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California's Crisis of Consumer Democracy

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California's fiscal crisis says as much about the state of the American Dream as it does about the state of California's economy. And it is related in a fundamental way to the sub-prime mortgage/Wall Street meltdown that has brought the country to its knees over the past year.

De-leveraging the American Dream will not be easy. America's crisis is not at root a banking or financial crisis. It is a crisis of consumer democracy. We have become a diet-coke civilization. Just as we want sweetness without calories, we want consumption without savings, we want good government without taxes; and, lately, with hedge funds and derivatives, we have wanted wealth creation without real production.

California, ultimate home of the American Dream, illustrates the point. We have not built serious
infrastructure here since the late 1950s and early 1960s when we organized a vast college and university system, brought water from the wet north to the parched south and built (for better and worse) the extensive freeway system -- all with higher taxation than the state has today. And, of course, with higher growth that followed in its wake.

In the 1970s we had the tax revolt. Prop 13, which limited property taxes is still considered the Third Rail -- the untouchable subject -- of political debate. Yet, through various direct democracy propositions over the years, voters nonetheless mandated all kinds of spending from schools to prisons without a parallel mandate for funding. With the shrinking of any public dimension of the good life, the American Dream was atomized into the possession of the single family home. Cheap credit, fueled by Chinese liquidity and low Fed rates, rather than domestic savings, financed that bubble, which finally burst.

So, today, along with the housing crash, California is in fiscal ruin. Prisoners are being released, teachers are being laid off and health care for poor children slashed. IOUs instead of cash are being dispensed to the elderly who need care. With a damaged credit rating, it is inordinately expensive if not impossible to raise funds in the still nearly frozen capital markets. The federal government refuses a bailout.

There are peculiarities that make California a special case. My former bosses (Governor Jerry Brown and his chief of staff Gray Davis, who later became governor himself) are fond of reminding whoever will listen how marginal the governor really is to governing California. "If it doesn't snow in the north (where the water melt from the Sierras slakes the state's thirst) or if the national economy goes south, then whoever is governor is screwed." Schwarznegger, however, is the first governor in modern times to actually make it even worse than usual. He won his first (recall) election against the former governor, Gray Davis, by calling for a repeal of the car tax. That was the most progressive tax in California: the rich paid more for expensive and more valuable cars, the poor less. That repeal cost the state $4 billion a year. Do the math: Schwarznegger's term in office x $4 billion roughly equals $26 plus billion deficit -- the current gap. And now, as part of the attempt to close that gap, the tax has been reimposed and increased in the midst of the biggest recession since the Depression!) Also, of course, the 2/3 vote requirement to pass a budget in the state legislature paralyzes policy because a small minority can, and does, block any solution.

For anyone who is watching, California's accumulated, inertia-driven insolvency is the writing on the wall for those -- the Chinese mainly -- to whom the US is seeking to sell $1.8 trillion in government bonds to finance the current stimulus package and private sector bailouts.

California's fiscal quagmire is surely giving them pause about the solvency of government in America. Will they only be paid in the end 25 cents on the dollar like GM's bondholders? If they don't buy up the bonds, then the Federal Reserve must, thus, effectively, print money wildly by buying up the bonds itself, leading to inflation and the plummeting value of any dollar holdings -- of which the Chinese already have nearly $2 trillion. When Treasury Secretary Geithner assured a student audience in Beijing recently that China's investments in America were safe, he was greeted with a broad round of cynical laughter.

No doubt the Obama administration is sincere when it says it knows the task ahead is to return to fiscal responsibility once the crisis has passed. But, just as central planning and labor market rigidities hobbled socialist societies, the rigidities of the consumer ideology hobble America's hope of getting out of this crisis. Do we have a political system that has the fortitude for tax increases once recovery has stabilized, or are we condemned by the rigidities of consumer democracy to a long bout of corrosive stagflation? This is the truly big issue for Americain the coming decade. What happens now in California will offer a big clue as to whether we can, as a society, kick the diet-coke habit and come back to reality.