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March 15, 2001

Capital California, Meet Indonesia IMAGINE A POLYGLOT culture with a hot economy, much envied by the rest of the world, that suddenly runs into trouble.

Its shell-shocked leaders are inundated with advice from economic technocrats, many of whom insist that nothing bad would have happened had their earlier advice been heeded. Investments that seemed to be sure winners look imprudent in hindsight. Washington pressures the government to raise energy prices, dismissing local protests. The lights go out. The search for scapegoats begins.

Indonesia 1997? Or California 2001?

California is hardly an emerging market; it emerged more than 75 years ago. The economy of Los Angeles alone is as big as South Korea's.

But the confluence of plunging Nasdaq stocks, soaring electricity prices, money-making energy traders and feckless political leaders resembles nothing so much as an emerging-market crisis.

In a stellar U.S. economy, California was a supernova. Its economy grew about 10% last year, twice the national average. Like booming Asian economies, it drew lots of capital. Some was profitably invested. Some was thrown at investments with little prayer of success. Southeast Asia got empty office towers; Northern California got worthless dot-coms. Forty-nine of the stocks in the Nasdaq 100 index, from Abgenix Inc. to Yahoo! Inc., are California companies.

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"It was our companies on Nasdaq whose valuations were frothing. It was our venture-capital firms. In those respects, it looked and felt like an emerging market in the throes of excessive exuberance and accommodative financial conditions," says Barry Eichengreen, an international economist at the University of California at Berkeley.

AND NOW IT'S OVER. California may skirt recession, but this year's growth will be painfully slower than last year's. And unless the weather is mild, more blackouts are likely in August.

For obvious reasons, California isn't headed for Asian-style devastation. But Mr. Eichengreen says two factors are particularly instructive.

First, California's banks are diversified; South Korea's weren't. BankAmerica Corp., swallowed by North Carolina's NationsBank Corp., now has more than four times as many real-estate loans outside California as in it. Message to emerging markets: If foreign banks buy into your banking system, your banks will be less exposed to local catastrophes.

Second, California doesn't have its own currency. So Gov. Gray Davis isn't worrying about the collapse of the California Avocado (or whatever the state might call its currency), which surely would have followed the blackouts and bickering of the past few months. Message to emerging markets: Abandoning your currency for the dollar can make sense.

Of course, Gov. Davis can't cut interest rates, no matter how bad business gets for Intel Corp. Without a currency of its own, California is stuck with rates set by the Federal Reserve.

California is demonstrating a third lesson, too. If you can borrow on your own credit, you can do whatever you want no matter how stupid folks in Washington think you are.

To buy electricity because generators won't sell to its utilities, California's state government plans to borrow $10 billion this year on Wall Street. That's roughly what the International Monetary Fund has lent Indonesia in the past three years, but Indonesia had to promise energy-price increases to get the money.

The precise understanding between Indonesia and the IMF is in dispute, but the Suharto government raised fuel prices sharply on May 4, 1998, triggering riots. Less than three weeks later, Mr. Suharto's 32-year rule was over.

ACADEMIC ECONOMISTS and federal officials insist that substantial increases in California electricity prices are essential to bring demand in line with supply. Gov. Davis is reluctant, largely because of the political risk. "If we were to pass on the full cost of electricity," he told Wall Street analysts recently, "an initiative to eliminate deregulation would pass in a heartbeat." He has a point; outsiders usually don't think enough about domestic politics.

Washington did offer California help earlier -- forcing generators to sell power, capping wholesale rates temporarily and posing Alan Greenspan at Gov. Davis's side. Unlike the IMF, the federal government didn't extract much in exchange.

So now California confronts two conditions familiar to emerging markets. The first is an illness -- in this case, flawed deregulation -- that has grown more severe since symptoms first emerged and weren't promptly treated. If you swallow the right medicine, IMF doctors advise, there is a chance you'll get better. Refusing treatment means you'll be sick for a long time.

The second is the difficult process of distributing pain. In emerging-market crises, there's always talk about sharing the burden with private investors. But the ones who end up paying the bill are the people of the country itself. California is paying out-of-state generators much more for electricity than it is charging customers. Perhaps utility parent companies or the generators will be nicked, but the big tab will be paid either by California ratepayers or California taxpayers -- and they're the same people. Sounds familiar.

-- David Wessel

Write to David Wessel at capital@wsj.com

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-- Martin Thompson (mthom1927@aol.com), March 15, 2001