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California on the brink of default

Jul 03, 2009

On July 1, 2009 the state of California ended its fiscal year $26 billion in the hole and decided to issue IOU's to pay debts owed. Other states may follow suit, because many are in the same financial trouble.


Recessions and depressions are caused by a shortage of money. Ironically, the Federal government has been going much faster into debt, partly by creating new money (last March), but mostly by inducing previously created money to return from abroad.

In other words, Americans buy foreign-made goods and send the money overseas. The foreigners go to the bank and turn dollars into their local currencies so they can pay their bills. The central banks, then, are stuck with a lot of depreciating dollars, so they have to spend them as quickly as possible before they lose too much of their value.

But they can't spend those dollars fast enough. So they buy U.S. bonds (our national debt). This repatriates the dollars, so that we can buy more foreign-made goods. And so the cycle continues.

But those countries are getting worried about default on the U.S. debt, and the situation with California is not helping the situation. More than that, however, is the fact that when the bonds mature, the return on their bond investment may look like they have received more money (at interest) than they invested, even so, the value of that money is less than the value of their original investment (because of inflation or devaluation of the dollar).

Yet they are forced to continue taking a beating, because if they let go of the tail of the tiger, they will be eaten alive. If foreigners stop buying our debt, the Fed will have to create an equivalent amount of new money out of nothing in order to fill the void. That truly would be hyperinflationary.

The current situation cannot last forever. With each passing month Americans are forced to buy cheap foreign-made goods, because American companies now use a huge amount of foreign labor to make the things that Americans want to buy. The "free trade" policies allowed this, and the moment the first company sent the jobs overseas, all of its competitors were forced to do the same in order to compete. Why? Because Americans love bargains more than they love American jobs. They want the personal privilege of buying a cheap product, but hope that everyone else will "buy American" at twice the price.

That will never happen.

Our "free trade" policies are a major cause of this situation. Free trade has created a business environment where it is not worth using American labor to manufacture anything that can be made by human hands. One may blame the unions, I suppose, for demanding higher ("unrealistic") wages, but unions were formed long ago as a reaction against the slave-labor practices of the big money men. I have no doubt that many union leaders themselves went to excess in their demands over the years. They did it in order to get elected by the workers who loved the new benefits they were getting.

"Free trade" was the inevitable reaction of the big money men, because they saw it as a way to maximize their own profits by lowering cost of production. This "solution" was short-sighted, because it was inevitable that the American consumer would eventually run out of money for lack of jobs. The shortage of money was then "fixed" by issuing huge numbers of credit cards. But once we hit those limits, the whole thing began to crash on the rocks of huge amounts of debt.

But now that our manufacturing base has been shipped overseas, we have little choice but to buy foreign-made goods, so the balance of payments continues to work against us. That is why foreign banks have no choice but to buy U.S. bonds and recycle dollars back to their American customers (consumers).

How long can this continue? I do not know, but it cannot continue forever, because recycling dollars is only a band-aid on the financial crisis. We may be able to bump along for a while, but day of reckoning will surely come at some point. When the first nation bolts for the door by dumping their dollars for other currencies, then all the others will be forced to follow suit. That will be the final end of the dollar. And I believe this will force us to take a new look at the economic system of the Kingdom of God.

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Category: Financial
Blog Author: Dr. Stephen Jones