The Theory Of Public Credit And Public Debts.

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
formjDf credit in general, and is, or ougnTto 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 in-
dividual, 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 prin-
ciple. . 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



576 PUBLIC FINANCE. [BOOK V.

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. The State that enters the money market for
a loan stands on a precisely similar footing to the indus-
trial 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
economies.

2. But though this general conclusion is abundantly
warranted, and may be usefully employed in dispelling cer-
tain 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 borrow-
ing 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



CHAP. V.] THE THEORY OF PUBLIC DEBTS. 577

will not justify the disbanding of the army, or the dis-
missal of civic officials. Consequently where 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 \ 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 re-
payment could only be adopted by a body of assured
continuance and growing resources, and in this respect the
greater industrial corporations, who 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. 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 should we not rather say retained by
such subordinate political bodies as the ' States ' of the
American Union, which at one period of their history ex-
tensively availed themselves of it 2 . But where no trace of
supreme power remains, this exemption disappears, and

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

2 The 'repudiations' of 1840-50 have deeply injured the credit of the
American States.

Pp



578 PUBLIC FINANCE. [BOOK V.

the ordinary local governments are as amenable to legal
process for recovery of debts, as any other kind of cor-
poration l .

The Sovereign State, though released from legal liability,
is in practice under very powerful inducements to honestly
pay its way. In the first place, where 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. With regard
to native creditors there is an obvious interest on the part
of the State to do nothing that will injure them, and what-
ever 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 for the sake of a temporary
gain shuts itself out from the future use of credit. A
national bankruptcy is a bar to any later borrowing unless
on ruinous terms. The American 'States* have never re-
covered the shock that repudiation inflicted on their posi-
tion 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 pre-
judices. 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 'realized alchemy'^. Credit was looked on as a fresh

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



CHAP. V.] THE THEORY OF PUBLIC DEBTS. 579

creation of wealth, and therefore all public debts were
naturally regarded as a clear addition to the national pos-
sessions. Less extreme, but just as erroneous in principle,
was the assertion that the debts of the State were quite
unimportant, as they were merely owed from the right
hand to the left 1 . This position an evident deduction
from the cruder mercantile doctrine was only strictly
applicable 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 2 . 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. The growth of debts in England and France in the
] 8th century produced a very different opinion on the sub-
ject in the case of the most prominent writers on political
and social matters. Montesquieu did not hesitate to con-
demn public debts ; he refutes the idea that they are
advantageous, and approves of the English conversion and
sinking fund 3 . 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

1 ^Les dettes (Tun Etat sont des dettes de la main droite a la main gaiiche, dont
le corps ne se trou-vera point affaibli' Melon, Essai Politique, ch. 23 in
Economistes Financiers du i8" le silde, 749.

2 Cp. Bk. i. ch. 8. 6, and Bk. iii. ch. 2. 2.

3 Esprit des Lois, Liv. xxii. chs. 17, 18.

P p 2



580 PUBLIC FINANCE. [BOOK V.

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 1 . 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' 2 . 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 generalizing
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 de-
clares that 'a long experience justifies us in believing that
England may, in the twentieth century, be better able to
pay a debt of ;i, 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,

1 Hume, Essay on Public Credit.' Wealth of Nations, 387.

2 History of England, ii. 400.



CHAP. V.] THE THEORY OF PUBLIC DEBTS. 581

and Hamilton as a vigorous critic, of the system of borrow-
ing. The former maintains that public loans are the
necessary result of the new method of conducting warfare,
and compares their advantages and disadvantages 1 . Hamil-
ton's work expounds with remarkable clearness the general
rules applicable to the management of debt, and contains
among its fundamental principles the following proposi-
tion : ' 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 Hurne 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 Sys-
tem,' in which he declares his preference for taxes over
loans, chiefly on the grounds that (i) imprudent expendi-
ture 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 bor-
rowing though the germ of the idea is in Ricardo's Essay
was given by Chalmers, who in his Political Economy

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

2 Hamilton, 9.

3 Bk. v. ch. 7. 3.



582 PUBLIC FINANCE. [BOOK V.

(1832) argued that the loan system was economically disad-
vantageous and oppressive to the labourers. His contention
was 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 neces-
sary 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 con-
tracted 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'' 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
it needs 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 deter-
mined.

This curious doctrine is evidently based on an applica-
tion 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 untena-
ble, and rests on a very partial interpretation of some

1 Chalmers, Political Economy, ii. 71 sq.

2 Principles, Bk. i. ch. 5. 8, Bk. v. ch. 7. i.



CHAP. V.] THE THEORY OF PUBLIC DEBTS. 583

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 l .

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 position, 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 book-keeping, and what is far worse,
an injustice to the actual taxpayers. From this point of
view 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 pro-
duce very serious practical consequences.