Welcome to Texas
Dallas Business Review
Fall 1996

This was an after-dinner speech to a group of European and Japanese investment executives visiting Dallas with their New York hosts.

"That's right, you're not from Texas. But Texas wants you anyway."
—Lyle Lovett

Howdy.

"Howdy" is Texan for "Welcome to Texas." I'm honored to be asked to explain Texas to you. But since you went to Billy Bob's last night, you know about all there is to know about Texas.

"Is Billy Bob's the real Texas?"

My answer is "Yes."

Texas is the land of guitars and Cadillacs, pickup trucks and gun racks, cowboy boots and hats and blue jeans with big belt buckles. And for the benefit of our Swiss, Japanese, and German guests tonight, I'm proud to say that Texans buy more than their fair share of Rolexes, Lexuses and Mercedes. Of course, I can't afford such luxuries myself, given the strength of the Swiss franc, Japanese yen and German mark. Just wait.

On the important question of big belt buckles, you are really supposed to win them as prizes in a rodeo, although most Texans don't these days. Our high standards for jeans have held up better. They must be starched, creased and tight cowboy-cut Wranglers. Cowboy-cut means cut long to bundle up on your boots.

I understand that you got your own cowboy hats last night. You will learn that the biggest problem is where to put them when you take them off.

You may remember JR Ewing from the TV program Dallas in the 1980s. JR would just walk into the room, hand his hat to the nearest girl, and say, "Here, darlin'." Of course, that would be politically incorrect today. Nowadays, all Texas girls are women, you can't call them "Darlin'" anymore, and even JR would have to take care of his own hat.

Speaking of Texas women, Texans prefer to call them "Texas ladies." The stereotypical Texas lady has big hair, long fingernails, and clothes that sparkle. Candace, my four-year-old granddaughter from Baltimore, has it about right when she calls her Big Mama a fancy girl from Dallas.

Except when they get their big hair caught in the ceiling fan, Texas ladies have a lot of fun, They drive fancy cars like Cadillacs, Mercedes, and Lexuses, all with gold packages. They also favor the national car of Texas, the Chevrolet Suburban, which is about 40 percent car and 80 percent truck. Go figure. And you'd be surprised at how popular extended cab pickups are with Texas ladies. While big hair and big cars are preferred, some of my favorite Texas ladies have small hair and drive more sensible cars like the Toyota Camry or faster cars like the Chevrolet Corvette. I even know a two-Corvette woman, although she lets her husband believe that one is his.

Cowboy garb poses a tricky problem for naturalized Texans, or Texans by choice, like myself. Native Texans, or Texans by birth as they prefer, are somewhat skeptical of us newcomers, especially if we try too hard to fit in. They say things like "I see by your outfit that you are a cowboy." When they say things like that, they don't mean it. They mean the opposite. They are calling you a drugstore cowboy, which is not a good thing. Less subtly, they also say things like "Don't call him a cowboy until you've seen him ride," or "He's all hat and no cattle," or "He's all foam and no beer." Such put-downs don't apply to guests. Drugstore cowboys from out of town are always welcome.

Since you aren't from around these parts, I should make it clear that the cowboys in question are Texas cowboys, not Dallas Cowboys. The Dallas Cowboys are the world's premier football team—America's team. You may not be familiar with the game of football. It's played with an oblong-shaped brown ball.

One more thing before we get to the economy. More often than not, the pickup trucks with gun racks are driven by good old boys named Bubba. Bubba is the shorthand term for a Texas redneck. And in case you don't have them in Europe or Japan, redneck is a term that comes from the sunburn you get on the back of your neck working out in the sun on the farm or ranch—in other words, doing the Lord's work. In Texas, Bubba is spelled with two b's, and is definitely not an acronym for the Bundesbank. That Buba is spelled with one b.

As you can see by now, Texas is more of a state of mind than a place. The Texas attitude results partly from the fact that Texas was once an independent country—from 1836 to 1846, which is a long time ago by Texas standards. You see, we don't go back as far as you.

