California Currency? A taste of things to come unless Percora II helps us leave discredited economic dogma behind

Tuesday, 07/14/2009 - 2:02 pm by Marshall Auerback | 10 Comments

As California’s IOUs signal desperation, Roosevelt Braintruster Marshall Auerback suggests that a Pecora-style Commission could help the public recognize the folly of past economic dogmas that led us into this mess.

At first glance, there would appear to be little connection between California’s mounting fiscal crisis and the renewed calls for a new Pecora Commission. But just as the original Pecora Commission created the conditions for a final discrediting of the prevailing ideology that had led to the Crash of 1929 and the subsequent Great Depression, so too does California’s innovative response to its impending solvency crisis potentially provide a breakthrough which may indeed end the hegemony of today’s bankrupt economics, which helped to engender our current financial crisis. The two are also related insofar as that it is only by holding wrongheaded ideas up to public scrutiny that one can create the political momentum to sweep them away once and for all. In both the 1920s and the earlier part of this decade, cozy little deals made outside the public spotlight amongst a group of privileged insiders created a climate which facilitated corporate predation and political corruption.

So let’s look at California today within the context of a political climate calling for a Pecora Commission II. According to the San Diego Union-Tribune, Republicans and Democrats alike embraced legislation last Friday that would make California IOUs legal tender for all taxes, fees and other payments owed to the state - an action that effectively would mean that California is entering the currency business . . .

While it might appear that the new law seems merely to allow California to deficit spend just like the Federal Government - in actuality, the effect is far more profound than that. Allowing the IOUs to be an acceptable payment method for state taxes, instantly imparts value to them - in effect, what you have is a state creating a sovereign currency right under the noses of the Treasury. They are stumbling their way into it, and as they do so, some of the true nature of contemporary money is being revealed. It will be viewed as a stop gap measure at first, and then could very well become entrenched as states realize they have a way to escape balanced budget requirements.

The legislation is below:

AMENDED IN ASSEMBLY JULY 1, 2009
AMENDED IN ASSEMBLY JUNE 29, 2009
AMENDED IN ASSEMBLY MAY 14, 2009
california legislature-2009-10 regular session
ASSEMBLY BILL No. 1506
Introduced by Assembly Member Anderson
(Coauthors: Assembly Members Adams, Bill Berryhill, Tom
Berryhill, Duvall, Fletcher, Gaines, Garrick, Hagman, Harkey,
Jeffries, Knight, Logue, Miller, Nestande, Niello, Nielsen, Silva,
Smyth, Audra Strickland, Tran, and Villines)
February 27, 2009
An act to add Section 17203.6 to the Government Code, relating to
state funds, and declaring the urgency thereof, to take effect
immediately.
legislative counsel’s digest
AB 1506, as amended, Anderson. State funds: registered warrants.
Existing law prescribes procedures for the issuance of registered
warrants and provides that a registered warrant is acceptable and may
be used as security for the performance of any public or private trust
or obligation.
This bill would require a state agency to accept, from any person or
entity, a registered warrant or other similar evidence of indebtedness
issued by the Controller endorsed by that payee, at full face value, for
the payment of any obligations owed by that payee to that state agency.
This bill would declare that it is to take effect immediately as an
urgency statute.

Contrary to most conventional economic thought, whereby people think we pay taxes to create revenue, in fact, it works the other way around under a fiat currency system (where paper money is declared by the government to be legal tender, rather than being backed by gold or silver). The government doesn’t need money to spend, but in fact uses tax to manipulate aggregate demand, not raise funds to “pay” for government. The tax is what gives the currency its value insofar as taxes function to create the demand for federal expenditures of fiat money, not to raise revenue per se. Value has been given to the money by requiring it to be used to fulfil a tax obligation, but the money is already in existence, not “created” by the revenue.

Most significantly, the Federal government retains this monopoly under our existing monetary arrangements. If California is successful here in allowing its IOUs to pay tax, it has profound constitutional ramifications. It certainly means considerably less muni bond issuance in the first instance, if the proposal passes constitutional muster.

It will be interesting to see what the exchange rate is between California IOU and US currency - the IOUs do offer a yield, so should be less than par by design. I wonder if NY is next.

This is like some sort of return to the 13 colonies with all kinds of ersatz currency floating about. It’s hard to believe the Rubinite wing of the Democrats will just let it be, given the threat it represents to Wall Street’s prevailing economic interests, but it is an understandable response to a federal government which continues to champion the interests of the rentier class above the vast majority of Americans by emphasising “fiscal sustainability” and destroying aggregate demand in the process.

