Inflation Means California Default

APRIL 29, 2011


A March 24 Los Angeles Times-USC opinion poll indicated that 80 percent of likely California voters favored putting a cap on state spending.

That is a remarkable statistic that didn’t make the original headline in the Times about the results of the poll.  Instead, the Times thought that what was a headline story was that 53 percent of survey respondents supported “tax hikes to help close budget gap,” when only 9 percent actually stated they favored tax increases.

Due to overwhelming negative online comments to the Times’ boosterism for tax hikes, the Times had to post a second story online with a different headline about how the major finding of the poll was that 80 percent of those surveyed favored a state spending cap much more strongly than they did a mixture of budget cuts and tax hikes to fix the state budget.

Despite the slant in the reporting of the USC poll, this raises the question: How would it be best to get out of the current bear trap the state finds itself in of looming inflationary bond interest rates on any new debt? And doing so while running continuing deficits that do nothing to address a coming $500 billion public pension Tsunami equating to about a $20 billion hit per year out of the state General Fund.

The current policy to close the pension funding gap is to gamble, just as Orange County Treasurer Bob Citron did in the mid-1990’s, that pension fund returns will always go up at compound rates of about 8 percent or higher — with no occasional dips.  Such a high-risk policy is based on a false upward linear trend of investment returns instead of the peaks and troughs of investment markets. Orange County’s policy led to bankruptcy.

California’s pension funds are shooting for the moon and Gov. Moonbeam is not alerting the public to the risks involved in yet another fall in the Cal-PERS pension fund.

But are the people right about a state-spending cap? Would it help or hurt?

Contra Dan Walters, Real Cal GDP Declined

Dan Walters, the dean of California newspaper journalists, has written that plugging the $20 to $25 billion structural budget deficit would amount to scarcely 1 percent of our Gross State Product of $1.9 trillion.

But what Walters is reporting is the face amount of state output, not the real output adjusted for monetary inflation.  If we look at an historical chart of the amount of the state’s real economic output, the Gross State Product grew about 30 percent in the last 10 years, or 3 percent per year.

But inflation measured by the Consumer’s Price Index averaged 3.2 percent per year. Discounting the current $1.9 trillion state GDP by the Consumer Price Index of 3 percent inflation per year indicates that real state output declined about 2 percent over the last 10 years.

Instead of using the Consumer Price Index, if we use the Producer’s Price Index (PPI), inflation was 4.8 percent per year over 10 years, which indicates an 18 percent decline in real state GDP (4.8 percent — 3.0 percent = 1.8 percent; then multiply that by 10 years and you get 18 percent).

The Producer Price Index is a measure of inflation for producers of finished wholesale goods, partially finished goods, and commodities. The Consumer Price Index is a measure of inflation of retail goods.  In other words, the CPI is a measure of inflation to the buyer and the PPI to the seller.  CPI means retail inflation and PPI means wholesale inflation.

If the 2010s look like the 2000s, and suffer a negative 2 percent to 18 percent state GDP “growth,” that would mean that real GDP would decline to $1.2 to $1.4 trillion. And if that happens, we would be right back to where we started before the housing bubble of the mid-2000s — or worse.

Dan Walters failed to perceive this when he only looked at the apparently rising GDP number of $19.1 trillion unadjusted for inflation.

However, economist John Mauldin in a recent article, “Get Ready for the ‘Miracle’ of Compound Inflation,” asked what would happen if GDP growth tracked at 4 percent and inflation tracked at 4 percent per year over the next 10 years?

Under such a scenario, the face level of GDP for the entire United States would be $30 trillion, double the current number for 2011. Mauldin calls this a “roaring economy, except gas would be $8 per gallon.”  Everything that cost $1 today would cost $2, and health costs would likely be even more. Your pay or pension income would have to double to keep pace. California’s middle class might be wiped out or would have to flee.

Inflation is another way to say default

To help you understand this, let’s say your household has gone on a spending binge made possible by easy money loans and you no longer have enough money to meet expenses.  So let’s say you start multiplying your own money supply by cutting dollar bills in half and giving the grocer, your mortgage lender and your credit card banker half of a dollar bill for each full dollar owed. You do that to pay for everything instead of going into foreclosure and bankruptcy.

In other words you need to make your insufficient number of dollars spread farther so you start asking everybody to take 50 cents on the dollar.

