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Jerry Brown's Legacy Train Wreck

California Governor Jerry Brown, along with an entourage of high-profile business and financial leaders from the Golden State, recently traveled to China on a trade tour. The agenda included government and private sector partnerships in electric vehicle production, trash-to-electricity technology, and green energy research and development.

But the tour’s main purpose centered on garnering Chinese financial interest in what Jerry Brown hopes to be his defining legacy: high-speed rail for California. (Embarrassingly for Brown, China indicted its former top rail official on corruption charges during the governor's junket.) China is currently sitting on $3.4 trillion in foreign exchange reserves. Traditionally, these have been invested in foreign government bonds. But in recent years, China has moved to diversify its holdings away from government bonds—which have been yielding historically low interest rates—and into more lucrative brick and mortar assets. Needless to say, the China’s banks and sovereign wealth funds would be fools to invest in Jerry Brown’s white elephant for several reasons.

First, the project’s estimated costs are ballooning before construction has even begun. Since a statewide ballot initiative in 2008 authorized the creation of a high-speed rail network, projected construction costs for the entire endeavor have ballooned from $34 billion. In a revised business plan published in 2011, the California High-Speed Rail Authority estimates construction will now cost $98 billion to $117 billion, and the estimated completion date of the full first section was pushed back by 13 years. In 2012, the rail authority claimed it found $30 billion in estimated savings, primarily by abandoning the initial full-build plan that would have required completely dedicated and electrified infrastructure and moving toward a “blended” model. Basically, this means the initial system will not be true 21st century high-speed rail, in that it will share tracks with electrified mass transit and trains relying on diesel motive power. The downward cost estimates are also the result of modified inflation projections that assume rates over the course of construction will be lower than previously assumed. These are the estimates before a single track has been laid.

Second, even if by some miracle California’s high-speed rail network is up and running at some point in the future (the expected completion date was pushed back from 2020 to 2033, and currently under the 2012 business plan stands at 2029), it is doubtful it could recoup its capital costs, let alone turn a profit for private investors. The profitability for any rail or transit project rests wholly on how many people decide to use this new mode of transportation. This is ultimately determined by how dense the area surrounding the rail network. Japan’s privatized Shinkansen system, for instance, is able to turn a profit. The country has a population density of 836 per square mile. Although the heaviest populated state in the union, California’s population density is a fraction of Japan’s at a pitiful 235 per square mile. Within 50 miles of the proposed line, the difference is even more apparent.

The final and most important reason for why the China’s sovereign wealth funds will not invest in Brown’s boondoggle is that these profit-seeking funds never had any interest financing high-speed rail. Since the start of construction in 2007, China’s Ministry of Railways has accumulated $340 billion in debts building 5,000 miles of high-speed rail infrastructure, the equivalent of 5 percent of China’s gross domestic product. Even with so many potential passengers, the network has delivered a return in 2011 of only $695 million. Because railroads require large capital investments long before the first tickets are sold, large profits are essential for private railroads to repay construction debts and pay for regular maintenance and operations. Lacking healthy profits, China’s high-speed rail network is currently kept alive by perpetual government subsidies. What interest would funds such as China Investment Corporation have in investing in such an unprofitable venture?

If Jerry Brown wants Chinese cash sunk into California’s proposed high-speed rail network, he should be soliciting the Chinese government for a welfare handout and not its sovereign wealth funds. These are institutional investors that are seeking the best return on their capital. They will provide as much funding to California’s trains as they gave to China’s own high-speed railways—zero.