The first president of the Republic of Texas was Sam Houston. I've been interested in the monetary views of Sam Houston, who was a protégé of Andrew Jackson, our first Populist president and the president who killed off the Second Bank of the United States, which some view as an early version of the Fed. As far as I have been able to determine, Sam Houston's views on money and banking were similar to Jackson's. They were for money and against banking. For sound money and plenty of it.

The Texas Economy: From Boots to Suits, Cow Chips to Computer Chips
In recent years, business interests in Texas have evolved from cow chips to computer chips and from boots into suits. But for many years, the Texas economy was based on cattle, cotton and oil.

The rise in oil prices in the 1970s created a boom and bubble in Texas oil, commercial real estate and the financial institutions that financed them. All three went down together when the bubble burst in the mid-1980s. To put it mildly, we had asset price deflation.

The Texas deflation and recession bottomed out by 1988 and growth resumed. Its momentum carried Texas through the national recession of August 1990 through March 1991 without serious impact.

The national recession merely meant slower growth in Texas. Since then, Texas has remained in the top tier of states in terms of employment growth. Texas generally does better measured by employment growth than by unemployment rates because so many people come to Texas looking for opportunity and jobs.

As for the major Texas cities, Houston's recovery lagged somewhat behind the others because of the continued importance of the depressed oil business. But Houston has shown significant improvement in recent months.

Austin has been on the leading edge of the high-tech boom, and San Antonio hasn't been far behind, either. The Dallas-Fort Worth Metroplex also has been strong, in part because of strategic location and transportation advantages, particularly the Dallas/Fort Worth International Airport.

Texas border towns boomed in the years leading up to the passage of NAFTA and in 1994—the first full year of the agreement. Of course, the Mexican peso crisis has hurt Texas somewhat in 1995, especially in towns along the border.

Keeping in mind that Texas has performed slightly better than the U.S. economy as a whole, let me review briefly the recent performance of the American economy.

According to the National Bureau of Economic Research, the recovery from the last national recession began in April 1991. The recovery was sluggish at first, especially in terms of job growth. For a while, pundits were calling it a jobless recovery since output growth was propelled more by productivity increases than by job growth. But that's ancient history now.

By recent standards, output growth has been fairly good for the past three years, and job growth has been pretty good for more than two years. By both measures, 1994 was the best of recent years.

Real Gross Domestic Product (GDP) grew by 4.1 percent. Total employment grew by 3.5 million workers. The year ended especially strong, with real GDP increasing at an unsustainable 5.1 percent rate in the fourth quarter and with the unemployment rate down to 5.4 percent.

Consumer inflation remained unchanged in 1994, although the year-over-year inflation rate bottomed out early in the year and backed up later in the year and into 1995.

The Consumer Price Index (CPI) increased 2.7 percent in 1994 (December to December), the same as in 1993 and slightly less than in the previous two years. The past four years have been the best years for price inflation since the early 1960s. The "misery index," the inflation rate plus the unemployment rate, was also the best in 1994 since the early 1960s.

Economic activity moderated in the first quarter of 1995 and slowed further in the second quarter. Inflation also picked up in the early months of the year but fell in the middle months. 1995 inflation now promises to be about as low as 1994 inflation.

The slowdown in the first half and the prospects for further moderation of inflation enabled the Federal Reserve to ease pressure on bank reserves in early July with a quarter point reduction in the Federal Funds target rate, the first easing move in three years.

Most private forecasters expect some strengthening of economic activity in the second half. The unemployment rate for September stood at 5.6 percent.

The importance of Mexican trade to the U.S. economy is illustrated by the fact that Dallas Fed economists estimate that the turnaround in Mexican trade in the first quarter of this year trimmed 0.75 percent off the U.S. GDP growth rate. Instead of growing 2.7 percent in the first quarter, we would have grown roughly 3.5 percent if our net exports to Mexico had not declined. The second quarter would have been about a half percentage point stronger—1.8 percent instead of 1.3 percent.

