MONEY AND WORK

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July 6, 2009

WHAT CALIFORNIA COULD HAVE DONE WITH ITS IOUs

Economic Outlook - The State of California, the worlds 8th largest economy plans to begin issuing IOUs - formally known as registered warrants - to the tune of $3 billion, to fund its commitments to various suppliers and contractors to government; university students; and welfare and pension recipients.

The IOU terms (interest rate, etc) will be determined by the Pooled Money Investment Board which will meet on July. The IOUs will mature on October 1, 2009. . .

This will be the second time in recent history that the Californian Government has issued IOUs. In 1992, when the economy recessed badly it was forced to do the same. See the graphs above to see the correspondence of labor market conditions then and now.
While two of the major banks that operate in California - the Bank of America and Wells Fargo - have said they are uncertain as to whether they will accept the state-issued IOUs in return for cash, they have an incentive to do so because they can then earn the interest payable once the redemption date is up.

Who will get the IOUs? The most disadvantaged . . . No other group would tolerate being treated in this way.

The State Controllers Office has some analysis of how the IOU system will work and who will be provided with them in lieu of cash. they also provide a FAQ page for the warrants system. We learn that the largest proportion of the IOUs will go to the aged ($590 million), the unemployed ($495 million), and the disabled ($363 million).

There are two interesting points to note from FAQ page. First, there is no guarantee of convertibility into cash. I say this even though the state will (if it has enough cash) accept them on October 1 for cash. But there is no stipulation that they can be traded in the meantime as if they were cash.

Second, there is no provision that a Californian resident can pay their state taxes using the warrants as contra payments. In other words, the warrants are not currency.

If the State of California, announced that it would accept these IOU vouchers (their face value in $US) as legitimate vehicles to liquidate one's tax obligations to the State then the situation changes dramatically. To circulate the vouchers, all State employees would receive some (or all) of their pay in the IOUs (bits of paper or via electronic transfer into special voucher banks), which they could then use to pay their taxes. If all Californian citizens could similarly extinguish their tax obligations using these vouchers then there would be a generalized demand for them, which means that state employees would be able to spend the IOUs in shops as they would the $US.

The State of California would have no financial constraint in the IOU vouchers. It would simply spend them (pay its workers) and collect the taxes later as people handed them back to satisfy their legal obligations. Imposing the tax obligation (in vouchers) creates a demand for them and allows them to circulate as a "currency".

Soon enough, the banking system would develop IOU Voucher Accounts and related products. In this way, the State of California could more easily maintain its level of services without imposing huge costs on the disadvantaged which they are forcing to accept the IOUs. The State could also expand public employment to attenuate the labour market impacts of the recession. . .

If the state had have decreed that any resident could extinguish their tax obligations using the warrants then they would become more broadly accepted as an alternative currency in California and the disadvantage that those citizens face who will be forced to accept them in lieu of cash payments would be considerably reduced (or eliminated entirely).

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