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The System Of National Finance - IXa

1. Preface

2. I

3. Ia

4. II

5. IIa

6. III

7. IIIa

8. IIIb

9. IV

10. IVa

11. V

12. Va

13. VI

14. VIa

15. VIb

16. VII

17. VIII

18. VIIIa

19. VIIIb

20. IX

21. IXa

22. X

23. Xa

24. Xb

25. XI

26. XIa

27. XII

In the next quarter,
when the big Government payments which attend
the end of the financial year have depleted the
Exchequer Balances and increased the supply of
funds available for short loans in the money
market; the Treasury renews the dormant bills on
better terms than it could have got in the previous
quarter, and refreshes the depleted Exchequer
Balances. There is one small inconvenience in
this arrangement, so small that it should not be
allowed to count for very much in comparison with
its great practical advantages ; it leaves the Treasury
with a contingent capital liability outstanding at the
end of the financial year. Since the dormant bills
are paid off before the end of the financial year
and renewed again afterwards, the record in the
Annual Finance Accounts of the floating debt at
the end of the financial year would, without further
explanation, make it seem as if the debt had been
permanently reduced by the amount of the dormant
bills, whereas the reduction is in fact temporary.
An explanation, however, can easily be made by
a footnote to the Finance Accounts, and that is
done. It should be observed, moreover, that the
temporary repayment of the bills which leaves
them dormant at the end of the financial year does
not make the national accounts, taken as a whole,
look more favourable to the nation than they really
are. Repayment of the bills depletes the Ex-
chequer Balances by the same amount as that by
which the floating debt is reduced; so that the
favourable appearance of a reduction of floating
debt, which is delusive because it is temporary, is
counterbalanced by the equally delusive unfavour-
able appearance of a reduction in an asset, the
Exchequer Balances, which is temporary also.
Were the Treasury to prepare accounts in a


commercial way, a gain of strength in its annual
balance sheet by a reduction in the floating debt
would be off-set by a loss of strength in the re-
duction of the carry-forward.

Renewable Treasury Bills, unlike Ways and
Means Treasury Bills, are a part of the permanent
debt of the country kept in a floating form. But
the chief reason for keeping a part of the per-
manent debt in this form is that Renewable Bills,
like Ways and Means Bills, can be made use of by
the Treasury to economise Exchequer Balances.
By issuing the bills for six months only, and by
the use of its 14 power to leave the bills dormant for
a time, the Treasury can use them as a means of
increasing Exchequer Balances in the lean months
when the revenue is coming in slowly, and of re-
ducing them in the fat months when the revenue is
coming in fast.

Having distinguished between the two classes
of bills and described their general purposes, we
may now deal with the incidents which are common
to both classes, in birth, life, and death. And first
we will deal with the manner of their birth. When
the Treasury has made up its mind to make an
issue of bills, it sends a warrant for the issue to
the Bank of England, and leaves it to the Bank to
do the work. The warrant is countersigned by the
Comptroller and Auditor General, whose duty it
is to see that there is parliamentary authority for
the issue. A public notice is sent out inviting
tenders for the bills ; it states their amount, the
day on which payment must be made for them,
and the day on which they will be repaid. The
notice is inserted in the official London Gazette,


which appears on Tuesdays and Fridays, and it is
circulated to bankers and financial houses in the
City and elsewhere, who may be expected to
tender. Technical regulations as to terms of
tender are laid down by the Treasury, under the
statutory authority of the Treasury Bills Act of
iS//. 1 When the day for tendering comes, the
banks, bill-discounting companies, bill brokers and
others, who make a business of financial operations
of the sort, send in their tenders to the Bank of
England. Their offers are expressed as the price
which they are willing to pay for the issue or for a
part of it, and they calculate that price by deduct-
ing from the amount which they will receive in
repayment on the maturity of the bills a certain
percentage as interest on the money which they
advance, during the currency of the bill. This
percentage is called the rate of discount. Ten-
derers fix the rate of discount, which is the interest
which they are willing to accept on the money that
they lend to the Treasury, in accordance with the
state of the market for loans at the time that the
tender is made. If the supply of funds for loans
for a short period is small at the time, they will
ask for a high rate of interest, and vice versd. Five
per cent, per annum is a very high rate of interest
for money lent on Treasury Bills ; it is obtainable
at times only at which a panic has dried up the
springs of money. One per cent, per annum is a
low rate, such as the tenderers have to be content
with only when there is a superfluity of funds. At
the Bank the tenders are considered in the office of
the Chief Cashier. Some discrimination, we may
1 Cp. Treasury Minutes 24/11/904 and 31/5/1889.


