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• Preface to the Third Edition
• From Preface to the Second Edition
• From Preface to the First Edition
• General Introduction
• Chapter I
• Chapter Ii
• Book I: Public Expenditure
• Chapter I: State Economy. General Considerations
• Chapter II: The Cost of Defence
• Chapter III: Justice and Security
• Chapter IV: Administrative Supervision. Poor-relief
• Chapter V: Education. Religion
• Chapter VI: Expenditure On Industry and Commerce. Constitutional and Diplomatic Expenditure
• Chapter VII: Central and Local Expenditure
• Chapter VIII: Some General Questions of Expenditure
• Appendix.: On the Classification and Guiding Maxims of Public Expenditure.
• Book II: Public Revenue the Economic Or Quasi-private Receipts
• Chapter I: The Forms and Classification of Public Revenue
• Chapter II: The State Domain. Lands and Forests
• Chapter III: The Industrial Domain
• Chapter IV: The State As Capitalist. Administrative Revenue
• Chapter V: State Property.—general Considerations On Quasi-private Revenue
• Book III: Public Revenue (continued) the Principles of Taxation
• Chapter I: Definition and Classification of Taxation
• Chapter II: The General Features of Taxation
• Chapter III: The Distribution of Taxation
• Chapter IV: The Tax System: Its Forms
• Chapter V: The Shifting and Incidence of Taxation1
• Chapter VI: The Principles of Local Taxation
• Chapter VII: The Canons of Taxation
• Book IV: Public Revenue—concluded - the Several Kinds of Taxes
• Chapter I: Taxes On Land
• Chapter II: Taxes On Capital and Business
• Chapter III: Personal and Wages Taxes
• Chapter IV: Taxes On Property and Income
• Chapter V: Taxes On Consumption: Their Classification: Direct Consumption Taxes
• Chapter VI: Internal Taxes On Commodities
• Chapter VII: Customs Duties
• Chapter VIII: Taxes On Communications and Acts
• Chapter IX: Taxes On Successions1
• Book V: The Relation of Expenditure and Receipts
• Chapter I: Introductory—state Treasures
• Chapter II: Public Indebtedness, Its Modern Development
• Chapter III: The History of the English Debt
• Chapter IV: History of the French Debt, Indebtedness In Other Countries
• Chapter V: The Theory of Public Credit and Public Debts
• Chapter VI: The Forms of Public Debts
• Chapter VII: The Redemption and Conversion of Debt
• Chapter VIII: Local Indebtedness
• Book VI: Financial Administration and Control
• Chapter I: Introductory—historical Development
• Chapter II: The Budget—its Preparation—the Collection of Revenue
• Chapter III: The Vote of the Budget—control and Audit
• Chapter IV: Administration and Control In Local Finance

BOOK V

the relation of expenditure and receipts

CHAPTER I

introductory—state treasures

§ 1. The preceding books have been devoted to the consideration of the various questions connected with public expenditure and revenue. We have seen that, under normal conditions, there ought to be a balance between these two sides of financial activity. Outlay should not exceed income, or—and this is more often the way in which the case is presented—tax revenue ought to be kept up to the amount required to defray expenses. The financier, so far differing from the business manager, should not aim at a surplus, but neither should he allow a deficit. Either is an indication of some defect in calculation or administrative system.

This general principle must, however, admit of modifications. Temporary deficits and surpluses cannot be avoided. In the management of a large financial organisation complete equalisation of receipts and expenditure could hardly ever be obtained, or, if it were, would be due to chance. The many different forms of expenditure and the varying productiveness, both of the quasi-private and the tax revenue, forbid minute agreement. All that can be claimed is a substantial approach to a balance in the two sides of the account. The safest rule for practice is that which lays down the expediency of estimating for a moderate surplus, by which the possibility of a deficit will be reduced to a minimum.

The foregoing consideration would apply to any system of finance in its ordinary or usual state, but the difficulty of adjustment is much increased by the operation of what has been described as extraordinary outlay.1 Occasions, as we saw, will from time to time arise, when it becomes necessary to spend large sums for particular objects. War and the execution of public works are the great causes of this sudden increase of expenditure, and the former is very hard to foresee and provide against. In any case it may fairly be said that exceptional charges of the kind should not be altogether met out of current income. As the advantages realised are of indefinite duration, it seems fair that the charge should, in popular language, be spread over a number of years. Without at present criticising this doctrine, we may remark that the political conditions place limits—elastic ones, it is true—on the revenue-collecting powers of the administration, and that in practice there are only two expedients for meeting abnormal outlay, viz. either the modern method of incurring debt, or the older one of storing up treasure or other disposable wealth for the time of need. The absence of equilibrium in public finance must show itself in the creation of a surplus store of wealth, or in the formation of liabilities. In the present chapter we shall therefore examine the policy of forming public treasures or other reserves, in order to provide for the necessities of the State in times of emergency.

§ 2. The system of public treasures can lay claim to a high antiquity. Thus the Athenians in the period immediately preceding the Peloponnesian war accumulated a sum of 9,700 talents, and at its outbreak had actually 6,000 talents in store. Even earlier, the Persian sovereigns had collected the tribute of their provinces in the shape of contributions of the precious metals, large stocks of which fell into the hands of Alexander.2 The same policy of hoarding was followed by the Romans. The stores of conquered sovereigns were accumulated, and the special tax on the emancipation of slaves was used in the same way. Indeed, the possession of the treasury became a leading object of the rival parties in the civil wars that overthrew the Republic.1

Like facts are noticeable in the mediæval period. One of the first objects of the successor to the Crown on the death of a king was to gain possession of the treasure. Both in England and France there were several instances of this eagerness.2 The treasure and the kingdom were regarded as a joint possession, each being in accordance with the conceptions of the time, looked on as equally a form of property. This practice lasted in England till the time of Henry VIII., who speedily dissipated the savings of his prudent father. Henri IV., who in this was guided by Sully, was the last French monarch who maintained a treasure.3

By the time of Adam Smith the practice had decayed; he notes that the canton of Bern was the only Republic, as Prussia was the only monarchy, that continued to keep a reserve.4 The latter country has been remarkable in this respect. Thus Frederick William I. (1713–1740), as Carlyle tells us, ‘Yearly made his own revenues, and his people's along with them, and as the source of them, larger: and in all states of his revenue he had contrived to make his expenditure less than it; and yearly saved masses of coin and “deposited them in barrels in the cellars of his Schloss.”’5 His successor, Frederick the Great (1740–1786), continued this system, and it affords a striking instance of the persistence of national policy when we find that the present German Empire follows what is virtually the same method.

§ 3. The reasons that induced so many States to accumulate treasure are to be found in the conditions of society existing at the time. A very rude community will have no need of a store of money; weapons and provisions would be more useful in its case. The system of money dealings must have come into being before hoarding can be regarded as the duty of a wise sovereign. Once that point has been reached, the great convenience of having a stock of a universally desired article on hand is too plain to be overlooked. The efficient maintenance of an army in the field depends in a great degree on the supply of what is so often called the ‘sinews of war.’ Cases are not unknown where expeditions failed altogether from want of this indispensable auxiliary. The superstitious reverence for the precious metals and the force of habit may partly account for the great treasures of ancient States; but they owe their continuance far more to their felt necessity. Where credit was undeveloped, and taxes were occasional and uncertain expedients, a State that had no treasure was in a dangerous situation, unprepared either for attack or defence. The position of the sovereign in earlier times as a large property-holder was contributory to the same result. Lands, forests, mines, and various lucrative claims were in the possession of the ruler. The treasure came to be looked on as one part of this extensive class, serving a particular purpose and completing the public economy.

As the system of state hoarding was produced by the economic conditions of the periods in which it was employed, so the change to the modern economic organisation necessarily led to its abandonment. The increased productiveness of taxes, and the facility with which credit could be used, relieved governments from the duty of keeping a stock of bullion for emergencies. The State ceased to be its own banker, and came to rely on the instrument supplied by the growth of credit. Not only were the ultimate advantages greater, but there was an immediate benefit in the saving of the amount required to replenish the store, when it had from any cause run down. Borrowing in times of need was more pleasant than a long course of previous saving. The change was, as we have seen, as gradual as the alteration in the ruling conditions that produced it. The keeping of stores of bullion died out slowly, and has even left, as in the case of Germany, survivals to the present day. This last instance deserves some further notice. The traditional policy of storing up a reserve for the pressure of war was applied to the German Empire by means of the resources obtained through the French indemnity. A sum of £6,000,000 was held in bullion and a much larger amount was invested in high-class securities, chiefly German railways and the debts of foreign countries. The ‘fund for invalids’ in 1901 amounted to over £19,000,000. There is, therefore, a reserve of over £25,000,000 held by the Empire in what is practically the form of a hoard, and apparently ready for use in time of war.

German economists have defended this proceeding on the ground that it is imperatively required for military necessities. The use of the treasure in the past is dwelt on, and it is further urged that at the outbreak of war the money market is so strained that a large loan is costly, if not unobtainable. The treasure or war chest is but the complement of the fortresses, equipment, and system of speedy mobilisation that constitute the safeguards of German unity.1 On the other hand, the general argument against state reserves is a forcible one. The retention of bullion by the State involves the loss of the interest that could be gained by its productive employment, while it is quite uncalled for in any country with an efficient system of banking. What is really required is a sufficient disposable metallic reserve to be drawn on in the time of trial. The state-treasure policy thus invades the domain of banking, and is at best inadequate. Three weeks of war would exhaust the store of £66,000,000 now held at Spandau.2 It is so hard to measure the precise amount needed, and error in either direction leads to such loss, that the policy is too uncertain in its effects to be advisable. The influence of state hoarding on trade and prices should also be considered. The withdrawal of a large mass of money tends to lower prices, and is so far a hindrance to the development of trade and the ever-present possibility of its sudden use has a disturbing effect.1 On the whole, then, it is beyond question that in any country with modern credit facilities the formation of a treasure is a mistaken proceeding. The case is still stronger against the use of a reserve in the form of securities. They, it is true, have the advantage of yielding interest, but where a public debt exists, it is better to use this available property for its redemption. To borrow with one hand, while lending with the other, is simply introducing an additional complication into the public accounts, without any corresponding advantage. The repayment of a portion of the German debt would be as much an investment as the policy actually pursued. But the method of investing in securities is not merely useless; it has direct disadvantages. If home securities are chosen, the State is drawn into the business of speculation and stockjobbing, with injurious results to trade. The interest on such investments may apparently exceed what would be saved by paying off debt; but this higher yield means diminished security or stability, a consideration that leads to another objection to such investments. The aim in view is the possession of a disposable fund for emergencies, but it is just at times of emergency that stocks are most likely to fall in value. A large sale of securities by a government at the outbreak of war would force down their price, and make the process of realisation a costly one. Moreover, the funds so obtained would be equally available for taking up a loan. To come on the market as a needy seller is the worst possible way of disposing of any kind of state property.

Where foreign securities are held the position is somewhat different. They will not be so much affected by the commencement of war, as they possess an international market. Political difficulties are, however, greater. Should the contemplated war be with the Power whose debt is used as an investment, the question of stoppage of interest would arise. In any case the relation between the investing and lending States is not a satisfactory one: it brings a sovereign power into the domestic affairs of another State, and in case of readjustments affecting the debt may cause grave difficulties. These considerations fully support the opinion that, speaking generally, the system of state treasures or reserves of securities is indefensible at the present stage of financial development.

Some exceptional cases have been suggested, but even they can hardly be admitted as modifying the principle just stated. A State, e.g., may have no public debt to redeem, and then the formation of a reserve may appear desirable, but there are other alternatives, viz. either (1) the remission of the less eligible forms of taxation, or (2) the increase of the agricultural or industrial domain of the State, a course which may be adopted on social, as well as economic, grounds. Again, the interest on the debt may be so low, that its redemption may not seem commercially profitable as compared with investment. The objections to state dealings with capital, already noticed,1 are too serious to be set aside on this ground. The remission of taxation, though it seems to be a sacrifice on the part of the State, may in many cases be the best course. The real source of state revenue is, need we say once more, the national income, and judicious remission of taxation has a beneficial influence on the growth of this reservoir, on which the State in the last resort depends for its tax receipts. The often-used phrase about allowing taxation ‘to fructify in the pockets of the taxpayers’ is here exactly applicable. The financial power of the State rests on the economic development of the people, and will be proportional to it. Any special resources in the form of money that may be required are best procured through the agency of bankers. The case in this respect is far clearer, than in the somewhat parallel one of manufacture of weapons and supplies, since the question of quality, or that of effectiveness of competition, does not arise.

§ 4. Whatever be the conclusion as to special and exceptional cases of state reserves, it is at all events plain that the older policy of hoarding as a general rule of finance is obsolete. It is, in fact, on its ruins that the modern phenomenon of public debts has arisen. From keeping a reserve to meet all emergencies States have passed to the opposite course of not paying even their working expenses. The problem of public indebtedness is becoming more and more important, and is giving rise to serious questions. The remaining chapters of the present book will therefore be devoted to an examination of the different aspects of this vital part of modern finance.

CHAPTER II

public indebtedness, its modern development

§ 1. The development of public indebtedness accompanied the decline of the older system of treasures. In its present form it is essentially a creation of the last two centuries, and even within the last fifty years it has gained more ground than in all preceding periods. The causes of its rise and immense expansion must be sought in the special circumstances, both political and social, of the time.

There is an appearance of exaggeration in the statement that public borrowing has only come into existence since the end of the seventeenth century. In all but the rudest societies credit has been more or less employed, and we can hardly conceive that the governing body would altogether neglect its use in times of need. So far, however, as classical antiquity is concerned, there is hardly any trace of loans to the State. The explanation of this fact lies in the characteristics of Greek and Roman society.1 Instead of borrowing from the wealthy citizen, the State adopted the more drastic, but in the long run less fruitful, method of levying a special tax on him. The small amount of floating capital also prevented a ready recourse to loans. Compulsory loans, or the farming-out of taxes, were, in default of a treasure, the favourite methods, to which may be added the rarer one of pledging some state or regal possessions. Temporary credit transactions with contractors were the nearest approach to a public debt in our use of the term.1

§ 2. The Middle Ages show little advance on—in some respects they fall below—the economic position of the Roman Empire. The strong sentiment against usury and the feeling that it was beneath the dignity of a prince to borrow from his subjects2 both tended to check the use of the royal credit. Where it was exercised the quasi-private nature of the feudal state system comes out clearly. The King borrows on his personal credit, or on his domain, which he even gives in pledge as a security for payment.3 These loans were usually obtained from the Church, or from foreign bankers. Hallam tells us that ‘in 1345, the Bardi at Florence, the greatest company in Italy, became bankrupt, Edward III., owing them, in principal and interest, 900,000 gold florins. Another—the Peruzzi—failed at the same time, being creditors to Edward for 600,000 florins. The King of Sicily owed 100,000 florins to each of these bankers.’4 Both in England and France these borrowings grew more common as wealth and the cost of government increased. Francis I. obtained various sums through the city of Paris, which kept a list of the creditors and distributed the interest.5 Appeals to Parliament in connexion with loans occur as early as the reign of Richard II. Forced loans were tried by Edward IV., and by the Tudors in the sixteenth century. The pledging of taxes as security for debt is the last step in the older forms of borrowing.1

A more advanced position is found in the loans of the Italian cities, especially Genoa and Venice, which raised money through the agency of banks established for the purpose. The bank of St. George in the latter city was the most important instance in this system. The superior commercial development of Italy contributed to the increase of state, as well as private credit, and more especially to complicated dealings in the farming of state domains and taxes.2

The commercial revolution of the fifteenth and sixteenth centuries, which depressed the Italian towns, brought those of the Low Countries into prominence. The system of state-borrowing and of lending to foreign countries was engaged in by the Dutch, who, in consequence of the low rate of interest, were anxious to enlarge the field of investment, and therefore undertook most of the limited international business of the time, such as the carrying trade and public loans. Imitation of Dutch methods of commerce and finance—so powerful an influence on the English policy of the seventeenth and eighteenth centuries—was a principal cause of the creation and advance of the English funded debt, which has in its turn been an example to other States.3

§ 3. It is thus plain that neither ancient nor mediæval finance possessed the modern public debt system. The latter, indeed, contained the germs from which our present expedients have been developed, but with so many differences that it is hardly right to place two such distinct groups under a common heading. They are, rather, separate species of a comprehensive genus. The increase of public debt in modern times is the result of economical and political conditions of the highest interest and importance. From one point of view, the vast indebtedness of States and smaller governing bodies is due to the transition to ‘credit economy.’ Money, as a medium of exchange, has been largely superseded by the use of credit instruments. In like manner, great masses of property, or, more correctly, the evidence of its ownership, have become freely transferable. The shares of companies, or their acknowledgments of debt, are very readily dealt in. Railways, banks, and other industrial undertakings by this means increase their business and the value of their property. It would be incomprehensible if the greatest of co-operative organisations—the State—declined to avail itself of a like expedient. In fact, governments,—supreme and subordinate, strong and weak,—have mobilised their credit, and thereby increased their immediate financial power. The mechanism of the Stock Exchange has remedied the weakest point in the earlier state-borrowing—the absence of any way of quickly realising the capital lent.

This connexion of public debts with the money market is, perhaps, most clearly seen in the modern methods of contracting loans. Whatever be the particular form adopted the substance of the operation is the same, and amounts to an investment of capital on the part of the lenders, carried out in nearly every case by the special class of dealers in stocks. To the investor there is no difference between taking up the stocks or bonds of a railway and those of a government. In the cases in which the latter are contracted on account of a particular undertaking, the resemblance is even closer. A loan to an Australian colony for railway construction is indistinguishable from one to a company for fresh capital outlay.

Though the modern money market affords the machinery for continued extensions of state-borrowing, it does not give the motive power. The amount of loan transactions must, it is plain, depend on the conditions of supply and demand; but, then, this somewhat general formula stands in need of further analysis. The reasons for the expansion of demand are discoverable in the increased public outlay of modern societies. We have often had to notice how both military and civil expenditure are growing, and also that some parts of this outlay are at once uncertain, and productive of durable advantage. War and public works require large immediate expense, and their full benefits are not reaped at the moment. To procure sufficient funds by taxation is both disagreeable and, on the surface at all events, unjust. The financier very naturally takes what he knows to be the most convenient, and probably believes to be the fairest, course in appealing to capitalists for assistance. It is true that all loans have not this plausible ground; they are often due to weak or careless finance, and are simply a mode of staving off the evil day. State credit is, like all modern credit, made up of both good and bad elements, and in its case the latter are often the more powerful.

As the increasing cost of the State gives us the motive for its greater borrowing, so do the development of the capitalist class and its greater influence on government explain the willingness to bring forward the needed supply. The earlier loans were either obtained by force, on the pledge of specific property or taxes, or finally on the honour of the personal ruler. In the constitutional epoch, advances are made to an administration over which the moneyed classes have influence. The close connexion of the English debt with the Revolution of 1688 and the maintenance of the system introduced by it is well known,1 and at an earlier time the Italian cities and the Dutch provinces were under mercantile influence. It is unquestionable that the development of representative government and its control of the administration have helped to secure a larger supply of loans than would otherwise be forthcoming. At the same time it is easy to overrate the significance of this fact. The mere existence of constitutional rule does not suffice to create borrowing, nor its absence to stop it, as the French debt of the eighteenth century and that of Russia at present will suffice to prove. A powerful class in the possession of disposable wealth will be in a position to act on the most irresponsible of rulers, and a prudent absolutism will recognise the wisdom of sustaining public credit. Nevertheless, the advance of constitutional government and the increase of indebtedness have been coincident, a circumstance due to the fact that both are products of the present stage of development, and not solely because ‘the moneyed interest has captured the machinery of government.’1 The greater attention to justice that, on the whole, characterises popular government naturally operates on public as on other economical relations.

Nor is there any reason to doubt that on the whole the change is advantageous. A strict observance of public faith, besides its immediate services both to lenders and borrowers, has a further influence in making the general financial administration more regular. When we remember the vital importance to a State of being able to secure assistance through credit at times of pressure, it is evident that anything tending to strengthen the guarantees for punctual payment is and must be for the general good.

In some respects, however, the development of public indebtedness has been accompanied by serious, though it may be hoped only temporary, evils. Where the administration is corrupt, or where the interests of the ruler and his subjects are opposed, there has been both undue use of borrowing, and terms far too favourable have been given to the lenders. The taint of rash speculation and of craft, amounting in some cases to fraud, which hangs round the modern Bourse has affected the great class of public loans. It may be that religious or political prepossessions have led some critics to attach too much importance to these dark features,1 but there can be no doubt of their existence. Immense advances have been made to governments that no prudent person would trust, and for objects that could not possibly be regarded as beneficial. Exorbitant rates of interest, in order to cover the great risk incurred, have been stipulated for, but not always paid; while, finally, the course of public policy has been sometimes influenced by sinister financial interests. Such practices naturally and justly arouse strong feelings of hostility in the minds of the sufferers, and of all whose moral standard is not debased; but in condemning them we should not forget the solid benefits that public credit has conferred on the world, nor the extent to which evil and good are usually blended in the ordinary economic transactions of men. There is, too, decided evidence of improvement. International public opinion is better pronounced, and, as in the case of individual credit, the sphere of the usurer in national transactions is being gradually restricted.

