The financial news in recent weeks has been dominated by concerns about the possibility of “sovereign default” in several key Eurozone countries. Often known as the PIGS (Portugal, Ireland, Greece, and Spain, sometimes called PIIGS when you throw Italy into the mix), their high levels of unemployment and debt are claimed to be a ticking time bomb for the euro currency and the European Union as a whole.

In recent weeks Greece has been forced into promising “austerity” – meaning huge budget cuts – in an effort to bring its debt levels down. Portugal is exploring similar options after a debt sale didn’t go as well as expected, and now Spain is expected to follow suit with the Socialist government proposing its own spending freeze.

The parallels to California are obvious, but that doesn’t mean they’ll always be drawn properly. One observer that does so is Gregor Macdonald, who points out that California’s problem is owed largely to overdependence on cheap oil:

I’ve identified seven large US states by four criteria that are sure to cause trouble for Washington’s political class at least for the next 3 years, through the 2012 elections. These are states with big populations, very high rates of unemployment, and which have already had to borrow big to pay unemployment claims. In addition, as a kind of Gregor.us kicker, I’ve thrown in a fourth criteria to identify those states that are large net importers of energy. Because the step change to higher energy prices played, and continues to play, such a large role in the developed world’s financial crisis it’s instructive to identify those US states that will struggle for years against the rising tide of higher energy costs….

The seven states to make my list are California, Florida, Illinois, Ohio, Michigan, North Carolina, and New Jersey. Each has a population above 8 million people. Each has had to borrow more than a billion dollars, so far, to pay claims out of their now bankrupt unemployment insurance fund. Also, each state currently registers broad, underemployment above 15% as indicated by the U-6 measure for the States. And finally, each state is a large net importer of either oil, natural gas, electricity, or all three of these energy sources….

21st century energy prices overlaid on a 20th century economy? That’s no fun at all. The mainstream economics profession, perhaps unsurprisingly, still does not pay enough attention to the interweaving of long-term stagnant wage growth, higher energy inputs, and the resulting credit creation that OECD countries took as the solution to resolve that squeeze….

My seven states of energy debt represent a full 35% of the total US population. As with other US states, they face looming policy clashes between protected state and city workers on one hand, and the growing ranks of the private economy’s underemployed on the other. The recent circus at the LA City Council meeting was a nice foreshadowing that the days of unlimited borrowing by governments-against future growth based on cheap energy-is coming to an end. Washington can print up dollars and fund these states for years, if it so chooses. But just as with the 70 million people in Portugal, Italy, Greece and Spain, the 108 million people in these seven large states are probably facing even higher levels of unemployment as austerity measures finally slam into their cashless coffers, and reduce their ability to borrow.

Over the flip I explain what all this means, and why Europe’s response to the problems with the PIGS shows why California and the US should not repeat it.

Macdonald’s point is one I’ve often made here on this site. The current economic crisis facing California isn’t part of some normal cycle, nor is it something that will naturally pass over time.

California’s present economic and financial crisis is due in large part to an overreliance on cheap oil to meet the population’s needs. As wages stagnated after 1975, the US turned to debt to make up the difference and enable economic growth. Here in California that took the form of using debt to fuel three successive asset bubbles that appeared to provide prosperity, growth, and balanced budgets, but proved in fact to be not only illusory, but setting up a bigger fall each time out.

The real estate bubble in the 1980s and again in the 2000s, with the 1990s stock market bubble, were all used and encouraged by state policymakers as the solution to California’s economic and fiscal woes. Each time it worked, for a few years, but then crashed down to earth again.

The underlying problem was that this was all built on the assumption that cheap oil would last indefinitely. If energy costs rose, then working Californians wouldn’t be able to service the debt they’d taken on to fuel the housing bubbles or the stock bubble. They’d instead have to pull back on their spending, crashing the economy and the budget along with it. Cheap oil helped provide a modicum of stability to an otherwise unwieldy system.

In 2006, that cheap oil began to vanish. Gas prices in California broke $3 per gallon for the first time that year, and stayed above $3 for much of the spring and summer. It was at that time that the housing market peaked in California. One estimate was that 60% of new jobs created in California in 2006 resulted from the real estate bubble.

