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Detroit, Greece, and Excessive Federal Debt

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Detroit is another reminder of the danger of excessive government debt. It leads to bankruptcy.

It doesn’t take a genius to figure out how a government gets to that point. The government begins spending more than what it is bringing in with taxes. To cover the difference, it borrows the money. As the process continues, year after year, the amount of debt it owes continues to increase.

Finally, the government gets to the point where its tax revenues are insufficient to cover its bills and pay the interest on its debt. Lenders are unwilling to lend any more money. Unable to pay its bills in a timely fashion, the only recourse is bankruptcy.

That’s what happened to Detroit. It’s also what happened to Greece.

The fact that excessive government debt is a bad and dangerous thing is, in fact, reflected by the so-called federal debt ceiling. The ceiling is a declaration that the amount of federal debt will not be permitted to go over a certain amount. That’s because Congress has decided that any debt over that amount is a bad and dangerous thing. The reason for that is found in Detroit and Greece.

Now, let’s assume that Detroit had the ability to print paper money. Would that have extricated Detroit from its fiscal woes? After all, that’s what statists say the federal government should do, through the Federal Reserve. They say that the federal government shouldn’t concern itself with incurring excessive debt. They say that the federal government should just keep spending and borrowing and then have the Federal Reserve print the money to pay off the debt. They also say that that’s what the European Union should do for Greece — simply print the Euros necessary to pay down the Greek debt.

So, why not the same solution for Detroit? Let’s assume that under the Constitution, cities were empowered to print their own money. The city government would crank up the printing presses and start paying off all its creditors, suppliers, and contractors in a timely manner with newly printed Detroit Dollars. What would be wrong with that process?

What the Detroit government would be doing is flooding the market with its newly printed money. The influx of new money into the marketplace would bring about a reduction in the value of everyone’s money. How would that debasement be manifested? By a rise in the prices of the things that the money purchases.

So, if gasoline is selling for 4 Detroit Dollars per gallon before the city’s inflation of the money supply, it would sell for, let’s say, 6 Detroit Dollars per gallon after the inflation. The Detroit Dollars would be worth less than they were before which means that they would buy less than they did before. Creditors who had loaned $10 Detroit Dollars would be repaid with $10 Detroit Dollars that would now purchase, let’s say, only $7 Detroit Dollars worth of merchandise.

For all practical purposes, the city would be declaring bankruptcy, albeit not in a legal setting. That’s because it would be defaulting on its debt by paying creditors with less valuable money than it had contracted to pay with its original debt.

It’s also important to note that the additional influx of new paper money would not increase real savings or wealth at all. It would simply be debasing the value of the currency that people are using. In fact, the process would actually decrease the amount of savings in Detroit since people would figure out that the value of their savings is constantly decreasing owing to the constant increase in the supply of money. Better to go out and spend your money before it loses any more value (or purchase gold, silver, or other precious metals in an attempt to maintain a store of value in one’s savings).

Thus, permitting Detroit to print its own money would be no solution at all. In fact, as people figured out what the Detroit government was doing to Detroit Dollars, they would dump Detroit Dollars and move into a sounder currency. Ultimately, Detroit Dollars “wouldn’t be worth a Continental.”

The principle is no different on a national basis. Having a central bank — a Federal Reserve — simply print the money necessary to cover the federal government’s excess spending and ever-increasing debt is no solution at all. It’s a way to breach its obligations to creditors by paying them off in devalued paper dollars. It also discourages real savings, which are the key to economic prosperity. It also sends false signals in the marketplace to investors, producing asset bubbles that ultimately burst.

So, what’s the ultimate answer to city, state, and federal spending and indebtedness?

The short-term answer, obviously, is to keep expenditures equal to tax revenues.

But the real solution is for people to ask: What is the role of government in a free society? Once people realize that socialism, interventionism, and imperialism are not legitimate programs, 99 percent of government expenditures disintegrate, which solves the problem of excess spending and debt.

That would necessarily mean no more Federal Reserve and no more fiat currency, leaving the free market to determine the nature and value of money, which in turn would lead to increased savings and ever-increasing standards of living and levels of prosperity and, most important, to economic liberty.

This post was written by:

Jacob G. Hornberger is founder and president of The Future of Freedom Foundation. He was born and raised in Laredo, Texas, and received his B.A. in economics from Virginia Military Institute and his law degree from the University of Texas. He was a trial attorney for twelve years in Texas. He also was an adjunct professor at the University of Dallas, where he taught law and economics. In 1987, Mr. Hornberger left the practice of law to become director of programs at the Foundation for Economic Education. He has advanced freedom and free markets on talk-radio stations all across the country as well as on Fox News’ Neil Cavuto and Greta van Susteren shows and he appeared as a regular commentator on Judge Andrew Napolitano’s show Freedom Watch. View these interviews at LewRockwell.com and from Full Context. Send him email.