Thread: California is turning to funny money to solve crisis

California is turning to funny money to solve crisis

California is short on cash so it plans to issue IOUs instead.

By Robert Cyran
Published: 8:16AM BST 02 Jul 2009

The last time it did so, most banks accepted the scrip at face value. This time, in light of the state budget woes and economic crisis, banks may demand a discount – hurting anyone paid with these promises.

The problem is simple. California doesn’t have enough money coming in to cover outlays. Since the government refuses to borrow to cover expenses, and the legislature can’t agree on how to balance the budget, it simply can’t pay all the bills. So it will issue an estimated $4.3bn worth of IOUs this month. If the crisis extends further, it will print even more.

When this last happened in July 1992, the result was a damp squib. Banks happily bought the IOUs at par because the crisis was widely regarded as political theatre and the notes paid interest.

The likes of Bank of America and Wells Fargo have yet to say how they will handle the new crop of IOUs. They have less capital lying around than they did during the last crisis. And California’s budget woes are more severe. Although it might annoy their customers, financial institutions might decide to pay less than par to compensate them for tying up limited capital in notes of uncertain maturity.

Moreover, scrip is inferior to cash. Only dollars are true US legal tender, and only the federal government can issue them. IOUs, on the other hand, can be issued by any municipality, business or person. And many do. Casino chips, gift cards, virtual currencies in online games and promissory notes from companies are all essentially scrip.

The problem is that, unlike dollars, banks and individuals are not obligated to accept IOUs. So these promises of payment tend to hold little value outside their user communities. A casino chip from Las Vegas is useless in Maine. Furthermore, a casino doesn’t have the right to levy taxes to back up the promise. Similarly, California currently has a limited ability to raise taxes without a referendum.

If banks do demand a discount, the unlucky recipients of this scrip – including some employees and suppliers – won’t find this funny money very humorous.

http://www.telegraph.co.uk/finance/fina ... risis.html

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