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Tuesday, June 30, 2009

California meltdown

http://www.latimes.com/features/health/medicine/la-ed-budget8-2009jun08,0,7552895.story

Time for California to pay the piper. There is a theme here which is not unique to California. Why is California broke? It is rather simple. They are attempting to live beyond their means. The largess which the state of California desires to bestow is limited by the how much stuff (goods and services) are produced. No matter who is elected they cannot change the iron rule of scarcity. You cannot allocate and distribute what has not been produced.

Prosperity depends upon people getting up in the morning and being productive. You cannot legislate around this. The state of California is like many of its citizens(and this is certainly not unique to California). It has borrowed against the future to pay for wants in the present and the bill on the credit card has come due. Throughout the country citizens have pulled equity out of their home mortgages to pay be immediate enhancements on the assumption that their assets will be more valuable in the future and future borrowing against inflated asset values can be used indefinitely to pay for present consumption.

Governmental spending works the same way. There is a limit to how much you cna borrow against future earnings in terms of taxes to pay for current consumption. Otherwise the model for financial success would be unfettered borrowing. I believe we are seeing a financial tipping point analogous to when individual borrowers can no longer find entities to finance their unsustainable spending. When key states like California, Arizona, and New York insist on borrowing massive sums of money in order to close present budget gaps, who will lend them these funds if they are concerned about defaults? Is this where you want invest your retirement nest egg?

What will be the result of California issuing IOU's in lieu of payments for promises given? Who will be first in line to get paid? What happens to faith and trust when some do not get paid? The ripple effect will extend substantially beyond those directly impacted financially.

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