suppose, is made as to the financial standing of the
tenderers, and then the best tenders are accepted
in order until the whole issue is provided for. An
announcement is made for the benefit of the public
that tenders at the rate of, say, gS 17 s. 6d. per cent,
will receive 20 per cent, of the amount applied for
and " above in full." A statement of the average
rate of successful tenders is also made which
might in this case be 99 per cent, and of the total
amount applied for, which is usually largely in
excess of the total amount offered.

Of late years there has been an extraordinarily
keen demand for Treasury Bills, and the Govern-
ment has usually been able to borrow money on
them at a rate of interest low enough in comparison
with the ruling market rates of discount for other
bills to make all ordinary borrowers' mouths water.
Treasury Bills are, in the first place, the finest bills
in the world, affording their holders the highest
security, and it is natural that they should be dis-
counted at a lower rate than even the best com-
mercial bills. But the rates at which they have
been discounted have often been so low as to be
out of all relation to the market rate of discount
for commercial paper. For that the reason is that
there has usually been a keen demand for them for
a special class of buyers. Their great charm is
that they provide a way for idle capital to earn a
little interest, with a certainty as great as can be
obtained in this world that the capital will be
punctually repaid at a fixed and early date, and
that it will be repaid intact. Affording such high
security, they can always be resold if the money
i needed before they rqature, and anybody will


accept them as security for a loan of little less than
their face value. These good qualities of theirs
make them specially suitable as a temporary in-
vestment for a Government office such as the
Post Office, which commonly has spare capital to
invest on account of its savings bank. The Japa-
nese Government is another buyer whose eager
bids for Treasury Bills keep down the rate at
which they are discounted, and prevent smaller
buyers from getting many of them. Its policy is
to keep large credits here to protect the rate of
exchange between Europe and Japan. To serve
that purpose, the credit must be kept either in
gold, or in an investment that can be sold for gold
speedily and without loss. It is cheaper for it to
keep the credit invested, because then it earns
interest; and as an investment Treasury Bills
meet ideally its special needs.

Amounts received for Treasury Bills at the
Bank of England are set to the credit of the Ex-
chequer Account. Conversely, when the bills
mature, if the Treasury decides to pay them off,
the amount due on the bills is issued from the
Exchequer Account to the Bank of England, and
the Bank pays the holders. If the bills are renew-
able, and the Treasury decides to renew them, it
invites tenders for the renewal in the same manner
as for a fresh issue, and a fresh discount rate is
fixed for the bills' new term of life. And so the
total amount of these securities outstanding rises
and falls, over a. range, under present conditions,
of some 15,000,000, increasing and diminishing as
occasion requires the National Debt and the balance
of the Exchequer Account, very much to the



convenience of the Treasury, and often very much
to the inconvenience of commercial borrowers and
lenders in the money market of the City of London.
Commercial lenders dislike nothing more than to
have the supply of capital available in the market
increased by the repayment of several million of
Treasury Bills just, it may be, when they are think-
ing of asking for an increased rate of interest for
the money which they have to lend. Equally un-
popular is it amongst commercial borrowers when
the supply of capital is diminished by an issue of
Treasury Bills just when they are thinking of a
reduction in that rate of interest on the money
which they have to borrow.


There is another sort of security of which the
Government makes use at times as a way of raising
money, which is of an amphibious sort, half floating
and half fixed. It is called an Exchequer Bond. It
differs from the true fixed debt of the nation in
that the money advanced upon its security has to
be repaid on a given day, usually, two, five, ten, or
at most fifteen years from the day on which it is
issued. From a Treasury Bill it differs in the
greater length of its life, and in bearing a fixed rate
of interest to be paid quarterly, instead of a rate of
interest which is all chiselled off as a discount
from the money received for it on issue. With
such comparatively long lives, the bonds are not
meant to be used and are not used as a means for
the temporary equalisation of income and expendi-
ture. The Treasury has no general standing


