Welcome to the Hotel, California

Greece is one of the famous European “PIGS”: Portugal, Ireland, Greece & Spain, the EU countries riddled in debt and run-away government spending.  We have “PIGS” right here in the United States.  California is the best example, because it is facing a perfect storm of out of control spending, deficits and a dysfunctional government.  What is happening in Greece today is a forecast of what will happen in California later this year.

Like the rest of the Euro-PIGS, Greece is a member of the Euro Zone.

When the Euro currency was adopted on January 1, 2002, many economists said that the currency union would crash and burn within a decade – when the first real monetary crisis arose.  That crisis has now arrived.  Originally adopted as the common currency of 11 European nations, it now serves as a straight-jacket for its 16 current members.  Here’s why.

There are two ways a government can manipulate its economy.  It can change its fiscal policy by spending more on government make-work and socialist entitlement programs.  When it does this, it has to raise taxes or borrow money to pay its bills. 

If the country is the United States, England, China or Japan, for example, it can also use its central bank, here the Federal Reserve, to change its monetary policy by creating more “reserves”: by printing up more money.  The central bank can then buy up the IOU’s of the government and inflate its way out of the debt by enabling the government to pay back its debts in the future using money that’s then worth a lot less.

The out-of-control Greek socialist government (and its “progressive” former center-right government) have been on a spending spree to mostly pay for union-controlled government jobs and their expensive benefits.  (Over 10% of Greeks are government employees).  In other words, the Greek government is a spendthrift.

Sound familiar?

If a government controls the printing up of its own currency, when it racks up huge budget deficits like the Greeks have done, the country’s bond rating collapses.  The Greek government deficit is running 12.7% of its GDP, and its national debt will exceed 125%  of its GDP by the end of 2010.  People and banks who might lend it money to buy its bonds fear that it won’t have the money in the future to pay them back. 

So Greece is forced to raise its bond interest rates – which measures the risk that the lender will be exposed to.  For Greece, this is very high indeed: over 2.5% above what Germany pays.

So, Greece must stop its irresponsible government spending, or raise its taxes to crippling rates, or print more money to pay off its future bills.  Throughout history, the politician’s solution has always been clear:  create more money.  The Greek Drachma would then drop versus the dollar or pound, and this devaluation of their currency – and loss of buying power – would partially equalize the problem by buying time to allow a more responsible future government to stop the run-away spending. 

Hard times would follow as everyone would be forced to tighten their belts and spend less.  Right. 

But there’s a problem here.  Greece doesn’t have Drachmas anymore. 

It uses Euros, and the printing of these is controlled by the European Central Bank – based in Frankfurt, Germany.  So Greece is dependent upon “the kindness of strangers”: the EU governments and the European Commission in Brussels bailing them out with massive loans.  Greece now owes €300 Billion ($419 Billion), for a population of just 11 million.  And their northern neighbors, especially the Germans, have been pinching and saving and working hard over the past decade while the Greeks have been living in a Mediterranean fantasyland Utopia of spend, spend, spend. 

Think the German’s are going to bail out Greece?  What will they get in return?  Unless they informally take over the Greek government and force the Greeks to live the hard-working frugal lifestyle of northern Europe, they know their money will be wasted.  This creates the problem economists love to call “moral hazard.”  Bailouts always work that way. 

This is the Achilles heel of Greece.  It’s a dysfunctional underachiever married in a monetary union to a virtuous overachiever, Germany.  And no divorce is legally allowed.

Next to fall will be Portugal, whose budget deficit reached 9.3% of its GDP in 2009, with a projected debt-to-GDP ratio of 85% in 2010.  Portugal also owes over $400 Billion with a similar population size of 11 million.   Then we have Spain, a country with 47 million people and a national debt of over $1.2 trillion, suffering almost 20% unemployment.  Interestingly, Greece, Spain & Portugal all had military dictatorships running their countries until the 70’s.  Then came the good-time socialists. 

