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The Administration of a Public Debt

THE ADMINISTRATION OF A PUBLIC DEBT.

It is the purpose of the present chapter to consider briefly those problems that present themselves to the financier in the administration of a public debt. These problems, which are more or less technical in character, pertain to the issue of a debt, the conversion of a debt, and the payment of a debt, and will be treated in the order of presentation.

81. The Issue of a Public Debt. It may be assumed that in issuing its obligations a government desires to realize the largest amount of advantage for the least outlay of promise. In judging of advantage and outlay, however, a provident financier will hold in mind the fact that the State as a per sonality continues in perpetuity, and he will not on this ac count sacrifice the interests of the future to the exigencies of the present. A long series of questions present themselves to the financier who contemplates the issue of a loan which, so far as touched upon in this chapter, pertain, first, to the motives to which the financier should appeal, and second, to the adjustment of the terms of the debt contract.

(I) To what Motive should the Financier Appeal? There are three motives to which the financier may appeal to induce men to place their loanable capital at the disposal of the State. These motives are generosity, fear, and personal interest, and the loans based upon them are called respectively patriotic loans, forced loans, and commercial loans.

It is sufficient to say respecting patriotic loans that they can form no permanent part of a credit policy, for patriotism as a motive to conduct, while strong during the period of its activity, is uncertain and unreliable. It does not lend itself to calculations and must be employed, if at all, when popular enthusiasm for a public cause is at its height. There are many instances in which an appeal to sentiment has secured for a government offers far in excess of the amount required, as was the case with the French loan for the payment of the war indemnity to Germany; or in which such an appeal has succeeded in obtaining funds after the commercial motive had apparently exhausted itself, as was the case with the United States loan secured when Mr. Fessenden was Secre tary of the Treasury; but the success of such appeals will not deceive the financier. It is the occasion surrounding them rather than the character of the motive upon which they rely that explains their success. Moreover, patriotic loans are dangerous to public credit, for should they fail the fact would be accepted by the commercial investor as evidence that the government no longer enjoys the confidence of the public. We can, then, conclude that patriotic loans, while they may at times render most efficient service, must always be subordi nated to the claims of commercial loans. It is their true func tion to create, to revive, or to support commercial confi dence.

Forced loans present themselves in the history of finance in many forms, but we shall confine our attention to that form familiar to modern financiering, that is to say, the issue of legal-tender treasury notes. That the issue of such notes is an act of borrowing becomes evident whether one considers the process or the result. So far as the process is concerned the government desiring goods or services buys what it needs and offers in return a promise of future payment. Could these promises be discounted like ordinary commercial paper so as to enable the merchant or manufacturer who receives them to obtain cash when necessary to meet his own obligations the transaction would present no unusual features. But the promises under consideration are not commercially negotiable. They neither bear interest nor do they name a date at which they mature, and it is not likely that a merchant or manufac turer, knowing that he is to be paid in such a form of credit, would care to secure the government as a customer. In order, therefore, to relieve those who first receive these promises in return for goods or services the government, availing itself of its constitutional right to determine all questions relating to currency, attaches to these notes the legal power of paying private debts. This means that these notes are forcibly in jected into the circulating medium of the country. They are received, not because men have confidence in them as a form of credit, but because the government threatens to with draw its protection in matters of contract from all who refuse to assist in floating its notes. The transaction under con sideration is a loan because by means of it the government secures goods or services in return for a promise to pay; it is a forced loan because no person who buys or sells within the jurisdiction of the government can evade the necessity of handling the notes.

The chief argument urged in support of legal-tender notes besides the argument of necessity, which the Science of Fi nance regards as a confession of ignorance or of weakness, is that by this means the government secures a fund of capital without the payment of interest. This advantage, however, is apparent rather than real, for it must be remembered that notes do not need the legal-tender quality to insure their acceptance except their issue is designed to make a redundant currency. Legal-tender notes, therefore, will inevitably inflate the circulating medium. It is of their nature to cause a rise in the level of prices. Since, now, the only purpose of the issue is to purchase goods or services, it is more than likely that what the government saves in interest it loses in the price it pays for goods. That this analysis of the argument is sound may be proven by a study of any attempt which any govern ment has ever made to obtain money by a forced circulation of treasury notes; at least the author knows no illustration to the contrary.

