speculators panic and overleveraged
homeowners unload their properties.
Local
elected officials will face an unfamiliar problem: tumbling
real estate assessments. While assessments have
skyrocketed over the years, local boards and councils
disguised the rising cost of government by cutting
property tax rates.
Assessments have been rising faster than rates have been
falling, with the result that the total tax burden has
steadily increased. Yet the process is opaque enough
that politicians running for statewide office, from
former Richmond Mayor Tim Kaine to Prince William
Supervisors Chairman Sean Connaughton, have gotten away
with the farcical claims that they cut
taxes in their jurisdictions!
As
property values fall, local governments will have no
choice but to raise rates. I predict that there will be
political hell to pay as the spending sins of the past
decade--and the fraudulent claims of elected
officials--are laid bare for voters to see. Many
local pols will be led to the electoral slaughter. At
the same time, local governments must go on. Municipal
lobbyists will intensify their pressure on the state to do something to alleviate the strain on local finances. The issue of
fiscal relief for local government will become a
defining issue in the second half of this decade.
Collapsing
real estate values also will crimp the sales tax by
making it impossible for consumers to continue dipping
into their home equity to pay off credit card bills.
Because Northern
Virginia
has
become such a dominant force in Virginia’s
economy, even state government needs to take precautions
against a slowdown in sales tax revenues. It was
prudent, therefore, for lawmakers this year to funnel
this year’s $1 billion+ surplus into measures that
will strengthen state finances or go to one-time
projects. Legislators need to proceed just as cautiously
in future years as the currency realignment works its
way through the economy.
Economic
development opportunities. As faithful readers know,
I have long criticized the folly of "chasing
smokestacks"--devoting economic development
resources to capturing an ever-shrinking pool of
corporate relocation prospects. I have articulated alternate
strategies based on the development and recruitment of
human capital and the building of an entrepreneurial
economy. In the long term, I believe strongly that those
strategies still will yield the greatest returns on
investment. However, the old corporate-recruitment
strategy may gain some legs as a result of a weaker
dollar.
It
pays to be attuned to nuance here. A "weaker
dollar" does not mean that the dollar declines in
value equally against all currencies across the board.
The Chinese government continues to peg the value of the
renminbi to the dollar, with the result that the dollar
remains grossly overvalued in our trade relations with
China. With the Chinese economy
dependent upon exports to the U.S., the Chinese central
bank may prolong that policy indefinitely. If so, U.S.
businesses will continue to "outsource"
manufacturing capacity to China. The same logic applies
to other Asian nations that, to a greater or less
degree, have deliberately kept their currencies weak
against the dollar to bolster exports.
But
the dollar has declined precipitously against the Euro.
That should present three distinct opportunities to
Virginia's economic developers.
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A
weaker dollar should provide U.S. businesses relief
from European price competition. American corporations
whose major competitors reside in Europe should
enjoy a resurgence. It's not clear yet, however,
whether this shift will lead to an increase in the
number of prospects looking to set up new
manufacturing operations in the U.S. Some companies
may prefer to invest in boosting productivity at
existing operations over building new plants. But
the Virginia Economic Development Authority and its
regional allies should position themselves to
exploit an upturn in prospect activity should it
occur.
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Foreign
enterprises will find it more attractive to invest
in the U.S., either to set up operations here, or to
acquire U.S. companies and invest in their
expansion. Now is the time that Virginia should
redouble its efforts to attract this foreign investment.
Virginia
economic developers need to move early to capitalize on
the changing capital flows. The advantage goes to the
early movers. If we wait until the trends are so obvious
that everyone recognizes them, someone else will have
seized the opportunities before us.
--
March 28, 2005
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