§ 4. The powerful effect of the influences that favour indebtedness is shown by the figures of every stock exchange, and by familiar facts of statistics. Out of the, in round numbers, 1,800 stocks quoted on the London market, 340 may be fairly described as public, of which the larger part are British. Berlin has something over half that number, of which about one-third are German.2 Paris has a still larger number. We may say that any State that pretends to be civilised regards the creation of a debt as one of the essential marks of its having reached that position. So does every colony and large city. The latest developments of municipal life are shown in the issue of bonds by the responsible authorities. Universality is one of the features of the modern debt system, and it is explicable only by reference to the conditions noticed in the preceding section, together with, in the case of backward States, the influence of imitation.

Public indebtedness is remarkable, not merely for its universal employment, but also for its great and growing amount. The following details are instructive, though in most cases the results are only approximate. The total public debts of the world in 1783 have been estimated at £506,000,000; by 1820 they had increased to £1,530,000,000; their amount in 1848 was about £1,730,000,000. According to a careful estimate, the national debts of European States in 1870 were, in round figures, £3,000,000,000, in 1885 they had risen to £4,600,000,000, or an increase of £1,600,000,000 in fifteen years.1 In 1900 the debts of the Great European powers and the United States were £4,000,000,000; Mr. Palgrave states2 the total debts of the various countries of the world towards the close of 1890 as £6,505,000,000, or an increase of over £1,000,000,000 on the debt existing in 1882. At the close of the nineteenth century the national debts of the world can hardly have been less than £7,000,000,000. This enormous sum does not include the local debts that are, if we may judge from all available facts, increasing even more rapidly. Both have been growing apace in such a manner as to excite the apprehension of reflecting observers. The reality and extent of the danger will demand examination later on—the existence of the circumstances that have caused alarm is all that concerns us at present; but even at this stage of the inquiry, it is well to notice the fundamental difference between two classes of debt, the one contracted for non-economic ends, the other for purposes of reproductive employment. War and public works have been mentioned as the two chief causes of abnormal outlay, and loans for these objects belong respectively to the different classes. To take obvious instances, the great addition to the French debt from the war of 1870–71 cannot be regarded in the same light as the indebtedness of Prussia and other German States for railway purchase and construction. The former involves increased taxation; the latter, if prudently applied, does not. The same contrast appears in the case of the English national, as opposed to the local debt, though this instance suggests the necessity of a qualification. Outlay on public works is not of itself, and apart from the revenue to be thence derived, different from the cost of war, or other unproductive expenditure. No readier or more dangerous mode of increasing debt can be found than the execution of works that are not economically productive. Vague assertions of indirect benefits should not be allowed to conceal the fact that ‘improvements’ of this kind should be paid out of income, and cannot be regarded as investments in the proper sense of the term.

§ 5. To summarise the results of the present chapter: state borrowing appears to be, in its leading features, a creation of the constitutional period, built upon the decay of the older method of state hoarding and having its germs in the Middle Ages. It is the result of the credit system, combined with the increase of public expenses and the greater security for observance of faith to the state creditors. Both on account of its universal employment and its rapid growth, it is one of the most influential factors in modern finance, and one whose tendencies and actual effects are deserving of close attention. To form a just appreciation of the system, a study of its history in the more important countries is desirable; and we shall therefore devote some space to this side of the question before passing to its theoretical aspects.

CHAPTER III

the history of the english debt

§ 1. The longest and in many respects the most instructive history of a continuous national debt is that supplied by Great Britain. The earlier attempts at systematic borrowing in Italy and Holland have ceased to have any practical effect, but the present English debt shows an unbroken record of more than 200 years. The Stuarts had not paid much respect to their obligations, and were quite prepared to repudiate inconvenient liabilities. Still, the expansion of the public economy made it impossible to avoid some floating charges. At the completion of the Revolution in 1689 the debt stood at a little over one million (£1,054,925); in 1691 it had risen to £3,130,000, bearing an interest charge of £232,000. An Act was passed in the next year which is regarded by Macaulay as the origin of the National Debt, and which provided that £1,000,000 should be borrowed on the security of the beer and other liquor duties. The yield of these taxes was to form a fund for the payment of interest, with the proviso that as each subscriber died his annuity was to be divided among the survivors until their number was reduced to seven, when as each annuitant died his share would lapse to the State.1 The necessities of the war with France compelled further borrowing. The funded debt is first mentioned in 1694. In that year the Bank of England was founded, and lent its subscribed capital, £1,200,000, to the Government at the rate of 8 per cent., which, with an allowance of £4,000 for management, made a total charge of £100,000 per annum. The connexion thus formed between the Bank and the Whig party continued as an influence in politics for several years.1

At the Peace of Ryswick (1697) the debt had reached £21,500,000, but in the four succeeding years of peace it was reduced to £16,400,000. The East India Company had lent £2,000,000 at 8 per cent. in 1698, which sum was applied to paying other obligations. There was thus a reduction of about £1,250,000 per annum during peace, as against the increase of £2,500,000 per annum during the longer war period, a state of things that we shall find repeated at several subsequent stages of the history. During the war of the Spanish Succession the debt rose at the rate of over £3,000,000 yearly, until at the Peace of Utrecht (1713) it came to £53,680,000.2

During the peace period, which, with a couple of slight exceptions, extended from 1713 to 1739, the movement of the debt was not uniform. In the first ten years owing to the South Sea Bubble, the war with Spain, and the method of dealing with taxation, it increased to £55,200,000. Then during the remaining sixteen years of peace, under the prudent administration of Walpole, some reduction was made, so that in 1740 the amount was just under £47,000,000, or an annual diminution of £500,000.

§ 2. This first half-century of the debt's existence presents several points of financial interest. The effect of war in adding to debt, to be a little reduced during the succeeding peace, has been noticed. A more important feature is the gradual introduction of funded debt. Annuities, tontines, anticipations of taxes, and floating or temporary liabilities tend to be absorbed in the now established form of capital advances for interest. The various separate debt accounts become blended in one indistinguishable charge. ‘The Aggregate Fund was established in 1715 and the South Sea and general Funds in the following year. To each of these funds a variety of branches of revenue were appropriated ... and each of them was charged with the payment of certain annuities then due by the public. The united surplus of these funds formed the basis of the sinking fund established in 1716.’1 This is the first appearance of the system which, at a later time and in a different form, was regarded as the most effective agency for reducing debt. The primitive sinking fund, usually called ‘Walpole's,’ was really due to Stanhope. It proved of little service for the purpose to which it was applied, as it depended on the existence of a surplus whether debt would be redeemed, and the contraction of new liabilities would always render nugatory the payments made towards redemption.

The first instances of the process know as ‘conversion’ also occur in this period. In 1714 the legal rate of interest had been reduced from 6 per cent. to 5 per cent., and three years later a like reduction was made on the interest of the public debt. Again in 1727 a further reduction from 5 per cent. to 4 per cent. was made, by which a saving of £400,000 per annum was realised. The good effect of Walpole's financial management was proved by the high price that the funds had reached. A 3 per cent. loan issued in 1727 stood at par in 1736, and in the next year at 107. Under such conditions it is plain that the whole redeemable debt might have been reduced to 3 per cent. or even lower. Political expediency, which made it an object to favour the fundholders, who were strong supporters of the Hanoverian dynasty, prevented this useful measure.

§ 3. The war of 1739–48 had the usual effect of increasing indebtedness. After the conclusion of peace it was found that £31,300,000 had been added to the previous incumbrances, bringing the total amount to over £78,000,000. The return of peace gave an opening for the application of financial management. Pelham in 1749 succeeded in carrying a conversion scheme, which may be regarded as the forerunner of the modern arrangements of the kind. Interest on part of the debt was reduced to 3½ per cent. for seven years, and 3 per cent. afterwards. Next year that on the remainder was reduced to 3½ per cent. for five years, and 3 per cent. afterwards. The fundholders at first dissented, but the high price of stock made it their advantage to accept the conditions. The consolidated 3 per cent. stock was established in 1751, and existed till the conversion of 1888 as the principal part of the debt. Its price in 1752 was 106¾, the highest point it ever reached. The sluggish condition of trade, and the difficulty of finding good investments sufficiently explain the existence of so high a price.

Up to 1756 the debt had been reduced about £6,000,000 and stood at £72,200,000 when the Seven Years’ War commenced. Expenditure at once rose so much as to lead to borrowing, which continued until, at the close of the war in 1763, the funded debt was £122,600,000 with a floating debt of about £14,000,000. The consequences of the war were apparent in the position of the Exchequer for some years afterwards. In 1766 the funded debt had risen to £129,500,000 with a further unfunded one of over £10,000,000. The succeeding years of peace allowed of small reductions, coming in all to about £10,000,000 in 1775, when the funded debt was £125,000,000 and the floating one £4,150,000, or a total of almost £130,000,000. As might be expected, the American war of Independence added seriously to this burden. At the conclusion of the Peace of Versailles (1783) the total debt was over £238,000,000 or an annual increase of about £13,500,000. During the latter part of the war the strain on English credit was shown by the low price obtained for the loans of that period.

Pitt's first administration dates from 1783, and its earlier part, which may be called the peace one, and which ended with the outbreak of the war with France, did not accomplish much in the direction of diminishing the capital of the debt. In 1786 the new Sinking Fund was established, and by 1793 it had redeemed about £10,250,000, leaving a net capital charge of £228,000,000.

The characteristics of the second half century of the debt history are found in the great growth of both capital amount and interest charge. After taking into account the small repayments in time of peace, there remained a net addition of £180,000,000 in the fifty-four years 1739–1792, while the annual payment for interest had risen from £2,000,000 to nearly £9,500,000 in the same period. The terms of borrowing varied, but up to 1780 the loans were usually issued at par: their capital therefore represented the amount really received, though they were accompanied by small annuities for terms of years, or other special favours. Lotteries were also combined with the loans, subscribers to an issue of stock receiving tickets. In 1781, however, a loan of £12,000,000 was raised at the rate of £150 of 3 per cent. and £25 of 4 per cent. stock for £100 paid, or a total capital of £21,000,000. The result of adopting this system was to add nearly £25,000,000 to the nominal capital of the debt without any corresponding receipt. It was probably due to the fear entertained by subscribers that their stock would on the return of better times undergo a reduction of interest, and also to the preference of the government for a large 3 per cent. stock. As mentioned above, the sinking-fund policy which so powerfully affected the course of the debt was started at this time, though its influence was not as yet very noticeable.

§ 4. By far the most important and critical period in the development of the debt is that during the protracted struggle with France, first under the Revolutionary government and afterwards under Napoleon I. Without the abnormal expenditure of the twenty-three years 1793–1815, the sinking fund of 1786 would have automatically wiped out the comparatively small capital liability; and the rapid growth of British industry, free as it would have been from the oppressive taxation that Pitt was compelled to impose, would have made the operation practically unfelt. The whole financial system of Great Britain has been profoundly affected, but the present debt is the most prominent of these results.

From the outbreak of war (1793) to the peace of Amiens (1802) loans were required in every financial year. The amounts, at first small, rose with the great outlay that the continuance of hostilities made necessary, till in 1797 the capital funded was over £67,000,000, the actual sum obtained for this acknowledgment of debt being £44,000,000. As nearly £7,000,000 were redeemed by the sinking fund, in that year, the net increase of debt was somewhat over £60,000,000. In the other years the additional debt contracted was not nearly so large,1 but the effect of the methods pursued was shown in the amount of debt at the conclusion of peace. It was just £500,000,000, an increase of over £270,000,000 since the opening of war in 1793, i.e. £27,000,000 per annum. The sinking fund had besides paid off £57,000,000 of the debt incurred, which must be added to the other liabilities of the time. The principal cause of this great addition was the unwillingness to impose taxes at the commencement of the war. For the four years 1793–7 the total amount raised in taxation was £70,000,000, or £17,500,000 on the yearly average, while for the four years 1799–1802 it was £134,750,000, or an increase of 92½ per cent.

The short peace did not allow of any reductions in expense, and on the recommencement of war the borrowing system was again applied, though not to so large an extent. At the opening of the year 1816 the funded debt was £816,000,000, with a floating one of £60,000,000, showing a total increase of £360,000,000, or over £25,000,000 per annum. This comparatively satisfactory result, notwithstanding the immense expenditure of the Peninsular War, is explicable by reference to the much heavier taxation imposed. The income tax was in full operation, and the tax revenue rose from £37,250,000 in 1803 to £75,500,000 in 1815. Mr. Gladstone has asserted that the early adoption of the income tax would have saved the necessity of borrowing, since the annual expenditure apart from the debt charge would in the later years have been met by the receipts from taxation.1 Whether this would have been possible may be a matter of dispute, but there can be no question that the system of loans was carried to excess.

From the facts just noticed we can see clearly the defects in the method of finance during this trying period. They are: (1) the dislike to impose sufficient taxation, a feeling very natural on political grounds, but indefensible from the purely financial point of view. Instances of this error occur chiefly in the earlier years. (2) An undue reliance on the purely illusory expedient of a sinking fund, which, taking the most favourable view, increased the expense of management and deranged the loan market. (3) The system of borrowing at a higher nominal capital than the amount actually received, thereby preventing, or at least hindering, future conversions of debt.

§ 5. The French wars brought the English debt to its maximum point. Since that date there has been some, though insufficient reduction of it. The whole course of treatment has tended towards the adoption of a sounder and more careful policy, guided in a great degree by the influence of theory. The criticisms of Hamilton and Ricardo1 exposed completely the sinking-fund fallacy. As the result of careful inquiry it was settled, in 1819, that a real surplus of £5,000,000 annually should be preserved; but after various difficulties and changes, the sinking-fund as a positive institution was abolished in 1829, whatever actual surplus existed at the end of each financial year being marked off for redemption of debt. The continuance of peace enabled the method of conversion to be tried with effect, though the field of operations was limited by the mistaken policy of borrowing in a 3 per cent. stock with a high nominal capital. In 1822 £152,000,000 of 5 per cent. stock was converted into 4 per cents., and in 1830 further reduced to 3½ per cents. The old 5 per cent. stock (76,250,000) was reduced to 3½ per cent., to which rate a small balance of 4 per cents. (about £10,000,000) was also reduced in 1834.

One of the most discreditable periods in English finance was that between 1830 and 1840. Hardly any fiscal reforms were carried out, and the debt was increased by budget deficits. Its amount in 1841 was £792,000,000, nearly £8,000,000 more than in 1830. The firmer administration of Peel restored the finances. A surplus was procured by the revived income tax, and a fall in the rate of interest made it possible in 1844 to convert the 3½ per cent. stock—£248,000,000—into 3¼ per cent. for ten years and 3 per cent. afterwards. The attempt made by Gladstone, in 1853, to create a 2½ per cent. stock, proved a failure, owing to the rise in interest and the pressure of the Crimean War (1854–5). This latter event supplied further illustration of the operation of war on indebtedness; though the progress of wiser views as to the treatment of extraordinary expenditure was evidenced by the increased taxation, which contributed the larger part of the total war expenditure (£70,000,000), leaving only £34,000,000 to be added to the debt.

§ 6. For nearly half-a-century (1856–1899) no important increase in debt took place, and the growth of wealth made the weight of the existing charge much less oppressive. Moreover though there was no energetic action for the repayment of the debt, the influence of the reformed sinking-fund, the terminable annuities, and conversion produced a decided effect on both capital and interest: in fact during this period the history of the debt consists in an account of their operation.

When the sinking-fund theory was abandoned, the old rule still applied by which the surplus remaining in the Exchequer at the end of each financial year passed to the Commissioners for the redemption of the debt. If large surpluses were realised year after year, this would be a satisfactory method, but with accurate balancing of receipts and expenses it is of little service. A considerable excess of receipts over expenditure gives rise to a cry for remission of taxation that is not easily withstood. Hence the need for marking off some special funds for the payment of debt Sir S. Northcote's sinking-fund measure (1875), by which an amount of £28,000,000 annually was permanently set apart for this end, is the most obvious course. Unfortunately it is very easy to find plausible reasons for cutting down the sum so fixed. Under Lord Goschen the £28,000,000 became first £26,000,000 and then only £25,000,000, a sum which left a comparatively small margin over the interest and terminable annuity payments but which was again reduced by Sir M. Hicks-Beach in 1899 to £23,000,000.1

The method of redeeming debt by the use of terminable annuities was on the whole more effective. In their commencement public debts were often raised by annuities in various forms,2 and during the Revolutionary and Napoleonic wars the system of adding long annuities to the funded loans was adopted, the periods being so arranged as to all terminate in 1860. By this system a considerable relief was gained when the date of expiry was reached. As an effective method of redemption fresh terminable annuities have been created, and an equivalent amount of stock cancelled. The largest creations were in 1868 and 1884. In the former year £24,000,000 of savings-bank stock was cancelled, and an annuity of £1,760,000 substituted. In 1884 Chancery stock to the amount of £40,000,000, and over £30,000,000 of Post Office savings bank stock, were similarly treated, with the result that the funded debt was brought within more moderate limits. In 1860–1 its total amount was £788,970,799. After thirty years it stood in 1890–1 at £579,472,082, or almost £210,000,000 less. On the other hand, the terminable annuities had risen in capital value from £16,500,000 to £68,500,000, an increase of £52,000,000. In 1889 the funded debt had risen to £583,186,305, owing to a reduction of floating charges, while the terminable annuities were reduced to a capital value of £36,250,000.

Within the last fifteen years the agency of conversion has also been employed with success. Mr. Childers's conversion scheme of 1884, by which 2½ or 2¾ per cent. stock might, at the option of the holder, be obtained for the existing 3 per cents., with an increased capital of 2 or 8 per cent., according to the stock chosen, failed to attract. Only £21,648,000 of stock was offered for conversion (more than half of it from public offices). But the failure of this attempt prepared the way for Lord Goschen's success in 1888. The principles adopted by him were: (1) the creation of a single new stock, so that holders were not confused by having to choose; (2) the avoidance of any addition to capital; (3) the use of the most effective technical methods, such as conversion without expressed consent, where this course was legal, commission to agents for the trouble imposed on them, and a small concession in the substitution of quarterly for half-yearly payments of interest. These contrivances, together with the persistent low rate of interest, enabled the conversion to be carried out with complete success. The whole mass of 3 per cent. stock, amounting to £558,000,000, was converted, or paid off.1 A new stock, bearing interest at 2¾ till 1903, and at 2½ from that date for twenty years, has taken the place of the older 3 per cents., and a relief in interest to the amount of £1,400,000 annually has been secured, with the certainty of an equal gain in 1903. As an incident of the process the floating debt became larger, and amounted in 1891 to £36,000,000 or more than double the normal level. But by degrees the greater part of this sum was funded, so that in April, 1899, the floating debt was only £8,133,000.

§ 7. A new chapter in the history of the debt began with the outbreak of the South African War in October 1899. It was at first believed that the cost would be small—£10,000,000 being the earliest estimate—and the only provision made was an issue of £8,000,000 in Exchequer Bills. By the close of the financial year 1899–1900 the real character of the contest was better understood, and a war loan for £30,000,000 was issued with an appeal to patriotic sentiment, to run for ten years, bearing 3 per cent. interest at the price of £98 10s., or 1½ per cent. discount. Further issues, in the form of Exchequer Bonds, with 3 per cent. interest, and redeemable, some in 1903, and the remainder in 1905, followed. These represented a capital debt charge of £24,000,000. In 1901 it was evident that the expedient of creating unfunded debt had been carried to its utmost limit, and accordingly one of the features of the budget proposals of that year was the issue of £60,000,000 of the ordinary Consols at the price of £94 10s. or a discount of 5½ per cent. As the war continued during the first months of 1902, another loan in Consols to the amount of £32,000,000 was arranged at the fixed price of £93 10s., giving a discount of £2,080,000 on the whole amount.1 Even the conclusion of peace did not relieve the country from the necessity of contracting this fresh liability, though it was hoped that a part of the funds obtained by it might be available for the repayment of debt. During the years 1899–1902 there was also a suspension of the operations for the redemption of the debt which provided a further resource of between four and five millions a year. The net result has been a decided increase in all the different forms of indebtedness. The floating debt has somewhat increased; the Exchequer Bonds and the £30,000,000 war loan represent short term loans of a class better known in American than in English finance. The terminable annuities have been raised to £60,000,000 by the provisions of the Budget of 1899.1 But the funded debt, though relieved by the adjustment just mentioned, has had two large issues of Consols added to it. In short, the total charge on March 31st, 1902, was £747,876,000, an increase of £60,000,000 over the total of the preceding year.

