California's empty Wallet: Turning crisis into opportunity!

Discussion in 'Economics' started by whitetiger, Jul 2, 2009.


    Ellen Brown, June 30th, 2009

    “Our wallet is empty, our bank is closed and our credit is dried up.”
    – Governor Arnold Schwarzenegger, June 2, 2009

    California State Controller John Chiang has warned that without a balanced budget in place by July 1, he will begin using IOUs to pay most of the state’s bills. On June 25, California Governor Arnold Schwarzenegger rejected a plan that would save the state $3 billion by cutting school spending, saying he would rather see the state issue IOUs than delay the funding problem with a piecemeal approach. The state’s total budget deficit is $24.3 billion.

    Meanwhile, other funding doors are slamming closed. The Obama administration has said it will not use federal stimulus money to prop up California; and Fitch Ratings, a bond rating agency, announced that it was downgrading the credit rating of the state, which already has the lowest in the nation. Once downgraded, California’s rating is likely to fall below the minimum level legally required for most money market funds, forcing the funds to sell their California bonds. The result could be a cost of millions of additional dollars in higher interest rates for the state.

    What to do? Perhaps California could take a lesson from the island state of Guernsey, located in the English Channel off the French Coast, which faced similar funding problems in the 19th century. Toby Birch, an asset manager who hails from there, tells the story in Gold News:

    “As weary troops returned from a protracted foreign war [the Napoleonic Wars ending in 1815], they encountered a land racked with debt, high prices and a crumbling infrastructure, whose flood defenses were about to be overwhelmed . . . . While 1815 brought an end to the conflict on the battlefront, . . . severe austerity ensued on the home front. The application of the Gold Standard meant that loans issued over many years were then recalled to balance the ratio of money to precious metals. This led to economic gridlock as labor and materials were abundant, but much-needed projects could not be funded for want of cash.

    “This led to a period of so-called ‘poverty amongst plenty’. . . . The situation seemed insoluble; existing borrowing costs were consuming 80% of the island’s revenues. What was already an unsustainable debt burden would need to be doubled to fund the two most essential infrastructure projects. This was when a committee of States members was formed . . . . The committee realized that if the Guernsey States issued their own notes to fund the project, rather than borrowing from an English bank, there would be no interest to pay. This would lead to substantial savings. Because as anyone with a mortgage should understand, the debtor ends up paying at least double the amount borrowed over the long-term.”

    To prevent an unwanted inflation of the money supply, the Guernsey States issued the notes with a date due, and on that date the bearer was paid in gold. The money came from rents on the finished infrastructure, supplemented with a tax on liquor. Birch goes on:

    “The end result of the Guernsey Experiment was spectacular – new roads, sea defenses and public buildings were established, fostering widespread trade and prosperity. Full employment was achieved, no deficits resulted and prices were stable, all without a penny paid in interest. What started as a trial led to a string of construction projects, which still stand and function to this day. Money was used in its purest form: as a convenient mechanism for oiling the wheels of commerce and development.”

    Like Guernsey, California is facing “poverty amidst plenty.” The state has the eighth largest economy in the world, larger than Russia’s, Brazil’s, Canada’s and India’s. It has the resources, labor, and technical expertise to make just about anything its citizens put their minds to. The only thing lacking is the money to do it. But money is merely a medium of exchange, a means of getting suppliers, laborers and customers together so that they can produce and exchange products.

    As has been explained elsewhere, today money is simply credit. All of our money except coins is created by banks when they make loans. The current crisis stems from a credit freeze that began on Wall Street in the fall of 2007, when banks were required to revalue their assets due to a change in accounting rules, from “mark to fantasy” to “mark to market.” Banks that were previously considered in good shape, with plenty of capital for making loans, suddenly came up short. Lending fell off, and so did the available money supply.

    Just understanding the problem is enough to see the solution. If a private bank can create credit on its books, so can the mighty state of California. It merely needs to form its own bank. Under the “fractional reserve” lending system, banks are allowed to extend credit – or create money as loans – in a sum equal to many times their deposit base. Congressman Jerry Voorhis, writing in 1973, explained it like this:

    “[F]or every $1 or $1.50 which people – or the government – deposit in a bank, the banking system can create out of thin air and by the stroke of a pen some $10 of checkbook money or demand deposits. It can lend all that $10 into circulation at interest just so long as it has the $1 or a little more in reserve to back it up.”3

    The 10 percent reserve requirement is now largely obsolete, in part because banks have figured out how to get around it. What chiefly limits bank lending today is the 8 percent capital requirement imposed by the Bank for International Settlements, the head of the private global central banking system in Basel, Switzerland. With an 8 percent capital requirement, a state with its own bank could fan its revenues into 12.5 times their face value in loans (100 ÷ 8 = 12.5). And since the state would actually own the bank, it would not have to worry about shareholders or profits. It could lend to creditworthy borrowers at very low interest, perhaps limited only to a service charge covering its costs; and on loans the bank made to the state, the state would ultimately get the interest, making the loans essentially interest-free.

