The grim news on the state front keeps piling up. I am confident that every state is in fiscal trouble so expect to see headlines like these for quite some time to come: California May Pay With IOUs for Second Time Since Depression.

California, the world’s eighth largest economy, may pay vendors with IOUs for only the second time since the Great Depression, State Finance Director Mike Genest said.

In a letter to legislative leaders Dec. 2, Genest said the state “will begin delaying payments or paying in registered warrants in March” unless an $11.2 billion deficit is closed or reduced. California, which approved its budget less than three months ago, may run out of cash by March, state officials say.

Governor Arnold Schwarzenegger warned that he may issue the warrants, which are a promise to pay with interest, to suppliers and contractors as the seizure in credit markets may make it too costly to borrow.

“It’s getting worse very quickly,” Schwarzenegger, a 61- year-old Republican, told reporters Dec. 1 after declaring a fiscal emergency and ordering the Legislature into a special session to find ways to close the deficit. “It’s like an avalanche in that it gains momentum. And that’s what we’re in right now, so it’s a real crisis.”

The warrants would be given to landscapers, carpet cleaners, construction firms, food services companies and other state vendors. They would pay an interest rate of as much as 5 percent, based on state law. California last issued the IOUs in 1992 when lawmakers and then-Governor Pete Wilson deadlocked on a budget for 61 days past the start of the fiscal year.

California’s two year budget shortfall is about $28 billion, accounting for one-third of the deficits faced by U.S. states, according to figures from the National Conference of State Legislatures in Denver.

Pain And Sacrifice In Minnesota

Governor Tim Pawlenty says Minnesota is $5.2 Billion in the Hole.

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Warning that Minnesotans are facing a time of “pain and sacrifice,” officials Thursday said they would slash state spending and rethink the role of government in the aftermath of a towering deficit that tops $5.2 billion over the next two and a half years.

Government will have to change “in a historic way,” he said. As part of that, he said, “there’s no question that there will be spending cuts in programs that have existed for a while.”

For starters, Pawlenty said he is ordering state agencies to cut 10 percent of discretionary spending. Only public safety, corrections, the military and veterans affairs will be spared.

Leaders of the DFL-controlled House and Senate said they will take a knife to the state budget and the pain could be substantial.

Unlike the Federal Government, states must have a balance budget even if at times they play deferral tricks like perpetually floating ever increasing numbers of bonds as does Schwarzenegger.

However the appetite for bonds has dried up and states will be going through withdrawal. Expect to see more job cutbacks and more cuts in services.

Once again I point out the deflationary effects of these state problems, even as other misguided souls are incorrectly focused on increases in money supply alone. The loss of jobs, loss of wealth in the stock market, and the collapse in credit continues to dwarf any expansion of money by the Fed. Furthermore, the monetary expansion by the Fed is pouring into treasuries, not remotely making its way into the real economy, as banks are reluctant to lend. The net of money supply and credit is decidedly contracting, and looking ahead there is no reason to expect this trend to change anytime soon.

Mike “Mish” Shedlock
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