But — your grocer, mortgage lender and banker start doing the same thing in reverse. They now want four half-dollar bills, or $2, for every full dollar owed because they don’t know how much your half-cut dollar bills are worth.

That means the value of the dollar has been diluted. You need more and more dollars to keep up.

This is inflation. It is just another way of saying that you are in default on your loans.

As Mauldin states it:

Higher inflation means…debt is easier to pay back, as nominal GDP is what we pay taxes on, not inflation-adjusted. Inflation is a tried and true method of dealing with too much debt. Inflation is also just another word for default, but it sounds so much better to the ear.

Lockyer Technically Correct

So when State Treasurer Bill Lockyer assures state bondholders that the state won’t default on its interest payments, he is technically correct. But if you are a bondholder making 5 percent interest and inflation rises to, say, 6 percent, you are losing 1 percentage point in real terms.  The amount you invested in bonds is being plundered.

This is why the Average Citizen and the state keep talking past each other when it comes to the issue of whether the state is insolvent. The Average Citizen keeps charging that the state is bankrupt. And the state keeps saying it isn’t.

What the state doesn’t tell you is that its policy is just to inflate its way out of default by paying off its debts in cheaper dollars.  Since California can’t print money like the federal government, it is going to inflate the wholesale price of everything by increasing electricity rates for Green Power, tacking a pollution tax on everything under what is called cap-and-trade regulations from AB 32, and inducing wet-droughts that pump up water rates.

All under the guise of global warming. Global warming is a euphemism for monetary inflation, but not inflating temperatures.

Citizens Support Spending Freeze

So the Average Citizen’s overwhelming support for a state spending cap is a viable solution to the state budget and bond crises. The Average Citizen has a better hunch about what would work than do the elites who put out booster opinion polls for higher taxes and California’s great weather.

This is probably because Californians know what works in managing their household finances when money gets tight. But don’t expect Gov. Moonbeam and his legislative lunar modules to freeze anything in a state impacted by “global warming.”



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  1. Stanley K
    Stanley K 29 April, 2011, 16:36

    Great article. Unfortunately it paints a very scary picture of Californians’ future if we proceed as usual. But how can we proceed as usual? Apparently at least 80% of Californians recognize that we cannot. And when 80% of Californians are saying the same thing, it’s time for Gov. Brown to LISTEN. A reasonable first step, it seems to me, would be an emergency suspension of AB32.

    Reply this comment
  2. EastBayLarry
    EastBayLarry 30 April, 2011, 07:56

    If only we could expect “A reasonable first step…”. Historically, when was the last time our state government responded favorably to the will of the people? The very existance of AB32 puts most of the reasonable first steps in the hands of the bureaucrats who have a vested interest in AB32 being implemented.

    Reply this comment
  3. Stanley K
    Stanley K 30 April, 2011, 12:02

    To EastBayLarry:
    I agree with you of course. But to put it in the most general and simplistic terms possible, let me ask you this: Does Governor Brown really have a choice? Unless he wants a ruined California on his hands, he must do what is necessary to avert disaster. He must use his limited executive power and (dubious) figurehead status to actually BE public-minded and to actually DO what is best for the future of the people who live in this state, not just the selfish and destructive folks who paid to get him elected. Does he really want to be the ex-Governor of a ruined California?

    Reply this comment
  4. Wayne Lusvardi
    Wayne Lusvardi 30 April, 2011, 13:18

    It is my understanding that Gov. Cuomo is doing in New York what Gov. Brown apparently won’t do in California – reduce state spending and eventually put a cap on it.

    If Brown and his Brownies in the legislature are going to intentionally inflate the wholesale price of everything and tax the retail price of water, but doesn’t put a cap on the state budget, there may be no budgetary recovery. For years we have been standing still but no one has reported on it because the low interest rates of the Bubble covered it up.

    Go to the following link for the article “Five Things You Need to Know About Visualizing State Debt”

    The link has interactive graphs from the Census Bureau that show California has the same amount of revenue as it did in 1998!!! Click on each graph and watch the time trends.

    Reply this comment
  5. RObert
    RObert 2 May, 2011, 09:19

    Intellectual drivel….until you adjust taxes to include contibutions by those not paying income taxes and making all citizens pay fees for gov. services, copays on health services and work details for those in jail you do not reach OUR REALITY….we pay way too much for goverment and the welfare state.

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