The chief argument against legal-tender notes is that their issue involves the suspension of specie payments. This simple statement ought to be ample for one who appreciates the evils that follow upon a disordered currency. It may be possible that an extreme exigency may warrant so drastic a fiscal measure, but the truth seems rather that no government with an approved cause can ever find itself in an exigency so ex treme, except as the result of an erroneous fiscal policy or of a long series of blunders in the administration of a policy ap proved by science and experience. To begin a period of deficit financiering by an act which must inevitably destroy the commercial machinery by which alone a sound financial policy can be successfully carried through must certainly be condemned.

Our general conclusion, then, is that patriotic loans are of restricted use, and that forced loans should be reserved for use, if used at all, as a last resort, from which it follows that commercial loans, resting on the ordinary business motives which underlie the processes of purchase and sale, should be employed in the carrying through of a credit policy.

(2) What should be the Terms of a Public Debt f—Recog nising 'the private interest of the lender to be the chief, if not the exclusive, motive to which appeal should be made in the placement of a public debt, and acknowledging the price paid to be the most apparent test of its success, we proceed next to inquire respecting the terms of a debt contract, and in what manner this contract may be adjusted so as to meet the wishes of the lender without injuring the interests of the borrower. It of course goes without saying that the obligations offered for sale should admit of a certain degree of variety, for it is not conceivable that all lenders will be equally attracted by the same form of contract, but at the same time the financier must not show such solicitude for the whims of lenders as to intro duce confusion into his accounts or to lose control of the situation.

The terms of a debt contract are three in number : first, the time for which it runs; second, the principal or amount to be paid; and third, the rate of interest or annuity. Theoreti cally any two of these may be determined by the govern ment and the bid of the lender be expressed in the third. Within limits these terms are mutually convertible. Thus if the time for which a bond runs is long, say forty or fifty years, the rate of interest or annuity will be low; if, on the other hand, the time be short, say from two to five years, the rate will be relatively high. Either of these terms also may be converted into the principal of the debt, although in this case a distinction must be made between the amount named in the bond and the price paid for the bond. It is not pos sible to consider in detail the relative significance of these terms, and we shall content ourselves with three definite state ments respecting the form of a public debt.

(a) It is preferable for a government to promise a definite rate of interest upon a stated amount for a specific time than to promise a definite annual payment. The former in com mon language is called a bond, the latter an annuity. The reason for preferring a bond to an annuity is that a bond secures to the government the liberty of reducing the rate of interest if, through the subsequent rise of public credit or on account of an increase in the amount of loanable capital, the market rate for loans should fall below the nominal rate at which the loan is issued. For example, suppose twenty thou sand dollars to be borrowed in the form of a bond at five per cent interest, the yearly payment would be one thousand dol lars. Suppose the rate for loanable capital to fall to three per cent, and that the government pay off the old debt with money borrowed at the lower rate, it is clear that the government saves four hundred dollars a year by the transaction, a saving that could not have been made had the government con tracted to pay six hundred dollars a year in perpetuity.

(b) The element of time in a public bond should be fixed by the government in preference to the rate or the amount. The reason for this is that under no other conditions can a government control its obligations. This would not be worth saying in addition to what has been already said if it did not lead to a consideration of the time element in credit financier ing, in respect to which several important considerations sug gest themselves. In the first place, the period during which the government guarantees its creditor against any modifi cation of the terms of the contract, which is the period be tween the issue and the maturity of the bond, must be suffi ciently extended to secure advantageous bids from those who loan the money. It is not possible to make a definite state ment upon this point further Than to say that the more highly developed the system of commercial credits within the com munity the greater will be the importance placed by lenders on the time for which an investment is guaranteed. Five years in a country like England, France, or the United States is little better than the mention of no date at all; twenty years, which a quarter of a century ago was ample, would now tend to depress the price of bonds, because it offers too short an investment; while a forty or fifty year guarantee is practically as good as perpetuity. The determination of the time for which a bond should run calls for a keen appreciation of commercial conditions and an exercise of good commer cial sense.