The preceding details afford certain obvious points for criticism. First, there is the large proportion of the war expenses supplied by borrowing. Some difficulty exists as to the exact figures, but it is well within the mark to say that more than two-thirds of the extraordinary outlay has been met out of loans, a position that compares unfavourably with the similar case of the Crimean War. Next, there is the curious policy of issuing loans at a fixed discount, instead of inviting tenders, or so arranging the interest that the par value should be obtained. Finally, there is the question whether all the issues should not have been in the form of a single uniform stock, which would command a better price, and if issued at 3 per cent. would in a short time be ready for conversion. But the most interesting question is one of the immediate future, viz. the method and extent of the proceedings for redemption. A good deal of stock will be ready for treatment in the years 1905 and 1910. Much, however, must depend on the market price of Consols, and therefore the agencies of redemption will have to be kept in an elastic form. In any case there has been a clear illustration of the way in which two or throe years of war will undo the work of eighteen or twenty years of peace.2

§ 8. Looking back on the course of the English debt, it is very plain that its growth has been altogether due to war expenditure, while its continued existence must be largely attributed to financial weakness. A comparison of the debt incurred during each war with the amount paid off in each succeeding peace establishes this. Over £600,000,000 was added in the great war (1793–1815); hardly £75,000,000 was paid off in the forty years’ peace. The Crimean War added £34,000,000; it took twelve years of peace to pay off this sum. The South African War has increased the capital of the debt by £160,000,000. It is safe to say that twenty years of unbroken peace will hardly suffice to remove this extra burden. Greater vigour in the use of terminable annuities, the maintenance of larger surpluses, and above all a wider employment of direct taxation in the form of income, property, and inheritance taxes are the means by which better results might be obtained. The pressure of the debt, however calculated, is too light to justify such remissness. When we remember that each million of debt redeemed means the power of permanently remitting as much taxation as is represented by its interest charge we can better understand the advantage of an energetic policy in regard to it.

CHAPTER IV

history of the french debt, indebtedness in other countries

§ 1. A natural division of the history of the French debt is that into two parts; the former dealing with the borrowing under the Monarchy, and the latter with that under the system founded during the Revolution. The history of the various loans previous to the present century has been concisely described as ‘a history of bankruptcies.’1 All forms of loans were tried; and all possible methods of evasion were used to escape repayment. The costly wars and the internal disturbances of the country partly explain this course of policy, but ignorance of financial and economic conditions was the great cause. Forced reductions of debt and debasements of the currency were frequently employed. An extensive revision was carried out by Sully in 1604, and further reductions were made by Mazarin. Colbert's administration introduced some system into this part of finance, but after his death the older confusion reappeared. One of the effects of the Mississippi scheme was a consolidation of the diverse forms of the debt, and a reduction of its amount to a sum, estimated at 1,700,000,000 livres, with an annual charge of 48,000,000 livres.2

The reign of Louis XV. (1715–1774) was marked by fresh loans and repeated forced reductions of the capital debt. In 1764 the sum of the different liabilities was 2,360,000,000 livres and the annual charge 93,000,000 livres; at his death the total annual charge was 120,000,000 livres, besides a floating debt of 235,000,000 livres. The increasing embarrassments of the State, which might have been overcome by Turgot, had he remained in office, were at least the proximate cause of the summoning of the States-General, and therefore of the Revolution.1 According to the report submitted by the committee of the Constituent Assembly in November, 1789, the annual debt charge came to 208,000,000 livres, to which the floating debt had to be added.2

§ 2. The financial difficulties that surrounded the revolutionary governments led to large issues of assignats, and to a consolidation of the public debt on a plan arranged by Cambon (August, 1793). By it all debt was to be inscribed in a ‘Grand-book,’ which was to be the conclusive evidence of the claim. The redeemable debt with 5 per cent. interest was first so treated, and the annuities were afterwards added. The result was the creation of an annual charge of £7,000,000 (174,716,000 francs), or a capital debt of £140,000,000. Unfortunately, the use of paper money and forced loans destroyed whatever benefit this systematic treatment might have conferred, and the straits of the government led to the measure of 1797 (Vendémiaire, Ann vi.), by which two-thirds of the debt was ‘paid off’ (?) in bonds to be exchanged for land, and, after some reductions for confiscations, the balance in annual interest was ascertained to be £1,600,000 (40,216,000 francs), representing a capital debt of £32,000,000. About £250,000 was added to the interest charge by the Directory, so that by the opening of 1800, 46,300,000 francs was the annual payment. The financial administration of Napoleon I., or rather of his advisers in such matters, Gaudin and Mollien, had two great merits. It resisted all temptations to issue inconvertible paper money, and it steadily refused to meet war expenditure by the method of borrowing. The result is to be seen in the position of the public debt at the fall of the Empire. In April, 1814, the interest had risen to 63,300,000 francs (£2,530,000). After allowing for the debts of the annexed provinces, the net increase was less than £300,000 interest, or £6,000,000 capital. In qualification of this favourable situation the immense burdens imposed on France and other countries must be taken into account. The Napoleonic system of making war support itself was a crushing one for the nations subjected to its operation, and probably far heavier than a well-managed public debt would have been.1

The Government of the Restoration had a series of difficult financial tasks to face. It had to meet the war indemnity levied on France by the allies; it had to compensate the emigrants; and it had to take up the unpaid balance of the Imperial outlay. It handled these various problems with honesty and firmness, refusing altogether to repudiate the debts of the Empire, as some of its supporters wished. The principal feature of debt history during the period 1815–1830 is the creation of new debts to meet the indemnities and other outlay. The total amount required for these purposes represented an annual charge of over £6,500,000.2 A second noticeable point was the creation of other than 5 per cent. stock. The emigrants’ indemnity was in 3 per cent. stock, and the conversion of 1824 was partly in 4½ per cents. and partly in 3 per cents. At the same time the policy of redemption was effectively carried on. The annual charge was reduced by 54,000,000 francs (£2,160,000), and conversion removed about 6,000,000 francs. These sums, with a few small escheats to the State, practically wiped out the debt existing in 1814, leaving that created by the Restoration Government (though it was not responsible for it) as the actual charge. From another point of view it may be said that in the fifteen years there was a net increase of £4,000,000 interest. The capital of the new loans amounted to nearly £132,000,000, less the sum of £43,000,000 redeemed, or a net capital increase of about £90,000,000.

The Orleanist Government commenced its career by borrowing. Its first loan added £280,000 to the interest charge, and was issued in 5 per cent. stock at 84, or nearly 6 per cent. on the actual sum received. Another loan of £4,000,000 at par only brought in £800,000. Further loans were made, in order to clear off deficits, to prepare for war, and to carry out public works, but the redemption of existing debt was also carried on, so that against £1,500,000 fresh interest created, about £1,000,000 was redeemed, leaving a net increase of £500,000 during eighteen years, but, it should be said, years of profound peace during which public credit stood high.1 The position of the stocks over 3 per cent. would have easily admitted of conversion, without any increase of capital, into a 4 per cent. or even 3½ per cent. stock, but to avoid popular hostility this financially prudent course was not taken.23

Short as was the duration of the Second Republic, it added £2,120,000 to the interest of the debt, and thus brought the total charge to nearly £9,200,000. The complete disorganisation of the financial system and the hazardous experiments of the provisional government sufficiently account for this state of things.

The first financial performance of the Second Empire was the conversion of the 5 per cent. stock, amounting to £140,000,000, into 4½ per cent., with a gain to the State of £700,000 per annum. Less than £3,000,000 of capital had to be paid to dissenting creditors. But the management of the war expenditure was not so satisfactory. The total cost of the Crimean War to France was £66,000,000 and of this sum £61,500,000, or 93 per cent. of the whole, was added to the debt. Further loans, issued much under par, followed for the Italian and Mexican wars. The total addition to the debt between 1852 and July 1870 was represented by an increased interest charge of £5,160,000. Thus the annual payment had risen to £14,400,000, and the capital was a little less than £480,000,000. Even more questionable than the large borrowing was the conversion of 1862, by which, for the sake of a premium, the 4½ and 4 per cent. stocks were converted into 3 per cents., with a proportionally increased nominal capital. This unjustifiable measure gained a premium of £6,300,000 for the State, but on the other hand it increased the capital of the debt by almost £64,000,000, and precluded the hope of further speedy conversion.1

§ 3. The Franco-German War of 1870–1 is as marked a period in the development of the French debt as the war with Napoleon I. was in the case of the English one. Its first effect was to place an enormous strain on the resources of the new government. In addition to the terrible expense and sacrifice due to the military operations there was the indemnity of £200,000,000 to the Germans. The total burden imposed on the State has been estimated at £393,000,000. Of that sum about £340,000,000 was raised through loans of one kind or other. Nearly £60,000,000 was received from the Bank of France by the inconvertible paper issues. Over £40,000,000 was borrowed in 1870, and two great loans, the first of £80,000,000, the second of £120,000,000, were raised in 1871 and 1872.1

The debt incurred to the Bank of France was cleared off by annual payments, at first of £8,000,000, and afterwards of £6,000,000, until in 1879 the whole was discharged. In other respects the treatment of the debt has been weaker. Fresh loans have been contracted for public works, and to meet budget deficits. M. Freycinet's plans accounted for a large part of this increase in debt, which was raised in 3 per cent. stock terminable after seventy-five years. Thus a new category of debt was added to the old perpetual rentes, with a nominal capital of £160,000,000, an interest charge of £4,800,000, and a further charge of £1,000,000 for redemption. The old 5 per cents. were converted in 1883 into 4½ per cents. without any increase of capital, and merely with the proviso that no further reduction would be attempted for ten years. In 1894 the expiration of this term and the high price of the stock allowed of a fresh conversion into 3½ per cents. which was successfully completed. Out of a total capital of £271,500,000, only £55,750 was demanded by the holders, the remainder being retained at the lower interest. In this way the State gained over £2,700,000 annually. A further step in the treatment of this stock has been made in 1902 by M. Rouvier's measure for its reduction to 3 per cent., accompanied by a bonus of 1 per cent. to those who accept the conversion, and a guarantee against redemption for eight years. Besides the reduction in interest there is the additional advantage of consolidating the stock with the larger mass of existing 3 per cents.

Notwithstanding these important economies, both the annual charge and the capital account of the French debt are extremely heavy. The consolidated debt amounts to £880,000,000, with annual interest of nearly £28,000,000. When the other liabilities are added we get the enormous total of £1,300,000,000, involving an annual cost of £50,000,000, of which about £3,500,000 is applied to its redemption.1

The French debt is by far the largest in the world, being double the English in annual charge, and over £500,000,000 greater in capital amount. This great accumulation of debt has been altogether the work of the present century. A comparison with the English debt will show the steps by which the latter has been approached and then passed. It is also interesting to note the widening distribution of rentes among the French population. In 1830 the holdings of stock were only 125,000 in number. By 1869 they had increased tenfold, while in 1881 they numbered more than 4,000,000. The great mass of the debt is in the hands of Frenchmen, and divided among all classes of society. This, though in some respects desirable, hampers a finance minister in such processes as conversion or repayment, as the fundholders’ interest is at once powerful, and in immediate opposition to that of the State.

Some alleviation of the burden may in the future be reasonably expected from (1) the gradual redemption of the 3 per cent. stock created since 1878, a process to be finished in 1952, and (2) from the falling in of the railway property, which, as we saw, will happen at about the same time.1 But the benefits to be thus received will largely depend on the methods employed in the next fifty years. If deficits are allowed to continue, if injudicious expenditure is carried on, and if new public works are started, it is certain that a fresh debt, perhaps exceeding that now in existence, will be formed by the middle of the next century.

§ 4. Italian unity has, at least from the financial point of view, been purchased at a heavy price. Not only has the weight of taxation been inordinately increased, but a large public debt has been contracted. The new kingdom had to take up the debts of its predecessors, and from its formation up to 1875 each year's budget showed an excess of expenditure over receipts.2 The use of loans, either openly, or by the issue of inconvertible paper, was the inevitable result. The latter expedient was in force from 1866 to 1883, when it was removed by means of a loan of over £29,000,000 in specie. Since then, however, there have been further deficits and an increase of liabilities, so that the total capital of the Italian debt at the close of the 19th century amounted to £514,500,000, involving an annual charge of £23,194,000.3 About £6,000,000 of this sum has been an inheritance from the earlier States, and the war of 1866 is accountable for part of the balance; but the great source has been the budget deficits in ordinary years, that have gradually accumulated in the present heavy burdens.

The situation of the German States is in sharp contrast with that of the countries already considered. They are not weighed down by debt charges, and they have the advantage of possessing assets against a good deal of their apparent liabilities. As appeared in connexion with the quasi-private income, the retention of the domain, both agricultural and industrial, has been more marked in Eastern Europe, and this difference in policy has affected the position of the public debt.

The use of a State treasure prevented the employment of loans by Prussia up to the French war of 1792. From that time the public necessities were too pressing, and some debt was contracted, which by 1820 came to nearly £33,000,000 with a yearly charge of £1,140,000, and a sinking fund which brought the total annual cost up to £1,500,000. During the next thirty years the debt was reduced by the sale of public property and by suitable taxation, until in 1848 the interest charge was only £650,000. Between 1850 and 1870 there were increases both for public works and war expenditure, that by the end of the latter year brought the total debt to £66,700,000. Since then the purchase of the railways has added heavily to the nominal debt. The process of redemption has also been carried on to such an extent that there is an actual diminution of the non-productive part. In fact, the railway receipts have in some years more than sufficed to meet their expenses and the whole cost of the interest and sinking fund on the debt. The total debt has grown to nearly £330,000,000, and the interest charge to nearly £14,000,000, but owing to the assets acquired by its means, the Prussian debt is less oppressive than that of any other European country.1

The four important secondary States in Germany are somewhat similarly placed. The whole debt of Baden is for railway construction, as is the far greater part of those of Saxony and Würtemberg. Two-thirds of the Bavarian debt was incurred for the same object. As the railways have in recent years contributed more than the interest on their part of the debt, there is a considerable relief to the taxpayers, and if liquidation were necessary, the assets would leave a balance.

At its establishment the German Empire took up the debt of the North German Bund, which consisted in loans for the war of 1870–1, amounting to over £30,000,000, and which has been almost entirely paid off. New loans have, however, been issued for extraordinary expenditure—and in the latest case to meet a deficit—which have brought the debt to nearly £120,000,000 with an annual charge of £4,400,000. The various Imperial funds must be placed on the other side of the account; they, as we saw,1 come to £25,000,000, thus leaving over £90,000,000 as the net liability.

§ 5. The United States, again, have a different debt history from any of the preceding countries, and one that suggests some points of interest. After the adoption of the Constitution, Hamilton prepared and carried a scheme of funding by which the debts due to France and Spain, those owed to natives by the Congress, and lastly the debts of the States, were combined. The total debt was in 1791 $75,000,000. Notwithstanding the creation of a sinking fund, the amount due increased in 1796 to $84,000,000. By 1812 it was reduced to $45,000,000. The war with England led to a greater outlay, which was for the most part met by loans.2 In 1816 the debt had reached $127,000,000. From that point there was a steady reduction, till in 1835 the total debt was only $37,000, or practically nil. During the following years some temporary loans were made, as e.g. for the Mexican War (1848), and the total debt stood at about $60,000,000 when the Civil War broke out.1

The first results of the contest were a serious disturbance of industry and commerce and a great increase of expenditure. No adequate tax-system was in existence, and accordingly the extraordinary expenditure was at first almost entirely met by the use of credit. Treasury notes, culminating in inconvertible paper issues, and funded debt were both employed. It was not until 1864 that the tax revenue was made a really effective contributory to the war expenses, but from that date its development was rapid.2 Soon after the close of the war the debt touched its highest point. According to Mr. Bolles, ‘On the 1st September (1865) the debt recorded on the books of the Treasury reached its maximum, though a large amount of war obligations, pensions, &c., were not yet paid.’3 This maximum was represented by the sum of $2,846,000,000, of which only $1,110,000 was funded debt, and about $460,000,000 inconvertible paper; the enormous sum remaining—$1,276,000,000—was in the form of floating debt, most of it immediately repayable. The cash reserve in the treasury was, however, only $88,000,000, leaving net liabilities to the amount of $2,758,000,000.

The great financial problems for the Secretary to the Treasury were therefore (1) to pay off, or fund, the floating debt, and (2) to provide a permanent scheme for the future extinction of the immense liabilities created by the war. The former required immediate attention, and was successfully managed. In a little over two years the floating debt was brought down to $408,000,000, and the inconvertible issues reduced by over $20,000,000, while new funded debt to the amount of $686,000,000 in 6 per cent. bonds had been issued. The temporary obligations were cleared off in 1868, leaving free scope for the repayment, and when possible the conversion, of the funded debt.

A sinking fund law had been enacted in 1862, but as there was no real surplus till 1866 it was inoperative, and in fact the payment of debt has not been carried on in conformity with that law. It has, notwithstanding, been on an immense scale, as the following short table proves:—

Thus in a little over a quarter of a century $2,100,000,000 was removed from the capital liability, and the annual payment reduced by nearly $130,000,000. This at first sight extraordinary result was due in part to the high credit of the United States Government, which enabled the 6 per cent. and 5 per cent. bonds, as they fell due, to be reduced to 4½ per cent. and even 3½ per cent. A more potent cause existed in the receipt of large annual surpluses, the natural consequence of the high duties on imports. The protective system was in this way the cause of the repayment of the war loans. From the financial point of view it is plain that a like result could have been reached at much less real cost and sacrifice, if moderate duties had been used; but then it is doubtful whether in that case the policy of repayment would have been so firmly adhered to.

As a result of this vigorous treatment the position of the federal debt ceased for a time to be a prominent question in American finance. Such importance as it had arose in connexion with the management of the treasury and the banking system. The first change in this satisfactory condition was the outcome of the depression of 1891–3. In order to maintain the gold reserve the plan of issuing loans was tried.1 Owing to the increase of expenditure and the policy of the Tariff Acts of 1890 and 1894 the surpluses which had been realised in every year since 1874 were replaced by deficits,2 which in the six years 1893–9 amounted to $281,000,000, the war with Spain only accounting for a small part of this sum.3 Consequently the debt increased from its minimum point of 1892 to $1,046,048,000, i.e. an addition in seven years of $461,000,000, or 78 per cent.1 The interest charge, in spite of the low interest on some of the loans, also advanced to $40,347,000. The financial years 1899–1900 and 1900–1 have both seen reductions of the capital charge and interest. The process of conversion has been actively carried on, three, four, and five per cent. loans being converted into a two per cent. stock. Thus the 4½ per cent. debt has entirely, and the 5 per cent. very nearly, disappeared, and almost half of the capital bears only two per cent. interest, while the average is less than three per cent.2 Should the revenue continue to show surpluses as large as those of 1900 and 1901 the practical extinction of the debt will be soon accomplished.

§ 6. The debt systems of other countries need not be considered in detail. They exhibit the same general features, but in some cases afford instructive variations on those already noticed. The most important countries are Austria-Hungary and Russia. In the former there is a separate account for the old common debt existing before 1867, and each part of the dual monarchy has its own debt account. The interest charge for 1902 is £14,750,000 for Austria, and £10,875,000 for Hungary. The combined capital amounts to £550,000,000. The Russian debt has been affected all through its history by the inconvertible paper currency and the autocratic character of the government. In recent years the expenditure on railway extension has been another cause of increase. In 1892 the debt capital was £575,000,000. After ten years it had increased to £693,000,000 with an annual interest charge of £27,600,000.1

Another interesting group of debts is that of the British Colonies and dependencies. The Indian debt is about £165,000,000; the Australasian colonies have a total debt of £240,000,000; the Canadian Dominion £70,000,000, and the South African colonies £40,000,000.2 Most of these sums have been borrowed for reproductive purposes.

One general fact is discernible in the course of the modern history of debts, viz. the universal tendency to increase and in some cases to press dangerously on the limits of national solvency. Any attempt to present the total amount of indebtedness at a given time soon becomes misleading, owing to the growing liabilities of the world.

CHAPTER V

the theory of public credit and public debts

§ 1. The peculiar position of the state economy and the great importance of public borrowing have both tended to obscure the fundamental truth that public credit is but one form of credit in general, and is, or ought to be, regulated by the same leading principles. Many of the most serious errors in this department of finance have been due to the belief that the State in its borrowing was emancipated from the restrictions that prudence imposed on the individual, and that it might safely indulge in experiments that would soon land the ordinary citizen in bankruptcy.

A reference to the nature of credit shows that a national debt is no creation of wealth; that at best it can only, in Bagehot's phrase, be ‘additive’ and give greater energy to production. Moreover, this position is only attained where the credit is ‘productive,’ i.e. used in assisting the creation of fresh wealth. Where the resource whose use is obtained by credit serves merely for some object which, however important, is not conducive to economic production, then, either for the individual or for the State, there is so far a loss of material power. Present borrowing of this latter kind implies less income in the future until the loan is repaid. In like manner the limits of individual and public capacity for borrowing are determined on the same principle. Each person can only borrow on his disposable income; a State or subordinate political body must depend on its quasi-private and tax receipts, and must deduct its necessary outlay. The fund on which a public body can call is that part of the income of individuals that the tax collector is able to appropriate, and it is on its amount that, in the last resort, borrowing power depends.

