The Forms Of Public Debts.

THE different forms that public borrowing may
take affect the actual course of public debt and its develop-
ment 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 ex-
pedients 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 for a different reason equally inad-
missible. 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 sug-
gested in 1866 would also have certainly met the same

1 Leroy Beaulieu, ii. 285-6 ; Roscher, 132. For a suggestion of a forced
loan by Pitt in 1796, Sinclair, History of Revenue, i. 344.



602 PUBLIC FINANCE. [BOOK V.

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
more effective guards against scarcity than state super-
vision 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 l . The issue of ordinary
life annuities has also been carried on, but only as a sub-
ordinate 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
ess 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 an additional advantage

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



CHAP. VI.] THE FORMS OF PUBLIC DEBT. 603

to float 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 de-
preciating year by year, and is therefore unsuitable for
permanent investment, Avhile 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, f To the State it 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. Bor-
rowing may even be necessary in order to keep the au-
tomatic process of repayment going on. As a means of
encouraging the redemption of debt it has undoubted
merits, especially when that object would otherwise be
neglected ; but it may often prove both costly and incon-
venient when sudden pressure comes on.

We have previously seen the American mode of borrow-
ing, with payment at a fixed term, or rather at one of two
prescribed dates at the State's option. /Thus the 'ten-
forties ' mean loans repayable either within ten or forty
years, but not at any intermediate date. /When a loan is
only for temporary use a short term may be suitable for its
repayment, while the privilege of extending the time gives
a safeguard against the creditors' demand. For the United
States the method may be admissible, though it puts
obstacles in the way of speedy repayment ; but for a
European country, where redemption is very slowly carried



604 PUBLIC FINANCE. [BOOK V.

on, it would be most undesirable, unless the stock was below
par and could therefore be purchased with advantage. An
issue of stock so calculated that it could be converted into
a much lower one at the first date fixed, and then repaid at
the final one might be unobjectionable, though it would be
very difficult to secure this exact result, and the disposal in
the mean time of the funds for ultimate repayment would
be hard to arrange. A sudden call for payment at the
expiration of the term might come at a most trying time
and compel refunding on disadvantageous terms.
/ 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 arrange-
ment 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 re-
turning 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 realizing 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

1 Thus the present English ' consols' will not be redeemable until 1923.



CHAP. VI.] THE FORMS OF PUBLIC DEBTS. 605

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. the lowest in
amount. The gradually improving credit of a prosperous
country will allow of the reduction of the original rate of
interest, as the offer of repayment will bring the state
creditors to accept the terms offered. This use of conver-
sion, 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 attracting 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 could hardly be allowed to exceed 100,000,000,
as that amount is quite sufficient to operate on 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. The 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

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.



606 PUBLIC FINANCE. [BOOK V.

drawings may suit a speculative class, just as life annuities
are sought after 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 the borrowing govern-
ment.

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 be carefully attended to. At the commence-
ment of the modern system of public borrowing in England,
a group of capitalists was invited 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
aim to keep up its price. 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 to conciliate opposition and to
gain 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. By such an expedient com-
petition 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 some municipal loans in England. With
the greater division of capital for investment the direct



CHAP. VI.] THE FORMS OF PUBLIC DEBTS. 607

appeal to the small lender is the 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 a
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 lower 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 un-
justifiable, and a departure from the plain and simple
course of borrowing.' 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/#r. This method, which
is one of the greatest blots on Pitt's financial administration,
has been defended on the ground that the interest charge



608 PUBLIC FINANCE. [BOOK V.

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 *. 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 V 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 9^. per cent., and
that even this should be reduced by the advance of interest
for the first year 3 . 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 P er cent., arid an
8,000,000 one in 4 per cent, stock. With sufficient deter-
mination, 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 for consistency compelled the State to

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

2 Lord Rosebery's Pitt, 210.

3 Hamilton, 197-206.



CHAP. VI.] THE FORMS OF PUBLIC DEBTS. 609

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. The 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 the 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/w, 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 any other way can justify the procedure.