authority to issue Exchequer Bonds, as in the case
of Treasury Bills, either under permanent statutes
or under statutes annually renewed. Every issue
of Exchequer Bonds must be authorised by an Act
of Parliament, based upon a special resolution
passed in the Committee of Ways and Means ; and
such issues are authorised for special purposes
only. When Parliament decides to incur some
expenditure which it is not convenient to meet at
once out of revenue, and which ought yet to be
repaid within a certain time and ought not to be
allowed to swell the permanent fixed debt of the
country, an issue of Exchequer Bonds for a term
of years is a convenient way of finding the money.
A recent case in point was the purchase by the
State of the business of the National Telephone
Co. Several millions had to be found as the pur-
chase price. To have found them at once out of
revenue would have meant extra taxation, and that
would have given the taxpayer good cause to
grumble. On the other hand, a business such as
that of the Telephones should be made to pay for
itself in time ; its capital value should not be added
to the dead-weight debt of the country. So to
provide the greater part of the funds needed for its
purchase an issue of Exchequer Bonds was created,
and was handed over to the Company in part
payment of the Government's debt. The Company
sold the issue to its bankers at a price, and the
bankers sold it to the public.

Another state of affairs in which an issue of
Exchequer Bonds may be found convenient is that
in which the Government wants to raise a loan for
a purpose for which it does not object to add to its


fixed debt, and cannot wait for the money; but,
owing to the congested state of the market for
loans at the time and the high rate of interest
which it will have to pay, it thinks that it can
do better by postponing for a time its final
bargain with the lenders, borrowing temporarily
in the meantime. It may then make an issue of
Exchequer Bonds, repayable in a few years, and
trust to finding a more favourable state of affairs in
the money market at the future date when the
Bonds fall due, so that it may then convert the
Bonds into fixed debt on better terms than it could
obtain in the present. Operations of the sort are
happily more common with the Governments of
South America than with ours ; for they are
almost always bad finance. They amount to a
gamble on the state of the loan market, and as
often as not when the time for conversion comes
the speculative Government finds that things have
gone from bad to worse, and that it would have
done better to have faced the music at once. There
is a peculiar vice in the operation ; it serves to
delude the Government into supposing that it can
escape from the restraint put upon it by the opinion
which lenders have of its credit. A Government
that refuses to temporise by the issue of securities
with a short life is subjected to the wholesome
control of the public opinion of investors. If
investors dislike the purpose for which it proposes
to borrow, or the idea of its making any increase in
its debt at all, they refuse to lend to it except at a
prohibitive rate. The Government must then
postpone its borrowing or give it up altogether,
and that is what it ought to do, because there is no


judge of the expediency and prudence of a loan so
good as an investor who is asked to find money for
it. But if, when the investor shakes his head over
a proposed loan and asks for a prohibitive rate,
the Government says, " Very well ; take your
usury on a short-term security to be repaid in a
year or two. Then we will convert the floating
debt into fixed debt, and perhaps something lucky
may have turned up by that time, to make things
easier for us," it is then dodging the restraint
which public opinion is seeking to put upon its
borrowings. Does it get much good out of the
transaction? It gets its money, of course; but it
would probably have been better without it. By
exhibiting itself as forced to borrow for short
periods at high rates it injures its credit. The
hawking about of its short-term bonds and bills
constantly advertises its difficulties ; and when the
time for their repayment comes, at which it once
hoped to be able to convert them into fixed debt on
favourable terms, it probably finds that the opera-
tion which was intended to tide over its evil days
has had no other effect than to prolong them. The
short-term securities have then to be renewed at
still more exorbitant rates because of the fresh
advertisement which their renewal gives to the
difficulties of the borrower. Worse still, the
gamble on the state of the money market involved
in the short-term issue may turn out so con-
spicuously ill that the bonds fall due at a time
of panic amongst lenders, when a loan can hardly
be obtained at any price. That is a risk inherent
in the issue of any security which must be repaid
without option on a given day ; and it is a risk


which should not be lightly run by responsible
financiers. Another objection to this form of
borrowing is that it is so fatally easy. In the early
days of the vice, before a Government has become
too notorious an issuer of short-term bonds and
notes and while its credit is still good, it can
always find a ready market for securities of the
sort with big banks and financiers. It has only to
drop a bond into the bank, and the money runs out
without trouble and without all the publicity and
uncertainty of an offer to the public and to the
small investor. It is as easy as the first steps of
another descent, and by its ease it tempts the
Government into reckless borrowings for purposes
which are not absolutely essential.