With regard to the mechanism of public credit the same fact exists. A State entering the money market for a loan stands on a precisely similar footing to the industrial corporation. It must conform to the usual course of business, and it must submit to have its solvency gauged in just the same way—by the price at which it can obtain accommodation. State credit is, then, we may fairly conclude, one branch of the modern credit system, and its general aspect is the same as that of industrial or non-industrial credit, respectively, in the case of private economics.

§ 2. But though this general conclusion is abundantly warranted, and may be usefully employed in dispelling certain fallacies on the subject, there remain for notice some special features of public economy that give a peculiar colour to its borrowing, more particularly in the case of the central government. The sources of individual wealth reside in property or personal capacity to earn; it is from them that all private income comes. But the State's revenue is mainly derivative; it can compel the taxpayers to supply it with funds. The method of borrowing is therefore naturally suggested, where heavy taxation is for the moment undesirable, and is further encouraged by the fact that public credit has the advantage of resting on a broader and more enduring basis. So far as a public domain is in existence, loans may be regarded as virtually mortgages raised on its security, as many early loans actually were in form, as well as in fact.

A second peculiarity of public economy is the difficulty of sudden retrenchment in its case. The individual, or even the industrial company, can cut down expenses, if receipts fall below their former level. Their expenditure is more elastic than that of the State. Decline in revenue receipts will not justify the disbanding of the army, or the dismissal of civic officials. Consequently, when under any given state of things a deficit is imminent, and new taxes are not for the moment available, borrowing is necessarily prescribed.

This apparent disadvantage is compensated by the greater permanence and wider field of public economy. Whatever may be the disasters of a few years,1 the normal feature during centuries is a growth of national wealth and income that it takes more than ordinary misgovernment to dissipate. We may readily explain the special forms of state loans by reference to this circumstance. The great variety of stocks and the complicated conditions for repayment could only be adopted by a body of assured continuance and growing resources, and in this respect the greater industrial corporations, that also have the prospect of long existence, present an instructive resemblance.

More important than any of the foregoing is the peculiar legal position of a debtor State. Unlike the private citizen or corporation, it rests within its own discretion to say whether or not it will meet its obligations. The creditor who wishes to enforce his claim against a State has not at his command the usual legal machinery, the necessity of which is proved by the frequent recourse to its aid.2 A national bankruptcy is a strictly legal proceeding, e.g. an Act of Parliament repudiating the National Debt would be quite as valid as any other measure. This privilege, which is inherent in any form of sovereignty, has been further extended to—or more accurately speaking retained by—such subordinate political bodies as the ‘states’ of the American Union, which at one period of their history extensively availed themselves of it.3 But where no trace of supreme power remains, this exemption disappears, and the ordinary local governments are as amenable to legal process for recovery of debts as any other kind of corporation.1

Though released from legal liability, the sovereign State is in practice under very powerful inducements to pay its way. In the first place, if its creditors are foreigners, a failure to fulfil its agreement lays it open to remonstrance on the part of the foreign States affected, and possibly to even more rigorous measures. The domain of international law is not yet a settled one, and it is quite conceivable that the observance of obligations to alien lenders may be one of its rules in the future.2 With regard to native creditors there is an obvious interest on the part of the State to do nothing that will injure them, and whatever political power they possess will surely be used in their own defence. Stronger than either foreign or domestic influence is the economic sanction that protects the security of loans. The repudiating State shuts itself out from the future use of credit for the sake of a temporary gain. A national bankruptcy is a bar to any later borrowing unless on ruinous terms. The American ‘states’ have never recovered the shock that repudiation inflicted on their position as borrowers. The best support to the policy of paying in full is derived from the economic advantage that a reputation for honesty secures ‘in the long run,’ and nations, it must be remembered, have a far greater interest than individuals in paying attention to what happens ‘in the long run.’

§ 3. The earlier theories on the subject of public credit were little more than the formal statement of popular prejudices. Ideas similar to those of Law on the nature of credit were somewhat widely diffused. Thus we find the public funds described as ‘a mine of gold,’ and state loans as ‘realised alchemy.’1 Credit was looked on as a fresh creation of wealth, and therefore public debts were naturally regarded as affording a clear addition to the national possessions. Less extreme, but just as erroneous in principle, was the assertion that the debts of the State were quite unimportant, as they were merely due by the right hand to the left.2 This position—an evident deduction from the cruder mercantile doctrine—was strictly applicable only to the domestic debt, and was so limited by Voltaire and Condorcet. Foreign creditors, it was thought, did take money out of the country, and therefore injured it; the resident received his interest, and spent it at home. There is little difficulty in exposing this fallacy, which really rests on the same ground as certain views about expenditure and taxation already rejected.3 The action of indebtedness on the economic system cannot be altogether without influence or effect, nor can the consumption of masses of wealth be of itself beneficial. The confusion—not altogether unknown in later writers—between wealth and evidences of ownership is the reason for the belief that public debts are an addition to the material resources of the nation. Though in some respects the existence of debt may be the cause of new wealth creation, this interpretation of its effects must be dismissed as erroneous.4

§ 4. But the growth of debts in England and France in the eighteenth century produced a very different opinion on the subject in the case of the most prominent writers on political and social matters. Montesquieu did not hesitate to condemn public debts; he refutes the idea that they are advantageous, and approves of the English conversion and sinking fund.1 Hume is even more pronounced. Though declining to ‘waste time in declaiming against a practice which appears ruinous, beyond all controversy,’ he yet states very forcibly his objections, some of which had been already given by Montesquieu. The high authority of Adam Smith is on the same side. He speaks of ‘the enormous debts which at present oppress, and will in the long run probably ruin, all the great nations of Europe,’ and his whole discussion of the funding system is in an extremely hostile tone.2 Both Hume and Adam Smith prophesied that national bankruptcy would be the outcome of the continuous English borrowing. The course of events has falsified this prediction, and later writers have not hesitated to pronounce it fallacious. According to Macaulay ‘the prophets of evil were under a double delusion. They erroneously imagined that there was an exact analogy between the case of an individual who is in debt to another individual and the case of a society which is in debt to a part of itself.... They were under an error no less serious touching the resources of the country.’3 The former part of this criticism is more than questionable. In all essential points the analogy between the public and private debtor does hold good, and should never be lost sight of It is no doubt true that the material power of England was under-estimated, but then it was impossible to foresee the Industrial Revolution and its extraordinary results. The real error of Hume and Adam Smith lay in generalising from a too limited experience, and in assuming that no new forces would come into operation; just as Macaulay has probably erred in the opposite direction when he declares that ‘a long experience justifies us in believing that England may, in the twentieth century, be better able to pay a debt of £1,600,000,000 than she is at the present time to bear her present load.’ The true view, which regards the debt as a pressure on an elastic body, implies the necessity of measuring both the weight and the expansive power of the object on which it presses.

The French war and the accumulation of debt that it caused brought forward Sinclair as a moderate supporter, and Hamilton as a vigorous critic, of the system of borrowing. The former maintains that public loans are the necessary result of the new method of conducting warfare, and compares their advantages and disadvantages.1 Hamilton's work expounds with remarkable clearness the general rules applicable to the management of debt, and contains among its fundamental principles the following proposition: ‘If the periods of war, compared with those of peace, and the annual excess of the war expenditure, compared with the annual savings during the peace establishment, be so related, that more debt is contracted in every war than is discharged in the succeeding peace, the consequence is a perpetual increase of debt; and the ultimate consequence must be, its amount to a magnitude which the nation is unable to bear.’2

Now, this is merely the statement in hypothetical form of the condition from which Adam Smith and Hume drew their dismal conclusions, and, as expressed, it is absolutely incontrovertible. A nation cannot, any more than an individual, keep adding continually to its liabilities without at last coming to the end of its resources.

The influence of Hamilton's teaching, which we shall have to notice again in respect to the method of repayment,3 is plainly traceable in Ricardo's ‘Essay on the Funding System,’ in which he declares his preference for taxes over loans, chiefly on the grounds that (1) imprudent expenditure will be checked by the dislike felt for heavy taxation and (2) the probability that taxation will fall on revenue, while loans usually come from capital. Thus the main current of economic opinion was decidedly opposed to state borrowing.

§ 5. A comparatively novel view of the effect of public borrowing—though the germ of the idea is in Ricardo's essay—was given by Chalmers, who in his Political Economy (1832) argued that the loan system was economically disadvantageous and oppressive to the labourers. He maintained that, whatever method be adopted, the whole amount must be taken within the period, but that by taxation the charge is spread over the whole revenue of the society, while by borrowing it is placed on that part of circulating capital that goes to reward the labourers, and, as a necessary consequence, lowers their remuneration to the benefit of the capitalists. In fact, in his opinion, the system of borrowing puts double pressure on the country that adopts it; for there is the original sacrifice when the loan is contracted, and the later one involved in the payment of interest, so long as it remains outstanding, and finally in its repayment. The practical conclusion that follows from this train of reasoning is of course that no borrowing should ever take place, and that all expenditure should be met out of current revenue.1

It is highly probable that Chalmers's argument, like many of the ingenious points made by the secondary writers on economics in the first half of this century, would soon have been completely forgotten, had not J. S. Mill seized upon and repeated it in an early chapter of his Principles. He asserts that the doctrine is substantially correct, though needing qualification, owing to the possibility of the migration of capital;2 and in a later part of his treatise he endeavours to assign what is clearly an erroneous criterion, by which the real effect of any actual loan could be determined.

This curious doctrine is evidently based on an application of the wages-fund theory in its most rigid form, and the general abandonment, or at least qualification, of that dogma would of itself suggest serious doubts as to the soundness of any deduction from it. As we shall see in a later section, the argument is almost wholly untenable, and rests on a very partial interpretation of some economic conditions peculiar to the time at which it originated.

§ 6. The exigencies of practical finance had made the use of borrowing so general that the more practical students of the subject recognised the necessity of the loan system. In Germany especially is this view to be found. Jacob, Malchus, Rau, and Nebenius, while all dwelling on the evil effects of loans, accept them as a legitimate expedient. The arguments of Adam Smith were blended with the results of positive experience, and if the combination was not always consistent, it at least had the merit of being eminently common-sense.1

The same judgment can hardly be passed on a later German theory, originated by C. Dietzel, which regards the loan system as the true mode of defraying extraordinary expenditure. This view, which has been already noticed in another connexion,2 regards the State as being a part of the immaterial capital of the society, and any unusual outlay for its service as, in fact, an investment. To charge to revenue what is really due to capital is therefore a mistake in public bookkeeping, and, what is far worse, an injustice to the actual taxpayers. So contemplated, the issue of loans becomes a normal part of the working of a progressive State. Instead of regarding the process as wholly condemnable, or at best as a necessary evil, we should, it is maintained, look on it as both just and beneficial.3 The upholders of the theory have arrived at a diametrically opposite position to that occupied by Chalmers, and one which, if generally adopted, would produce very serious practical consequences.

§ 7. A criticism of the preceding doctrines supplies the first steps towards a true theory of public debt. The idea of Chalmers that the system of borrowing presses too heavily on the labouring class can be easily shown to be fallacious. In the first place, it is not true that all loans come from capital; they may be obtained from savings made for the purpose.1 The prospect of a new and secure investment is a stimulus to abstinence, and so far as it is operative the labourers will not suffer. But even granting this erroneous assumption, it by no means follows that loans derived altogether from capital are taken from wages. ‘The loan,’ says Mill, ‘cannot have been taken from that portion of the capital of the country which consists of tools, machinery, and buildings. It must have been wholly drawn from the portion employed in paying labourers.’2 He, however, offers no proof, or attempt at proof, of this proposition, which is plainly untrue. The amount taken in loans comes at first from floating capital that would otherwise have been applied to fixed capital, raw material, or the payment of workers in proportions determined by the actual circumstances. Again, the effect of the employment of the loan is altogether disregarded.3 In so far as it is expended on hiring services it actually tends to raise wages, so that, reasoning from the wages-fund position, what is taken by the abstraction of capital is restored by the outlay of the borrower on labour. The utter unsoundness of the doctrine that all loans come from wages will appear from the absurd result to which it leads—viz. that where wages are at the minimum it would be impossible to borrow without starving some of the workers.1

The facts that public loans are in many cases international, and that in any event capital is capable of migrating from country to country, are allowed by Mill to have weakened the theory that we are considering. If loans really come from the international market, any pressure must fall on the labourers of all the countries which contribute—e.g. South American borrowings would have injured English labourers. He is therefore led to suggest that so long as public borrowing does not raise the rate of interest, the labourers are not damnified. This qualification is again unsound; for every loan must, pro tanto, tend to raise the rate of interest or to keep it from falling. There is no line or wall of separation between capital for home and that for foreign investment.2 The growth of international relations has rendered antiquated any argument from the hypothetical case of an isolated country.3

Such considerations as the foregoing make it difficult to understand the acceptance of the doctrine by Mill. The explanation is to be found partly in a special case which seemed to give it support, and partly in a portion of truth that it did, in fact, contain. The great instance of state borrowing known to Chalmers and Mill was that by England in the period 1793–1815, and at that time the labourers were suffering, while the capitalists seemed to prosper. The real causes were of course different,4 but the concomitance of the two series of facts gave a plausibility to the theory that it would not otherwise have had. The element of truth contained in it was that public borrowing is a demand for loanable capital which helps to raise its value—i.e. the rate of interest.1 Higher interest leaves less for the other shares in distribution, and as the employer and the landlord were able to hold their own, the pressure fell on the labourers; but this could not be ascribed solely to state borrowing. Taxation that really fell on capital would have the same effect. We cannot therefore adopt, as a sweeping and absolute rule, the proposition that the State should never at any time obtain funds by borrowing.

§ 8. The opposite theory, which puts forward the loan as a normal process of meeting expenditure of the extraordinary class, is open to quite as weighty objections. The expenses of the State do, no doubt, vary from year to year, and any sudden increase which has to be met by taxation may prove inconvenient, but on the other hand we have to remember that so-called ‘extraordinary’ expenditure is itself recurring.2 To treat all fresh claims as extraordinary, and to meet them from loans is an easy, but a dangerous course. There is also the further consideration, that in the long run the revenue from economic receipts and taxation must, if the State is to remain solvent, balance the outlay. So far as debt is not redeemed it is a permanent charge on the revenue, while its redemption must come from that source. If, taking a somewhat lengthened period, we find that the ordinary state revenue meets expenditure, there is no reason why—special emergencies excepted—it should not do so in each financial year. Sudden changes in taxation may be more or less inconvenient, but the system should be such as to secure some elastic sources of revenue. The English income-tax is capable of discharging this function, and the duties on commodities would also allow, in case of need, of large increases. A theory that so markedly separates ordinary from extraordinary expenditure, and assigns different funds for their immediate payment, errs by unduly emphasising a non-essential distinction.

That borrowing is justifiable to meet ‘reproductive’ outlay is a further part of the theory, which is at once true or false according to the meaning given to the term. Actual purchase of productive property or creation of revenue-yielding works may fairly be defrayed by loans. The property or particular work may be regarded as the primary object of the debt, and is at hand to pay the interest on it. What we have called ‘economic’ outlay has a claim to be met by borrowing that does not hold in respect to other forms. Taxation imposed for the purpose of adding to the domain has the disadvantage of taking the citizens’ wealth for the purpose of accumulation, and should be employed sparingly, if at all. To meet the cost of the purchase of the Prussian railways, or even of the English telegraphs, by immediate taxation, even were it practicable, would not be correct.

This concession to the policy of borrowing should not be stretched to include the cost of works or other state action that yields no revenue. Non-economic expenditure is primarily to be met out of income, and unless it can be so dealt with ought not be incurred. National culture, education, the promotion of social progress are all most desirable; but their promotion is not so urgently required as to need the use of borrowing by the public powers. It is, indeed, true that much of state expenditure may be regarded as indirectly productive, and as likely to add to the national income in the future. A loan for the purpose of extending education, or for improving the housing of the workers, though it does not directly provide the interest needed, may yet so increase the income of the community as to make the tax receipts greater, without any increase either in rates or in rigour of collection. Regarded in the abstract such a proceeding seems defensible; the real objections to it arise from the difficulty of application. The results of expenditure of the kind are hard to trace or measure, and any statement respecting them must rest in a great degree on conjecture. The cost of the loan is definite and precise, and it constitutes a real burden on the resources of the society. Prudence seems accordingly to suggest that borrowing should hardly ever be adopted except for strictly economic expenditure, and then only when the extension of the state domain is clearly advisable. Political and social conditions come in to limit the purely financial action of the public powers.1 With an individualistic organisation of society the extension of public industries has naturally to be kept within narrow bounds, and will not comprise all possibly gainful employments.

One great objection to the use of borrowing, unless there is an equivalent revenue obtained by its application, is the necessary curtailment of the future power of spending. Large immediate outlay may, as we shall see, be requisite in certain cases, but for most of the usual forms of state activity the funds obtainable by taxation are quite sufficient, and can be continually renewed. Each year meets its own expense without causing any unevenness in the employment of the fund to be devoted to the purpose. Heavy borrowing, on the other hand, if persisted in for several years, so cripples the ordinary revenue as to compel retrenchment, or further borrowing on disadvantageous terms, until the limit of solvency is touched. This appropriation of resources that will surely be needed in the future is a grave weakness in the borrowing policy.

§ 9. We have now to examine the real effects of the system of borrowing, and for this purpose it is requisite to clearly distinguish between the mere mechanism of a loan, and the actual economic phenomena that are its outcome. Reduced to its simplest form, a loan is a transfer of so much of the wealth of private holders to the State or other public body. By its aid the borrower obtains the disposal of the wealth in question, and as a consequence affects, or can affect, the production, distribution, and consumption of wealth. Thus we cannot doubt that the enormous English loans during the Revolutionary and Napoleonic wars had a powerful influence on the economic condition of the country, and we must believe that other cases of borrowing so far resembled this particular one. The application of public loans is, therefore, to be taken into account when seeking to estimate their effects. If contracted for a purely industrial purpose—say railroad construction—it is quite conceivable that their influence on the state economy may be almost imperceptible. It may even happen that the actual application will be the very one that private capitalists would have selected for their investment, in which case the public credit is only interposed as an intermediary between the real investors and the industry in which the wealth is placed. There is, of course, the additional complication of public management, but in essence the State is an unnecessary additional wheel in the mechanism.98 The expediency of borrowing for reproductive purposes accordingly depends on the policy to be pursued in reference to public industries. Where, as in Australasia, there is a decided tendency to keep certain classes of works under the public authorities, the policy of borrowing is by that fact justified.2

Turning to the opposite case of loans applied unproductively, the first effect is the diminution of capital and the resulting loss of wealth. The typical example is that of a loan for carrying on war. Its use is turned from the support of productive industry to the purchase of commodities and services to be employed unproductively. It is, however, important to note that this distinction is not the consequence of borrowing, but of the circumstances that have led to its destination: it results from the extra expense, not from the particular mode of meeting it.

But granting that the primary cause of the economic disturbance that accompanies extensive public borrowing is to be found in the forces that have produced the increased state expenditure, it does not follow that the system of meeting that outlay by loans, instead of by taxation, has not a serious influence on the economic conditions of the society especially as there are, beyond dispute, some pointed contrasts in the action of loans and of taxes. The first, of these has been already emphasised in Chalmers's theory. A loan, it is said, comes from the nation's capital; taxes from its annual income; the former reduces the fund that assists production; the latter curtail immediate enjoyments. By borrowing we are sacrificing the permanent interests of the country for the sake of immediate relief. That there is some truth in this position is undeniable, but it is very easy to exaggerate its importance. The sharp line thus drawn between revenue and capital does not, in fact, exist, as there is an evident reaction of each on the other. Revenue is, indeed, the spring from which capital is fed, or rather at any given time ‘revenue’ and ‘capital’ are but names for different applications of the collective wealth of the community.1 Large public borrowing stimulates saving, and thereby checks expenditure on enjoyments, while oppressive taxation reduces the fund from which new savings are made, and so far hinders the accumulation of capital. A loan for unproductive purposes is not always a pure destruction of national capital. Though the debt charged on the national wealth is increased, there may be some compensation in the larger available assets.

A second point of contrast is in favour of borrowing. A loan is voluntary, and supplied by willing givers; taxation is levied on the willing and unwilling alike, and, if heavy, is sure to cause discontent. The former has, therefore, the advantage of putting less immediate pressure on the individual citizen, though on the other side there are the future charges, and the effect on borrowers and labourers through the increased value of loanable capital to be taken into account.

Thirdly, the equitable distribution of heavy taxation is not easily attained. Where very high imposts are laid some classes and persons are likely to suffer unduly. The division of the charge over a longer period by the use of borrowing makes the proper apportionment of the burden far easier, and more especially allows of sufficient time for its full consideration. Great and sudden changes in taxation—particularly if they are increases—are always evil. Some time is needed for the definitive incidence of a tax to become settled; a truth exaggerated in the doctrine of Canard, but still having much weight in this special connexion. It might even be said that, to avoid disturbance, taxation should always be maintained at a level sufficient to meet the average outlay over a long period. Excessive expenditure in some years would thus be compensated by savings in others, and complete equilibrium between income and outgoings would be the final result. The utter impossibility of forecasting the future course of expenditure makes this method quite impracticable. The effort to carry out such a plan would end in an accumulation of debt that would not be paid off in the prosperous periods. But though so thorough an adjustment is not to be reached, the diffusion of the burden of loans, in opposition to the immediate pressure of taxes, is a difference to be taken into account in considering their respective operations.

