If You Want to Understand Germany Think of Texas and California

As Greece’s exit from the Euro appears more likely, the draconic and heartless Germans are being raked over the coals throughout Europe. Germany’s stingy Merkel refuses to lend a helping hand to a drowning neighbor. Merkel and her austere Germans are not  real “Europeans.” Were it not for the Germans, Greece would have its stimulus, which it would promise to pay back when it is out of danger – sometime far down the road.

If you really want to understand the Germans, think of Texas and California. Texas must constitutionally balance its budget. A state official estimates forthcoming revenue, and the legislature must trim spending accordingly. Texas makes minimal use of gimmicks; it makes real cuts when cuts are necessary. California also must balance its budget, but it does not. It uses extreme gimmicks to overstate anticipated revenue and spending cuts that will not take place.

Compared to Texas, California is a spendthrift, spending fifty percent more per capita than Texas. Despite much lower state spending, Texas seems to do quite well. It attracts the jobs California is losing.

Imagine the reaction if some higher authority told Texas to pay for the shortfall in California’s budget? This is exactly what the Californias of Europe and  European Union bureaucrats are demanding of Germany. Germany’s reaction is exactly that of Texans to bailing out California.

Thanks but no thanks.

Rhode Island Is Smarter Than Everyone Else

A new Rhode Island state law places bondholders before other creditors in the case of bankruptcies of municipalities.

The town of Central Falls declared bankruptcy recently, but its bondholders are scheduled to be paid in full. The pensions of retired city workers will  suffer a cut of one third.

Why did Rhode Island take this unusual and politically-costly approach?  A Rhode Island official explained it as follows: “We do not want bondholders to think this state was not a good place to put their money.” He also noted that without this law, Rhode Island municipalities will have to pay higher interest rates for its borrowing.

How is it that such economic rationality trumped politics in Rhode Island? Why could we not have had such rationality during the federal debt limit debate?

Municipalities in states borrow in highly competitive markets. They must compete against 49 other states. If the state’s investment climate is inferior to others, they cannot attract lenders. If you wanted to buy municipal bonds, would you buy from Rhode Island or California?

The federal government faces less competition, and the competition it faces is weak (such as European and Japanese sovereign debt).  Our federal government believes it can sell its debt not matter how badly it misbehaves.

The recent Standard and Poor downgrade may change this way of thinking.