Tuesday, July 07, 2009

California Budget Bust: The Nightmare Scenario for Democrats?

With California mired in a budget crisis,...a political impasse that makes spending cuts and tax increases impossible, Controller John Chiang said the state planned to issue $3.3 billion in IOU’s in July alone. Instead of cash, those who do business with California will get slips of paper...The California morass has Democrats in Washington trembling...If Obama’s health-care plan passes, then we may well end up paying for it with federal slips of paper worth less than California’s...The publicity surrounding the California debt fiasco almost assures his resounding defeat...It takes years and years to make a mess as terrible as the California debacle, but the recipe is simple. All that you need is two political parties that are always willing to offer easy government solutions for every need of the voters, but never willing to make the tough decisions necessary to finance the government largess that results...California has engaged in an orgy of spending, but, compared with our federal government, its legislators should feel chaste. The California deficit this year is now north of $26 billion. The U.S. federal deficit will be, according to the latest numbers, almost 70 times larger...Kevin Hassett, Bloomberg News, July 6, 2009

Is Hassett's doomsday view wishful thinking? If you've watched California over the last decade, a sequence of legislatures and governors suggests that Hassett is wrong, that, at least in the life-is-a-beach state, there is no longer any check on out-of-balance accounts. Indeed, detailed examination suggests that the legislature's in-house political encyclopedia doesn't include the phrases fiscal responsibility, balanced budget, or rational planning. A Federal bailout is more likely, I think, with the White House encouraging the Fed to simply buy the bonds issued to pay taxes that Californians showed in their votes on a recent public initiative that they are unwilling to bear. And bailout is what the one-party government in Washington views as the basic solution to all our problems. The doom, it seems, will be for you and me, as we see a dollar shrink in value as our taxes (and tax-related prices – see cap-and-cronyism) go up.

However, look at what's happening. If the White House and Congress decide to monetize the debt (print the money), whether for their ill-considered programs, or for federal debt, some previously happy consumers of American government bonds may decide that it's not worth the trouble. While China is still buying, signs are good that Japan and other major creditors are slowing their purchases down. If the Feds can't sell American bonds overseas, and domestic investors think the rate of return is worthless, that will put grave inflationary pressure on the dollar.

In the 1970s, when a similar policy was used to pick up the tab left behind by Johnson and the “veto-proof” majorities of Democrats in Congress for the Vietnam War and the Great Society, the cost, in a shrinking dollar and higher taxes, was borne mostly by Americans. As expensive as those bills were to pay, in terms of lost value to the dollar, they were modest compared to what irresponsible governments are expecting bondholders to absorb this time, whether the governments of New York, California, or that in Washington, DC. Explosive inflation, 10, 20, 30 percent a year, is political dynamite. Even 12% during Carter's Presidency overturned the government, bringing Reagan and a rightist thirty-year domination of politics. That carried us through the wealthiest era in American history, a good thing, but such a result is hardly guaranteed. You could look it up in histories of Germany and Argentina.

As such, Republicans shouldn't act like Democrats, and pray for an inflation disaster, because inflation after a certain level favors no party. When inflation in Germany exploded, it brought a fascist government that nearly wrecked the civilized world. When inflation in Argentina exploded in the 1950s, it brought a fascist dictator to power. Dictators are no better for business than the socialists. Argentina has never recovered from Peron.


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