However, the British Government is almost
free from the special temptations which attend the
practice of borrowing for general purposes on short-
time securities. With the highest credit in the
world, when it wants to borrow it can always do so
by means of permanent and fixed loans on reason-
able terms. It is therefore at very exceptional times
only that it is legitimate for it to borrow by means
of Exchequer Bonds, or even of Treasury Bills, with
the intention of converting them into fixed debt on
maturity. At times such as war times it may have
an urgent need to borrow which it cannot postpone,
and owing to the troubled state of the world it
may not be able to borrow the money perma-
nently save at a very high rate of interest. It may
then be .prudent for it to borrow the money on
short-term securities for a year or two, with a view
to their conversion into permanent, debt on more
favourable terms when they fall due. But that can


only be prudent if it is wholly impossible to post-
pone the borrowing; and it needs an emergency
as great as that of war to oust the presumption
that, if the rate of interest which investors ask is
very high, it is because the borrower has no
business to be borrowing at all.

With the possible exception of emergencies of
the sort described, the only purpose for which an
issue of Exchequer Bonds is quite legitimate is,
not to approach by easy stages towards a per-
manent addition to the fixed debt, but to provide
funds for some capital expenditure which is not to
be a permanent addition to the debt, but is to be
replaced within the life-time of the security.
Whenever Exchequer Bonds are issued, arrange-
ments ought to be made at the time of their issue
for paying them off by degrees. Unless the
Government makes an arrangement of the sort
the whole amount falls due in a lump, and when
that lump falls due the Government is probably
no more able to find out of revenue the money
to repay it than it was when the bonds were first
issued. Contrary to its original intention, it has
to renew the securities or to convert them into
fixed debt, both evil courses. Clear common sense
as it is that Exchequer Bonds and any other sort
of short-term issue should be arranged to fall due
in sequence and not all together, the precaution
has usually been neglected. To meet the cost of
the South African War, for instance, 14,000,000
of Exchequer Bonds were issued (inter alia) in
1903, expiring all together in 1905. In 1905 of
course there was not money enough in the Ex-
chequer to repay them all, and 10,000,000 had to


be replaced by fresh Bonds. But this time it was
provided that the new Bonds should be repaid by
ten equal annual drawings of 1,000,000, with the
result that in the course of the ten years the whole
was safely paid off.


When the Government needs a loan for a few
days or weeks, it gets an Advance from the Bank.
When it needs it for a few months, it borrows on
Treasury Bills. When it needs it for a few years,
it borrows on Exchequer Bonds. When it needs
the loan for a long term of years and wants to
make sure of repaying it, there is another way in
which it can raise the money, and that is by what
is called a Terminable Annuity, a security rather
less floating and rather more fixed than an Ex-
chequer Bond.

Of Terminable Annuities the sort best known
to the unfinancial man is the life-annuity which is
bought by an aged person with a small capital and
nobody to whom to leave it when he dies. He
pays his capital over to an insurance office which
undertakes to pay him in return so much a year
until his death, on condition that it shall then have
for its own all that is left of his payment. On this
understanding it will pay him more every year
than he could get by investing his capital at
interest. It calculates by statistical tables how
long he will live, and arranges to pay him each
year, not only the interest on his capital, but a
part of the capital itself. Repayment of his capital
to him in this way is arranged so as to leave an


adequate profit in the hands of the insurance office
if he dies at the right time according to the
statistical tables. Some live longer than they
should, to the loss of the insurance office; some
die sooner, to its gain ; but on an average the
office can trust the tables to make the business
profitable. The essential characteristic of the
arrangement is that his capital is returned in
instalments to the holder of the annuity; and that
is the essential characteristic of every terminable
annuity. It is a contract by which a lender, the
annuitant, advances a sum to a borrower, and
receives in return a limited number of periodic
payments, calculated to return to him bit by bit
the sum advanced, together with interest on the
amount outstanding at the time of each payment.
Thus each periodic payment is made up of some-
thing for interest and something for capital. A
life annuitant probably spends the whole as income.
Under other circumstances when one receives an
annuity in return for an advance, the part due
to capital repaid may be invested in some other
security, and then when the last periodic payment
of the annuity has been made, there is the whole
capital amount of the advance, safely replaced and
intact, and the annuitant has received interest on
it in the meantime.

