G – I = ΔM + ΔD
Where G is public spending, I taxes, M the money supply and D debt. It will be clear to everyone that the left-hand side of the equation determines the deficit, and the right-hand side determines how it is financed. Obviously, if G be overtaken by I, we would be facing a scenario of a surplus, and the increases would result in a reduction in debt or even in the money supply.
The deficit must therefore be covered by an increase in the money supply and/or by the issuance of public debt. But what happens when a state has complete budgetary freedom but no monetary freedom? Let us consider the example of California, the equation for which is simply: G – I = ΔD An equation that must be balanced in every annual budget. This leads us to a scenario where a constraint on borrowing capacity causes the state to go bankrupt, for which there is only one sustainable solution: bringing G and I into balance. In other words, in a crisis environment where revenue is falling, the only solution is a drastic cut in public spending, which in turn will cause the crisis to deepen.
There is, of course, a limit to borrowing capacity. And to a large extent, this will be determined by the market, since the lower the creditworthiness perceived by the investor,, the higher the interest rate the State will have to offer to attract money into its debt. A debt that is becoming increasingly waterlogged. The other limit will be set by the legislation that regulates – or attempts to regulate – solvency, defining what is known as «country risk». However, in the case of California (an economy which, on its own, would rank among the top eight in the world), there is no escape via increased debt due to the already excessive ‘wetness’ (insolvency) of its paper, nor does it have the capacity to print banknotes. Both possibilities are a matter of decisions foreign, that is to say, the market and the US as a whole. When the deficit is spiralling out of control and tax revenues are falling, the issuance of debt It ceases to be difficult and becomes an impossible task. Attracting funding when investors« confidence has been lost is like trying to stop a house of cards from collapsing with your bare hands. And at present, it seems unthinkable that California could issue and print its own banknotes in its own currency. It therefore seems plausible that the US as a whole will »bail out’ California’s debt so that it can continue to be placed with investors with the backing of the US Treasury. This will have to be accompanied by rigorous austerity in public spending, something Schwarzenegger is already implementing in line with his neoliberal playbook.
There is also talk of the possibility that the fifty US states might be given the power to issue currency (or at least those that are unable to balance their books), but it seems, in the case of the US, that it would be less traumatic for the federal government to underwrite the guarantees needed by the spendthrift Schwarzenegger to continue inflating California’s public debt.
Interestingly, every day I see more and more parallels between Schwarzenegger and Spain’s Zapatero, even though their strategies for tackling the crisis are radically opposed (neoliberal versus socialist). Both are leading countries facing serious insolvency problems and an inability to balance the books. It seems unthinkable that the US would allow California to collapse, but I do not find it so implausible that the EU would leave to their own devices those countries with a large gap between G e I. The PIIGS equation It could be balanced by injecting I from the wealthy countries of Europe, of course, but it is clear that patriotism within the EU does not reach the same levels as in the US. Of course, the idea of allowing an independent monetary policy within the EU is difficult to imagine, but it would bring many pieces of the puzzles and would balance the equation. However, it is even harder to imagine that the wealthy EU countries would pay up and bail out, without so much as a murmur, states that only a few years ago abandoned their flexible exchange rates and joined the monetary union with virtual pride.
Krugman He had already warned Zapatero four months ago that It’s as if the European Union didn’t exist. In other words, warns that no help should be expected from it because, in fact, it is a sham organisation when it comes to coordinating exceptional measures. This, combined with the inability to devalue the currency, due to membership of the monetary union, means that (as he said on his blog) to be in the eurozone It does not guarantee that the crisis will be overcome or that the outlook will improve; quite the contrary. The situation is likely to be even more difficult for Spain, Italy, Portugal, Ireland and Greece.
For the time being, Schwarzenegger has written a letter to the Three Kings (Obama) begging for a bailout from the US government. Zapatero has copied his letter, but the real drama – for Spain and the rest of the PIIGS – is that there’s nowhere to send it. Meanwhile, the equation is becoming deeply ingrained in our macroeconomic figures. And mathematical equations are truths that know nothing of politics or social upheavals.