    Precedent for this approach is to be found in North Dakota, one of only three states currently able to meet its budget. North Dakota is not only solvent but now boasts the largest surplus it has ever had. The Bank of North Dakota, the only state-owned bank in the nation, was established by the legislature in 1919 to free farmers and small businessmen from the clutches of out-of-state bankers and railroad men. By law, the state must deposit all its funds in the bank, and the state guarantees its deposits. The bank’s surplus profits are returned to the state’s coffers.

    The bank operates as a bankers’ bank, partnering with private banks to loan money to farmers, real estate developers, schools and small businesses. It makes 1% loans to startup farms, has a thriving student loan business, and purchases municipal bonds from public institutions.

    Looking at California’s budget figures, projected state revenues for 2009 are $128 billion. At a reserve requirement of 10%, if California deposited all $128 billion in its own state-owned bank, it could issue $1.28 trillion in loans, far more than it would need to cover its $23 billion budget shortfall. To lend itself the money to cover the shortfall, it would need only $2.3 billion in deposits and about $2 billion in capital (assuming an 8% capital requirement). What Sheldon Emry wrote of nations is equally true of states:

    “It is as ridiculous for a nation to say to its citizens, ‘You must consume less because we are short of money,’ as it would be for an airline to say, ‘Our planes are flying, but we cannot take you because we are short of tickets.’”

    As a card-carrying member of the banking elite, California could create all the credit it needs to fund its operations, with money to spare.
  2. Humpy


    The above post is very interesting to anyone interested in saving

    Cali, but could they ever agree on making a State bank ?

    Why haven't they tried this approach ?
  3. Is an IOU issued by the State Of California equal to money?
  4. That's the dumbest proposition I've ever heard. While the idea of a state bank is great, the reason for it at this time is absurd if not fraudulent.

    A state like California, which often gets itself into these situations would then use the 'bank' to fund everhigher deficits out of control. The problem is not one of liquidity, available paper money but of fiscal prudence. It's citizens spend too much, suck from the state too much, import too much and don't produce enough to cover it!

    Spend Less is the solution not some Ponzi bank scheme.
  5. A similar story:

    "The wars waged by Louis XIV left the country completely wasted, both economically and financially.

    Since, following the devastating War of the Spanish Succession, France's economy was stagnant and her national debt was crippling, Law proposed to stimulate industry by replacing gold with paper credit and then increasing the supply of credit, and to reduce the national debt by replacing it with shares in economic ventures.

    In May 1716 the Banque Générale Privée ("General Private Bank"), which developed the use of paper money, was set up by [John] Law.

    Law's pioneering note-issuing bank was extremely successful until it collapsed and caused an economic crisis in France and across Europe."

    Ellen Brown, May 26th, 2009

    “I understand that these cuts are very painful and they affect real lives. This is the harsh reality and the reality that we face. Sacramento is not Washington – we cannot print our own money. We can only spend what we have.”
    – Governor Arnold Schwarzenegger quoted in Time, May 22, 2009

    Christmas comes early, Governor. You CAN print your own money. Fiscally solvent North Dakota is doing it . . . and so can California. Now!!!

    In a May 22 article in Time titled “Billions in the Red: Fiscal Reckoning in CA,” Juliet Williams reports that since California voters have now vetoed higher taxes and further state government borrowing, Gov. Arnold Schwarzenegger has indicated that he intends to close the budget gap almost entirely through drastic spending cuts. The cutbacks could include laying off thousands of state workers and teachers, ending the state’s main welfare program for the poor, eliminating health coverage for about 1.5 million poor children, halting cash grants for about 77,000 college students, slashing money for state parks, and releasing thousands of prisoners before their sentences are finished. Schwarzenegger bemoaned the fact that the state could not print its own money but said it could only spend what it had.

    But the state can create its own money. After all, banks do this every day. Certified, card-carrying bankers are allowed to do something nobody else can do: they can create “credit” with accounting entries on their books. As the Federal Reserve Bank of Dallas explains on its website:

    “Banks actually create money when they lend it. Here’s how it works: Most of a bank’s loans are made to its own customers and are deposited in their checking accounts. Because the loan becomes a new deposit, just like a paycheck does, the bank . . . holds a small percentage of that new amount in reserve and again lends the remainder to someone else, repeating the money-creation process many times.”

    President Obama has also acknowledged that banks create money, through what he calls the “multiplier effect.” In a speech at Georgetown University on April 14, he said:

    “[A]lthough there are a lot of Americans who understandably think that government money would be better spent going directly to families and businesses instead of banks – ‘where’s our bailout?,’ they ask – the truth is that a dollar of capital in a bank can actually result in eight or ten dollars of loans to families and businesses, a multiplier effect that can ultimately lead to a faster pace of economic growth.”