When the Government wants to raise a small
capital sum and to arrange for its gradual repay-
ment out of revenue over a term of years, no way
of doing so is as convenient as the creation and sale
of a terminable annuity. Statutory authority is
needed for its creation, as for that of any other
form of debt. When that has been obtained, all


that is necessary to create the annuity is an entry
on the register of annuities kept at the Bank of
England. When the Government has disposed of
it to some annuitant, his name is entered on the
register, the capital sum received from him is paid
into the Exchequer Account, and the annual sum
to be received by him for principal and interest
is added to the general charge of the Consolidated
Fund as a Consolidated Fund Service, or it is
charged to the account of some particular Vote for
a Supply Service. When all the instalments of
the annuity have been paid the debt is wiped off
and the annuity cancelled.

At the present time money is raised in this way
every year to provide for capital expenditure on
some of the businesses carried on by the Govern-
ment, especially the business of Posts, Telegraphs,
and Telephones, 1 and for Military Works and new
Public Buildings. Telegraphs are responsible for
by far the greater part of these annuities. Authority
for the borrowing is derived in each case from a
special Act of Parliament which limits the total
amount which may be borrowed. Annuities
created as security for money borrowed for the
Telegraphs are charged to the Post Office Vote,
for Military Works to the Army Vote, and for
Public Buildings to the Public Buildings Votes,
and so on. They are not offered as investments
to the public. There are some Government de-
partments which always have money to invest.
Of these the Post Office itself, with big accumula-
tions of capital through its savings bank, is by far
the largest investor. Through the National Debt
Commissioners, of whom more hereafter, they buy


the Terminable Annuities as they are created. To
them, through the same Commissioners, are paid
the periodic instalments of the annuities, and as
they are received the Commissioners re-invest that
part of the instalments which represents capital,
either in fresh annuities or in Government stocks.
So part of the savings bank deposits received by
the Post Office dodge round through the channel
of an annuity charged upon the Votes back into
use in the business of the Post Office. Sums
received into the Exchequer Account in respect
of these annuities are entered in the record of the
Account in the Annual Finance Accounts as
" Money raised by the Creation of Additional
Debt"; and their expenditure is recorded by a
corresponding entry of " Issues to meet capital
expenditure." In making up the annual statement
of the nation's total debt, its capital liability in
respect of these annuities is calculated as the
amount of capital included in the instalments
which have still to be paid.

Instalments of the Terminable Annuities which
we have just been considering are paid out of the
appropriate Votes of supply granted annually by
Parliament, and the Government receives cash for
them from the investors therein, of whom the chief
are the National Debt Commissioners, as adminis-
trators of the funds which public departments
have for investment. It spends the cash on its
telegraphs and so on. Those circumstances dis-
tinguish them from another sort of annuity which
appears on the Finance Accounts as part of the
debt of the nation. That other sort includes two
annuities, one called the Savings Bank Annuity


and one the Book Debt Annuity. They are not a
way of borrowing money, but of paying it off; and
it will be more convenient to deal with them at the
same time as Sinking Funds.

First in order of magnitude amongst terminable
annuities as a capital liability, and last in order of
importance as part of the financial machinery of
Government, stands the nation's liability to the
public in respect of annuities for life and terms of
years. It is the result of the sale to private
persons as investments of annuities of the com-
mercial sort which has already been mentioned.
Anybody can turn into the Office of the National
Debt Commissioners in Old Jewry and buy from
the Government an annuity for a term of years,
for his life, or for two specified lives, paying for it
a price which depends upon his age and the price
of Consols at the moment. A long line of statutes
beginning in the time of King George IV. gives
the Commissioners power to carry on this traffic,
which is, in fact, a business undertaking in which
they compete with the Life Assurance companies.
Purchasers of these commodities may pay for
them in money or Government stock, and if in
money, then the Commissioners buy stock there-
with, and the stock bought or transferred in re-
spect [of such annuities is cancelled. Instalments
of the annuities are charged upon the Consolidated
Fund. In the case of such commercial annuities,
as in the case of the Terminable Annuities charge-
able to Votes, the capital liability of the nation in
respect of them is estimated as the amount of
capital (as distinguished from interest) included
in the remaining instalments of the annuities.


For annuities for terms of years the number of
remaining instalments is certain ; for life annuities
it must be estimated with the help of tables show-
ing the probable duration of human existence.

Treasury Bills, Exchequer Bonds, and Ter-
minable Annuities, each serving their own pur-
pose, complete the tale of the nation's floating
debt and of its amphibious debt. Its other debts
are fixed, funded, and permanent ; which we now
proceed to consider.

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