California leading the Nation

California has a history of “firsts”, first to regulate auto emissions, first to ban smoking in public spaces, etc. We are now about to witness another first, the first state to be forced to rationalize the role of government due to debt market restrictions. The following article describes California’s financial condition:

http://www.reuters.com/article/topNews/idUSTRE55F5VK20090617?feedType=RSS&feedName=topNews&pageNumber=1&virtualBrandChannel=0

The White House press secretary had this to say:

• "We'll continue to monitor the challenges that they have, but this budgetary problem unfortunately is one that they're going to have to solve," Gibbs said.

This response is very interesting as up until now the Obama Administration has been ecstatic about loaning money and taking control of private enterprise. Why the sudden change of tactics? Why doesn’t the Obama Administration want to control California?

I think that some of the answers are contained in the above article, consider this quote:

• 
  Washington's view toward California is one more reason to not hold the state's debt, said Tom Tarabicos, a financial adviser at Wells Fargo Financial Advisors Network in Roswell, Georgia. "We're selling every California bond we can," Tarabicos said. "We don't like them."
  "Sometime next year you'll be able to buy California GOs somewhere around 7 percent or 8 percent," Tarabicos said, referring to general obligation bonds.”

Bond traders have had a prominent role in government policy since the founding of the nation. Consider this famous quote:

• 
  “You mean to tell me that the success of my program and my reelection hinges on the Federal Reserve and a bunch of f***ing bond traders?”
• 
  That’s how Bill Clinton responded in 1993, according to an account in Bob Woodward’s The Agenda, after his advisors told him that his ambitious economic plan had to be put on hold because of deficit jitters in the equities markets.

Two other examples: In 1896 presidential candidate William Jennings Bryan, for instance, railed against Wall Street’s “cross of gold” and decades later FDR threatened “to drive the money changers out of the temple.”

In my opinion the Obama Administration has recently realized that they have squandered their ability to borrow. There have been stern warnings from the markets but probably more importantly blunt words from primary lenders such as China.

The inability to sell more massive amounts of debt has forced the Obama Administration to talk about how it is going to pay for new programs. An example of this new “pay as you go” strategy is the current hoax being promoted about Medicare savings being used to pay for the single payer health care plan.

The inability of the Federal Government to raise the necessary capital to bail out California will now force that state to reduce government spending. This trend could sweep across the nation as other states fall deeper into budget deficits.

Will this trend materialize at the federal government level? The federal government seems to have run out of borrowing power, but they have the one capability that states do not, they can print money.

At some point the Federal Government will find itself in the same position as California. Additional borrowing will be prohibitively expensive. The options then will be to reduce government spending at the federal level or flood the world markets with US dollars.