    Money in a government-owned bank could give us the best of both worlds. We could have all the credit-generating advantages of private banks, without the baggage cluttering up the books of the Wall Street giants, including bad derivatives bets, unmarketable collateralized debt obligations, mark to market accounting issues, oversized CEO salaries and bonuses, and shareholders expecting a sizeable cut of the profits. A state could deposit its vast revenues in its own state-owned bank and proceed to fan them into 8 to 10 times their face value in loans. Not only would it have its own credit machine, but it would control the loan terms. The state could lend at ½% interest to itself and to municipal governments, rolling the loans over as needed until the revenues had been generated to pay them off. According to Professor Margrit Kennedy in her 1995 book Interest and Inflation-free Money, interest composes, on average, fully half the cost of every public project. Cutting costs by 50% could make currently-unsustainable projects such as low-cost housing, alternative energy development, and infrastructure construction not only sustainable but actually profitable for the government.

    If all this seems too radical and unprecedented to venture into, consider that one state has had its own bank for 90 years; and it has not only escaped the credit crunch but is doing remarkably well . . . .

    Only three of fifty states are now solvent, meaning they have the revenues to meet their state budgets; and one of them is North Dakota. It is an unlikely candidate for the distinction. It is a sparsely populated state of less than 700,000 people, largely located in isolated farming communities afflicted with cold weather. Yet since 2000, the state’s GNP has grown 56%, personal income has grown 43%, and wages have grown 34%. The state not only has no funding issues, but this year it actually has a budget surplus of $1.2 billion, the largest it has ever had.

    North Dakota boasts the only state-owned bank in the nation. The Bank of North Dakota (BND) was established by the state legislature in 1919 specifically to free farmers and small businessmen from the clutches of out-of-state bankers and railroad men. The bank’s stated mission is to deliver sound financial services that promote agriculture, commerce and industry in North Dakota. By law, the state must deposit all its funds in the bank, which pays a competitive interest rate to the state treasurer. The state rather than the FDIC guarantees the bank’s deposits, which are plowed back into the state in the form of loans. The bank’s return on equity is about 25%, and it pays a hefty dividend to the state, which is expected to exceed $60 million this year. In the last decade, the BND has turned back a third of a billion dollars to the state’s general fund, offsetting taxes. The former president of the BND is now the state’s governor.

    The BND avoids rivalry with private banks by partnering with them. Most lending is originated by a local bank. The BND then comes in to participate in the loan, share risk, and buy down the interest rate. The BND provides a secondary market for real estate loans, which it buys from local banks. Its residential loan portfolio is now $500 billion to $600 billion. Guarantees are also provided for entrepreneurial startups, and the BND has ample money to lend to students (over 184,000 outstanding loans). It purchases municipal bonds from public institutions, and it backs loans made to new farmers at 1% interest. The BND also has a well-funded disaster loan program, which helps explain how Fargo, when struck by a disastrous flood recently, managed to avoid the devastation suffered by New Orleans in similar circumstances.

    North Dakota has also managed to avoid the credit freeze, through the simple expedient of creating its own credit. It has led the nation in establishing state economic sovereignty. In California and other states, workers and factories are sitting idle because the private credit system has failed. An injection of new money from a system of publicly-owned banks on the model of the Bank of North Dakota could thaw the credit freeze and bring spring to the markets once again.
  7. I've been posting this message for months now on this board, no one really listens.

    The fact is that arguments of both proponents and detractors of a State bank have merit.

    A state bank would certainly halt the credit contraction and boost the economy in the short term, freeing consumers and businesses from the unproductive shackle of interest-debt.

    However, it would only put a band-aid on the long-term problem, which is unstoppable. Massive amounts of credit has been overproduced and overconsumed due to the relentless lending of banks over the past half a century. The money supply has expanded to unfathomable heights. The only reason hyperinflation hasn't been the result of such unquenchable credit is simply because consumers and consuming businesses are too awash in debt to stimulate the level of demand required for serious inflation in consumer goods. Further, higher levels of inflation force money out of consumption and into investment in equities, producing bubbles in asset classes on a consistent basis.

    With such a wholesome view of the monetary system, we can see that a state bank may alleviate the burden of interest-debt, but it will only hasten the arrival of massive amounts of inflation in the goods markets and even greater bubbles in the securities markets (why do you think equities have been raising for the past 3 months? The printing of money going on by the Fed is akin to a State Bank...).

    Inflation that has been laying dormant for years under the burden of debt.

    There is no easy solution to this problem, the only decent solution is to ban private, unaccountable, profit-maximizing entities (banks) from creating a single dollar going forward, and switching to responsible, transparent and accountable government-run banks.

    And hope the tide of inflation doesn't sink us, if we choose that option.
  8. Not all that dormant. Sure, if we accept the official government bilge which claimed "don't worry, be happy... inflation is only 2%"... when it was really closer to 8%, by my guess.

    So, now we have the "head in the oven, feet in the freezer... on balance, you're comfortable", scenario. Assets shrinking in value and wages declining... but many of the "things" we buy going up in price.
  9. I am talking about inflation over and above the 8% being dormant, I understand the government messes with the CPI.
    #10     Jul 2, 2009