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krschultz

I don't understand how the IOUs are constitutional

Article 1 Section 8 (Powers of the Federal Congress)

"To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;"

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Clearly states and townships are allowed to borrow money.

Which means that they can issue bonds.

If a bond is tradeable on the open market, how is it different from currency?

In short: financial engineering has evolved a bit in the last 200 years, muddying some formerly clear cut issues.

Were bonds actually issued to the small business owners in this case? The article only mentions the nebulous "IOU's"

Yeah, the SEC determined they are "securities" or bonds...they pay an interest rate.

They're IOUs because the average person reading the stories about them won't understand what it means if they said they were bonds (they'd think commercial paper, if anything).

If you read hardcore financial papers, they're effectively bonds backed by the State of California.

I don't think it's any violation of the Constitution per se.

Put it this way. As is pointed out in the other comment a Bond is not considered currency and states issue those. A Bond in is just a certificate of debt. Whoever issues the bond is borrowing money from you and then paying you interest in return. So it represents currency but is not in itself currency.

An IOU is simply a Bond that doesn't collect interest. California is in effect using it's governing power to force it's vendors to buy high-risk, no interest Bonds from them.

An IOU is simply a Bond that doesn't collect interest.

A dollar is a t-bill with an interest rate of 0% and a maturity of now.

Look, I didn't make the rules. But the bottom line is in economics there is currency and there is debt. Is debt just the absence of currency? Isn't Debt worth as much as the currency it represents? Does that make the line blurry?

Yes on all counts. But that's how it works. Debt does not count as currency.

Yeah, but when companies issue bonds, they use the real money issued from the sale of these bonds to pay down debts of creditors. In this case, if the IOU's are like bonds then they should be sold on the market, and the real money collected should be used to pays these small businesses, which are the state's creditors. I know a state is not a company, but when raising capital via debt, you can't just force someone to accept these IOU's when they are owed money.

But California can't sell them on the open market which is the point.

Think of it this way. California is at a point where they can't stop themselves from spending more than they owe and the result of that is no one in their right mind would ever buy a Bond from them. Because there's a really good chance they'll be bankrupt before they could pay it off.

So what the state is doing is taking the people they have complete power over (those who did work for them expecting payment at a later date) and giving them a certificate of debt so they can continue to pay creditors whose services they need and who they have no power over.

Why can't they sell them?

http://en.wikipedia.org/wiki/Municipal_bond

Many other states and munis do.

Whether its a good investment or not is dictated by the risk and interest rate associated to it. You can't not pay your obligations which in this case would be the interest rate to cover today's expenses. Otherwise we are talking about a larger issue which would be bankruptcy.

I think he meant that they can't afford to sell them. The financial condition of an issuer dictates the yield (i.e. interest rate) that investors will require to buy the bonds. California's condition is so poor that the required yield would be very high, so they have decided to force feed this debt to people who are already their creditors (in short term payable/receivable sense) but were expecting to be paid in currency.

California IOUs do pay interest, at a rate of 3.75%. Since you are resident in CA, I am surprised you did not check the basic facts about this. http://www.sco.ca.gov/5935.html

It is Article 1, Section 10 that is of interest because it expressly forbids states from coining money or emitting bill of credit.

"Section. 10. No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility."

Just because this is an enumerated federal power doesn't mean it's automatically denied all other entities, and money issued by sources other than the federal government was once common in the US. See:

http://www.clevelandfed.org/research/Commentary/2007/010107....

IOUs are not currency, and so no government body is compelled to accept them as payment...including the government body which issued them.

Private entities are not regulated by the constitution, which is why you can have tokens and gaming chips as legal tender in arcades and casinos.

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