The state of California, one of the top ten largest economies in the world, will run out of money by February, causing “financial Armageddon”, according to dire new budget projections.

As of yesterday, the state’s debts were mounting at a rate of $1.7 million (£1.1 million) per hour.

The de facto insolvency of America’s most populous state — home to such economic engines as Silicon Valley, the Central Valley agricultural region, Hollywood, Napa Valley, the Long Beach ports, and the defence research and production facilities of Los Angeles, San Diego and the Mojave desert — would represent a new scale of catastrophe in a year in which financial markets and economies have imploded globally.

Bill Lockyer, the treasurer of California, has cautioned that $5 billion of public works projects, including road and school construction, will have to be cancelled because the state’s lenders are worried about an impending Iceland-style bankruptcy. California — which has a GDP of $1.7 trillion — already has the worst credit rating of any of America’s 50 states. “Without a budget solution, state financing of infrastructure projects will stop. It’s as simple, and dire, as that,” Mr Lockyer said this week.

For California’s Republican Governor Arnold Schwarzenegger, the crisis represents a humiliating final act to his second term. Mr Schwarzenegger, 61, came to power in 2003 because of an almost identical financial calamity, which resulted in his Democratic predecessor, Gray Davis, being “recalled” from office.

At the time Mr Schwarzenegger promised an end to California’s tax-and-spend policies and runaway expenses, yet over the past four years of his administration the state’s budget has grown by 40 per cent to $144.5 billion. Thanks to the housing crash, recession and credit crunch, the state can no longer afford this with tax collection.

As the crisis continues and California’s credit rating deteriorates, the cost to the state of borrowing keeps rising — a process that could ultimately cause the same kind of deadly spiral that this week tipped the Chicago-based publisher of the Los Angeles Times into bankruptcy.

Mr Schwarzenegger is proposing the same kind of emergency tax rises that in 2003 turned Mr Davis into a pariah. He has suggested a 1.5 per cent increase in sales tax — the equivalent of Britain’s VAT — and a tripling of the car tax. When Mr Schwarzenegger first ran for office, he did so on a promise to revoke a similar car tax increase proposed by his predecessor.

So far, however, Republicans in California’s legislature have refused to go along with the proposals and Democrats have refused to cut government programmes, hence the stalemate.

Mr Schwarzenegger has declared a “fiscal emergency” to keep California’s legislature in session until a solution can be found. “When you have a crisis the most important thing is to make a decision,” said a clearly frustrated Mr Schwarzenegger at a hastily called press conference on Wednesday. There, he presented an electronic display showing how much the deficit is growing in real time: $470 per second, $1.7 million per hour, and $40 million per day. He put it outside his office in Sacramento in an attempt to get the state’s legislators to reach some kind of agreement. “The worst thing is not to make a decision,” he said. “The most costly thing we can do is not to take any action.”

California’s biggest problem is the precipitous decline in tax revenues over the past year. The state’s property taxes — the equivalent of Britain’s council taxes — are based on the value of a house when it was first bought, and can then rise by no more than 2 per cent a year. This means that by far the most tax revenues come from new property sales, and these have all but dried up.Tax revenues have also been hit by the global recession. and credit crunch.

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