The San Andreas Default?

The State of California is paying people with IOUs, because it is broke. Well, perhaps not broke (Willem Buiter points out its debt levels are comparatively trivial) but stuck with a broken political system. Like a lot of US States it lives under a formal constitutional requirement of having to balance the budget. But since its' political representatives can neither agree the formal definition of a balanced budget nor, especially, agree a budget which requires a 2/3rds majority in each of their two State houses, it is paying people with what Buiter calls 'funny money'.

Paul Solman summarises the impasse:

"California is desperate. Like so many of us, it lived beyond its means, or taxed below its spending, or both. Three classes are now resisting the reckoning: those who "spent" the money and owe the shortfall (taxpayers); those on whom the money was spent (employees, vendors, other recipients of state funds); and those who loaned the state money (bondholders). Understandably, no class wants to take the hit, or take the hit first. For political reasons at least, the Obama administration is reluctant to come to the rescue...."

Buiter reckons the only way out is direct rule from Washington, though the comment on his blog suggests he has a bit of a tin ear for American constitutional niceties and, ahem, 'States Rights' to coin an unfortunate phrase. (Which doesn't mean he can't still be right on this point). He says,

"When the banks stop accepting the IOUs except possibly at massive discounts, which will happen soon unless an early resolution of the budgetary stalemate is achieved, the state of California will close down for business. Municipalities and counties dependent on state funds will follow suit. Before long the teachers won’t teach, the fire fighters won’t fight fires, the police won’t maintain law and order and neither garbage nor taxes will get collected. It will be a grand Hobbesian experiment."

Hence his expectation of federal intervention.

But the really interesting question, at least for a saddo like me, is whether these IOUs constitute money. Mark Thoma discusses this point, and the comments on his post educate this Brit on one of the less well known passages of the US Constitution,

"Article I, Section 10 of the US Constitution:

Powers prohibited of States

No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit*; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility." (my emphasis)

So, on one reading, there's no need to wait for Willem Buiter's 'grand Hobbesian experiment': California has already declared Independence and it's time for Obama to send in the troops and restore the Union.