While we don't have precise estimates by state, we estimate that foreign trade with Mexico is about four times more important to Texas as to the United States as a whole. There is no doubt that the impact on Texas has been severe, especially along the border.

On the other hand, several mitigating factors have lessened the negative impact on the Texas economy. One was the fact that the maquiladora industry along the border received a relative boost from the peso devaluation with spillover effects north of the border. Also, petrochemical exports from Texas to the rest of the world have accelerated recently, as have exports of computers and other electronic equipment.

Nevertheless, the net impact of Mexican trade had been negative within the context of overall positive Texas foreign trade.

The Peso Crisis
One of the great tragedies of the peso crisis is that it occurred despite basically sound macroeconomic policies in the years leading to the major problems.

Privatization was continuing, the federal budget was basically balanced, Mexico had been opening its closed economy by joining the General Agreement on Tariffs and Trade (GATT) and initiating the NAFTA process. Mexican monetary policy, operating primarily through a strong peso policy, had brought inflation down from triple digits in the 1980s to about 7 percent in 1994.

It's true that Mexico had a large current account deficit that was financed—as it had to be—by an equally large capital inflow, but that pattern is not inappropriate to a developing country with good growth prospects. It is the same pattern the U.S. has in its balance of payments, which is much less appropriate for a developed country.

In the end, the Mexican authorities were forced to devalue the peso because political developments and uncertainties caused a reversal of the capital inflow and their exchange rate regime was too inflexible to adjust to the changing circumstances.

The pressure on the exchange rate and the reserves used to defend it began around March of 1994. Until then, the peso had been strong and the Bank of Mexico had been buying and accumulating dollars to hold the peso below the limit of its exchange-rate band.

Once the pressure reversed, the peso moved to its lower limit, and the authorities were forced to use their dollar reserves to support the peso. Since the capital outflow and the pressure on the peso resulted from political uncertainty, the authorities expected it to reverse after the elections.

To hold the line, they not only used their dollar reserves, but they began issuing government debt—Tesobonos—with a dollar exchange-rate guarantee. This was supposed to allay investor fears of a devaluation by giving them the guarantee and by putting the Mexican authorities in a position not to benefit from a devaluation—something economists might call "commitment technology," but Texans would call burning your bridges behind you.

Of course, burning your bridges may stiffen your backbone, but it does complicate matters if retreat becomes necessary. Obviously, the strategy didn't work, but it might have. Quarterbacking is always easier on Monday morning.

The attempt to devalue by a modest amount in December 1994 failed as market forces pushed the peso sharply downward. In order to prevent a downward spiral of devaluation, inflation, further devaluation and more inflation, the authorities imposed draconian fiscal and monetary measures to stabilize the situation.

The results for "financial Mexico" have been encouraging. Mexico's negative trade balance turned positive in February and its full current account is approaching positive territory. The peso, which had declined to 7.4 to the dollar, has been trading stronger than that recently.

Interest rates, which had exceeded 80 percent, are below 40 percent. The Bolsa, Mexico's stock exchange, has recovered a substantial portion of its early loss in peso, if not dollar, terms.

Of course, financial Mexico has benefited at the expense of real Mexico, although there was no choice in the matter. A sharp spike in inflation and a sharp decline in economic activity have resulted from the devaluation and its aftermath. Unemployment is at very high levels.

Monetary and fiscal tightness may have added to the near-term pain, but will tend to limit it over the long run as the price-exchange rate spiral is stabilized. When a country is forced to eliminate its trade deficit and capital inflow almost overnight, its standard of living is necessarily reduced under the best circumstances.

Policies that would prolong the adjustment would make more of an adjustment necessary. The most urgent requirement to restore economic health is control over the money supply by an independent central bank. That requirement is apparently being met.

Back to Texas for a moment. One of our finest Texas exports is country music. Tim McGraw has a new song, "Refried Dreams," that sums it up nicely for me. Like Mr. McGraw, "I'm messed up in Mexico, living on refried dreams."

About the Author Bob McTeer is president and CEO at the Federal Reserve Bank of Dallas.