CHAPTER XIX

FINANCING AN EMERGENCY

223. Expenditures for War Furnish the Best Example
of Emergency Financiering. The question of how to meet
emergencies which may overtake a nation or any of its
minor political units has always assumed an importance
of some magnitude. Emergencies have frequently arisen
when there has been an immediate demand for funds in
excess of those provided in the regular budget. Modern
fiscal systems can be much more definitely organized than
could those of earlier generations. Preparation can now
be made beforehand for many events which previously
came unexpectedly, and which entailed increased expendi-
ture. The preventive measures, also, which governmental
units have undertaken, have done much to eliminate un-
expected and unprepared-for events.

Famine and pestilence formerly were common examples
of emergencies with which states were compelled to cope,
yet they are seldom given a second thought by the officials
of modern civilized countries. The regular expenditure of
funds to eliminate the cause of such occurrences is con-
sidered a better method of meeting the situation. The
expense entailed in exterminating the mosquito, for exam-
ple, is considered preferable to an expenditure to cope
with an epidemic of yellow fever. Likewise the expendi-
tures in experiment stations and colleges, where systems
of increased and stabilized production are devised and dis-
seminated, are considered much wiser than the attempt to
take care of hundreds and thousands of famine sufferers.

While states have done much to eliminate the necessity



446 OUTLINES OF PUBLIC FINANCE

of emergency expenditures, they will never succeed in
making the elimination complete. Forces of nature are
still to be reckoned with, and emergencies which arise
therefrom can never be foreseen nor prevented. Earth-
quakes and volcanic eruptions will likely continue to
occur and leave in their wake suffering and loss, the alle-
viation of which will often call for the aid of governments.
Tornadoes, cyclones, fires, and floods will also continue to
occur with similar results, so that officials can never hope
to be entirely free from some unexpected expenditures.

The importance of the funds which have been used and
are still needed for the classes of emergencies just indi-
cated, sinks into utter insignificance when the costs of
war are taken into consideration. Whatever may be the
future status of war, nations in the past have not suc-
ceeded in eliminating this greatest of all emergencies, but
have been compelled, continually, to face it as a possi-
bility if not a probability. The attempt to make provi-
sion through the maintenance of a war chest, and its im-
practicability, have been indicated in a previous chapter.
The enormous cost of modern warfare, where expendi-
tures of a single day exceed the outlay of a total conflict
of a century ago, with the enormous burden which is
imposed upon a nation's citizenship, makes a study of this
class of expenditure of vital importance. The principles
of war finance present, in a magnified form, the principles
underlying all emergency financiering. In this chapter,
then, consideration will be made of some of the underlying
principles which should be taken into account in raising
funds to prosecute a war, as well as the systems which
different countries have employed.

224. The Problem Is to Secure Revenue or Materials.
After the breakdown of the war chest as a method of
financing emergencies such as war, other methods of secur-
ing funds had to be found. Various schemes were hit
upon, the efficacy and advisability of which caused no
little discussion from fiscal authorities and theorists. The



FINANCING AN EMERGENCY 447

demands of the Great War renewed and intensified the
interest in this subject. The sums demanded by the vari-
ous countries surpassed those contemplated by the wildest
imaginations, while the estimated expenditures for a year
usually sank into insignificance when compared with the
sums which were actually demanded.

Superficial Aspect of Money. While the demands for
revenue have been monetary, and the calculations have
been in terms of money, in reality the money represents
but a superficial aspect of the situation. During the
Revolutionary War, when the revenue was insufficient
to meet the needs of the government, requisitions of goods
were made upon the Colonies. In the end, the demand
of the government is for goods clothing, munitions, food
and it is with these that the war is actually fought.
The situation is much the same as with the money income
and real income of individuals the important item is
what the money will purchase. When the war is over the
stock of money may be intact or increased, while it is the
goods, over which it has given command, which have
been used up. The value of the goods destroyed, more-
over, may vastly exceed the total stock of money values,
for the same money may be used more than once by a
government in making purchases. Funds secured from
taxes, for example, may be used to purchase uniforms;
the manufacturers of uniforms will purchase bonds and
the same funds will be used again by the government.

Burden upon Present Production. A large part of the
goods must be taken from present production, though it
is possible that both past and future incomes might be
made to contribute. Past production could be made to
pay by the indefensible scheme of taxation so severe that
it would deplete a part of the capital which had already
been produced. Future income could be made the basis
of payment by buying the goods abroad and mortgaging
future production to pay for them. Neither of these plans
can be used extensively; consequently the burden falls



448 OUTLINES OF PUBLIC FINANCE

upon present production. This cannot be accomplished
without some rearrangements and, perhaps, hardships in
industry. The slogan, " business as usual," current in in-
dustrial circles at the beginning of the Great War, presents
an impossible situation. The demands of war are not the
demands of peace, and industry does not have time to go
through a process of evolution to meet the demands of
war, but must adjust itself by revolution. This may be
done in a number of ways. Capital and labor, which have
been producing goods nonessential to the conduct of the
war, may be put to producing necessary materials.
Machinery which has been idle one third of the day may
be run the full day. The public may substitute cheaper
products for more costly goods, and save hi productive
energy. All these changes necessitated by the sudden
demands will bring about some deviation from former
business procedure.

