Thursday, May 27, 2010

The Inability To Monetize Debt: Why California And Greece Are Alike

The ability to monetize debt or, in other words, to print more money to cover overspending is something that is reserved for government entities that can float their own currencies. The United States practices this constantly. But, the downside is that the currency becomes less valuable (devalued) as more is printed and it takes more of it to buy the same product or service from one time period to the next.

When Greece stopped printing its own currency, the drachma, in favor of the euro (the currency of the European Union), it lost it's ability to monetize its own debt and keep its financial problems isolated from the rest of Europe. Now, Greece's financial woes will have to be shared by all the other Eurozone countries as the central bank of Europe, the ECB, prints more euros to cover Greece's problems. Just as when the U.S. prints more dollars, it takes more euros to buy anything because the currency is worth less. This is one of the many facets of the concept of "contagion" that Europe now faces. This, too, will be exacerbated if and when Portugal, Spain, Ireland, and Italy have to follow Greece in being bailed out.

For this reason, our own troubled states, like California, are a lot like Greece. California has no ability to monetize its debt. It can't print its own money. It can only float debt or reduce expenditures to fight deficit spending. Therefore, it is wholly dependent on the Federal Government to cover its losses if the state can't effectively implement an austerity program to avoid defaulting on its debts. So, in effect, we have our own Greece and many other Greece-like states sitting on our doorstep and "contagion" might also be our problem in the near future if places like California, New Jersey, New York, Michigan and so many others don't work their way out of the massive deficits they have created. Literally and economically, the U.S. could be a house of cards, just like Europe, if these states don't get control of themselves and avoid being bailed out by the Federal Reverse Bank or our U.S. Treasury.

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