• What has thus far been said respecting time pertains to a great national debt contracted for general purposes, as, for example, a debt contracted for the prosecution of a war. Such a debt not only rests on taxes, but is of such magnitude as to demand special taxation for its support. The purpose for which it is issued also presents no considerations which bear upon the time for which it should be drawn. With temporary debts, on the other hand, or investment loans, whether com mercial or non-commercial, the case is quite different. Tem porary loans designed to balance the casual deficits and sur pluses in the income of succeeding years will probably be drawn as interest-bearing treasury notes, and may or may not mention a date of maturity according to the whim of the market, but in any case three years is ample time for such notes to run. The time for which a non-commercial invest ment loan should run, let us say a loan for building a twenty foot channel from the Great Lakes to the sea, should be cal culated by the engineer and not by the financier, and the theory upon which his calculation should proceed is that the enterprise ought to become a clear property to the public before a new loan is needed for its reconstruction. Investments of this sort constitute a separate branch of credit financiering. The time for which a commercial investment loan should run also must be determined by considerations that pertain to the enterprise established through its proceeds. Such a loan, while guaranteed by taxes, rests upon earnings, and, holding in mind the fact that it is the purpose of the government to establish the undertaking as an unincumbered public property, the time for which the obligation should be guaranteed against repayment may be largely determined by ordinary business considerations.

An analysis of the time element in public bonds emphasizes what has been already suggested : that credit financiering is of several sorts, and that the administration of a debt depends primarily upon the purpose for which credit is employed. The rule is as follows : temporary debts should be drawn with a view to their quick payment, exigency debts with a view to their subsequent conversion, and investment obliga tions with a view to their gradual expungement.

(c) The rate of interest named in a bond should be suffi ciently high to secure its placement at or near par. The reason for this is bound up in the argument which favours the payment of a public debt. It is doubtless true that, other things being equal, a bond bearing a low rate of interest will, for the same annuity, permit the government to realize a higher amount of cash at the time of issue than a bond which bears a higher rate of interest. The lender will bid relatively higher for such a bond. Assuming for purposes of illustra tion that a hundred-dollar bond at five per tent will sell at par, a hundred-dollar bond at three per cent ought, mathe matically calculated, to sell for $66.66; but as a matter of fact it will sell for something more, so that in reality the government secures its money for something less than five per cent. But is this immediate gain worth the ultimate loss? Assuming the debt to be paid at maturity, the government will in the one case pay no more than it received; in the other case it will be forced to pay par for an obligation which it originally sold at a discount. The contention, then, is that a loan should be issued at par, and that a rate necessary to float obligations at par should be freely offered. The truth is that discount financiering is in large measure responsible for the burden of perpetual debts now resting upon the world. " This is the principal cause," says M. Leroy-Beaulieu, " for the duration of public debts in Europe." 82. The Conversion of a Public Debt. By the conver sion of a public debt is meant a modification of any of the terms agreed upon at its issue. It may be assumed that the government is at liberty under the terms of the co.nract to effect changes, and that the changes will be to its advantage.

Commonly the conversion of a debt contemplates the substi tution of a lower for a higher rate of interest, by which the burden of a debt as measured by the annual payments which it occasions are lightened, and such will be the only modi fication of the contract we shall here consider.

The process of conversion is simple and scarcely merits the reputation granted the financiers who effect it. It consists in the issue of a new debt in place of an old one, and, pro vided the financier has just regard to the conditions of the money market, the holders of the old debt will in all proba bility exchange them freely for corresponding amounts of the new issue. There is no need, as in 'the case of the creation of new obligations, for the financier to consider the question of ways and means wherewith to float a debt; indeed, it is likely that the operation will permit the reduction of taxes. Nor is there any need for the financier to trouble himself about sus taining public credit, for the fact that conversion is possible shows that public credit is high, and every step in the process tends to raise it yet higher. We may, then, say that the merit which attaches to conversion belongs to that successful ad ministration of the national finances 'by which public credit was established and public bonds rendered attractive; and it might be well for those who advocate repudiation in the in terest of the taxpayer to remember that in so far as their advocacy is effective it not only increases the price which the government must pay for money when it borrows, but it causes the burden of a debt to continue longer than might otherwise be the case. The reduction of interest through con version is the reward which comes from the scrupulous ap plication of commercial honesty to public affairs; the con tinuance of a higher rate of interest than the market rate after the maturity of bonds is the penalty justly imposed upon a people careless of their public credit.

