As is well-established by now, there are several fiscal problems confronting California and its citizens at once. To wit, we have crushing pension commitments to public employees that are very difficult to get out of, plenty of upside-down and unaffordable mortgages (despite the inept government efforts to prop up housing), and major budget deficits that are almost locked in place due to the various procedures in Sacramento.
What underlies all these problems? They are all based on obligations of US dollars. If we have uncontrolled inflation for a time, as bad as that would be, it could constitute a de facto bailout of California and other states in similar predicaments. The value of equities in dollars would likely rise if properly invested, and the liabilities themselves are not fully indexed for inflation.
Mortgage debt would shrink in real terms, as well as nominal, because home prices in many areas would have to rise. Take as an example a borrower owing $700,000 on a $500,000 home. Assuming a 30% inflation where the real value of housing is more or less stable, his real obligation becomes closer to $400,000 and the nominal loan-to-value ratio would be under 100% again.
Finally, California’s real liabilities would shrink somewhat. Taking all of these ideas together, you would see a more functional California at the expense of all the holders of US dollars around the world, and at the expense of more responsible state governments.
Not only is this a potential way out, it may be the only way out. I’d recommend against massive holdings of US dollars themselves and instead diversify into hard assets and other currencies as well as equities. And, as a nice extra touch you may want to borrow as many dollars as possible. This could end up as a pretty good trade.