The contrast may also be turned the other way. Just as direct taxation is often advocated on the ground that it brings the real cost of the State more clearly before the contributors, so has the policy of paying all expenses out of taxation been regarded as ‘a salutary and wholesome check’ on the natural disposition to indulge in extravagant outlay. To make things smooth for the present at the cost of the future is not the duty of the wise and far-seeing statesman.

Loans for war expenditure are particularly open to this objection, and it was in reference to them that Mr. Gladstone pronounced his forcible condemnation of the policy of borrowing.1 There can be no doubt that the immediate increase of taxation will to some extent damp the ardour of a people for war, which, however, is sometimes a doubtful advantage. From the point of view of the administration the method of borrowing is decidedly preferable; as, where taxes have to be imposed it is necessary to exercise economy and to keep expenditure within bounds, while by the use of loans a government may even secure favour with the moneyed interest, and at the same time become popular amongst other classes by profuse outlay.

Lastly, there is, or there may be, an opposition between borrowing and taxation in respect of their ultimate incidence. With proportional taxation increased to meet abnormal expenditure there is very heavy pressure on the receivers of industrial, or more generally of temporary, incomes, which may have ceased to exist when the burden is removed. In the succeeding period of low expenditure the same class of incomes escapes lightly, though the recipients have benefited by the sacrifices previously incurred. This failure in just distribution between different times may be met by the loan system, the interest on debt being paid by those who would otherwise have escaped altogether, but as we saw,1 it can also be avoided by the use of taxes falling on property, such as succession duties, or direct imposts on realised wealth, though this course is surrounded by difficulties of its own.2

§ 10. So far the contrast of borrowing and taxation as modes of meeting extraordinary expenditure, does not seem to lead to any very decisive result. Some broad considerations favour the use of taxation: others of no slight weight give support to, at least, a moderate use of loans. But, in truth, there is not quite free choice. After expenditure has passed a certain point, borrowing becomes, if not necessary, at all events highly expedient. The productiveness of every separate tax has its limits, and so has that of the tax-system taken as a whole. Each additional charge implies a more than proportional sacrifice by the contributors, and greater difficulty in getting in revenue on the part of the State. The existence of the condition of ‘diminishing returns’ in public receipts is a valid ground for the employment of loans, when, all things considered, they will be less onerous than further taxation. It appeared that 15 per cent. was probably the largest proportion of the national income that, under ordinary conditions, could be taken for the state services, and though the limits of productivity are capable of being expanded at times of trial, we can hardly doubt that an income-tax of five shillings in the pound would prove too much for even the United Kingdom.

This principle admits of more extended application. If, when taxation is exhausted, a loan has to be employed, it is evident that before that extreme point is reached, borrowing may advantageously be combined with taxation, and that the exact extent to which it should be used will depend on a complicated calculation of the different elements involved. The cost of taxation, varying as it does according to its forms and amount, must be weighed against the burden, present and future, of the loan. This is no easy matter, and it can only be approximately worked out, if, indeed, it has not to be decided at once by the insight and instinctive knowledge of the statesman, who will be guided as much by the political, as by the purely financial conditions.

The practical solution is not, however, so difficult as would appear from the preceding paragraph. A good tax-system requires as one of its qualities a considerable amount of elasticity, and, as far as possible, the first appeal should be made to taxation. The English income-tax is a valuable instrument for this purpose—as its employment in the Crimean, and, again, in the South African War shows—and its place in this respect is with difficulty filled by other taxes. Still, the customs and excise, if moderately well administered, will allow of increases for a special emergency. Tea, wine, and beer would bear much heavier duties in England, and sugar has proved to be a productive object. Some of the duties on ‘acts’ could also be advanced in case of need, and would soon yield a larger return.1 Thus, even if the actual expenses are at first met by creating a floating debt, the new duties will speedily pay off what has been incurred. But when the limits of ready expansion are reached, a loan is the suitable mode of obtaining further supplies. Where there is a pre-existing debt in course of redemption, the suspension of that process will add to the available funds,1 while if there is no debt, the light taxation previously levied can be largely increased. This last consideration suggests a disadvantage in the existence of a permanent debt, in that it brings future borrowing nearer, by imposing so much additional charge on the annual revenue, and thereby reducing the disposable balance.

The probable duration of extraordinary expenditure is an important element in determining the mode of providing for it. A sudden and large demand for a single year may well be met by borrowing (unless the movable taxes and the suspension of debt redemption suffice), as it would not be desirable to disturb the whole tax-system for such a purpose. Where there is a fair prospect of continuous outlay on the increased scale, a readjustment of taxation at the outset is the prudent course.2 Failure in this cardinal point of sound finance was the cause of the great accumulation of debt in England at the opening of this century, and was also noticeable in the treatment of war expenditure by the United States both in 1812 and 1861, to which instances the treatment of the French expenditure for the Crimean War, and recently that of England in South Africa, may be added.3

On the whole, then, the rules applicable to the treatment of abnormal outlay for other than economic purposes may be stated as follows:—(1) Expenditure should, as far as possible, be met out of the annual receipts, and therefore increased outlay should be balanced by heavier taxation. (2) In the case of non-recurrent expense of large amount, a loan is preferable to a serious disturbance of the normal tax-system, and may fairly be employed. (3) Where the abnormal expenditure extends over a series of years, the various forms of taxation should, speaking generally, be adjusted to meet it. (4) This general principle, however, fails where either (a) it would be impossible to secure an equitable division of the heavy taxation necessary, or (b) where the limit of productiveness with regard to the several taxes would have to be exceeded, or finally (c) where for political reasons it is inexpedient to press heavily on the taxpayers. Under any of these conditions resort to loans as a supplement to the tax revenue even for a somewhat lengthened period is defensible.

§ 11. The fact that part of the funds obtained by public borrowing is derived from abroad is of some weight in judging the loan policy. Not that a foreign loan is in its purely financial bearings so different from a home one as is sometimes supposed, but that the possibility of drawing on the capital of other countries weakens the argument in favour of taxation on the ground that, in any event, the expenditure must be met from the national resources. When taxation fails to respond to new demands, a foreign loan may supply the necessary sums, and the competition of alien with native lenders will enable the state to borrow on better terms, and with less effect on the rate of interest, and therefore to the advantage of the labouring class. But from a purely financial point of view the source of a loan is really immaterial. In any case it is an immediate relief to the taxpayers, counterbalanced by greater charge in the future. Whether the wealth to be consumed in the outlay, which is the primary cause of borrowing, be derived from the stores of home or foreign lenders may have some immediate influence, but when we bear in mind the close connexion of all the countries of the world, and the great mass of private borrowing from foreigners, it is evident that the distinction may be easily exaggerated.

The political and economic effects of the greater mobility of loan capital in recent times are highly important, and deserve careful study, but they do not belong to public finance. The possibility of political complications in consequence of a default in the payment of foreign creditors has been previously noticed.1

§ 12. Some important questions arise respecting the absolute amount of public debts, the pressure that they impose on the borrowing States, or other bodies, and the best mode of measuring that burden. For this purpose very different methods may be used. The most obvious is that which takes the nominal capital of the debt as the basis of measurement. Thus, in 1870, France and the United States had approximately the same capital debt,2 and therefore, it might be said, an equal liability. The defect of this method is evident from the fact that it takes no account of the interest on the borrowed capital, which latter, is moreover, not payable at the creditors’ demand. ‘The public debt,’ as Lord Grenville put it, ‘consists not in capital but in annuities,’3 and the capital amount of debt is therefore no guide to the actual burden that it imposes. A second method might be employed by which the actual, instead of the nominal capital value, or in other words the market price of the stock, would be used as the test, but this again is open to the objection that the real value is incessantly fluctuating, and at any given time represents only the value of the small amount sold, not of the total mass of stock.4 A third mode, by which a very different result will usually be reached, takes the interest charge as the measure; e.g. in the just-mentioned case of France and the United States, as the former had most of its stock at 3 per cent., while the latter paid 6 per cent. on much of its obligations, the comparison was altogether in favour of France.

All the foregoing methods deal with the absolute amount of the several public debts, and of themselves furnish but a slight clue to the sacrifices undergone by the people of the country. For this purpose a further combination is necessary, and the most popular plan is to divide the capital or the interest charge by the number of the population, and so get the charge ‘per head.’ How fallacious any test of the kind must be, has been already shown in respect to expenditure;1 and it is equally plain here, as a comparison of the debts of England, the United States, and Victoria against those of India, Italy, and Russia, suffices to prove. The mere population of a country, any more than its area, is no measure of its wealth and financial capabilities, which must depend on so many different circumstances.

A far better test would be the relation of debt to the national revenue, or, again, to the collective wealth of the society. Such comparisons are, however, by no means easy. The annual income—and especially that part of it which is disposable—must always be more or less doubtful, and estimates of national wealth, whatever method be employed,2 have even less chance of approaching accurately the real position. Nevertheless inquiries of the kind give a good rough result, and in relying on them we may fairly compare the annual charge of the debt with the national revenue, and in like manner its capital value with the sum of national wealth. The annual charge of £23,000,000 for the English debt should be compared with the £1,400,000,000 of national income, as the £750,000,000 of capital—subject to whatever deduction may be required for its being under par value—should be placed against the £12,000,000,000 which may be taken as the sum of British wealth.1 In this way we get less than two per cent. as the proportion of income, and over six per cent. as that of capital assigned to the public creditors. This great discrepancy indicates the omission of some important element in the capital estimate, which can be no other than the capitalised earning power of the human beings who make up the community. Wages, and industrial and professional earnings, are a part of the revenue, but not of the ordinary capital account of the nation.2

For practical purposes it is often convenient to take the proportion of the total state expenditure required for the payment of the annual debt charge as measuring its weight. Thus the smaller proportion of the English expenditure on debt in the later, as compared with the earlier years of the nineteenth century shows so far a reduction in the burden. The relations of public outlay to national revenue and the amount of service performed by the State are both elements to be considered before this ready test can be used with any accuracy.

Finally, in estimating the weight of public debt, it is necessary to take account of the public assets that are available for its liquidation. The property employed in the discharge of the various public functions cannot be regarded in this light. The buildings and other non-revenue-yielding possessions of any government could only be sold at the cost of abandoning the discharge of normal administrative duties. Such property is an essential condition of state activity.3 Very different is that part of public property—the domaine privé of French administrative law—which supplies revenue. Land, forests, mines, railways, and other industrial enterprises have all a market value, and would by their sale provide funds that could be employed in paying off debt. The real value of such state property is therefore fairly to be set off as a deduction from the debt before computing its capital amount, as for precisely similar reasons its annual yield must be regarded as a mitigation of the interest charge. The importance of this consideration comes out very strongly in respect to countries in the situation of the German States, the Australasian Colonies, and the Indian Empire.1 The greater part of the debt incurred by all these countries has been for the creation of public works, which—be their value more or less than the wealth expended in their creation—are undoubtedly worth very large sums, and if in the hands of private individuals or companies would be regarded as constituents of national wealth. The real debt burden of the countries so situated is much less than the apparent one. It may even be altogether removed.

For the purposes of this allowance it is quite immaterial whether the property has been created by means of loans, or obtained in other ways. Revenue from the rent of land is as much an aid towards the payment of debt, as receipts from railways constructed by loans. The economic revenues of the State are a compensation, more or less effective, for debt expenditure.2 It is in connexion with the original application of loans that the distinction between property obtained by their employment, and that otherwise derived comes up for consideration.

Estimates of the real weight of public debts are, it is now plain, by no means easily formed; the considerations to be taken into account are too complex for ready and off-hand treatment. The only way of arriving at a satisfactory result is by the use of each of the different methods of calculation, and a combination of their results with the due allowances previously pointed out. Where all point in the same direction a conclusion is easily reached: where they differ the selection of the proper ones depends on the object for which the inquiry is made. If annual pressure is to be ascertained, interest is more important than capital; if the cost of redemption is wanted, capital or market value should be the primary object of investigation.

CHAPTER VI

the forms of public debts

§ 1. The different forms that public borrowing may take affect the actual course of public debt and its development so much as to need careful notice. Nor is the method of classification quite simple. From one point of view loans have been divided into the three groups of forced or compulsory, patriotic, and voluntary business loans. The first was a favourite method with sovereigns in earlier times. Up to the reign of Charles I. it was used in England, and still later—as under Mazarin—in France. Spain and Austria have supplied more recent instances.1 Such expedients are, however, unworthy of a well-managed State. The compulsory loan is in fact rather a tax than a credit transaction, and it may be regarded as an advance of tax revenue. Its injustice and inconvenience ought to effectually exclude it from the list of fiscal contrivances. The patriotic loan is, though for a different reason, equally inadmissible.2 Experience shows that an appeal to national feeling is far less powerful than one addressed to self-interest. The British ‘Loyalty Loan’ (1796), though fully subscribed, was one of the most unsatisfactory in its results. Other countries, e.g. France in 1848 and Germany in 1870, have altogether failed in their appeal to patriotism and for the same reasons; the Italian patriotic loan suggested in 1866 would also have certainly met the same fate. This result is not entirely due to the mastery of self-interest over other considerations in the minds of investors. For the success of a loan certain technical conditions are required. It needs the aid of the dealers in money to be successfully ‘floated,’ and in this respect the sentimental loan is wanting. Judged by its fruits the appeal to national feeling is a useless effort on the part of the State.

Voluntary loans issued on strict business principles are therefore the only eligible mode of procuring funds in time of need. Just as the normal agencies of supply are a more effective safeguard against scarcity than state supervision, or private benevolence, so is the system of depending on the investors’ desire of a reasonable return the right one in the case of public loans. So long as good security is offered a supply of wealth will be obtainable by any State that requires it, and the most rigid application of business methods and the strictest conformity to the usages of the money market will generally prove to be the cheapest and most convenient course.

§ 2. Another kind of distinction between loans is found in the conditions on which they are contracted. The first state debts were what would now be regarded as ‘floating,’ i.e. they were advances repayable on demand. The need of keeping the funds, so advanced, for a lengthened period led to the adoption of life annuities, which in the tontine form were a popular method both in England and France. Under this plan the share of each deceased annuitant lapsed to the survivors, until with the death of the longest liver the whole payment ceased.1 The issue of ordinary life annuities has also been carried on, but only as a subordinate part of the debt, and in England as a convenience rather for the annuitants than for the State.

The terminable annuity has certain advantages over the less definite plan of life payments; its exact charge can be estimated, and the time of extinction foreseen. As we saw, the annuity for a term was used as a bonus to assist in the floating of many English loans, and, later on, as a convenient way of redeeming debt. When employed as the chief mode of borrowing it has the great disadvantage of depreciating year by year, and is therefore unsuitable for permanent investment, while to the purely selfish person it offers even less attraction than a life annuity. It is only as an agent for the redemption of debt, and when used in connexion with the available capital of public departments or banking companies, that the terminable annuity becomes effective.

The modern system of issuing bonds redeemable in sections by annual drawings is a refinement on the preceding method.1 To the State the effect is precisely the same, as it is possible, by fixing the amount redeemable in each year, to make the annual payment even all through the period of redemption, while the capitalist is sure of the principal advanced, and of interest until he receives it. Still, it introduces a gambling element into the value of the stock, and makes the suspension of redemption at any time, no matter what the pressure, a breach of faith. Borrowing may even be necessary in order to keep up the automatic process of repayment. As a means of encouraging the redemption of debt it has undoubted merits, especially when that object would otherwise be neglected; but it may prove both costly and inconvenient at times of sudden pressure.

Another modification has been employed in the United States. It is that described by Professor Adams2 as the system of ‘limited option.’ Under it a minimum period is fixed before which the State cannot repay the loan, and also a maximum one at which the creditor can insist on repayment. During the intermediate time the State can repay at its pleasure, but the creditors cannot insist on repayment. Thus the ‘ten-forty bonds’ could not be paid off for ten years; they might, if convenient, be discharged at any time during the following thirty years, but become finally due when forty years have passed since the loan was contracted. The advantages of the method are that it prevents the loan being a floating one, while it fixes a limit to its existence. The time for final repayment may, however, happen to be inconvenient, and therefore such loans should be steadily reduced during the term of their optional existence.

Opposed to, and simpler than, the foregoing forms is what is known as ‘perpetual’ debt, i.e., where the stock is issued without any date for repayment, but redeemable at any time at the pleasure of the debtor. Limits to this power of redemption may be introduced to add to the lenders’ security, or in consequence of some special arrangement,1 but the general form is as stated. On examination it appears that the real nature of the obligation is to pay a specified annuity, with the option of wiping it out by returning the original capital. Further conditions may be added which prohibit repayment for a fixed period, but this is not usual, and, when the time elapses, the ordinary form is re-established. It is in this shape that the bulk of European debts exist. England, France, Italy, the German States give instances, and a reference to the advantages of the arrangement will account for the fact.

In the first place the borrowing State is relieved from the risk of demands for repayment of capital, and has only to provide for the periodical discharge of the interest. Extraordinary expenditure is distributed into a series of smaller payments, which may be regarded as ordinary, and in consequence its pressure assumes a milder form. The creditor is not, however, prevented from realising the capital value of his loan. The modern stock exchange makes the evidence of his debt a form of intangible wealth which he can always sell at the market price. This may be more or less than the original sum advanced, but it is the value of the interest claim at the time of exchange. Again, the State is always able to redeem so much of the debt as it wishes, by purchasing in the market or repaying the capital, whichever is most convenient, i.e. involves the smallest expense. The gradually improving credit of a prosperous country will allow of the reduction of the original rate of interest, as the threat of repayment will induce State creditors to accept the terms offered. This use of conversion, as it is called, has been already illustrated in reference both to England and France, and its service as a mode of redeeming debt will appear later on.1 It is most easily employed in regard to the ordinary perpetual debt, which is therefore so far superior to the other kinds.

§ 3. But though the simple system of contracting debt redeemable at the debtor's pleasure is, on the whole, the best, it does not follow that the total mass of liabilities should be reduced to that shape. Life annuities, terminable annuities, debt redeemable by annual payments, are all useful forms under certain conditions. As agencies for reducing debt, or contracting certain special classes of lenders they have a real function to discharge, and it is the part of the trained practical financier to say how far each should be employed. Thus in England, the terminable annuities ought hardly to be allowed to exceed £100,000,000, as that amount is quite sufficient at any given time.2 The French ‘redeemable’ debt should also be kept much below the perpetual rentes. The necessity of adjusting financial arrangements to the actual conditions is quite as imperative with regard to borrowing as to taxation. One great advantage of the perpetual debt is its close resemblance to the stocks and shares of ordinary industrial companies. The debt paid off by periodical drawings may suit a speculative class, just as life annuities are sought by those who desire to use their disposable wealth in their lifetime. To suit loans to the taste of the market is one of the chief duties of a borrowing government.

§ 4. This function commences at the inception of a loan. Not only have its terms to be such as will draw the required amount in the cheapest way; the mode of offering it must also receive careful attention. At the commencement of the modern system of public borrowing in England, the usual course was to invite a group of capitalists to furnish the required amount, as at the creation of the Bank of England, or a list was opened to which all persons might contribute. In this way the utmost competition of capitalists was invited. The French method of confiding the business to bankers was probably less efficient. It had, however, the merit of enlisting a powerful class in its support, and making it their interest to keep up its price, as their profit, in fact, depended on the premium that they could obtain for the stock, over and above the subscription price. Where capital is not widely diffused, and where the money-market interest is powerful, this may be the best way of conciliating opposition and gaining assistance. Where a loan is not peremptorily needed, the issue of bonds at a fixed price—as close to par as possible—which will be gradually taken up, is convenient, while in cases of great and pressing need an appeal to the public is decidedly the best. Where this latter course is chosen, the issue may be at a fixed price, or, better still, it may be to the highest offers, with a minimum rate below which no tenders will be accepted.1 By such an expedient competition brings the price up to the highest point, and those who offer the least favourable terms are not accepted. The Australasian colonies have largely employed the method of taking the highest tenders down to the price at which the loan is covered, and the same system has been applied to municipal loans in England. With the greater division of capital for investment a direct appeal to the small lender is most likely to secure satisfactory results, as it is on him that any syndicate of bankers must, in the last resort, depend.

In many cases, however, a loan is floated abroad, and then, especially if the credit of the borrowing State does not stand very high, the intervention of a group of large capitalists who will advertise the loan cannot easily be dispensed with. But in the case of a large State there ought to be no necessity for such aid. It borrows on sound security, and appeals primarily to native investors, whose subscriptions, as in the case of the French loans in 1871–2, may often be derived from their sale of foreign stocks.

