As Goes California . . .

If you look hard enough, you can almost see the writing on the wall.

TheStar.com: California issues IOUs to avoid bond default

To conserve cash, state controller John Chiang plans to issue IOUs by today to vendors, local agencies overseeing health programs and various recipients of state aid – including the elderly and disabled and college students.

He plans to send $3.36 billion (U.S.) in IOUs this month to safeguard $10.9 billion for payments he must make, including money owed to investors holding California’s general obligation debt. “The general obligation bonds will be paid,” he said this week. “California has never defaulted on its debt obligation and we don’t plan to.”

The world’s eighth largest economy in 2006, according to its Legislative Analysts’ Office, now needs to reassure Wall Street.

State officials see the need to sell $7 billion to $9 billion of short-term debt to maintain cash-flow once there is a budget agreement.

George Washington Blog: An economy bigger than Russia, Brazil, Canada, India or Spain is about to Default

It might be useful to look up the phrase Patacon, which refers to the IOUs issued by the largest province in Argentina, just four months before it collapsed in 2001.

The Patacón (officially called Letra de Tesorería para Cancelación de Obligaciones de la Provincia de Buenos Aires) was a bond issued by the government of the province of Buenos Aires, Argentina, during 2001. The patacones were used to pay government bills, including state employees’ salaries during a period when the economic crisis caused regular currency (Argentine pesos) to be scarce. Patacones then circulated in the economy in much the same way as pesos.

First issued during the peso/U.S. dollar convertibility regime, just like other complementary currency Patacones could be attractive due to a revenue scheduled for payment in 2003 in pesos (practically equivalent to dollars). When the convertibility was abandoned amid fears of hyperinflation, the attractive of this revenue practically disappeared. The basis for the acceptability of complementary currency shifted to their use to pay taxes.

However, the value of Patacones became eroded as the series “B” was issued because as a way to put pressure on the Government to cancel a large debt, the company that printed them eliminated many safety features deemed too expensive, thus making them easier to counterfeit. Also, the revenue of series “B” was scheduled for payment just in 2006. The economic importance of Buenos Aires province ensured the acceptability of Patacones because there were plenty of large companies that found use for them as payment of provincial charges. Patacones were accepted outside the Buenos Aires province and eventually circulated (albeit informally) in border areas of neighboring countries.

If we look at this event as a milestone (or tombstone) in fiscal collapse, it might be four months before California’s mess filters through the rest of the economy. Maybe it’s a good thing the markets are closed today – the US doesn’t need an economic collapse heading into the July 4th weekend.

I’m not the only one who sees this four month rule at work:

Dr. David Bronner, CEO of the Alabama Retirement Systems, the 43rd largest investment fund in America, spoke at Rotary Club here yesterday. He is one of the most respected fund controllers in the United States today by his peers.

One of my grad school professors e-mailed me notes detailing what Bronner had to say:

1) Next month (July) California hits the wall financially, that will send a ripple effect across the US economy, AND over the next two years one state after the other will fall to it’s knees financially as the federal government stimulus package ends by 2011. It has helped various states at different levels comparative to their economic condition. He says the stimulus package is what’s been keeping the states alive for now…except for California which was in such terrible shape the stimulus package wasn’t enough to really help them. “They go first” he said. Alabama would hit the wall in February of 2011, late in the game as Alabama is in better shape than other states. Bronner says Alabama might dodge the bullet if the economy revives enough by then. But, he doesn’t really think things will improve enough by then to avoid a crisis.”It will be the largest economic crisis in the history of the State of Alabama.” Bronner says Alabama will experience such significant shortfalls by 2011 that taxes will have to be raised substantially to avoid collapse…probably on property. And that practically all states will face a similar fate.

2) Within 120 to 150 days from now the commercial real estate market nationally begins to collapse as stores, malls, and shopping strips, and industrial plant have enough closures (store and plant) and loss of rental revenue to make them unable to pay their mortgages. They will start going into foreclosure unable to pay their mortgages in a significant way at that time creating a second wave of economic disaster starting three to four months from now. LINK