In securing funds, then, the fiscal authorities should
keep continually in mind not only the securing of revenue,
but what effect the method of securing it will have in the
ultimate source of all revenue the wealth of the citizen-
ship. The maintenance of the patrimony of the state is
an important consideration, and this patrimony should
be impaired just as little as possible. In the securing of
the funds, such questions as the probable incidence, the
equalization of burden, the return, and the effect on future
generations should not be overlooked. The means for
securing revenue lies in the power of the state to tax, to
borrow, and to issue fiat money. Any combination of
these three possible methods might also be used. The
insufficiency of the use of fiat money to any extent has
often been demonstrated, consequently most of the pres-
ent discussion as to means of raising revenue is concerned
with the relative merits of taxation and borrowing as
methods of supplying the government with funds.

225. Borrowing Possesses Some Evident Advantages.
Opinions vary greatly as to the proper method of war



FINANCING AN EMERGENCY 449

finance. Some contend that the entire burden should be
met from taxes, while others go to the opposite extreme
and conclude that the proper method to pursue is to rely
entirely upon borrowing to secure the necessary funds.
Many others would adopt some combination of the two
processes as the most logical course of procedure. It will
be profitable to review some of the advantages and
disadvantages arising with the use of each method,
which should be kept in mind in formulating a fiscal
system.

Produces Revenue Quickly. The demands made by war
upon the Treasury will likely be greater than the ordinary
sources of revenue can provide unless the entrance into
it has been premeditated and proper provision has been
made for the needed funds. Recourse must be had to
some plan that will provide funds quickly, and borrowing
is adapted to meet this need. This is true because, in
making a loan, the individual does not feel the sense of
sacrifice which is involved in the payment of taxes. Loans
to the government are looked upon as investments an
annual return is paid in the form of interest, while the
principal is also payable in the future. In the mind of the
individual, the bond which he has purchased simply rep-
resents his property in another form. Taxation, on the
other hand, even if adequate machinery were hi existence
to secure results, would be felt by the individual as a
burden from which no remuneration would be received.

Borrowing likewise possesses the advantage of quickly
mobilizing idle capital and putting it to work in the prose-
cution of the war. At any time there is more or less idle
capital seeking investment, but because of the uncertain-
ties which exist at the time of a declaration of war, the
amount is likely to be larger than usual. The government
can secure this idle capital by a proper appeal to the in-
vestment it offers, supplemented, perhaps, by the appeal
to patriotism, and can much more quickly put it to serv-
ing the needs of war than through the use of any other



450 OUTLINES OF PUBLIC FINANCE

policy. The more idle capital which can be secured, the
less will be the necessary demands upon existing industry,
and to that extent the derangement of business caused
by the war will not be so keenly felt.

226. Borrowing Is Likely to Increase the Costs of War.
The outstanding objection to the use of fiat money as a
means for meeting an emergency is that the inflation of
the currency causes a higher price level, which not only
enhances the cost of the war since the government must
buy at the new level but places a burden upon all who
purchase goods. It is possible that borrowing will cause
an inflation of purchasing power, and consequently an
increase in prices, but just to what extent it is difficult to
determine. Under the modern system of exchange a vast
amount of purchases is made with credit, and to the ex-
tent that borrowing manufactures credit instruments
which can be used directly or indirectly as purchasing
power, a rise in prices will result. In so far as bonds are
purchased with funds which would otherwise enter the
market and command goods, this effect is not felt. The
government has simply substituted itself as purchaser for
the individual from whom the funds were secured.

Causes Expansion of Credit. The expansion of credit
from borrowing is likely to come through the institution
of the modern bank. Individuals, spurred on by patriotic
zeal, may secure credit accommodation which would not
otherwise be considered, and turn this over to the govern-
ment in exchange for bonds. The banks themselves have
been relied upon extensively as aids to the government.
The percentage of reserve has been decreased, frequently,
in order to extend credit to the government. The govern-
ment, hi order to help the banks lend assistance to itself,
has made deposits of specie on the implied condition that
aid would be given. With this specie as a basis, several
times as much credit could be extended in the purchase
of bonds or certificates of indebtedness. The use of the
obligations of the government, moreover, as the basis for



FINANCING AN EMERGENCY 451

the issue of bank notes, forms another means for the in-
crease in purchasing media. The issue of the Federal
Reserve Bank notes, based upon certificates of indebted-
ness, forms a good example of this form of transaction. 1

From the nature of the case it is impossible to calculate
just how much purchasing power exists because of the
issue of evidences of indebtedness, which would not other-
wise be found. Even if this could be accurately deter-
mined, to calculate the precise effects on prices would
still be more or less of a conjecture because of the derange-
ment in the production of commodities caused by the war.
The fact remains, however, that it is quite likely that
government borrowing will cause a perceptible expansion
of purchasing power, and with it a consequent increase in
the general price level.

