California is asking Congress to take the unprecedented step of guaranteeing the state's sovereign debt with the "full faith and credit" of the United States.

The Economic Success of the United States Explained

There is nothing inherently special about the land upon which the United States is located.  Land is for the most part land.  We are fortunate to be located within favorable latitudes, have in our possession the Fruited Plains and enjoy strategically valuable access to the Atlantic and Pacific Oceans.  But plenty of other countries have had or currently enjoy similar resources.

There is nothing inherently special about the people of this country.  People are for the most part people.  When individuals come to the U.S., regardless of their race, color, religion and cultural values, they tend to perform well if they possess an appreciation for unfettered opportunity.

What transformed the United States from 3.79 million miles of untamed forest into the most impressive economic success our civilization has yet nurtured was the pervasive, intentional design of our society’s structural underpinnings. 

From its inception the United States was ordered in a novel manner which optimized the productivity of its citizens.  This structure included:

A Legal and Judicial System which:
   •  Existed to recognize and protect the freedoms of American citizens
   •  Placed the rights of the individual above those of the State
   •  Afforded Americans protections from their Government
   •  Affirmed The Rule of Law over a Rule of Men

A Political System which:
   •  Limited the power of the Federal Government
   •  Restricted the power of any individual component of the Federal Government
   •  Rejected taxation without representation

An Economic System which:
   •  Embraced the free flow of capital, labor and resources
   •  Enforced Contract Law which affirmed and protected property rights
   •  Rejected Government interference in private enterprise in favor of free markets

The Federal Government’s guarantee of California’s debt would directly or indirectly degrade the above constructs so instrumental to the economic prosperity of the United States.

The World’s Most Dynamic Economic Laboratory

A beneficial attribute which has contributed to the perpetual reinvention and flexibility of this country is America's composition as a union of states.  We owe to this fortunate structure credit for our status as the World’s greatest laboratory for economic experimentation.

Each state has its own degree of sovereignty.  The federal government exists to provide for those needs of the nation which can not be provided effectively by individual states.  Beyond this Constitutionally defined role, the states are free to operate at their own discretion.

This dynamic has been extraordinarily productive.  The states are free to experiment for better and for worse.  This is no theoretical exercise.  Citizens and companies vote every day on the success or failure of state-specific, public policies with their money, business activities and with their feet.  

   •  If New York raises sales taxes too high, New Yorkers choose to shop in New Jersey
   •  If California’s state income tax is too onerous, Californians move to Colorado
   •  If Michigan adopts rules that inhibit business, companies relocate out of the state

The ability of Americans to flexibly respond to state-specific policies produces a free market feedback loop.  The results of this response are evident in state-by-state prosperity trends, population migration patterns and unemployment rates.  State policies that work persist and are adopted by other states.  Policies that do not work are quickly abandoned by politicians and voters, or reversed by the inevitability of economic reality.

Personal Anecdote

After my UK work visa application was rejected in 2008 I spent several months evaluating the prospect of relocating to San Francisco or San Diego.  At one point I was packing my car to drive cross-country to California.

I decided not to relocate to the Golden State because of the irresponsible manner with which its politicians had chosen to manage public and fiscal policy.  I had no interest in paying the state’s high and increasing income tax rate.  I was amazed by proposals to raise the already excessive sales tax, gasoline tax and car registration fees.  The state has committed itself to a painful future by choosing to consistently spend more than it can possibly collect in revenue.  The state legislature continues to contemplate further tax increases in defiance of the obvious need for massive spending reductions.  Given the state deficit, the government’s unwillingness to reduce expenses and the inevitability of future economic decline, further tax hikes seem to be a foregone conclusion.

California’s Situation

It is my understanding that many people are moving out of state precisely because California is an economically oppressive place to live.  The high and pervasive tax rate explains why the state had an 11.2% unemployment rate in April.  Were it not for so many Californians presently trapped in their homes due to underwater mortgages and a stalled housing market, the population exodus would be even more extreme.