The financial question involved in the conversion of a pub lic debt makes its appearance when one considers the relation of conversion to ultimate payment. A large debt cannot be paid at once. Not only would it be impossible for the govern ment to obtain adequate funds through taxation, but the let ting loose of a large fund of capital looking for investment might seriously embarrass commercial interests. A debt must be extinguished gradually, whether one looks at the matter from the point of view of the administration of taxes or from the point of view of current commercial investments. It is not always possible at the time a debt is created for the finan cier to hold in mind the necessities of judicious and easy payment, but it is a serious criticism upon the financier who funds a series of floating obligations or who converts a funded debt that any reasonable policy of debt payment should there after be embarrassed by the terms of the contract in the newly created obligations. The conversion of a debt should be re garded as an opportunity for bringing the debt under control so far as ultimate payment is concerned. The funding scheme of Alexander Hamilton and the refunding programme of Sec retary Sherman are alike open to criticism from this point of view.

Not only should the financier modify the terms of the debt if need 'be so as to aid the possibility of ultimate payment, but he is at liberty to avail himself of the process of conversion to introduce changes designed to make the debt of use to the community while it may last. A commercial nation is in need of sound credits to be used as collateral security in business transactions. Nothing serves better this purpose than the bonds of a government financially strong; and, While no public interest should he sacrificed to this commercial de mand for available collateral, it is proper, other things being equal, for the financier to draw the new bonds so as to serve this purpose in the highest possible degree. This means that as a preliminary step to the conversion of a public debt a financier should study the commercial uses that may be made of public bonds, and so diversify his offers as to enable the debt naturally to come into that shape in which it will be of the greatest benefit to the community while it lasts.

83. The Payment of a Public Debt. Revenue from public credit is not a final but an anticipatory revenue. This means that the nature of public credit involves the necessity of debt payment, and we might in strict logic proceed at once to consider the appropriate means of accomplishing this end. As a matter of fact, however, 'the necessity of debt payment is not universally conceded, and we shall, therefore, before asking how a debt may be paid inquire why it should be paid.

(I) Why should a Public Debt be Paid f—The reasons for the payment of public obligations may be the most efficiently suggested by consulting the principal argument urged against it. The burden of a debt, it is claimed, and rightly claimed. does not depend alone upon the amount of indebtedness or of the annuity which that indebtedness entails; it is equally important to consider the resources of the indebted nation. The debt rests upon resources, and relief from the burden of a debt may be secured either by reducing the debt or by strengthen ing the resources. A weight constitutes a burden according to the ratio it sustains to the strength of that which bears it; what reason can be urged for exhausting the energy that might go to the development of the nation's strength in re ducing the burden to be carried? Such is the argument against debt payment, and that it has done effective service is shown by the vast amount of perpetual obligations which now bear down upon the industries of all civilized states.

Respecting the claim that industrial development decreases the burden of a debt there can be no doubt. The pressure of England's debt, for example, in 1815 is computed as equi valent to nine per cent of her yearly income; it is at the pre sent time between two and three per cent of that income, but its reduction has not been effected so much by the expunge ment of obligations as by the growth of national wealth. The actual result, so far as debt 'burden is concerned, is the same as though two-thirds of the principal had been paid, the amount of her wealth remaining stationary. Other in dustrial nations show similar results, but the recognition of this necessary relation between the increase of resources and the decrease in the weight of public obligations is not final against the policy of debt payment; for if it can be shown that the payment of the principal of a debt has no tendency to retard the industrial development of a nation the argument fails to be conclusive. As opposed to the idea from which this reasoning must proceed I venture to place the following proposition, which if maintained will furnish an incontrover tible argument in favour of the policy of debt payment.

The payment of the principal of a debt tends neither to im poverish a nation nor to retard its material development; but, an the other hand, the maintenance of the principal and the con stant payment of accruing interest tend to cripple the productive capacity of any people.

The two parts of this proposition should receive separate attention, and we are led first to inquire if the industries of a country are injuriously affected by the process of payment. It is admitted by all that somewhere in the course of deficit financiering—either at the time the debt was established, or during the period that it was carried, or at the date of its payment—a loss is sustained chargeable to the adoption of the loan policy. Should one reason from the analogy of pri vate debts he will conclude that this burden is borne at the time when the debt is paid, for when an individual debtor clears himself from obligations he loses control over a certain amount of free capital, and consequently lessens his impor tance as a member of industrial society. But such reasoning cannot be applied to the State. The State is not an individual, it has no life separate from the united lives of all citizens, and it recognises no interest but the collective interest of society. The State is the corporate representative of all citizens, credi tors as well as debtors, and is ndt at all interested in the pro prietary residence of capital, provided only it be judiciously employed. Since, then, the payment of its own obligations effects no more than a transfer of control over capital from one set of men to another, it cannot be said that the industrial development of the country is thereby obstructed.

