5.3 Public Debts
The welfare of a nation is similar to the welfare of a man: in isolation, both must produce all the necessities and luxuries they need to consume. Failure to produce in sufficient amount leads to depravation, and production in excess of need is merely waste unless it can be set aside for future consumption. In the presence of others, they may be cooperative or contentious.
A nation or a man may be enthusiastic or lazy in production, thrifty or wasteful in consumption, in comparison to peers. A nation or a man that is productive and thrifty will have greater prosperity than another less so, and over time some will grow wealth while others remain destitute, each the benefactor of its own nature with neither the assistance of interference of the other.
Where some have amassed wealth, others jealous of their success may seek to obtain it. They may seek to do so by means of violence, or they may seek to do so by means of agreement. The latter arrangement forms the basis of the institution of credit, among men or among nations, by which one becomes the debtor of the other, desirous of having immediate possession of some share of his neighbor's wealth, for the promise of its later repayment.
The Facilitation of Credit
While the practice of informal borrowing is common to even the most unsophisticated state of society, the necessity of credit and the facilities necessary to the institution of credit requires a society to have achieved a relatively advanced state of manufacturing and commerce.
To borrow or lend something requires that thing to be in a condition in which it can be transferred - usable goods or money.
- In a primitive state, man has few possessions that are fit to be lent - what few tools and artifacts he has are needed in the course of his daily life, what he gains by their use is little more than is needed for his immediate consumption.
- Even in an agricultural state, much of capital exists productive assets of land and crops that are of little use to anyone but the farmer. Only once or twice a year does the farmer harvest his crops and, by doing so, has capital that can be lent, whether as goods or money.
- In a manufacturing state, significant capital is invested in facilities and equipment, but crude materials are more often turned to finished goods. The stock of materials and finished goods are transferable assets, as is the regular stream of money from the sale of goods.
- In a mercantile state, little capital is invested in nontransferable assets, and the vast majority exists in an inventory of transferable goods and a constant supply of money from frequent sale of them.
Not only do manufacturers and merchants have the capability to lend, but they also have the inclination to lend or borrow according to the variances in production and sales. An unusual opportunity to earn greater profit than normal, by creating or purchasing a greater inventory than normal, gives rise to the need of more money than normally needed. With a source of credit, they can seize such opportunities - borrowing to buy the inventory they need to satisfy demand and repay shortly thereafter when goods are sold.
(EN: I don't agree that credit is exclusive to merchandising and manufacturing, as a farmer may borrow funds to buy seed and hire workers and repay the debt at harvest - an agricultural operation is similar in that way to manufacturing - so credit is useful and possible even then, but with much less frequency.)
The primary benefit to the creditor for the loan of goods is the interest earned on any sum borrowed. If an individual has produced a surplus of goods, and has no immediate use for it in his own production, that sum would lie fallow. While the benefit of savings is future consumption, this benefit may be increased by loaning money and gaining interest rather than having wealth sit idle.
There is, to the creditor, a secondary benefit of extending credit in the improvement of the economy of his vicinity. A manufacture may extend credit to a merchant for the purchase of his goods, or vice-versa for a merchant to enable the manufacture to create goods he will sell. Even when there is no direct connection, credit facilitates an indirect benefit from the general buying and selling of goods and increase in employment in an area that may ultimately result in some benefit to the creditor.
If an individual borrows a sum of money he is easily capable of repaying, it is of little consequence, but he can become financially ruined by borrowing more than he is capable of repaying. This is no less true of government, and given the accrual of government debt, there is some concern for their fiscal solvency and their ability to gain the credit they require in future. Unlike an individual, a government does not suffer the consequences of its actions, but the indiscretion and foolishness of rulers are visited upon their subjects.
Legal Requirements of Commercialism and Credit
The author digresses to consider of some of the ancillary requirements of commerce and manufacturing:
Production and sale of any kind requires people to be secure in the possession of their property. In a state where the capital of people can be seized by government, or where government fails to provide assistance when it is seized by others, there is too much risk to commercial trades. In such situations, individuals would be inclined to produce only what is needed for their own immediate consumption and to keep hidden what few assets they have, for fear of seizure. Commerce, manufacturing, and even agriculture would be discouraged and society would revert to a primitive state.
Likewise, credit requires the support of law and the authority of state to enforce credit agreements. Were a creditor to have no confidence in his ability to collect payment, he would not extend payment, or would by necessity have to seize the assets of his debtor to recover. Were the debtor not protected by the state from the premature seizure of his assets by a creditor, there would be little use in borrowing, as the duration of a loan is as important as its amount.
Production and commerce, in short, can not flourish and likely could not even exist in any situation in which there was not a sufficient degree of confidence in the justice of law.
Credit and the State
Under the conditions that enable men to loan and borrow money to one another, they are also disposed to extend credit to the state. While a loan to the state is not repaid from production and sale of goods, there is great confidence in the state to obtain by taxation the means to make repayment, and to pay the interest on the sum borrowed.
The state meanwhile sees advantage to using credit, in much the same way as any individual does, when he has need of funds that exceed his normal income and accrued wealth.
Moreover, the ability of a state to obtain funds by borrowing reduces its need to accumulate savings. While the accumulation of wealth in savings is encouraged for productive individuals, the only means by which a state can accrue funds in its treasury is to burden its citizens more than is necessary to collect taxes beyond its needs.
