California is stirring. Here are a few outcomes, as I see it.
1. The state issues some IOUs, and then bites the bullet cutting 25B from a 125B budget. This puts a shotgun hole in the economy (previously CA would have borrowed the money to maintain spending levels) that completely negates any of the Keynesian stimulus on its way from DC. Parks, schools, police, lawyers, architects, software providers--anyone and everyone who has contracts or paychecks from Sacto who gets cut then gets dumped out onto an economy with 11.5% unemployment. Key concept: Sacto has NOT cut the budget yet. Anyone dumped off state payrolls already over the past year would be joined by an army of those tipped out of state payrolls or contracts.
2. Number 1 happens, and then D.C. comes in and federalizes "some" of those jobs like teachers, police, fireman.
3. DC caves before any of this happens, and prints up, oh, at least half of the shortfall thus forcing CA to cut only 10%+ of payrolls, contracts.
4. DC does nothing. CA is forced to take route number 1.
5. DC does nothing but still cannot get itself to cut the budget. The issuance of IOU's goes on for months and reaches farcical levels. CA credit rating dives, and muni bond market finally begins to react. A crisis unfolds as DC steps in.
My take: Number 5 is the worst route, as the CA muni markets could suffer permanent damage. Either one of two things are going to happen in my opinion: either DC is going to abandon CA and eventually this will cause a crisis in Muni Bonds everywhere. Or, DC will cave and help CA which is going to have implications for the USD.
My bet is that DC finds a way, at all costs, to avert a crisis in Muni Bonds. If they have to they will print 25 billion and deliver it on pallets via a C-130 to Sacramento, to avoid a muni bond crisis.
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