The position here assumed may be easily understood if one hold firmly in mind the nature of capital. Capital is the subsistence fund, and he who controls it has it in his power to direct labour. It is capital which the State wants when it borrows money, and in borrowing capital it draws to its own use that which, had it not been thus appropriated, might have been applied to some productive industry under private management. The obligations which the State creates against itself are written in the language of money, because this is the most convenient language known for the expression of indebtedness; but the State has no use for money except to effect the transfer to itself of control over existing capital.

Suppose a State to borrow a billion dollars; it cannot be said that industrial society is thereby necessarily rendered any the poorer. Capital is not destroyed by the borrowing. Before the loan was filled the nation was the possessor of a cer tain amount of capital, distributed in a thousand funds under the direction of a thousand wills; after the loan the nation as a whole holds the same amount of capital as before, the only difference being that control over it has passed to the State. Whether or not this operation is industrially detrimental de pends upon the use to which the State puts the proceeds of its loan. If this be consumed in the prosecution of a war the nation is impoverished to the extent of the unproductive con sumption, since capital, in the form of bacon, flour, clothes, implements, mules, and the like, has been destroyed. We may, then, conclude that the injury sustained on account of a loan for war purposes is sustained at the time the loan was contracted, and is due to the fact that the State has caused a certain amount of capital to disappear without hope of re covery.

Let us now turn to the process of payment. The obliga tions which the State has created against itself call for the payment of a certain amount of money. The money which it obtains by means of taxation is held for a moment, then transferred to the public creditors, and in this manner the State is freed from its indebtedness. It would, of course, be incorrect to say that this transfer of money from one set of citizens to another does not in the least disturb capital, but it may be rightly claimed that iet does not destroy capital. Before the payment one set of individuals controlled the subsistence fund of the country to the extent of the pay ment; after the extinction of the debt ownership rests with another set of individuals. The government is freed from the necessity of providing an annual sum in the form of interest, and, measured by the amount of capital in the country, the nation is in no wise impoverished. There is the same amount of food for the subsistence of labourers, and the same amount of raw stuffs upon which to set them at work. If the new masters of capital are as enterprising as the old the nation loses nothing by the payment of its debt. This is the explana tion, and in the explanation lies the defence of the proposition that the payment of a public debt does not necessarily im poverish a nation. The injury to industrial society is worked by the destruction of capital at the time the loan was created; the labour required to create again the capital thus destroyed constitutes the burden imposed upon the nation; the payment of the principal of the debt is at most but a readjustment of ownership in existing capital. It is a fallacy to argue that the expungement of public obligations destroys capital.

But how is a people impoverished by the maintenance of the principal of a debt? In so far as bondholders live from the proceeds of their bonds they form a class not immediately interested in current industries. At same time in the past they may have furnished the government with large sums of capital, thus averting the inconvenience of excessive taxation or of a sudden change in rates; and in return for this service they received from the government the promise of an annuity until an equivalent of the original capital should be returned. Such persons are guaranteed a living without labour.

There is but one way in which the government may escape the necessity of supporting in idleness this class, and that is by paying its members their respective claims. The 'bond holders would in this manner be deprived of their secured annuity, but they would in its stead hold a sum of free capital; and if they now wish to continue in the enjoyment of an in come from their property they must apply their funds to some productive purpose. In this manner the country gains by bringing to bear upon industrial affairs the interested atten tion of those who formerly were secured a living from the pro ceeds of public taxes. For another reason also is the payment of a debt advantageous. No people can long retain that hopefulness so essential to the vigorous prosecution of indus tries if the past lays heavy claims upon the present. As a rule they only should partake of current product who are in some way connected with current production. Carelessness an I jealousy are not characteristics of efficient labour, but they are sentiments naturally engendered by the payment of taxes for the support of a favoured class. It is the permanency of this payment, rather than its amount, which exerts a depressing influence upon labour, and its extinction is a first step toward the establishment of confidence and contentment. It is for such reasons as these that we conclude that the policy of debt payment vigorously prosecuted will assist rather than retard industrial development.

