California's budget gap is lens into US structural challenges

http://www.bloomberg.com/apps/news?pid=20601087&sid=avfMxsPMiQzE&refer=home

The headlines have been clear: California is facing an enormous budget shortfall and legislation under the Republican governor is making its way through government to RAISE taxes to fill the gap. Given California by itself is the 6th largest economy in the world, it is as good a lens as any through which to understand the macro structural problems that face the United States and many other sovereign nations.

Like the US, California finances its spending via sales of state bonds and taxes; lately, however, those bonds are seeming less attractive to investors who fear California may not be able to pay back its loans. Unlike the US government at large, the State of California does not have the ability to print more dollars to boost liquidity if investors don't want to buy their bonds. The grim reality for politicians and government financial officials is that taxes must be raised so that the state doesn't collapse.

This is occurring at precisely the moment when the US government is caving in to the fiscal conservatives who argue that CUTTING taxes is the main path to fiscal growth and stability. It is clear in the case of California that a decrease in tax revenues would be a death knoll.

Widening the lens, then, to the US structural problems, the question must be asked: how does the US plan to pay for social security, medicare, wars in multiple countries, budget stimuli, and many other massive spending initiatives (enacted mainly under Bush, for the record, although Obama will be pegged as the socialist between the two of them)? Not by raising taxes as California is doing, but by cutting taxes and borrowing more by selling more Treasury bonds (IOU's borrowed from our children and their children)? Worse still, the US government is using quantitative easing which is simply printing money to pay these obligations and expenses.

It seems inevitable that taxes will have to be raised substantially, not just in California, but across the country to pay for the excesses and tax cuts of the past two decades.

On a side note, the price of gold continues to rally in terms of most major currencies, another sign that investors are betting that inflation will erode the value of individual currencies such as the dollar. I have a short-term position betting gold down, but will reload on any weakness in price, say, down to $850-900/ounce, but it should safely break the peak of ~$1040/ounce by year end if not sooner. I like oil at $35/barrel given my view the dollar should deteriorate in value and send oil back to at least around $60/barrel. OPEC, Russia, and Venezuela need oil to trade around $70-90/barrel to spur more production; supply cuts will be evident later this year from decreased spending on project development precisely because of the drop in price.

Our lifetime should be a wild ride of significant structural change in the world and I am keen to watch and take action accordingly.