§ 5. From the form and mode of issuing loans we now come to a much disputed question in this part of finance, viz. the respective merits of loans bearing high interest with small nominal capital, and loans with high nominal capital and low interest. At first sight it would appear that all loans should be contracted at par, or as close to it as the conditions of the market will allow. Thus, if £10,000,000 is the sum required, it is obviously better to issue £10,000,000 of 5 per cent. stock than £12,500,000 at 4 per cent. The interest charge is indeed the same in both cases, but when the time for repayment comes, the holders are entitled in the latter instance to £2,500,000 additional, unless they sell under par, and the prospect of converting the debt into a stock bearing low interest is pushed further off, as a 5 per cent. stock will be nearer par than a 4 per cent. one. The issue of a nominal capital higher than the amount actually received seems accordingly unjustifiable, and a departure from the plain and simple course of borrowing.1 So regarded, most of the English loans during the American and French wars would be unhesitatingly condemned, as they were borrowed in 3 per cent. stock at a price greatly under par. This method, which is one of the greatest blots on Pitt's financial administration, has been defended on the ground that the interest charge was reduced by it, since 3 per cent. stock commanded a relatively higher price than 4 or 5 per cent. stock. The proper proportion between them would be 60, 80, 100, but the actual one was more favourable to the 3 per cents. The explanation, of course, was that the lower stock offered a chance of gain through subsequent increase in value, which would be stopped in the case of the higher ones by conversion.2 A further plea is that of necessity. It is said ‘that Pitt had no choice ... he had to borrow, not in accordance with his own views, but with those of the lenders.’3 Neither defence is at all convincing. Hamilton has clearly shown that the difference in interest between the 3 and 5 per cents. was only about 9s. per cent., and that even this should be reduced by the advance of interest for the first year.4 Now, such a gain is by no means enough to counterbalance the great creation of capital with its certain cost in the future. There was a small immediate saving, but on the assumption that the extra charge had been defrayed by loans, their amount would have been less than the nominal capital added to the actual sum received. The plea of necessity is met by the existence of loans to the amount of over £60,000,000 in 5 per cent., and an £8,000,000 one in 4 per cent. stock. With sufficient determination, it is plain that far larger sums might have been obtained on the same conditions.

The real explanation of this grave error is to be found in three distinct circumstances, viz. first, the belief in the virtues of the sinking fund which led to neglect of the future course of the debt; it was expected that by a mechanical process the liability would be wiped out, no matter what its amount. Next, there was the hampering influence of the usury laws which made interest over 5 per cent. illegal, and compelled the State, for the sake of consistency, to keep within that limit. A 6 per cent. or 7 per cent. loan would have been readily taken up, and at the close of the war would have been converted into a much lower stock, as happened in the United States after 1868. Lastly, there was the natural desire to keep the debt uniform, and as the great bulk of existing obligations bore 3 per cent. interest, the new issues were modelled on their pattern and became an indistinguishable part of the general mass of consols.

The two former reasons were wholly bad; neither the sinking fund nor the usury laws contributed in this respect to the public benefit. Uniformity of stock is no doubt desirable. A large stock sells better than a small one, and there is less confusion and complication where a single rate of interest prevails. But this advantage may be too dearly purchased, as it certainly is by increasing the amount to be paid in the course of redemption. At the lowest point of credit that the English Funds touched in 1797, when the 3 per cents. were only 47, it might have taken 9 per cent. or 10 per cent. (or, perhaps, 7 per cent. irredeemable for thirty years) to get a loan at par, but then, as credit improved, this load, not so much greater even at first, would have been reduced, and less than half the capital sum would have sufficed for repayment.

The system of unduly increasing the nominal capital has been extensively used in France with still less excuse than the English government could offer, and with the evil result of making the capital liability much greater. Nothing but either very favourable offers for a loan under par at low interest, or the absolute impossibility of getting advances in any other way, can justify the procedure.

§ 6. There remain for consideration two other forms of state liability, that are both in contrast with the classes of debt previously described. These are (1) the floating debt, and (2) the issue of inconvertible paper money. The former is perhaps the oldest kind of debt, and comes into being in the most natural way. In the management of so large a business as that of the public Treasury, it must often come to pass that the payments for services or commodities will not be made at once, and that at some periods of the financial year the outgoings will exceed the revenue obtained. As a necessary consequence, either the actual persons who supplied requirements are for a time unpaid, or others advance the funds. Whichever it be, there is a temporary or floating debt. As the modern State is engaged in various business transactions, and is a lender of money to local bodies,1 it will always have a number of outstanding accounts against it, with corresponding assets on the other side. Should there be a series of budget deficits, the floating debt will, unless it is funded, speedily accumulate to a formidable amount, as has been the case in several countries. A failure in national credit generally drives a government to increase its floating obligations, which attract less notice than the regular issue of a loan; and in all countries war or other special pressure may cause a temporary expansion of this kind of debt.

As a general principle of finance it is unquestionable that the floating debt should be kept within the narrowest limits possible. The ordinary working expenses of the administration can be covered within the year, and usually, with the steady influx of the duties on commodities, in a far shorter period. The special liabilities in connexion with savings-banks, or advances to local bodies, allow of being treated as distinct accounts, and the latter can be managed by a funded debt. A growth of floating charges is at best a mark of weakness in the treatment of the state liabilities. Though it may not always be convenient to fund a mass of temporary debt, and a little delay may be admitted, this case is too exceptional to qualify the general rule.

The great evil of a floating debt is its uncertainty. To be open to the risk of a sudden demand for payment is to be in the position of a banker without the securities with which he provides himself; and it is precisely in times of commercial difficulties that the call is most likely to be made.

Among examples of unduly swollen floating debts the cases of the United States at the close of the Civil War, of England after the French War, when its amount was over £60,000,000, and of France at present, may be taken. Both England and the United States remedied their position by funding, and the same course is doubtless advisable in France. It might indeed be suggested that the floating obligations should never exceed a year's interest on the funded debt, but where the latter is very small this rule could hardly be applied, and that of keeping the temporary charges under one-fourth of the annual revenue might be substituted.1

§ 7. Inconvertible paper issues and their effect on economic and social life have been abundantly considered in works dealing with political economy and with monetary and currency questions. The present is no place for such topics. Here we have only to examine the use of a forced paper currency as a financial expedient. A country with a stock of the precious metals in circulation has a store of wealth which it can obtain for use by the expedient of substituting paper for metallic money, and making it legal tender. A loan up to the value of the gold and silver in circulation is thus procured free of interest, and to a hard-pressed government this is no inconsiderable attraction. Actual and historical illustrations readily occur. England, France, the United States, Austria, Russia, Italy, not to speak of smaller States, have employed this agency, and have realised therefrom an immediate gain. The ulterior effects are not so desirable. The tendency to over-issue is too strong to be resisted, and therefore we can hardly find a case of inconvertible paper permanently keeping its nominal value. This almost inevitable depreciation involves a disturbance of the standard of value, and a nominal rise of prices that is on the whole injurious to the most important interests. Carried to a great height the issue of paper money is ruinous to national credit, while it makes the return to specie payments more difficult. At the utmost all that can be gained by the policy is the saving of the interest on a sum equal to the metals in circulation and reserve in the country, which can never be very large in proportion to the total revenue.1 Excessive issues, on the other hand, mean a heavy tax, levied on the creditor class, and a disturbance of the tax receipts of the government, which will be in depreciated paper,2 and immense loss to all holders, if the forced currency is not redeemed at its ‘face’ value, or expense to the State, if it is.

There seems to be a great body of evidence in support of M. Leroy-Beaulieu's view that the outbreak of war will in nearly every case lead to a forced currency,3 but this does not in the slightest change our belief that such a course is both unnecessary and pernicious. The modern system of international borrowing is quite capable of supplying whatever loans may be required, and these, as already argued, need not be much in excess of what is raised by taxation. An inconvertible paper currency, if it secures a somewhat paltry gain, is, on the whole, an expensive, dangerous, and unjust form of forced loan.

In a work like the present there is no occasion for further considering the technical forms of loans, whether by inscription, by coupons, or other instruments. To keep in accord with the actual money-market system will be the aim of the prudent financier, who will naturally adopt all suitable expedients to make the stock as easily transferable and as secure as possible.

CHAPTER VII

the redemption and conversion of debt

§ 1. A study of the conditions and limitations under which public borrowing is alone admissible naturally leads to the conclusion that the maintenance of a permanent debt ought to be avoided. If loans should be contracted only under great pressure, and to prevent the exhaustion of the agency of taxation, and if, while they exist, they act as a drag on the financial power of the State, it cannot be disputed that their speedy redemption must be eminently desirable. The same reasons that made taxation preferable to borrowing give support to the policy of raising taxes in order to pay off existing debt. So far as loans are derived from capital, their repayment by taxes obtained from revenue is a restoration of the wealth previously abstracted from the work of production to its earlier and more economic use. In any event the return of their wealth to the fundholders will not diminish the economic power of the community, as some productive employment will certainly be found for it, in order to escape the loss of income that the holders must otherwise suffer. The redemption of debt is thus a mode of increasing the amount of national capital, unless on the hardly possible assumption that the whole amount of taxation raised for the purpose is drawn from capital, or in the case of a foreign loan.1

§ 2. The assertion of the general position that the redemption of public debt is desirable has necessarily to be qualified by reference to the particular circumstances of each case. As it is sometimes allowable to borrow, so must it be admitted that cases may occur in which neither borrowing nor repayment is judicious. In the crisis of war, or under extra pressure of any kind, the suspension of the mechanism of repayment is obviously prescribed, and it is quite conceivable that such a state of things may long continue. The utmost that English financiers could have done during the protracted war with France was to pay the current expenses of the State, and even this, as we know, they failed to accomplish. The postponement of debt redemption is in such cases a necessity, the non-recognition of which was one of the blots in the sinking-fund theory.

On precisely similar grounds should the amount of debt to be paid off in any given year be determined. Sudden demands may make it prudent to reduce the sums devoted to this purpose, as a preferable course to the hasty increase of taxation. A review of the last forty years of English financial history supplies a series of illustrations. Exactly the same redemption of debt could not be right in such years as 1868, 1885, and 1900, when large extra expenditure was incurred, as in years like 1873 and 1889, when considerable surpluses were realised. Rapid changes in the public burdens are if possible to be avoided; indeed one of the great services of developed public credit is the assistance that it gives in escaping this evil. But here, again, there is a further influencing condition. A plan of redemption or reduction is generally organised as a permanent system, and is intended to operate through a long series of years. Suspension of an arrangement of the kind for any slight cause has a disturbing effect that is as objectionable as a small increase of taxation. To stop the normal action of the English terminable annuities for a few millions’ increase in expenditure would be a departure from a settled policy and a bad precedent for the future. The increase in outlay must be large in proportion to the total amount to justify such action.1

Debt redemption must also be affected by the position of taxation. Where inconvenient and oppressive duties are levied it may be wiser, even with a view to ultimate repayment of loans, to relieve industry and trade from their burdens and trust to the increased productiveness of the reformed system for compensation. This was the policy of Peel in 1842 and 1845, and of Gladstone in 1853 and 1860. As proved by these great examples, a thorough reform in fiscal policy may prove the best sinking fund, or, at least, its best feeder. Between the remission of very bad taxes and their retention for the redemption of debt, there is often ground for deliberation. Still, on the whole, the reasons in favour of substantial redemption preponderate. There is no hard and fast line between good and bad taxes. Every tax is so far an evil, and any one may, if raised sufficiently high, become oppressive and unproductive. Now if we hesitate to redeem debt on account of the badness of the necessary taxes, we must remember that we are thereby rendering necessary the retention in the future of worse taxes than would otherwise be required. For let us suppose the several forms of contribution to be arranged in the order of their eligibility as follows—A, B, C, D, E, F. Then the surrender of F—the worst tax—in preference to paying off debt means the prolongation of the existence of E, which, ex hypothesi, is worse than D, since with the disappearance of the debt the taxes appropriated to its service would also disappear. The true adjustment is therefore more complicated, and requires for its scientific solution more refined calculations than are ordinarily recognised.2

§ 3. In the preceding section it has been taken for granted that all payment of debt is made out of surplus revenue. That, in Hamilton's words, ‘the excess of revenue above expenditure is the only real sinking fund by which public debts can be discharged,”1 is a position too evident to require formal vindication. Any valuable property possessed by the State can be employed to pay off liabilities, but only at the sacrifice of the revenue obtained from it. Both of public and private credit it is indisputably true that repayment can be made in no way except by excess of receipts over expenditure. The only possible mode by which either the individual or the State can get rid of liabilities is by making income greater than outlay. Hence in all well-organised financial systems the surplus of each year is applied for this purpose, and in the continuous action of those excess receipts lies the hope of complete redemption.

So simple and obvious a fact ought to have commanded universal assent, but the phenomena of credit have always had a remarkable tendency to create misapprehensions respecting their true character, and nowhere more than in respect to public finance. The whole history of the ‘sinking fund’ doctrine is an illustration of this tendency. In its earlier form the sinking fund was simply the surplus of certain parts of the public revenue set apart for the discharge of debt, and it derived all its efficacy from the excess of revenue over expenditure. But very soon the fund, from being a part of the financial mechanism, was transformed. into a positive entity, and treated as if it had an independent existence. On its security fresh loans were contracted, and the absurdity of borrowing with one hand while repaying with the other, was frequently perpetrated.

The theory propounded by Dr. Price led to a new development. This writer dwelt on the great effect of compound interest. He truly calculated that a very small sum would with interest upon interest accumulate in a few centuries to an enormous amount. If such a principle were applied to the treatment of debt, it would, he argued, secure its speedy repayment. All that was needed was a definite capital to start with, which would increase automatically by reinvestment of the interest, until it would equal the whole debt. If to every new loan a sinking fund of moderate amount were attached, its redemption would be secured by the growth of the fund through interest.1

This extraordinary theory was reduced to practice in Pitt's ‘sinking Fund’ of 1786, by which a special board of commissioners was created and £1,000,000 annually assigned to them for the purchase of stock, which was not to be cancelled, but allowed to accumulate, the interest being applied to fresh purchases, until each original £1,000,000 had risen to £4,000,000. Further additions were made in 1792. The surplus of that year, amounting to £400,000, and a further annual sum of £200,000 were voted to the fund; it was also provided that all future loans should have a sinking fund of one per cent. attached to them, by which they would be paid off in, at farthest, forty-five years.2

The pressure of war proved too much for the strict observance of this condition and various modifications were introduced, but the fundamental mistake of regarding the sinking fund as a separate and distinct source of wealth was still obstinately adhered to. From this error followed the simultaneous borrowing and redemption that were supposed to keep up public credit, but which really confused the accounts, and increased the cost of management. Purchases of stock for the sinking fund and the issue of new loans at probably lower price meant so much loss to the State. A calculation of the differences shows that the annual charge imposed by the use of the sinking fund during the period 1794–1816 was over £550,000.

So mistaken a policy could not be maintained in the face of the rational criticism, which was supplied by Hamilton and Ricardo. The true principle of regarding the surplus as the sinking fund was recognised in 1819 by the resolution of the House of Commons that a real surplus of £5,000,000 annually should be provided for the repayment of debt; but this course was not adopted owing to the bad position of the finances, and finally, after a careful inquiry, in which it was established that the method used had added £1,600,000 to the charge between 1785 and 1829, the sinking fund in 1829 was abolished as a separate institution, and the stock held for it cancelled.

The sinking fund has also been employed in the United States, where it was introduced, on Alexander Hamilton's proposal in 1790, in order to deal more effectively with the war debt. Opinions have differed as to the relation between Pitt's scheme and that of Hamilton,1 but in any case the circumstances were widely different. Under Gallatin's administration of the Treasury the system was reformed, and his admirers claim that he anticipated the doctrine of Robert Hamilton that surplus income is the only source from which debt can be paid off.2 The later sinking fund of 1862 has hardly operated in practice, as owing to the large surpluses more debt was redeemed than the sinking fund provisions contemplated.

From the foregoing facts it is evident that a sinking fund can be useful only in so far as it is based on a surplus of revenue over outlay, and, therefore, the belief in its efficacy rested on a fiction. Its sole advantage consisted in the pressure that it brought to bear on the finance minister to supply the requisite funds, while ‘its operations are scarcely perceptible to a public, justly if sometimes ignorantly impatient of taxation.’1 The effect was in practice to keep the surplus at a higher point than it would otherwise have reached, and to prevent the reductions of revenue, which as, subsequent experience amply proves, were certain to be demanded. But this benefit was too dearly purchased by the extra cost, and was always exposed to the risk of being swallowed up by fresh loans.

§ 4. The modern methods of redemption are all founded on the necessity of providing surplus revenue for the purpose; while at the same time they endeavour to secure the stability of the sinking fund, by ear-marking a special sum to be used in repayment. Such is the idea common to the new English Sinking Fund, by which a specified sum is annually devoted to discharge of debt, to the ‘terminable annuities,’ and to the ‘redeemable’ debt as it exists in France. Under all these systems there is a determination of part of the revenue to the purpose of repayment, which, if steadily persisted in, will extinguish the liabilities, unless the relief so obtained is used for fresh loans.

The chief difficulty in the way of debt discharge arises from the carelessness or positive dislike of the great body of the taxpayers in respect to the adoption of vigorous measures for its attainment. The simple and straightforward policy of appropriating a large surplus, maintained expressly for the purpose, to the useful function of reducing the public liabilities is not regarded by them with approval. Unless surrounded by some rather complicated financial arrangement, which disguises the true nature of the process, the surplus is apt to be frittered away in expenditure, or to disappear by reductions of taxation. The redemption of the English debt after 1829 suffered in this way, and nothing but very exceptional circumstances could have brought about the great repayments of the United States debt after 1866.

Nevertheless it is perfectly evident that the redemption of debt must sooner or later be faced. If in times of peace and low expenditure no surplus is raised, and if borrowing is freely resorted to whenever exceptional demands occur, then the proposition previously quoted from Hamilton1 will certainly be applicable, and the debt will ultimately ‘amount to a magnitude which the nation is unable to bear.’ Insistence on this fundamental point is the duty of the wise financier who regards the future as well as the present, and is concerned for the continuous prosperity of his country. The extent to which taxation should be carried for this purpose, and the particular arrangements adopted, must necessarily be varied, but the general principle always holds good.

An additional advantage of debt redemption should also be noted. All repayment tends to raise the credit of the State and to improve the basis for possible future loans. A real sinking fund—i.e. one based on an actual surplus—keeps up the price of stock, though a fictitious one does not.2 Each portion of debt withdrawn from the market reduces the amount available for investors, and though this cannot alter the permanent conditions affecting interest, it yet improves the character of the particular stock. Where the debt is below par, redemption by purchase at the market rate steadily brings it up to that point, when a new agency can be brought into operation.

§ 5. This is the process known as ‘conversion,’ by which a stock bearing a given rate of interest is altered or ‘converted’ into one at a lower rate. We have seen several examples of its use in England, France, and the United States,3 from the first conversion of 1716 down to the recent English conversion in 1888 and the equally successful French one in 1894. The principle is very simple, and is applicable to both public and private credit. A landlord who has a mortgage on his estate on which he pays 5 per cent. will naturally, if he can borrow the amount at 4 per cent., give the mortgagee the option of taking 4 per cent. instead of 5 per cent., or of repayment of the principal. Loanable capital, like other commodities, will be sought on the cheapest terms, and conversion is only an example of the general tendency. Indeed, we may go further, and say that, where it is practicable, there is a duty imposed on the finance minister, who is the agent of the taxpayers and bound to consult their interest, to carry out a scheme of conversion on the best terms. Such a view does not, however, commend itself to the fundholders, and where they form a numerous class very strong opposition to any measure of the kind may be expected.1

As the method of conversion can only be effectively applied when stock is over par, it requires as a condition precedent a good state of public credit. Punctual payment of interest, adequate provision for debt redemption, and prudent administration generally will all assist in this work. It need hardly be added that the higher the original rate of borrowing the greater room there is for the employment of this agency, a fact which we found to be one of the strongest arguments against the creation of a higher nominal capital than that really borrowed, but bearing low interest.2

Certain plain general rules hold good with reference to this part of finance. First, the capital of the debt should not be increased, unless for a sufficient consideration, as it amounts to an addition to the future burden. English conversions have for the most part been free from this mistake, but the offer in 1883 of £108 of 2½ per cents. for £100 3 per cents. was a doubtful step. Some of the French conversions, notably that of 1862, were tainted by it. Next, it is desirable to make the scheme simple and free from complicated stipulations, in order that it may be readily understood. A direct reduction of interest, with, perhaps, a guarantee against further conversion for a period, is on the whole the best. The fundholders will not of their own accord accept any plan of reduction; the motive power comes from the capital available elsewhere, and therefore the plainer the offer, the better is its chance of acceptance. Thirdly, it is well to choose the time for the operation carefully. The commencement of the period of returning prosperity that usually comes some years after a commercial crisis is the most suitable. Loanable capital is then abundant, and the rate of interest is low, so that the chances of succeeding are at their highest. Fourthly, there is an advantage in using the conversion to consolidate stock of different kinds, as has been accomplished in several English cases;1 but this consideration should not be carried too far, as it may be essential to separate stocks bearing the same interest, but issued on different terms, and in any case the operation will deal with that part of the debt that bears the highest interest.