(2) How should a Public Debt be Paid f--Accepting the policy of debt payment, by what means should it be carried through? For many years this question was so befogged by the intricacies of sinking-fund accounts as to mislead both financiers and the public. We shall not endeavour to follow the bibliography on this subject, but content ourselves, as when we considered the conversion of public debts, with a few definite statements respecting debt payment.

(a) It is not necessary at the time of creating a debt to include in the Contract the terms of 'the payment, but, on the contrary, the law which authorizes the treasurer to borrow money and the law which authorizes him to repay the money borrowed should be separate and distinct acts of the legisla ture. The reasons for this are that public credit, in which a government is most vitally interested at the time of creating a debt, is not strengthened, bu't rather it is weakened, by the fact that the government binds itself to repayment. He who invests in the obligations of a strong State prefers an obliga tion that runs in perpetuity, and any promise looking to its payment will, other things being equal, tend to depress the price he is willing to pay. From another point of view also is a clause contracting repayment out of place in a law which creates a debt, for if it be conformed to it may necessitate that money be borrowed at high rates to pay an outstanding obligation at low rates. This is conversion inverted, and is absurd as a financial procedure. The result under such con ditions is that as a matter of fact a government will disregard that part of the contract which calls for payment until the ne cessity of creating new debts shall have passed away. If, then, credit is depressed by a formal promise of repayment, and if the promise will be disregarded except under conditions when it is wise to pay the debt, is it not reasonable that the law which creates the debt should drop all consideration of repay ment? A positive reason also may be urged for separate legis lation in the two cases. It is not possible at the time a debt is created, except in the case of a temporary debt or indus trial loan, to forecast with any certainty the date at which or the conditions under which it .may be wise to undertake repayment. It is much better for a present legislature to put confidence in the legislatures of the future. They will in all probability be as wise and as patriotic, and, inasmuch as they stand nearer the transaction contemplated, it may be assumed that they will adjust the conditions of payment more perfectly to the requirements of the time. The law creating a debt should confine itself to the definition of those terms upon which public credit depends, and not undertake to forecast a policy that may in the exigencies of financiering lie a quarter of a century in the future.

(b) A law designed to extinguish a debt should provide for the application of a clear income to the payment of the principal, and should not be encumbered with sinking-fund calculations. The reasoning upon this point is in one respect the same as that upon the point just passed in review, for the chief argument against sinking-funds is that a govern ment should not be placed under the necessity of borrow ing money to meet its promise of debt expungement. The theory of a sinking-fund, if theory it may be said to have, is simple. Assuming that a government enjoys an income equal to the interest on an existing debt, and a slight surplus, let us say equal to one per cent of the debt, which may also be assigned to the debt service, it is evident the debt is in a condition of gradual extinction. One per cent of the prin cipal is paid the first year, and the interest payment for the second year is correspondingly reduced. During the second year not only can the one-per-cent dear income be used to further reduce the principal, but the saving of interest upon the purchase of the first year may also be used for that purpose, so that at the end of the second year the principal of the debt would stand as something between ninety-seven and ninety-eight per cent of its original amount. In other words, the government buys a portion of its own debt, pays to itself the interest accruing upon that portion, and employs this amount for the purchase of more principal. Two things are evident : first, so long as the appropriation originally as signed to the service of the debt is kept up the process of debt payment continues, and second, the rate of payment conforms to the rule of compound interest.

If this idea of compound interest be firmly grasped the student can understand the form of argument urged by the advocates of a sinking-fund. It is wise, so said these mathe matical experts, to borrow money at six per cent in order to continue the purchase of five-per-cent bonds, because the former represents an operation in simple interest, while the latter represents an operation in compound interest. The error of this 'statemnt does not lie in its mathematics, but in the assumption that the purchase by a government of its own obligations is a productive investment. The argument overlooks the fact that whatever the government pays for the support of the debt, whether it goes through the sinking-fund or not, comes from taxes, and it is bad financiering to take six dollars out of taxes to pay the interest on one hundred dollars of new debt in order to pay off one hundred dollars of debt which demands an interest payment of five dollars only. The principal of the debt is not changed by the operation, while the burden of the debt is increased. So long as one holds in mind the total of the debt and the total of the amount assigned each year to the service of the debt he will not be misled by sinking-fund calculations. The theory assumes the sink ing-fund to be productive, whereas it is not productive. It is not a productive process to pass money from one account to another when both accounts belong to the same person.