There are political benefits for Obama to rid himself of the shackles of conventional (and wrongheaded) economic thinking: If the Federal government allows this proposal of the state of California to go unchallenged, it would relieve the President of a major political quandary, which is, does he help California and then open himself to aid requests from other states? (Which his advisor, David Axelrod doesn’t want), or, does he let California go and lose 56 electoral votes in the next election?

By allowing Californians to “solve” their own problem in the manner proposed by the legislation he avoids the quandary. And given that, from a money paradigm at least, he and his team probably don’t know how destabilizing (to the current system) this is, they just might let them do it until the import is fully understood.

It is true that this legislation represents a profound break from all federal laws. It is almost bound to incur some sort of constitutional challenge, representing as it does, a profound threat to the Federal government’s currency monopoly powers. But this is another instance where Obama’s inattentiveness to the ramifications of the states’ respective fiscal crises has come back to haunt him. This situation would not have arisen had Obama embraced a simple revenue sharing plan with the states (so that the states’ respective fiscal policies would be working in harmony with his proposals, rather than mitigating the impact of the Federal fiscal stimulus), as recommended by any number of prominent economists, such as James K. Galbraith of the University of Texas.

It will be interesting to see how this plays out. As California goes, will the nation follow? Will we ultimately be confronted with the spectacle of “President Schwarzenegger” trying to legalize the drug output of the Emerald Triangle so he can tax it, thereby enabling us to shut the borders on the rest of this mess? Arnold always wanted to be President, but the Constitution would need to be changed. Maybe this is his path to President of the 8th largest nation?

So how does this relate to the Pecora Commission? California is moving, albeit tentatively, to embrace much more radical measures than we have hitherto seen from an administration which came into office promising “change we can believe in”. Yet as Kevin Baker noted in his recent Harper’s magazine piece, “Barack Hoover Obama; The Best and the Brightest Blow It Again“:

“The most appalling aspect of the present crisis has been the utter fecklessness of the American elite in failing to confront it. From both the private and public sectors, across the entire political spectrum, the lack of both will and new ideas has been stunning…Much like Herbert Hoover, Barack Obama is a man attempting to realize a stirring new vision of his society without cutting himself free from the dogmas of the past–without accepting the inevitable conflict. Like Hoover, he is bound to fail..”

And fail he will unless Obama begins to understand that the economic dogmas of the past 25 years have been fully discredited. That is the message from California, even if it is not seen as such by most of our feckless leadership. A properly constituted Pecora Commission would help to uncover this and provide the political impetus for our President to adopt a more radical course, which is what the times demand, but which he has hitherto been reluctant to embrace. The original Pecora Committee’s findings helped change the political mood, and laid the groundwork for the sweeping reforms of Roosevelt’s New Deal. Assuming this is not a whitewash, a properly constituted “Pecora Commission II” could have the same sort of dramatic effect. The alternative will be significantly more social unrest and many more radical initiatives from states like California, where reform is embraced from the bottom up and forced on the plates of these windy, politically-compromised satraps who still operate with discredited economic dogma which should be discarded into the dust bin of history.

Perhaps the courage it takes to make great leaps into the unknown is quite rare, and Obama would rather reconcile than radicalize. The Rubinites clearly got to him before the likes of James Galbraith and crew could, and the state of misinformation or ideology in the understanding of economic and financial systems of American citizens is such that Obama would have needed to be convinced and of a clear mind about functional finance and third ways before he took office if he was going to play a lightning rod role in shifting popular misconception at the pace required to confront the debt deflation challenge head on. In the meantime, crumble and decay look ready to rule the day for this old empire. A Pecora Commission could facilitate the education process.

Or maybe California’s IOU experiment points to a different way: a devolution of power to the city, state and regional level, with the more adventurous regions willing to take their own futures in the their hands, leading the way. Maybe out of all of this comes a cultural shift from money maximization to something more civic minded, or at least more aware of our interdependence. That is the hopeful outcome, but something far worse could easily occur as well. The escalation of desperation is tangible in California and many other parts of the country, and soon the police forces will be smaller, as a consequence of state budget cuts. Let’s hope Pecora II leads us in a different direction.

Roosevelt Institute Braintruster Marshall Auerback is a market analyst and commentator.