The funds set free by conversion are of course available either for the remission of taxation or for further redemption. It seems, however, that the latter use is the preferable one. Gains from skilful management of the debt are in justice to be credited to it, and their application in this way is, unless in exceptional cases, to be recommended. The retention of the fixed debt charge at £28,000,000 would have brought the present English provisions for repayment nearer to the position they should occupy.

§ 6. Among the plans proposed for getting rid of a national debt, that of a general contribution by the holders of property has commanded most support. Ricardo declares that ‘a country would act wisely by ransoming itself, at the sacrifice of any portion of its property which might be necessary to redeem its debt,’ and Mill allows that this course ‘would be incomparably the best, if it were practicable.’1 The objections are, however, overwhelmingly strong. The method would place the whole burden on property-holders, as earnings could not contribute to the extent that would in fairness be required. But all property is not equally disposable, and some of it will at any given time be almost incapable of realisation. As a consequence this class of wealth would be sacrified, or its owners compelled to borrow on far more onerous terms than the State has to pay. In fact, the same arguments that prove the necessity of borrowing at times of pressure also prove the impossibility, or at all events the great inexpediency, of wiping out debt by a general contribution.

The use of capital in investments at a higher rate of interest has also been suggested as a mode of creating a surplus. Such a method really involves the action of the State as a capitalist, the danger of which appeared in connexion with the economic receipts,2 and, in any event, it is rather a mode of increasing state income than a simple means of debt redemption. If the policy be justifiable, it is so quite apart from the existence of public liabilities, and it should be judged on its own merits.

§ 7. It has often been pointed out that, altogether independent of the agencies already noticed, there are certain normal forces in operation which tend to diminish the pressure of debt, and which will, in the future, make its redemption easier. The progress of society, so much relied on by Macaulay, adds to the national wealth, and makes a public debt, that once seemed formidable, of comparatively little importance. The progress of Great Britain in the last century would have reduced the debt charge as it stood in 1791 to a very small part of the present public revenue. Other countries show the same phenomenon, and therefore there is some apparent force in the argument that the redemption of debt should be postponed to a more seasonable opportunity. In a country like the United States the steady increase of national wealth is sure to make the debt burden much lighter as time passes on.

But though this fact undoubtedly deserves recognition, it hardly supports the inference drawn from it. The repayment of debt is not a weakening of national power, nor ought it to be a severe pressure on the existing members of the society. Its amount should be kept within the bounds set by the extent of suitable taxation which would not press heavily on any class of taxpayers. The reduction of debt is, moreover, an effective aid to public credit, and by its progress affords the means for reducing taxation. Again, as each period has its own charges to meet, the neglect of repayment will make the future burden at least equal to the increased resources. Such a policy is a dangerous discounting of the future, and the tendency to adopt it is one of the worst symptoms in modern finance. There is, it must be added, no sure ground for concluding that economic progress will continue indefinitely. Many possible causes, some of them in action at present, might bring it to a standstill. Jevons has familiarised us with the idea that England's prosperity depends on her coal supply, which must at some time be exhausted.1 This relation of industrial expansion to the possession of certain material agents points to the necessity of taking careful account of the potential extent of these conditions of progress before allowing the accumulation of debt. We cannot foresee the precise line of economic change, but it is well to err on the side of safety, and provide for the liquidation of existing liabilities within a reasonable period.

Another supposed alleviation of the pressure of state debts has been discovered in the progressive depreciation of money or, in other words, a change in the standard of value. That the Australian and Californian gold discoveries had, among other consequences, the effect of making the real weight of public debts lighter is evident enough. All depreciation favours the debtor at the creditor's expense, but so does appreciation give the latter a like advantage. The mention of this possibility shows the weakness of the position of those who look to monetary depreciation as a source of relief. For the last twenty years the weight of debt has been increasing, and we cannot say whether in the distant future the standard of value will rise or fall, so that no satisfactory conclusion can be based on its probable movement. But even on the assumption that depreciation will ultimately take place, it does not follow that the State will gain. Is it not likely that lenders will hesitate to make advances on a depreciating security, unless they receive compensation in higher interest for the risk they run?1 There is in addition the objection that to count on this change is really to speculate on a defect in the standard of value. Neither on grounds of fact nor of equity can we regard the relief of the state debt through depreciation as well established or desirable.

§ 8. The distinction drawn between home and foreign loans and the error of exaggerating its importance have been previously noticed. In connexion with repayment it has been said that a public loan held by foreigners is, when productively applied, an augmentation of the country's capital, and that its redemption is not desirable. Not to dwell again on the fact that the boundary between inland and foreign loans is not very easily determined, it may be remarked that the service of a loan consists in its application, not in the existence of the obligation. The advances made to the Australian colonies for railways were of service by allowing those agencies of transport to be speedily built, for which purpose the continuance of the debt is not needed. The real question at issue is rather between the use of state funds for redemption, or for fresh production, or again between raising loans to pay off debt, and leaving that wealth in the possession of the citizens. To settle this question the rate of interest and the probable effect of the other courses open must be duly considered. When gains are high the continuance of a loan at a low rate of interest may be expedient, but effective provision for repayment is the best mode of securing loans at a low rate.

CHAPTER VIII

local indebtedness

§ 1. The rapid increase in the debts of local governing bodies has been noted in an earlier chapter as likely to give rise to serious financial difficulties in the future. A national debt, whatever be its evils, is open and conspicuous; it is under the control of the government of the whole people, and is based on the total wealth of the country. It, moreover, has usually been incurred for objects of general interest, the ultimate value of which can be measured, and its treatment can be effected by public opinion guided by judicious criticism. In all these respects local indebtedness is less favourably placed. Instead of the single State, there are many bodies of very different character and importance, and with altogether diverse requirements. Each distinct administration borrows on the security of its special revenue, which may be adversely affected by local conditions. The expenditure of the innumerable loans is very hard to follow, and intelligent criticism is almost wholly wanting. Sectional interests and ignorance of financial principles have the same influence on borrowing that they have on taxation and expenditure: they tend to lower the probability of obtaining either economy or just distribution. Under such circumstances it is the more important to examine the chief features of the system of local borrowing that has spread so widely in the last fifty years.

§ 2. As regards the fact of increase, there is the most positive and convincing evidence. In 1875 the local debt of England and Wales was £92,000,000. Six years later it came to £144,000,000. By 1888 the total was £192,000,000. In 1891 it had become £201,000,000, while in 1899 it had risen to £276,000,000, showing for the period of twenty-four years an annual increase of over £7,600,000. This general growth is made up of special increases, which in such an instance as that of London are very striking. The metropolitan debt, which was only £21,000,000 in 1875, touched on £51,000,000 in 1899, showing a steady advance in the last twenty-five years.

The Irish and Scotch local debts, though insignificant in comparison with those of the English towns, are also becoming greater, and are now over £50,000,000.

Other countries show the same tendency. The debt of the French communes (excluding Paris) has risen from £13,600,000 in 1862 to nearly £23,000,000 in 1869, and to £30,300,000 in 1878. In 1891 it exceeded £54,000,000; at the end of 1900 it was £59,670,000. The Parisian debt is by itself a formidable sum. In 1870 it was £59,000,000. In March 1890 the various debts of the French capital were £75,000,000, and at the close of 1900 they were £94,350,000.

Many of the Italian communes are also increasing their debts. At the close of 1896 the total due by them was over £48,000,000, though this amount was small compared with the debt of the central government.

A great development of local (and particularly urban) debt is also to be found in the United States. As Professor Adams has pointed out,1 the great creation of municipal debts was after the opening of the Civil War. He estimates the total indebtedness of the smaller divisions in 1860 at $100,000,000, of which over one half was due by towns having over 7,500 inhabitants. Ten years later (1870) this liability came to $515,800,000, in 1880 it had further increased to $822,100,000, while in 1890 it had grown to $906,200,000.1

§ 3. The causes of this general movement are not difficult to trace. Local, like national, borrowing is dependent on the existence of favouring conditions; and these are to be found, first in the greater power conceded to local bodies, or rather in the extension of their administrative functions during the 19th century. Another cause is the far larger amount of disposable wealth seeking investment, and the natural desire of its holders to get good security, and this is undoubtedly afforded by most public bodies. Thirdly, the needs of city life call for the creation of works involving much capital outlay. Drainage, water-supply, lighting and transport agencies, have, at the lowest, a semipublic character, that has led to their being in many instances placed under the suitable regulative body, which had to employ its credit in order to procure the required funds. It is in this last respect that local and national debts present the greatest contrast, though some of the latter have been created in the same way.2 Defenders of the modern system of local borrowing point to the valuable estate formed by its use. Waterworks, gasworks, tramway lines, and market buildings may all be looked on as sources of revenue, which, after meeting their liabilities, will in some cases give a surplus for other objects. The element of truth contained in this mode of regarding debt has been already considered, but it is here desirable to indicate the qualifications to which it is subject. Granting the superiority of ‘reproductive’ over ‘unproductive’ debt, it does not follow that the former is in itself desirable. That public property, if revenue-yielding, is an asset to be set off against liability has been already explained. Whether either item should be preserved in the financial system is a distinct and separate question. Thus the various municipal industries are obviously a great aid in meeting the local debt charge, which, however, except for them would hardly have existed. The real point at issue is the expediency, socially, economically, and financially, of the conduct of such industries by public authorities. If public is superior to private management, a financial gain may be looked for, though it by no means holds good that all profitable industries should be taken up by the public powers.1

There are some further considerations which tend to limit the use of borrowing for this purpose. The loan system involves the interposition of the credit of a public body between the lender of capital and the actual investment. Whether gas or water works be economically successful or not, the interest on the debt incurred for them has to be met. Such investment may prove to be profitable, but, on the other hand, it may be unsuccessful, and in the latter case the burden falls on the contributors to the particular revenue affected. It is in this undertaking of risk that the borrowing system appears to show its weakest side. Speculation is a task altogether unfit for public bodies.2 In another way the local revenue may suffer. The absorption of a class of industries into the public property reduces the amount of private wealth available for taxation, and it is quite possible that the loss in this way may exceed the supposed gain on the working of the industries. The burden of proof rests on those who favour the process of forming a municipal domain, and they are bound to establish (1) the strong probability that the community runs no financial risk, and (2) the superiority of their method to all alternative ones. The control of special industries, as indicated when considering the industrial domain,1 is a less pretentious but in many cases a more effective method.

§ 4. But though the policy of using public credit in a systematic way for the establishment of profit-giving industries should not be hastily adopted, and, if attempted, should be kept within comparatively narrow limits, there nevertheless remains a legitimate field for local borrowing. The needs of any modern community are such as to make increased expenditure unavoidable, and that expenditure is largely devoted to the supply of educational, sanitary, and social requirements. Schoolhouses, baths, drainage, libraries, and museums have to be provided by heavy immediate outlay, and as under the circumstances they cannot directly yield a revenue, it falls within the province of the public power to take them in hand.2 The economic conditions impose the necessity of getting such works done quickly, as otherwise the earlier expenditure would be for a long time useless. Loans are accordingly the only available means; for taxation must be kept within bounds, so as not to swell up the net revenue of a single year. The burden is by this contrivance distributed over the time during which the works are of service, or at least over a fairly long period.

A great deal of modern local debt has been incurred for such objects, some of which, e.g. waterworks, pass imperceptibly into the strictly reproductive part of local expenditure. In the case of London, for example, almost the whole of its liabilities has been so created. Paris in like manner borrowed for the ‘improvements’ of the second Empire, and to repair the damage of the war of 1870–1.

This process of anticipating revenue has greater justification in the case of a local than in that of the central government. The former deals with a smaller revenue, on which any extraordinary outlay will have greater effect, and it is restricted in its taxing powers, while the national government can more easily distribute its outlay from year to year, and possesses full control over its means of revenue. As a general rule, therefore, it is true that loans are a convenient, indeed an indispensable, part of the financial machinery of the smaller bodies.

§ 5. The forms or classes of local borrowing may next be considered, and here also its difference from that of the State is noteworthy. The absence of sovereign power brings the town or district more nearly on a level with the industrial or trading company, while its necessary subordination to the central government makes control and regulation by the latter expedient. Just as local expenditure and taxation need the watchful care, and at times the restraining hand, of the sovereign,1 so does local borrowing. There is, besides, a financial benefit in the interposition of state credit to assist the smaller subdivisions. Local loans, therefore, fall into two classes, viz. (1) those raised directly by the borrowers, and (2) those obtained by advances from the State. The former until recently gave evidence of the undeveloped character of local credit. Mortgage loans or floating obligations were the usual forms. Now, however, the funding system is making rapid way, and nearly every important town has its consolidated stock, modelled on the type of the national debt. Corporation stocks form a distinct class of securities in the money market, and command a good price. This higher organisation has the great advantages of procuring loans on better terms, and of bringing the amount of borrowing before the public. So long as the debt of a town or district is broken up into several separate kinds its real amount is hard to ascertain, and it may be increased without attracting notice.

Local stock is sometimes redeemable by annual drawings (like the French 3 per cents.), or, more often, it is automatically worked off by a sinking fund, the established method in the second class of loans—those provided by the instrumentality of the State. For very small divisions the issue of separate stock would be impossible, and any ordinary loan could only be obtained at a high rate of interest. The central government can, without inconvenience, make advances in such cases, and arrange for repayment by instalments at suitable times. In Great Britain the Treasury acts as the intermediary, and makes the advances from capital, which is really a part of the national debt.1 Belgium also has a special fund for this purpose, and in Germany the fund for invalids—one of the assets of the Imperial treasury—has lent more than £10,000,000 to the Gemeinden. The convenience of thus providing local bodies with advances on reasonable terms is very great, while at the same time it enables the central government to exercise effective supervision over the borrowing so conducted.

§ 6. Repayment of local debt has to be regulated in accordance with its general features. As it is generally incurred for objects that are useful, or at least assumed to be so, the time of redemption ought to be adjusted to the duration of the utility created. Some improvements are much more speedily exhausted than others, and it cannot be well to have a debt charge which represents no present benefit. Again, local debt does not ordinarily arise from any pressing emergency. Its use is rather to get the work quickly completed, and therefore a sinking fund that will remove the charge within a definite number of years is often serviceable, since at the conclusion of the term new objects of outlay can be dealt with in the same way. The larger bodies may prefer the issue of stock, redeemable in parts or by annual sections, or even take the chance of further reductions of interest, and the power of conversion thence arising.1 The danger of this course lies in the possible neglect of the necessary provisions for repayment, and in the undue accumulation of debt. A sinking fund that makes repayment compulsory has decided advantages. A difficult question, however, arises in connexion with the determination of the proper period for redemption. If it is very short the immediate taxpayers suffer, while their successors in after years are free from the burden. When a longer time is fixed the pressure may fall chiefly on those who hold leases extending over the time, leaving the benefit to a reversioner who has perhaps contributed nothing to the payment of the charge.2 This failure in just distribution is, however, primarily a question of taxation. We have seen that local charges should be distributed on different grounds from those that regulate general taxation,3 and that the chief reasons for making this distinction are the predominance of the economic element in local expenditure, and the necessity of taking the several interests benefited into account. The use of loans enables a just distribution to be more closely attained, since future interests come under liability as they are realised. But at the same time their service in this respect must be subordinate to their general working. Direct taxation of reversionary property may also be desirable, though this course is limited by serious difficulties. A still better way of reaching justice is to maintain a steady policy with regard to expenditure. By so dividing outlay as to keep it in a nearly constant proportion to the rateable value of the wealth liable, it is clear that in the great bulk of cases the partition of charges between holders of property at different times will not be an unjust one, though some exceptional instances may occur. Very heavy and irregular expenditure by means of loans will be almost certain to cause serious practical grievances, which would, however, also be found if taxation were employed in the same way.

§ 7. Up to the present our attention has been chiefly directed to the urban and smaller rural divisions, and they are no doubt the most important. But the indebtedness of intermediate bodies, such as the English Counties, the French Departments, the Prussian and Italian Provinces, and on a higher scale the German and American States, deserves some notice. Special conditions have prevented the counties in the United Kingdom from coming forward as borrowers.1 A different reason has closed the loan market to the American States, but there are general causes for the smaller development of provincial borrowing. The works of utility for which local debt has been incurred are for the most part confined to small areas, or are of national importance. They fall either into the hands of the State or into those of the commune. The duties of the province are such as can, generally speaking, be met out of revenue.

It would, however, be going too far to conclude that there will be no expansion of this kind of public debt in the future.2 In relation more particularly to transport, there is an opportunity for creating or purchasing railway lines or canals of secondary importance, as in other instances there may be one for an extension of public forests. The German States show an example of the former which is also found to a smaller extent in the French Departments. Arterial drainage or reclamation of waste land might also be carried out in the same way, and the loans for such objects should be governed by the same principles as those applicable to municipal debts. So much depends on the future course of political movement that no prediction is possible; but for finance it is sufficient to dwell on the necessity of applying the same rigid tests to all classes of borrowing, and to insist on the danger of its undue use.

§ 8. The great importance of adequate control by the central government has been already indicated, but it is desirable to again lay emphasis on the point. If expenditure and taxation cannot be safely trusted to administrators who may be led astray by ignorance and prejudice, still less can the power of mortgaging the property of those under their rule. For this reason rigid supervision is exercised in most countries. Local bodies in the United Kingdom can borrow only by a special legislative act, or after a semi-judicial inquiry by officials of the State. In France authorisation is in like manner needed for communal and departmental loans. The American State constitutions often place limits on both State and municipal borrowing powers, and the latter are also regulated by the State legislatures. The convenience, indeed the necessity of some method of the kind is obvious; without it a numerical majority of the inhabitants of a district, perhaps possessing little monetary interest in its future condition, could burden all the holders of property and future residents with a load of debt. Heavy taxation soon brings a remedy in the impatience of the taxpayers; but borrowing is, for the time, an agreeable process whose evils are only perceived later on. Thus the creation, the amount, and the mode of repayment of debt all stand in need of due regulation by the supreme authority of the State. The method employed will of course vary with the particular circumstances, but it seems best to reduce the system to a set of general rules, limiting the amount obtained to a certain proportion of the taxable value,1 requiring definite reasons for the issue of each distinct loan, and providing for a sinking fund, or other effective means of repayment, within no very distant time. These conditions are all insisted on by the English Local Government Board, and they seem to be necessary for the protection of those concerned. A direct appeal to the central legislature is the proper way of dealing with exceptional cases when they arise.

The character and scale of the particular bodies concerned should, further, be taken into account. Temporary loans by a large city, repayable on demand or within a short period, must be soon met out of taxation, and they may be allowed under the same rules as those controlling the taxing power. There is no need for the same constant check as that essential in the case of small areas.

This power of regulation and its efficient exercise show the real unity of all public liabilities. Whether contracted by the State or by local administrations, they result from the use of the credit obtained through public property and the power of taxation. Their examination, therefore, must be conducted on the same principles, and their effects must be combined to form a proper estimate of the true financial position of the country.

[1]Cp. Bk. i. ch. 8, §§ 1 sq.

[2]Thucydides, Bk. i. ch. 13; Grote, Hist. Greece, xi. 498–500; Roscher, § 124, n. 1.

[1]Roscher, op. cit.; Merivale, Romans under the Empire, ii 169.

[2]Sinclair, Hist. of Revenue, i. 76.

[3]Wealth of Nations, 386.

[4]Ibid.

[5]Frederick, i. 290.

[1]Roscher, § 124; Wagner, i. 173–7; Cohn, § 169.

[2]2 Cohn, § 169.

[1]The accumulation of silver by the American Treasury, though primarily a matter of policy rather than one of finance, has in the last few years been a disturbing element, and has affected both the trade and the revenue of the country.

[1]Bk. ii. ch. 4, § 1.

[1]Introduction, ch. 2, § 1.

[1]Roscher, § 130.

[2]Turpe est et multum regali reverentiae derogat a suis subditis mutuare pro sumptibus regis vel regni. Thomas Aquinas (?), De Regimine Principum, ii. 8. The approval of state treasures by so many early writers was intended as a condemnation of the alternative method of borrowing.

[3]‘The king was both in theory and practice the financier of the nation.... if he had to provide security for a loan he did it upon his own personal credit, by pledging his jewels, or the customs, or occasionally the persons of his friends for the payment.’ Stubbs's Constitutional History, ii. 558. See the whole section for borrowing in mediæval England.

[4]Middle Ages, iii. 340. Loans by the French kings can be traced back to 1287. Vührer, Histoire de la Dette Publique, i. 2 sq.

[5]Vührer, i. 16–20.

[1]For a good account of the character and defects of mediæval public credit, see Ehrenberg, Zeitalter der Fugger, i. 18–31, 55–63.

[2]On the loans of the city States, see Ehrenberg, i. 38–41.

