Friday, July 03, 2009

California's IOU and Money Supply

I promised to write if something important happens while I am still on vacation. Something has.

California, deep in a fiscal hole, unable to get its State legislature to pass a budget, is issuing IOU's as a money substitute. Go to this link:

Why is this important?

Remember only the Fed can print money. If all the states in United States of America begin to print IOU's to finance their debt, then there is not just one printing press. There will be 50 of them.

Amigos, that's how Argentina got its world class financial crisis 7 years ago because the provinces began to do exactly what California is doing. The country lost its control of quantity of money issued.

Argentina's much ballyhooed 1 to 1 fixed peso to dollar link cracked under massive inflation and the debasement of its currency.

Paul Krugman, the noted Nobel laureate economist, tirelessly reminds readers in his NY Times columns that higher savings rate in the US would mean a firmer US dollar. That maybe so in normal times. Indeed, current higher savings rate is probably sustaining a dollar that should have been a lot lower given the massive amount of credit and money printed or committed by the Fed to pop up a variety of institutions.

However, the precedent set by California could be a game changer if the size of IOU's gets bigger and if other states follow the same practice.

Get ready to take your $ to the nearest bank and buy Euro or Australian dollar. So watch how thie IOU"s business evolves in the weeks and months ahead.

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