Wednesday, June 3, 2009

California finds a backdoor to the Fed's magic printing press. Will it be unlocked?

Doug Reich, The Rational Capitalist, has made a crucial observation that needs to be understood far and wide. Be sure to read his entire post, also up at simply Capitalism.

Now Your State Can Print Money Too!

One reason why spending at the state level can rarely get out of control is because states lack the power to print money. In other words, they must rely on taxation or municipal bond offerings to raise money to fund their budgets. Since taxation is unpopular, there is an obvious political limit to increased tax rates. Since private municipal bond investors can only buy so much debt before asking for higher interest rates, there is also a limit to the amount states can raise through borrowing. The federal government figured out how to get around this limit by creating the Federal Reserve System which is a pseudo private bank with the power to create money. The Fed can buy federal government debt from the public with fake money. Therefore, the federal government always has a buyer for its paper.

Now, the states want to get in on the action.

Of course, the states will not ask for the direct power to print money. They have a more clever way...


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