But once gas prices hit $3, it became difficult for all those folks who took out huge mortgages to service that debt, especially in places where many buyers had long commutes. It’s no accident that Stockton-Modesto and the Inland Empire were hit hardest by the foreclosure bubble, since residents there tended to have the highest energy costs.

The Center for Neighborhood Technology and the Urban Land Institute put out a study last fall, Bay Area Burden, showing that high transportation costs meant that housing in exurban areas that seemed more affordable than in the urban cores actually weren’t affordable once transportation costs were included. CNT has also showed that foreclosures correlate closely to high transportation costs.

But none of this was expected by California politicians and planners, who assumed that oil would remain cheap for the foreseeable future. Debt levels were predicated on the 20th century model lasting forever – ongoing economic growth fueled, literally, by cheap oil.

Those days are now over. Even in a severe recession like this, gas prices continue to flirt with $3/gal. Most observers expect gas prices to rise once economic recovery sets in, whenever that is, potentially strangling that recovery – unless we take steps to get off of oil.

That isn’t looking very likely. Although high speed rail will be a major boost to efforts to wean ourselves off oil, budget cuts are at the same time slashing transportation spending and leaving the public with fewer options to travel affordably. Fiscal austerity is worsening our exposure to rising energy costs.

Of course, that’s not the only cause of the state’s fiscal crisis. The three asset bubbles over the last 30 years made it possible for both Democrats and Republicans to leave Prop 13 alone and refuse to confront its anti-tax legacy. State government began borrowing money to replace funds it used to get from tax revenues. This was dramatically accelerated when Arnold Schwarzenegger used bonds to close the budget gap when he took office.

California is a rich state, even today, and there is plenty of money out there to help ease our fiscal problems. But there is no political willingness to go out and get it, even though polls and election results make clear that voters would support this instead of imposing austerity on schools and health care.

Of course, the argument that California has to embrace austerity or else face default or some other significant debt-related problems has been used since 2008 to justify massive spending cuts. This is, to bring the post back full circle, exactly what is being adopted in the PIGS countries in Europe. As former IMF economist and leading commentator Simon Johnson argues, however, these European policies are a recipe for disaster, that Europe risks another global Depression:

What are the stronger European countries, specifically Germany and France, doing to contain the self-fulfilling fear that weaker eurozone countries may not be able to pay their debt – this panic that pushes up interest rates and makes it harder for beleaguered governments to actually pay?

The Europeans with deep-pockets are doing nothing – except insist that all countries under pressure cut their budgets quickly and in ways that are probably politically infeasible.  This kind of precipitate fiscal austerity contributed directly to the onset of the Great Depression in the 1930s.

Indeed, here in the US the reaction from many other states to California’s fiscal crisis is “fix your own mess,” as if they won’t be dragged down by California if we experience a prolonged downturn thanks to budget cuts. The White House has not taken the fiscal problems of the states seriously, since their own focus on economic recovery is instead on Wall Street. So California is destroying its educational system, jeopardizing our future ability to create jobs and grow wages, and is destroying its public transit system, destroying our ability to avoid the costs of rising oil prices.

It’s a destructive cycle that will merely ensure that California’s recession is not only prolonged, but that we face serious long-term risks. The massive levels of household debt, still-inflated real estate values, and ongoing wage inequality are not going to be resolved if we are vulnerable to the effects of peak oil over the course of the decade.

There is some hope. At last week’s confirmation hearing for Abel Maldonado’s appointment to Lt. Gov., Darrell Steinberg asked Maldonado if he thought budget cuts were prolonging and worsening unemployment, to which Maldonado answered yes.

Hopefully this portends an end to the “we must cut the budget or else the bond markets will be pissed!” nonsense that is actually worsening our problems. As Simon Johnson points out, the only outcome of austerity is Depression.

California can avoid this, if we tax corporations and high incomes in order to wean ourselves off of oil, reduce income inequality, and support the public services that are essential to future prosperity. And we need federal support and assistance to help prevent those cuts.

The 2010 elections will help determine whether that happens, or whether we slide deeper into recession.