So Goes the Nation

It has often been said that California is a trendsetter among states – anything that comes to pass in Cali will eventually find its way throughout the nation and into federal policy.  From social movements to Hollywood and internet first-adopters, there’s always been a sense that the future was already happening on the west coast.

If this maxim, “As California goes, so does the nation” proves to be correct again, then the rest of us had best pay some attention to the current financial crisis and how the politicians have chosen to deal with it.

Faced with rising costs and declining budget revenue, they’ve indirectly chosen a solution out of fear of making tough decisions.  The printing presses have literally been fired up, and the state is issuing IOUs.  While these are technically bearer bonds paying at 3.75%, the state is rumored to be printing them on dark green paper and encouraging banks & businesses to treat them like cash.

And How Far We’ve Gone

For most of America’s history, cash has been backed by some sort of commodity.  Gold has long dominated as a medium of exchange, and silver has also been used as payment for paper notes.  FDR figured out to devalue the dollar for a more flexible monetary policy, but Nixon figured out how to get Americans to give up all the tangible value of their money itself.

With no commodity backing the currency, the only thing that stops California from ordering a few trillion from the Treasury is political will and a fear that we’ll eventually go “too far” and ruin the dollar’s reputation as a reserve currency.

Let’s be honest anyway, someone who had invested in dollars under the gold standard would be brutally unprepared for something like retirement.  Other nations have been sending “stuff” to America in exchange for these dollars, so they’re the ones taking the investment losses.   Some have started inflating their own currencies in defense (see Japan’s carry-trade), some are also openly calling for a new monetary regime. With financial heavy-hitters like Russia, India, Brazil, and China meeting to discuss alternatives to the dollar, this dollar reserve reckoning day seems like it may be closer than we’d like.

So instead of being paid in a dollar that is literally “as good as gold,” residents of California will be receiving a debt promise – and the interest on that debt is going to come out of the future taxpayer’s pocket… somehow.

Heads or Tails?  The Bank Wins

If the government itself is in a cash crunch, who has the liquidity on hand to give state workers real cash in exchange for their state IOUs?  Conveniently, we’ve just pumped a few trillions of liquidity in to the banking system and these banks are more than happy to trade IOUs for dollars.  By some accounts, transfers and insurance policies have added five or six trillion dollars to banks’ balance sheets, and they’ll be able to use this money to buy up as many IOUs the states can print out. Of course, the banks were supposed to use this TARP & bailout money to extend business & consumer credit, but those individuals and small groups seem like a big risk compared to the state itself…

Eventually, California will figure out how to raise taxes or cut services (or probably some combination of the two).  In the meantime, the banks will collect a nice stable interest payment in a chaotic economic environment. Indeed, we’ve fallen a long way from paying workers out in gold – we’ve leveraged our paper treasure against our own citizens for the benefit of the banks.

Can We Break the Spiral?

Financial dissent is our secular heresy:  of all the thoughtcrimes, perhaps none is so shocking as questioning the nature of what we call modern capitalism.  As a society, we have invested so much collective faith into this abstract concept that we are unwilling to reform the root causes and financial power centers – even if they are relatively new institutions that conflict with older parts of our national identity.

Its never even clear what it is that we have faith in.  Is it the politically connected speculators or the regulators handing them our tax money?  Either way, solutions must be kept on the edges of their playground – suggesting significant core reforms is a sure-fire way to be uninvited from offering your opinion next time.  As long as this paradigm rewarding blind faith holds, things will continue to decline in a slow and methodical way.  At the next wave of mortgage resets, there will be another rather steep cliff, but odds seem high that we’ll cushion the banks and resist substantive changes.

Its not a great outlook, but I don’t believe anything can get significantly better until our so-called leaders take on some of these tough decisions and set up institutions designed to promote general wealth and opportunity.  Fundamental changes in our approaches to credit and money has to pay bigger dividends than bailing out the same bank for the fourth time…