Jul 7, 2009

Currency currents

This article in WSJ (originally found from Uncle) is worth a close read. Short form: several large banks have decided to stop accepting California's state-issued IOUs.

Now, a brief lesson in currency. The US currency is the dollar. Various pieces of linen paper and chunks of metal represent multiples and fractions of that dollar. Each piece of paper or metal, however, is backed ONLY by the "full faith and credit" of the US Government. This is known as "fiat" currency. Beyond the intrinsic value of that piece of paper or metal, it is worthless. Once upon a time (yeah, this is a fairy tale) that slip of paper represented a piece of gold in a vault somewhere. In the 1930s, that ended...

Now, present day California has this to say:

State officials said they were disappointed by the banks' decision. Garin Casaleggio, a spokesman for Mr. Chiang, said: "We don't want anybody to suffer who can't redeem them when they need cash."

California's bond rating has already been reduced from A- to BBB. This is the lowest of the "investment" grade bonds, and one step above "junk" status. California is disappointed that banks aren't willing to assume the credit risk for a state whose financial rating is one step over "junk"?

Economics is a simple process, really: if you have revenues/income of "X", you have to spend LESS than "X" in order to remain solvent. Spending more than "X" is known as "credit" and involves someone else risking their own financial solvency on you. These banks have just been slapped hard by the federal government for taking risks beyond reason and "causing" a "collapse". Now California is whining that the banks won't extend them credit? I don't think so, Tim.

The interesting potential here - what happens when a large enough group of these folks gets together and files a class-action lawsuit for fraud? These IOUs are being issued for tax refunds and other state liabilities.

California is sliding down the spiral; my home state of New York probably isn't too far behind. I think it's time to adjust my tax withholdings to the minimum necessary to cover liability; I won't take an IOU.

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