Like dominoes, if Germany doesn’t prevent the first one from falling over, the next one will likely topple, and on it goes through Ireland and possibly Italy.  The Euro will be dead.  But if Germany does bail out Greece, this will likely simply prolong the agony and take the pressure off the socialist Greek government making real positive changes.  The moral hazard rot will set in throughout Euroland, and…the Euro will probably disappear.

Belt-tightening and fiscal responsibility is tough to do for socialists as nary a one has ever understood real-world economics.  And surely not one in 100 have heard of Ludwig von Mises, Friedrich Hayek, Murray Rothbard, and the other great Austrian School thinkers.  The creation of fractional-reserve funny-money central banks in the early 1900’s set the downward ball rolling.  And it’s moving faster and faster every quarter.

California is Greece writ large. 

The state has nearly 37 million people and a spendthrift dysfunctional legislature which is dominated by big-union lobbyists and special-interest groups.  These have forced cockamamie laws like mandating the poison MTBE to be added to the gasoline to “improve the air” (but destroy the drinking water) and bankrupting the two great investor-owned power companies PG&E and Southern Cal Edison (thank you Enron!). 

The result?  Gasoline costs, on average, 50 cents more per gallon than in the rest of the United States.  And electricity, which used to cost 6 cents a kilowatt hour, now costs from 12 cents to 42 cents per kilowatt hour for the homeowner.  State sales tax is a tad under 10% and income state taxes exceed 11% for the top taxpayers.  More taxes, please?

Add to the economic burden mandatory union laws, a bloated bureaucracy, and a socialist welfare system supporting legal residents and several million more illegal aliens (including between 26% to 44% of prison inmates). 

Top it off with anti-growth, anti-industry, anti-farming and anti-energy regulations and a passion for wasting money in unionized schools and you have the perfect fiscal storm. 

In spite of using every slight-of-hand trick known to politicians, the California legislature still couldn’t balance its $119 billion 2010 budget.  It’s shy $20 billion.  Today.  But by the end of the year, it will likely be in the red by as much as $40 billion.   Meanwhile California’s roads are falling apart as the state has seized the gasoline highway taxes to pay instead for its government salaries and socialist spending programs.

In 2010, the California government now owes a staggering debt of $3.3 trillion.  This is 220% more per person than the out-of-control US federal government owes.   Like Greece, California is broke, and is having a problem selling its government bonds into a skeptical market.  Also like Greece, the rating agencies have knocked down its credit rating, making the cost of borrowing money more expensive.  This creates an ever-downward spending-borrowing spiral.   Finally, like Greece, California can’t print up its own money to inflate its problems away.  Like ancient Greece, is California too doomed to fall into slavery?

Oh, what to do?

Perhaps like modern-day Greece, California can turn forlornly to Big Brother to bail it out.  In this case, that’s Washington. 

But Federal money comes with federal strings, and California will have to give up its political control over its own destiny when this happens. 

Moreover, the Feds don’t have the money.  With wacky healthcare trillion dollar spending schemes and wackier “cap and trade” kill-jobs schemes, and failed “stimulus” schemes, Washington’s professional politicians-for-life are worried about being caught out by an increasingly angry voting public.  This includes, Republicans, Independents and even Democrats – whose blue-collar workers are increasingly finding themselves in the unemployment lines. 

Then there’s Texas. 

Why should the hard-working people in Texas bail out the Mediterranean spendthrifts in California whose motto is fun, fun, fun and spend, spend, spend?  They won’t.  And Texas votes will matter big-time in the next national election. 

Finally, California is not the only state in deep financial trouble.  What about the other 40+ states which are also suffering a fiscal meltdown?  Should the federal government bail them out too?  That’s another $250 billion in 2010, and every year forward.  And what about “Moral Hazard”?  It will infect every hemorrhaging statehouse just as it has infected Washington.

So where goes Greece will likely go California.  Two peas in a socialist pod. 

Will the Germans bail out Greece and save the EU from the abyss for another few years?  What will Washington do?  My bet is that they’re going to “kick the can” down the road one again.  Then it won’t be our children whose future lives we will have destroyed.  It will be our grandchildren — if our children, like the Europeans, can afford to even have a future.