This freedom of choice and mobility is at the core of why this country has been so successful.  50 states acting in their own perceived best interests are free to experiment with how they operate.  And each citizen is able to flee from oppressive or depressed areas in favor of economically free, vibrant and opportunity-rich destinations.

California has chosen to spend money it does not have.  The legislature decided to squander the largest boom in tax receipts in U.S. history.  When the economy faltered and state revenue contracted politicians opted to continue spending money they did not have.  This is a social experiment and Californians may believe this dynamic to be sustainable.

Either way, California must be required to deal with the problems of its own making.  The State must be held responsible for its decisions and actions. 

Implications

If the Federal Government guarantees California’s debt this economic laboratory ceases to exist.

I chose not to move to California because I did not want to pay its taxes, reward the State for its bad decisions and facilitate the perpetuation of their fiscal irresponsibility.  If the federal Government assumes California’s liabilities, Americans would no longer have such a choice.  The farmer in Wyoming, the fisherman in North Carolina and the banker in Florida would all be responsible for another state’s debt.

The burden associated with the implicit guarantee is not theoretical.  The country’s credit rating is already imperiled by Federal spending and our growing deficit.  The rate of interest we pay on existing and future debt is directly related to perceived credit risk.  Guaranteeing the debt of the World’s 10th largest economy may be sufficient to imperil this rating and increase borrowing costs.  Given the size of our existing debt burden, which needs to be constantly refinanced, this commitment would represent a material risk to the country’s solvency.

What Would Happen Following a California Guarantee

1.  California would feel little pressure to reduce spending or balance its budget.  Its deficits would no longer matter.  For all I know, the state’s progressive politicians might decide to increase spending and accelerate debt accumulation.

2.  Onerous conditions would either proactively or retroactively be placed on California by the Federal Government.  These conditions would be designed to restrict the state’s financial activities as the cost of receiving Federal assistance.  
 
These conditions would fail in their mission, be circumnavigated by the state and have unintended, distorting economic effects.  Given the Federal Government’s track record during the broader economic downturn, the solution to California’s solvency issues might easily be worse than the problem.

Consider the bail-out of the other entities deemed “too big to fail”.  The banking industry, AIG, CitiGroup, Bank of America, the Auto Industry, etc…  None of these bail-outs accomplished their stated missions.  All produced unintended consequences.  Each was economically distortionary and has been misused to political gain.  A California bail-out would be no different.

3.  The Federal Government would have effectively recreated the combustible trigger that led to the United States’ formation.  Taxation without representation.  The citizens of 49 other states have no vote in the spending policies or political representation of the State of California.  Yet those citizens would be taxed, either directly or indirectly, to support the unsustainable spending of California’s legislature.  I do not believe this would be well received.

4.  If the Federal Government assumes guarantor status for California, politicians in other irresponsible states will demand similar treatment.  Why should California receive special status?  If New Yorkers are being taxed by the Federal Government to insure California, shouldn’t New York also be insured?  Once the Government insures one state, they will inevitably have to insure all.  Given such a dynamic, why bother to preserve individual state governments or tax rates?

5.  Before the Federal Government got around to assuming the liabilities of all 50 states, its credit rating would be wrecked, its borrowing costs would go through the roof, and its ability to finance its expanding debt called into question.  The value of the dollar would collapse and our solvency would be imperiled.

Conclusion

I like California, greatly enjoyed living in San Francisco, and would happily return to the state should conditions warrant it.  I have chosen not to live in California because it is economically oppressive and financially insolvent.  Given my conscious choice, I will not be forced to pay for the sins of California’s legislature while I live elsewhere.

I believe that other Americans feel the same way.  Even if they don’t presently share my vigor for the subject, they would should California’s debt be forced down their collective throats. 

The United States is an ingeniously designed country and, despite its current political leanings, may return to the structural underpinnings which made it prosperous.  But we are at a dangerous place in the nation’s history.  A few tragic and difficult to reverse mistakes could irreparably harm our economy and hobble our future.  The nationalization of California’s debt would be such a mistake, and should be identified and resisted as the detestable threat it represents.