California’s Ballyhooed Recovery? Oh Dude!

There’d been some excitement on Monday about manufacturing data in the US. The Purchasing Managers’ Index (PMI) had edged up to 51.5, from 49.6 in August. The first month above 50, indication of growth in US manufacturing, however feeble, after three consecutive months of declines. Halleluiah. But in California, despite the current hype, the manufacturing index suddenly collapsed.

“Manufacturing” in California is to be taken with a grain of salt. Much of it migrated to low-wage countries like China and Mexico. In Silicon Valley, once the center of high-tech manufacturing, chip startups are “fabless”; they design chips and outsource manufacturing to foundries in China. The iPhone and similar devices have never been manufactured in the US. Computers are manufactured worldwide, not in California. The big thing these days is software in all its forms, from run-of-the-mill photo-sharing apps to “Big Data.” And everyone wants to create “the next Facebook.” Um, well, minus the IPO fiasco. Biotech research outfits are sprouting up. And then there is Tesla, the electric-car startup, trying to make a go of it at a plant where GM and Toyota had thrown in the towel. It’s burning through hundreds of millions of dollars in investor money, taxpayer money, and customer deposits, and it hasn’t manufactured very much yet. So “manufacturing” in California needs quotation marks.

But even the VC-funded bonanza in the Bay Area appears to be drying up. VCs are still making deals at a good clip: $4.16 billion in the second quarter, up from $4.04 billion for the same period last year. But the Facebook IPO fiasco—you still can’t have a conversation around here without it—and other IPO fiascos have weaned limited partners off their wildest dreams. And they’re having an impact…. on fundraising. Ever more VCs are chasing down fewer and more skeptical investors who, inexplicably, have become reluctant to part with their money. It has been a “dismal fundraising climate.”

The trend has been going on for several years, as investments by VCs have outpaced their ability to raise funds. At some point, these funds will be drawn down, and investments in startups will wither. We’ve been through this before. And it might be at the cusp of happening again. It will take the sheen off the Bay Area. Meanwhile, manufacturing in Southern California, where this exotic activity is still practiced, is leading the way.

California has its own manufacturing PMI, the Inland Empire Report on Business, sponsored by San Bernardino and Riverside Counties in Southern California, commonly called the Inland Manufacturing Index. After the recent high of 60.8 in March—above 50 indicating growth—it zigzagged down to 52 in August, and then in September, it crashed to 43.4—the lowest level since September 2009.

All five key components were weak. And three fell off a cliff: Production tumbled from 55 in August to 37.5 in September; New Orders—a harbinger of pain to come—fell from 52 to 37, and Exports fell from 51.1 to 35.7. “Disturbing,” the report called it.

So, with orders, production, and exports going south, the employment index sank to 44.6, indicating declining employment in manufacturing for the first time since December 2011. But thanks to the serial and now infinite QE, the Bernanke effect has kicked in: one component actually rose to 64.1, namely commodity prices. These higher input costs are adding to the pressures that businesses face.

Optimism about the local economy for the next quarter dropped sharply, replaced by outright negativism: 42% of the purchasing managers now expect the economy to be weaker, a jump from 29% in August. Only 12% felt it would be better. Their comments were largely negative. “Business is real slow” or “slowing orders” were common themes. While there is some seasonality in this index, the fact that it dropped so sharply and, on the way down, blew past the lows of the last three years is troubling—and not only for California.

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