Effects of Increased Price. To the extent that borrow-
ing increases prices, the effect is much the same as the
issue of fiat money. The burden is increased to the gov-
ernment and, ha varying degrees, to the citizenship. The
materials for war are, to a large extent, purchased in the
open market, and the inflated prices must, of course, be
paid. While this burden may not be insignificant, it does
not compare to that felt by the citizens, since they too
must buy at the higher price level. Wages do not rise as
rapidly as prices, thereby entailing a burden upon the
laboring classes which often brings about a derangement
of industry because of the increased prevalence of strikes.
Individuals and institutions whose income is fixed, en-
counter the most severe difficulties. Industries such as
public utilities fall in this class. The rates for their
services are fixed, while expenses mount with the price
changes.

Some industries, on the other hand, reap benefits from
the situation. Manufacturers who are paying wages and
buying raw materials at one price level, and selling finished

1 See p. 499 for statistics showing the increase in purchasing media during
the Great War.



452 OUTLINES OF PUBLIC FINANCE

products at a higher price level at a later period, find a
larger differential to go to the profit account. Enterprisers
in the extractive industries, such as farming, mining, and
lumbering, usually find that increased expenses do not
absorb the increased returns. The interest secured from
the increased expansion of bank credit tends to make the
situation a profitable one for banking institutions. The
net result of borrowing, then, in so far as it increases
prices, is to saddle a burden upon the citizenship by neces-
sitating greater government expenditure, and by causing
a greater expenditure by individuals to secure the same
commodities.

The interest charge, moreover, is no small item in the
total cost when the length of time which government
securities usually run is taken into consideration. Sup-
pose, for instance, that a war were entirely financed by the
issue of twenty-five-year 4 per cent bonds. The cost in
this case would be doubled, since the interest charge
would amount to as much as the principal. Even if there
were no effect on prices, the interest charge which results
from borrowing necessarily makes a war more costly.

227. Borrowing Does Not Shift the Burden of War to
the Future. One of the most popular of the arguments
which have been used to justify extensive borrowing to
finance a war is that future generations are recipients of
the benefits, and hence should share the burdens. It is
believed they share the burden by paying off the bonds
which are issued during the progress of the war. There
is no question but that war entails a burden upon the
future the sinking of battleships and merchant marine,
the destruction of factories, cities, mines, railroads, and
agricultural lands, which otherwise would have been
handed down to posterity, is conclusive evidence that war
places a burden upon the future. The contention, how-
ever, that the burden may be shifted has, in reality, no
foundation. In only one way can this be possible. If
the nation which borrows secures its loans from a foreign



FINANCING AN EMERGENCY 453

country, and in turn purchases abroad the products with
which to prosecute the war, it may continue to live
as usual and the burden will fall when the bonds are
payable.

Burden Felt During War. The usual situation is for
loans to be made at home, and the revenue thus secured
to be spent within the country. In this case the burden,
as far as the national aspects are concerned, cannot be
shifted. A war is waged by using up large numbers of
men and vast quantities of goods; consequently men
who will reach maturity, and goods which will be pro-
duced twenty or thirty years hence, cannot be used to
fight present battles. An individual who has one thou-
sand dollars has a command over commodities, but just
as soon as he turns this over to the government in exchange
for a bond he gives up this command. It is impossible
to eat one's cake and have it too one cannot spend his
money for goods and at the same time turn it over to the
government to purchase war materials.

Borrowing, then, does not lessen present material sac-
rifices, for just as much private consumption must be
forgone, just as many commodities are destroyed, as if
the war were financed by gifts or taxes. The difference
to future generations is that, in the case of borrowing,
bonds are handed down to them which they must be taxed
to pay, while if no bonds had been issued they would be
saved the expense of going through the process of taxing
themselves to pay for their bonds.

The above reasoning applies where the same class which
purchases the bonds is to be taxed to redeem them. Take
a simple illustration. If there were no discounting of the
future, in what light would an individual consider the
purchase of a ten-year 5 per cent bond if the interest and
principal were to be met by the bondholder? He is simply
compelled to save enough each year to pay the interest
to himself, and at the end of the ten years must have
saved enough to pay him his principal.