Montreal, Canada

If not for federal handouts more than a dozen states would be officially bust in early 2010. Not least among the deadbeats is California, which last year issued IOUs to cover its budget shortfall.

The average U.S. state has seen a 12% drop in revenue as of Q1 2009 with California home to the third worst drop in revenues behind Oregon and Arizona. Chapter Nine bankruptcy might not be in the cards for these and other states because Washington is in the business of bailing-out just about everyone it deems critical to American systemic survival.

California has a bad habit of going from boom to bust. Orange Country went under back in 1994 after dabbling unsuccessfully with derivatives – an appetizer to the Big Bang that shook U.S. and foreign markets starting 13 years later. State revenue increased by only 22% since 2000 while debt service costs climbed 143%.

The 2011 U.S. federal budget sets aside $646 billion dollars for state transfers, including an extra $85 billion dollars for Medicare. Build America Bonds, issued by the Feds in 2009, remains a popular program since states can tap into zero interest rate financing with Washington's full guarantee.

California serves as a template for what lies ahead for the federal government as ballooning budget deficits are eventually exhausted at some point in the future by the bull market now in progress in financing these deficits or debt servicing costs. This is what threatens Greece; it has already exhausted Dubai and Iceland.

Interest expense will devour government revenues if the country can't control its spending or, at the very least, fails to introduce a VAT, or Value Added Tax, to service its monster-sized obligations. But just in case Congress doesn't pass a deficit VAT then we can count on the Fed to monetize the debt or buy what Treasury can't auction. Montreal-based Bank Credit Analyst claims 17% of all Treasury issuance in 2009 was purchased by the Fed in its quantitative easing program.

The United States remains one of the last industrialized countries without a VAT or broad-based consumption tax; it's inevitable that such a tax is on the way – either introduced by government or forced upon by its creditors.

The alternative is to inflate the debt through inflation and fiat money creation. This is what America can do – and most nations cannot. The Feds print and issue debt in depreciated dollars and simply create all the cash they need to finance these obligations through even more printing.

And so it goes, and where it stops nobody knows. But stop it must.