BOOK V, 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.*3 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.*4 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 Adams*5 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,*6 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.*7 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.*8 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.*9 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.*10 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.*11 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.'*12 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.*13 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,*14 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.*15
§ 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.*16 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,*17 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,*18 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.
Notes for this chapter
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.
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.
This system was named from Tonti, its inventor or populariser.
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.
Public Debts, 162.
Thus the present English 'consols' will not be redeemable until 1923, and the reduced 3 per cent. French Rentes are irredeemable up to 1910.
Bk. v. ch. 7, § 5.
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.
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.
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.
See Newmarch's paper, 'Loans raised by Mr. Pitt,' in Statistical Journal, xviii. 104 sq., for an ingenious defence of the policy.
Lord Rosebery's Pitt, 210.
Cp. Bk. ii. ch. 4, § 4, and Bk. v. ch. 8, § 5.
The increase in the English floating debt in consequence of the great conversion of 1888 was merely temporary.
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.
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.
ii. 685; cp. the statements by Viscount Goschen and Lord Avebury to the same effect. Hansard, April 28, 1882.
Book V, Chapter VII
End of Notes
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