Website owner: James Miller
People who are unable to live within their means usually get themselves in trouble. The same goes for governments.
If a person, by habit, spends more than he makes, if on a continuing basis, his outgo exceeds his income, he is likely, sooner or later, to find himself in trouble. If your outgo exceeds your income and you have some savings, you can make up the difference with your savings until the savings are used up. If you don’t have any savings, but you have good credit, you can borrow and make up the difference with borrowed money. But you have to pay interest on the borrowed money and that increases your outgo. If you continue doing this, your debt gets bigger and bigger and the portion of your outgo that is interest gets larger and larger and eventually you get to the point where you just can’t pay your bills. And if you can’t pay your electric bill they cut off the electricity. If you can’t pay the water bill they cut off the water. If you can’t pay your rent they evict you. If you find yourself with bad credit and without a home, you are in real trouble. You don’t want to let things go that far.
The situation with governments is very much like that with individuals. A government has only so much money coming in. If it just can’t control its spending, if, for example, politicians in their desire to please the population keep creating more social programs than the government can afford, if its outgo is more than its income on a continuing basis, it is likely to get into trouble. What can it do in this kind of situation where outgo is greater than income? What are its options?
1. Raise taxes. It can increase income by raising taxes. But it is limited in how much it can raise taxes. It can only raise them so far. If it raises them too much it will kill incentive and have a counter-productive effect. Capital will flee the country, go elsewhere. Overall production will decrease. They will be killing the goose that lays the golden egg. The government income, instead of increasing, will actually fall due to the slowing of economic activity.
2. Borrow money. Just like with an individual, the government can borrow money to make up the difference between its outgo and income. It borrows money by issuing government bonds. People buy government bonds and thus lend money to the government. But, just as with an individual, if it borrows money, it has to pay interest on that money. If you continue doing this your debt load gets bigger and bigger, the interest on your debt gets larger and larger, the portion of your outgo that is interest gets larger and larger, and you have less and less money to spend on your programs. In addition, if you borrow too much money, if you get too deep in debt, just as with an individual, people may become hesitant about lending to you. They may become concerned about your creditworthiness, worried that you might default on the debt, worried that they might not get paid back. They might prefer to put their money into precious metal or land of some other investment that they feel more comfortable about. To get them to buy your bonds, you might have to pay high interest rates. That pulls you down into the hole even further, gets you in even deeper trouble.
3. Print money. Unlike an individual, a government has the power to print money. Yes, I mean just print a whole lot of unbacked money. Then it can pay its bills with that new money, make up the difference between outgo and income with that. You can get away with this for a while but it always brings disaster if you keep doing it. Many governments have tried it and it always ends in hyperinflation with the money becoming worthless (as happened in Germany after World War I with the German mark). When you, in desperation, just print a lot of money to get out of your predicament, people lose confidence in your money, don’t want to hold it. They would prefer to put their money in precious metal, land, another currency or something else. Your money is unwanted and drops in value.
The currency of a country sits on a foundation of trust. The dollar, for example, is just an IOU issued by the United States government. It value depends on perceptions concerning the creditworthiness of the US government. One doesn’t want to hold IOU’s from issuers he doesn’t trust. Some questions to ponder: How far can you go with this stratagem of printing money? How do you know where to stop? Why should a government borrow money if it can just print it? Why should it tax its people if it can just print it? Why tax, why borrow? Why can’t we all live on government welfare with the government just printing money and sending us a check every month? Would it work? At one time the US dollar was backed by gold and the government would exchange it for so much gold. Now it is not backed by anything. How does this system work anyway? What sort of foundation is it based on?
4. Cut expenditures. The government can cut its expenditures to the point where it is living within its means.