[3]‘Einen Bürgerstaate, der Republik der Vereinigten Niederlande, ist es unter allen modernen Staaten zuerst gelungen, sich einen wirklichen Staatscredit, und mit dessen Hülfe die Unabhängigkeit als Vorbedingung glänzenden Gedeihens zu schaffen.’ Ehrenberg, ii. 321.

[1]Macaulay, Hist. of England, i. 141.

[1]Adams, Public Debts, 9. So far as the influence of the wealthier classes is directed to securing public credit it is decidedly beneficial.

[1]The Socialists and some Catholic writers are very vehement in their attacks on La Haute Finance. For more moderate criticism see C. Jannet, Le Capital, La Speculation et La Finance, ch. 12. He, however, shows (ch. 11) that at the commencement of the modern loan system the evils were greater. The student of the history of the money market feels the truth of Emerson's remark, that ‘the first lesson of history is the good of evil.’

[2]Cohn, §§ 535, 536. “At the present time over one hundred States that possess practical sovereignty for debt purposes offer their bonds to the choice of an English investor, and if to this number were added the obligations of quasi-sovereignties, the London Market would show over 150 sorts of public securities. There are here found the bonds of China, Japan, Persia, Siam, Egypt, Liberia, Orange Free State, Zanzibar, besides many other peoples of the Old World. The South American States are nearly all represented.’ Adams, Public Debts, 5.

[1]Neymarck, Les Dettes Publiques, 86.

[2]Dict. of Pol. Econ. art. on ‘Debts, Public,’ i. 509. The estimate given in the United States Census Report for 1890 is somewhat lower.

[1]Macaulay, Hist. of England, ii. 398.

[1]Macaulay, Hist. ii. 479; Rogers, First Nine Years of the Bank of England, xiii. xiv.

[2]One curious item, the oldest of all, and hence sometimes regarded as the origin of the debt, was added in 1706. The Cabal Government of Charles II. bad in 1672 seized on the Goldsmiths’ loans to the Exchequer, a proceeding known as the ‘shutting of the Exchequer,’ and had simply paid interest on the amount of £1,328,000 detained. In 1683 even the interest was stopped. Legal proceedings were taken by the sufferers, and after a series of trials the House of Lords decided in their favour; but by an Act of 1699 it was provided that after December 25th, 1705, one-half the amount (£664,000) should be added to the existing debt, to bear interest at 6 per cent.

[1]Hamilton, 64.

[1]The following was the capital funded for each year between 1793–1802:—

See Hamilton, 256.

[1]Financial Statements, 16.

[1]Hamilton's Inquiry was published in 1813, and Ricardo's Essay on the Funding System in 1820.

[1]By the budget of 1894 an aggregate sum of £2,123,000 was placed on the reduced sinking fund, thus lowering still more the amount devoted in that year to the redemption of debt.

[2]See § 1, and ch. 6, § 2, of present Book.

[1]The total was composed as follows:—

About £58,000,000 was held by government departments, leaving £500,000,000 in the hands of the public.

The amount for which payment was demanded was very small; in the case of the ‘new threes,’ only £761,000, or less than ½ per cent.

[1]The following are the details of the different loans:—

National War Loan £30,000,000, 2 3/4 per cent. interest, redeemable April 5th, 1910, issued at £98 10s. 0d.

Exchequer Bonds, £10,000,000, 3 per cent. interest, redeemable August 7th, 1903, issued at £98.

Exchequer Bonds, £3,000,000, 3 per cent. interest, redeemable December 7th, 1905, issued at £98 2s. 11d.

Exchequer Bonds, £11,000,000, 3 per cent. interest, redeemable December 7th, 1905, issued at £97 5s. 4d.

Consols, £60,000,000, issued at £94 10s.

Consols, £32,000,000, issued at £93 10s.

Treasury Bills in various amounts. Total for War purposes, £13,000,000.

[1]This operation consisted in the cancelling of £28,000,000 of Consols and the substitution of two annuities arranged to expire in 1923.

[2]The figure of £747,876,000, given above as the debt burden in 1902, is slightly higher than that of 1884, which was £746,424,000. The inclusion of the latest loan of £32,000,000 would bring us back to 1873 with its total of £779,222,000.

[1]Vührer, i. 320. Cp. Ehrenberg's account of Spanish finance in the 16th century. ‘Es trieb rettungslos aus einer Krisis in die andere. Staatsbankerott und Zwangsconsolidation wurden gewöhnliche Finanzmittel,’ Zeitalter der Fugger, ii. 259.

[2]Ib. i. 181. The estimates, however, are not in agreement. Ib. 1. 178.

[1]Necker's policy of meeting deficits by borrowing, in opposition to that of Turgot's, is justly condemned by Gomel, Causes Financières de la Révolution Française, i. ch. 8.

[2]Vührer, i, 336. But see for a higher estimate, Gomel, i. 487–9.

[1]On the debt system of the First Empire, see Vührer, ii. 31–58.

[2]Vührer, ii. 160.

[1]In 1845 the highest and lowest prices of the several stocks were:

[2]Leroy-Beaulieu, ii. 498.

[3]Vührer, ii. 238.

[1]For the finance of the Second Empire, see Vührer, ii. 258–369.

[1]The loans contracted were as follows:

Cp. Vührer, ii. 538; Leroy-Beaulieu, ii. 573. For a full treatment of the finance of the early years of the Third Republic, see Léon Say, Les Finances de la France, vols. i. and ii. His account is first hand evidence.

[1]The constitution of the French debt on January, 1st, 1901, was as follows:

The conversion of the 3½ per cent. rentes will bring the general 3 per cents. to 22,000,000,000 frs. The capital value of the life charges cannot be put at less than 25,000,000,000 frs.

[1]See Bk. ii. ch. 3, § 13.

[2]These annual deficits, ‘which began with £15,000,000 for 1860 and rose to nearly £29,000,000 in the war year 1866, became less than £3,000,000 in 1871, and only a little over £500,000 in 1874,’ amounted in the aggregate for the fifteen years 1860–1874 to £166,000,000.

[3]The principal stock is the consolidated 5 per cent.; its capital exceeds £320,000,000.

[1]For the Prussian debt, see Cohn, §§ 488–94; Neymarck, 3–6.

[1]See Bk. v. ch. 1, § 3.

[2]Out of $70,000,000 war expenditure, $64,300,000 was met by loans, and $5,700,000 out of the tax receipts, or 92 per cent. and 8 per cent. respectively. Adams, Public Debts, 124.

[1]The smallness of the debt in the period 1836–60 will be best realised from the fact that its capital amount rarely exceeded, and in several years was much under, the annual income of the Federal Government.

[2]The following table shows the relations of loans to tax revenue in the years 1861–66. See Adams, 132.

[3]Bolles, Financial History (1861–1885), 306. According to Prof. Adams, ‘the interest-bearing obligations of the United States stood at their maximum in August, 1865, amounting at that date to $2,381,000,000.’ Public Debts, 249.

[1]See Noyes, Thirty Years of American Finance, chs. 9, 10.

[2]The following figures show the position of the United States balances for the last fourteen years:—

[3]A special 3 per cent. ‘ten-twenty’ loan of $198,000,000 was issued in 1898 for this war.

[1]The highest point was in Nov. 1899.

[2]On June 30th, 1901, the following were the several stocks:—

By March 1st, 1902, the capital charge was further reduced to $937,021,160.

[1]The assets available against this charge are not easily valued. Much depends on the future policy of the State.

[2]The settlement after the South African War will certainly double this figure.

[1]Thus the situation of France in 1871 was an entirely unexpected one, and could be no criterion for judging the usual position of that country.

[2]The peculiar treatment of Egypt and Greece is noticeable, as indicating the tendency towards international regulation in the case, not only of non-sovereign, but also of small independent States.

[3]The ‘repudiations’ of 1840–50 are the best known examples.

[1]It must, however, be remembered that the method of procedure may often be complex, and make recovery of the debt difficult, if not hopeless.

[2]The case of Greece, just referred to, and the possible difficulties of European States with the South American Republics may be referred to.

[1]The former is Berkeley's account, Querist, No. 233; the latter phrase is used by Pinto, a Dutch writer. Roscher, § 125, note 1.

[2]‘Les dettes d'un État sont des dettes de la main droite à la main gauche, dont le corps ne se trouvera point affaibli.’ Melon, Essai Politique, ch. 23 in Économistes Financiers du 18me siècle, 749.

[3]Cp. Bk. i. ch. 8, § 6, and Bk. iii. ch. 2, § 2.

[4]Macleod's theory of credit is tainted by this fault.

[1]Esprit de Lois, Liv. xxii. chs. 17, 18.

[2]Hume, ‘Essay on Public Credit.’ Wealth of Nations, 387.

[3]History of England, ii. 400.

[1]Sinclair's History of Revenue, Pt. ii. ch. 2, i. 350 sq.

[2]Hamilton, 9.

[3]Bk. v. ch. 7, § 3.

[1]Chalmers, Political Economy, ii. 71 sq.

[2]Principles, Bk. i. ch. 5, § 8, Bk. v. ch. 7, § 1.

[1]On these writers see Cohn, §§ 511–14; Roscher, Geschichte, §§ 152, 160, 195.

[2]Bk. i. ch. 8, § 1.

[3]See C. Dietzel, System der Staatsanleihen; Stein, iv. 421; Wagner, i. 144 sq., for statements of the doctrine. Cohn, §§ 515–7, supplies a pointed criticism.

[1]This was probably true of part of the French loans of 1871–2.

[2]Principles, Bk. i. ch. 5, § 8.

[3]Mill briefly refers to this point in a footnote to his later editions, Bk. i. ch. 5, § 8 (6th ed.).

[1]Mr. MacDonald (Economic Journal, xii. 24–28) misapprehends the doctrine of Chalmers which he criticises.

[2]Mill, Principles, Bk. v. ch. 7, § 1. His error has been exposed both by Cairnes, On the Best Method of Raising the Supplies for War Expenditure, 10, 11, and by Cliffe Leslie, Notes (privately printed), 17, 18.

[3]For a clear statement of the modern mobility of loan Capital see Cunningham, British Association Report (1891), 727.

[4]The labourers' sufferings were really due to the continued bad harvests, the depreciated paper money, the restrictive laws against labour, the old Poor Law, the check to imports by war, and the industrial revolution. The capitalists gained by the greater use of machinery and the command that England at times obtained over the supply of foreign markets.

[1]Cp. Sidgwick, Pol. Economy (1st ed.), 323, for the possible effect of inventions in so raising the rate of interest as to injure labourers.

[2]Cf. Bk. i. ch. 8, § 1.

[1]See Bk. i. ch. 1, § 2 for this peculiarity of public economy, and cp. Bk. ii. ch. 3, § 21.

[98]

[2]The occasional depressions in colonial securities and the difficulty at times of procuring fresh loans illustrate the danger that attends such a system, and the need for caution in its use.

[1]Cp. Bk. iii. ch. 2, § 5, and for a discussion of the conception of revenue see Marshall, Principles, Bk. ii. ch. 4, §§ 3, 4, (3rd ed.). Prof. Fisher and Mr. Cannan urge that the distinction between ‘capital’ and ‘income’ turns on differences in respect to time, Economic Journal, vi. 509 sq., vii. 199 sq., 278 sq.

[1]‘The expenses of a war are the moral check which it has pleased the Almighty to impose upon the ambition and the lust of conquest that are inherent in so many nations. There is pomp and circumstance, there is glory and excitement about war, which, notwithstanding the miseries it entails, invests it with charms in the eyes of the community, and tends to blind men to those evils to a fearful and dangerous degree. The necessity of meeting from year to year the expenditure which it entails is a salutary and wholesome check, making them feel what they are about, and making them measure the cost of the benefit on which they may calculate.’ Hansard, March 6th, 1854. Cp. the useful criticism in Northcote, Financial Policy, 259–264.

[1]Bk. iii. ch. 3, § 12.

[2]On this ground the imposition of a property tax to contribute to the cost of the South African War would have been justifiable.

[1]Professor Adams (Public Debts, 94) objects to the use of the income-tax for the purpose described in the text, but it seems on insufficient grounds. He hardly makes due allowance for the speedy yield of new taxes. ‘The financier,’ he thinks, ‘may hope for assistance from his new taxes within eighteen months of their levy,’ ib. 140. The first duties would surely come in much sooner. Speaking of the income-tax Mr. Blunden remarks, ‘A further great merit in the tax is the promptitude with which its machinery can be brought into operation, the flow of funds in response to an increase of the rate beginning almost at once, and the full addition for the year being brought into account within from nine to fifteen months, according to the period of the year at which the increased rate is decided upon.’ Economic Journal, ii. 642.

[1]In England, e.g., the suspension of the terminable annuities and the new sinking fund,—which was employed in 1885, and again from 1899 to 1902—provides nearly £5,000,000 for meeting the fresh expenditure.

[2]For the passage of ‘extraordinary’ into ‘ordinary’ expenditure see Bk. i. ch. 8, § 1.

[3]For the weak treatment of the English debt see Bk. v. ch. 3, § 4; for the American instances, Adams, 112–133; Ross. Sinking Funds, 21–82; for the French one, Bk. v. ch. 4, § 2.

[1]Bk. v. ch. 5, § 2.

[2]France had £550,000,000, the United States, including the ‘State debts, £532,000,000, as their respective capital liabilities. Leroy-Beaulieu, ii. 597. The French debt, so far as the central government is concerned, is probably here placed too high, but it serves as an illustration of the principle.

[3]Essay on Sinking Fund, 29, quoted by McCulloch, note 33 to Wealth of Nations, 632.

[4]Cp. Jevons’ Theory, 119, 120, for this distinction.

[1]Bk. i. ch. 8, § 4.

[2]The best methods are: (1) that of Sir R. Giffen, which capitalises income, and (2) that of M. de Foville, which takes the property changing hands by succession as the base of calculation. Giffen, Growth of Capital; De Foville, La France Économique (1887), 437 sq.

[1]If we assume that the annual increase of wealth has not changed since 1885 we can add over £2,000,000,000 to Sir R. Giffen's estimate of £10,037,000,000 for that year.

[2]Cp. Prof. Nicholson's essay on ‘The living capital of the United Kingdom’ (Money, 2nd ed. 354–373), in which the highly conjectural value of £47,000,000,000 is assigned to this factor, or group of factors, of production.

[3]Cp. Bk. ii. ch. 5, § 1 for this position.

[1]Its application in local finance will appear in Bk. v. ch. 8, § 3. The same plea is put forward by the Russian Government in mitigation of the criticisms on its growing debt.

[2]Thus the revenue obtained by the English Government from the Suez Canal shares is a deduction from the debt. The suggested debt of £30,000,000 to be placed on the Transvaal is of the same kind.

[1]Leroy-Beaulieu, ii. 285–6: Roscher, § 132. For the suggestion of a forced loan by Pitt in 1796, see Sinclair, History of Revenue, i. 344.

[2]The British war loan of 1899 was described as a patriotic proceeding, but the subscribers were immediately able to obtain a small premium, and, therefore, self-interest sufficiently accounts for the large amount applied for.

[1]This system was named from Tonti, its inventor or populariser.

[1]For a comparison between the terminable annuity and the stock redeemable in sections, see Léon Say, Les Finances de la France, iii. 589–92. M. Say preferred the latter.

[2]Public Debts, 162.

[1]Thus the present English ‘consols’ will not be redeemable until 1923, and the reduced 3 per cent. French Rentes are irredeemable up to 1910.

[1]Bk. v. ch. 7, § 5.

[2]The stock held by government departments does not exceed £70,000,000, and it is by its use chiefly that annuities are created, as private persons do not regard them with favour.

[1]The recent English loans for war purposes have been at a fixed discount, which increased with each issue. By this course some loss was incurred, but the money-market interest was conciliated.

[1]Justification may, however, exist in the fact that the gain by lower interest exceeds the loss through the creation of more capital. As Prof. Miller justly remarks (Journal of Pol. Economy, i. 141), ‘The whole question is largely one of financial arithmetic.’ The point may be illustrated by taking the opposite case of a loan bearing high interest and issued at a premium. Here the State gains in capital and loses on interest, but it is tolerably evident that the lenders will take the two sides of the transaction into account and guard themselves against loss. The great objection to the creation of extra capital is the generally improvident character of state administration, especially where future advantage is concerned.

[2]See Newmarch's paper, ‘Loans raised by Mr. Pitt,’ in Statistical Journal, xviii. 104 sq., for an ingenious defence of the policy.

[3]Lord Rosebery's Pitt, 210.

[4]Hamilton, 197–206.

[1]Cp. Bk. ii. ch. 4, § 4, and Bk. v. ch. 8, § 5.

[1]The increase in the English floating debt in consequence of the great conversion of 1888 was merely temporary.

[1]The metallic stock of the United Kingdom has been variously estimated at from £70,000,000 to £110,000,000, the interest on which would not exceed £4,000,000. In other countries the amount would be greater, but the shock to established habits would also be more felt.

[2]Governments have to accept legal tender money in payment of taxes, unless in the case of customs duties, which are often made payable in gold under the erroneous idea of drawing money into the country. Leroy-Beaulieu, ii. 692.

[3]ii. 685; cp. the statements by Viscount Goschen and Lord Avebury to the same effect. Hansard, April 28, 1882.

[1]Sir R. Giffen has declared ‘that it would now be the wisest thing for us to give up any attempt at the reduction of debt, so long, at least, as the mean for paying are really derived from taxes on capital.’ Economic Journal, ix. 363–4.

[1]Perhaps ten per cent. of the total amount would represent the limit within which increased expenditure should not alter the established system.

[2]Cp. Mill, Principles, Bk. v. ch. 7, § 2, for a statement of the cruder view.

[1]Hamilton, 10.

[1]Price, Observations on Reversionary Annuities: criticised by Hamilton, 129–48.

[2]For Pitt's Sinking Fund, Hamilton, 97–8; Ricardo, Works, 517. For criticisms of it, Hamilton, 149–60; and for a more favourable view, Rosebery, Pitt, 81–3.

[1]See Adams, Public Debts, 265; Ross, Sinking Funds, 51–3 Dunbar, Quarterly Journal of Economics, iii. 46–54.

[2]‘There is disclosed in the administration of Mr Gallatin the true policy of debt payment ... Under the guidance of his clear insight this country departed from the pernicious methods of English financiering.’ Adams, 268. Cp. Ross, 60.

[1]Lord Rosebery, Pitt, 83.

[1]Bk. v. ch. 5, § 4.

[2]The very high price of English Consols in the period 1894–9 was mainly due to their purchase by the National Debt Commissioners, operating in a limited market. See Giffen, ‘Consols in a Great War,’ Economic Journal, ix. 353 sq.

[3]Bk. v. chs. 3 and 4 passim.

[1]In France, for example, conversion has not for this reason been attempted at certain favourable periods, viz. (1) under the Orleanist governments, and (2) between 1878 and 1883.

[2]Bk. v. ch. 6, § 5.

[1]Those of 1716, 1751, and 1888 are examples. The conversion of the French 3½ per cents. is another good instance.

[1]Ricardo. Works, 149; Mill, Principles, Bk. v. ch. 7, § 2.

[2]Bk. ii. ch 4, § 1.

[1]This important question is again exciting public interest.

[1]This statement is in accordance with Prof. Irving Fisher's theory that appreciation of money tends to lower interest. See his Appreciation and Interest; also Prof. Clarke's articles, Political Science Quarterly, x. 389 sq., xi. 249 sq., 493 sq.; and Marshall, Principles (3rd ed.), 673–4.

[1]Public Debts, 343 sq.

[1]The following table shows the comparative indebtedness of the several divisions in 1880 and 1890 respectively:—

It thus appears that state indebtedness is declining, but that of the smaller divisions is increasing, though this advance has been checked in recent years by legislative restrictions.

[2]Prussia, Austria Hungary, Russia, India, and the Australasian colonies may be given as instances.

[1]Cp. Bk. i. ch. 1, § 2 for the limitation of public activity in this respect.

[2]This is the really crucial point in connexion with the vexed question of municipal trading.

[1]Either by special taxation or the sale of concessions, Bk. ii. ch. 3, § 6.

[2]Even on the assumption that Adam Smith's ideas as to the limits of state action should be observed, ‘The duty of erecting and maintaining certain public works’ is one of those prescribed by him. Wealth of Nations, 286.

[1]For expenditure and taxation, cp. Bk. i. ch. 7, § 7, and Bk. iii, ch. 6, § 8.

[1]The separation of the local debt carried out by Lord Goschen marks this very clearly.

[1]Many of the larger British towns are favourably situated for this purpose.

[2]Cp. Fawcett, Political Economy, 629–31.

[3]Cp. Bk. iii. ch. 6, § 5.

[1]The County Councils will probably in the future make greater use of their borrowing powers.

[2]It is quite possible that the ‘intermediate’ bodies (cp. Bk. i. ch. 7, § 5) will grow in relative importance. See Prof. Marshall's suggestions in Memoranda, &c. [c. 9528], 123–4.

[1]Two years’ valuation is the limit in British and Irish towns.