DOW JONES NEWSWIRES

Pacific Investment Management Co. fund manager Bill Gross says California and the U.S. both are poorly positioned to compete in a global economy where capitalism has moved to a more production-oriented system from one emphasizing finance and levered risk.

A new emphasis on a more conservative, regulated form of capitalism gives an edge to countries which focus on thrift and "deferred gratification" - leaving out in the cold not only the U.S., and California, but also "global lookalikes" such as the U.K., Spain and Eastern Europe nations, the bond king said in his monthly letter to investors.

Despite the financial system's stabilization, Gross questioned whether California Gov. Arnold Schwarzenegger and the Obama Administration have "the capital, the vision, and indeed the discipline of its citizenry to turn things around."

Gross noted the downturn in fortunes of "once-golden" California, including a 12% unemployment rate, near a national high; the country's lowest bond rating; poorly rated schools; jammed freeways and what was a $26 billion budget deficit resulting from laws shaped from an outdated democratic system. He called "perverted" the state's form of government, which requires a two-thirds vote by lawmakers to pass a budget.

"California's problems, while somewhat unique and self-inflicted, are really Americas problems, and not just because the California economy is 15% of national GDP," Gross said.

Both the state and the U.S. suffer from "a lack of discipline" and "vision" to perceive that the "strong growth in revenues was driven by the same excess leverage and the same delusionary asset appreciation that was bound to approach cliffs edge," Gross said.

State tax revenue is largely reliant on California's richest residents, with money rising and falling sharply as the economy strengthens and weakens. A commission earlier this week recommended a flatter income-tax system and elimination of the corporate income tax and the 5% of the sales tax that contributes to California's general fund. They would be replaced by an up-to 4% tax on what businesses produce, minus their costs of purchases from other firms.

Also highlighting human capital, the fund manager lamented his home state is "losing rapidly .. its crown jewel education system that led to Silicon Valley miracles" like Hewlett-Packard Co. (HPQ), Apple Inc. (AAPL) and Google Inc. (GOOG).

-By Mike Barris, Dow Jones Newswires; 212-416-2330; mike.barris@dowjones.com;