TRAVERSE CITY – As Detroit begins to sort through the ill-begotten public liabilities that have driven it to bankruptcy, an important opportunity is at hand to revitalize the city that was once the epicenter of American entrepreneurship and manufacturing, while setting an example for other municipal governments that appear to be headed toward a similar fate. Here is an “Austrian moment” in the making, a potential libertarian awakening guided by the market-oriented, non-interventionist principles of the Austrian school of economics.
For years, Detroit’s expenditures vastly exceeded its revenues. With the tax base eroding, owing to a declining population and diminishing private-sector jobs, efforts to boost revenue by raising taxes would have been futile. (Detroit’s 2012 income-tax rate of 2.45% and its property taxes, which are among the country’s highest, are inexplicable, given the inadequacy of basic public services.) In this context, Detroit’s “Ponzi”-like fiscal situation would have continued to deteriorate, with no options other than to borrow more.
But, as long as investors were willing to purchase risky bonds, neither politicians nor unions would admit how unsustainable Detroit’s situation was. With the Federal Reserve’s near-zero interest-rate policy and purchases of trillions of dollars in long-term securities driving demand for such bonds, Detroit’s leaders were able to delay public-sector reform for far too long (a situation that is frighteningly similar to the federal government’s today). Detroit’s bankruptcy is thus exactly what the financial system needs.
Before any tears are shed for the bondholders, it is important to consider the fundamental differences between private and public debt. Private debt is an inter-temporal, contract-based exchange between two entities: the debtor, who needs capital, and the creditor, who is willing to provide that capital in exchange for a sufficient rate of return.