The Large and the Small

What do small European countries have in common with large US states?

Both are in fiscal distress. Countries like Greece, Ireland, and Spain are facing significant budget gaps. Greece was downgraded, Spain’s outlook is negative. States like California, New York, and Illinois are also facing downgrades and are delaying payments and issuing scrip to conserve cash.

None of these entities can issue their own currency. Oh yes, California’s scrip is a kind of currency, but it’s really an I.O.U. But because the legal tender is out of the government’s control, the governments need to find a way to plug their fiscal gaps. And therein lies the rub.

During the boom years these places got used to growing revenues and ready credit. So the governments expanded services and increased their bureaucracy. (Did you know that the California Division of Water Resources has its own staff lawyers?) When the boom ended, the revenues dried up. Reducing spending is the logical answer, but this is always harder than adding services. Unions strike; lawyers sue, and everybody votes. Budgets only get balanced when the political will to do so is present.

In the end, the political will determines what happens next. The global recession’s fallout will include some fiscal crises. The only question is where.

Douglas R. Tengdin, CFA
Chief Investment Officer
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