An apparent exception to this sweeping condemnation of sinking-funds may be made in favour of local financiering and industrial loans. A local government is but a small frag ment of the nation. It is a corporation among corporations, and it may occur that taxes which it has imposed for the ex tinction of its obligations cannot be judiciously used on ac count of the high market price of its bonds. This being the case, it would probably be wise, rather than remit the taxes or divert them to some other use, to invest their proceeds in some form of commercial paper. This investment would undoubtedly be called a sinking-fund, but it would differ from the sinking-fund of the sort we have considered in that the investment constitutes a source of income to the local govern ment independent of taxes. It is true the taxes must be maintained to pay the interest on its own outstanding obliga tions, so that so far as income and expenditure are concerned there may be neither gain nor loss; the gain from the trans action becomes apparent when, the bonds of the local govern ment having matured, and their price on that account having been brought down to par, the property in the investment fund can be sold and the proceeds of the sale applied to the extinction of the local debt. The advantage of such a pro cedure is that a local government can continue the application of a free income to the reduction of its debt, and at the same time obviate the necessity of paying a premium on unmatured bonds.

The case of industrial loans is yet simpler. Each indus trial loan represents a specific investment, and probably an investment subject to deterioration through use. We have already considered the time for which such loans should run, and it may be wise, as a precaution against their non-payment by the time the investment is worn out, to establish a sinking fund in connection with the loan.

Our conclusion, then, is as follows : Nothing pays a debt except clear income, and the interest which accrues to a government through the purchase of its own bonds does not constitute such an income. In order to continue a policy of debt payment, and at 'the same time obviate the purchase of bonds at a premium, however, it may be wise for local govern-, ments to make a temporary investment of the money assigned to debt payment in interest-bearing paper other than its own bonds. For industrial loans, also, the fact that the speciali zation of investments is essential to sound administration war rants the use of sinking-funds.

(c) The third observation respecting the policy of debt payment is that it is better to provide for the expungement of a debt by operating upon the principal than by converting the principal into a series of terminable annuities. By an an nuity is meant a specified annual payment; a terminable annuity is a payment that terminates at a specific date. It is not an unusual practice to convert a bond into an annuity to run for a series of years, and by this means to provide for the payment of a debt. Suppose, for example, that an hundred dollar bond bear six per cent interest : 'the annuity will then be six dollars. Suppose the government offer to receive this bond which runs in perpetuity in exchange for a simple promise to pay eight dollars a year for twenty-three years: at the expiration of the period the debt will be extinguished. The application of two dollars a year to the payment of the principal, increased by the interest accruing on the principal paid, will have extinguished the debt.

The argument against terminable annuities is the same as the argument against the sinking-fund. Indeed, a terminable annuity is a sinking-fund that cannot be alienated from its purpose, because the payment is a part of the contract and so interwoven with the interest accrual that it cannot be separated. The interest and the payment are lumped together in the contract. It is thus evident that annuities realize in practice the error that sinking-funds imply in theory, namely, the inviolability of a payment upon a specific portion of a debt, even though the government may find itself in a situation where it must borrow new funds at a higher rate of interest. This by no means exhausts the discussion upon terminable annuities as a means of debt payment, but it at least indicates their financial character and suggests the point of view from which that discussion should proceed. It may be laid down as a principle that the policy of debt payment for a govern ment exposed to fiscal exigencies should be at all times under absolute control; this is not contemplated by the theory of sinking-funds, it is not possible under the practice of termi nable annuities.

(d) It may perhaps be added as a final observation that the policy of debt payment should be formulated at the time the debt is thrown into its definite shape, which means that both the funding of floating obligations and the process of conversion, which inevitably follow the creation of a debt under the stress of an exigency, should be so carried through as to bring the debt into shape for orderly and uniform pay ment. There is no other single act in connection with this branch of financiering that calls for so high a grade of busi ness judgment. This, however, has been suggested in con nection with the analysis of the process of conversion.

rugs.

payment, government, time, capital and loan