Considered thus, the ability of the state to borrow is of benefit to society: it is more sensible and just for citizens to bear the burden of actual costs of state, by paying additional taxes to repay a debt, than for citizens to pay the additional measure of tax imagined to accrue wealth for imagined future costs.
A state that became so burdened by debt that it could not repay it in the foreseeable future, and which had raised taxes to the highest level its citizens could afford to pay, was left in the position of being able to obtain no further credit should the need for it arise - unable to capitalize on opportunities, and unable to react to emergencies. As such, states established sinking funds for the retirement of long-term debt, but such funds were routinely misapplied for other purposes.
Smith provides details of the solvency of the British government over the course of the eighteenth century, in which time a series of military conflicts led to the accumulation of debt in excess of one hundred million pounds.
The Costs of Warfare
In times of peace and stability, governments had fewer expenses and could better predict their need for funds. But in a state of war, a great and unpredictable expense fall upon the state. Few kingdoms maintain a surplus of wealth, and while the notion of a "war chest" is common, such funds are almost always plundered for other purposes.
As such, a state at war finds itself in need of significantly increased funds at the same time that productive workers are called away from productive work to military service. To increase taxes to pay the expenses of war would visit a greater expense on those who have diminished revenue. With the greater number of its troops engaged in conflict, the state could not as readily defend itself from a civilian revolt, and could not risk rousing public offense.
Even if it war is acceptable to a civilian population, the burden of financing it would sour their sentiment, so there was a limit to the state's ability to increase taxes to cover the costs of war. As such, a state at ware accumulates significant debt that will be carried over long after the military conflict has concluded.
The Costs of Expansion
Another significant expense facing governments of Europe in Smith's time was that of exploration and colonialism, an endeavor that requires the investment of significant amounts of capital for returns to be recognized at a distant future time, if at all.
To this end, states turned to the practice of chartering companies to leverage private resources beyond the resources of the treasury, yet sought to remain the primary investor in such endeavors to reap the benefits of the potential profit.
Founding such a company constituted a significant and unusual expense for the state - nearly ten million pounds was extended in 1711 to fund the South Sea Company - requiring the state to accrue significant long-term debt that could only be repaid if the venture turned out to be profitable. Even when ventures succeeded, the state bore the burden of debt for many years before receiving sufficient revenue to retire it.
Methods of State Borrowing
The use of bills is a common method for states to borrow money: a bond is sold to any buyer for an amount less than that for which it can be redeemed at a later time. This method is generally used for relatively small amounts of money that is needed for a short amount of time, most often as a method of accessing funds that are received periodically (such as a tax collected annually) to pay ongoing expenses (such as the salaries of employees, who will not wait to be paid until the taxes are collected).
Smith's take on the situation is a bit less forgiving: "Like an improvident spendthrift, whose pressing occasions will not allow him to wait for the regular payment of his revenue, the state is in the constant practice of borrowing of its own factors and agents, and of paying interest for the use of its own money."
When the state finds that the revenue it receives is insufficient to repay the debt it has incurred, it extends the debt, but often the debt is not repaid in the following year, but extended again. Smith provides an account of the deficiencies over the course of several years, which generally ranged between one and two million pounds.
As such, it became clear that the amount of debt accrued by government could not be repaid by the taxes of a single year, or even the tax revenues of several years, so it sought to extend the duration of its credit over a greater course of years, through instruments that grant an annual payment of interest but forestall the repayment of principal, leaving the retirement of the debt to future generations.
Life Insurance and Annuities
Smith also details various life insurance and annuity schemes instituted by England and France, which provided the state with funds to be paid to a beneficiary on the death of the creditor, and state support of totines as a method of raising more funds and holding them until all but the last of a group of people expired.
As London was "the greatest mercantile city in the world," the English government found itself in the debt of merchants, who regarded holding government debt to be a method of increasing their capital, who would hold debt instruments or trade them as commercial paper. Life insurance policies were commonly traded, though at a discount that reflected the age and state of health of the insured.
In France, the government found itself in the debt of farmers. men of "mean birth, great wealth, and great pride" who wished to marry above their class, but were considered unacceptable by those of established wealth, and so remained bachelors all their lives. Having no posterity, they had little interest in life insurance, and sought instead investment vehicles that paid interest during their own lives. Annuities and pensions were more commonly in demand, which were less often used in trade than held for personal income.
Retirement of State Debt
In the repayment of public debt, a state gains nothing by repaying debt - revenue extracted from some citizens is given to other citizens, and the nation as a whole is "not a farthing the poorer." However, this is "sophistry" which conceals a less pleasant truth: that the repayment of debt arises from burdening productive members of society with additional taxes to transfer the fruit of their labors to the less productive, from whose coffers the state borrowed funds. In situations where the state raises the taxes of an individual to repay the money borrowed of him, it is little different than the state merely defaulting on the loan.
This also fails to account for the debt of a nation that is held by citizens of foreign nations. In regards to the debt of Britain, the Dutch and several other nations of Europe held a considerable share of the public debt, hence its repayment resulted in the reduction of funds from the British economy and an increase in the capital of foreign nations. This is exceedingly objectionable when the debt accrued to defend the nation is repaid to the wealthier members of a nation that has attacked those whose taxes are now increased to pay, with interest, the expense of their own defense.
Smith returns to the notion of taxation as a drain on the national economy and the welfare of the people: whatever tax is levied, it ultimately detracts from the ability of the citizens to obtain the necessities and conveniences of life. Even when tax is placed on the wealthier members of society, it ultimately is treated as an expense of production and is collected from the buyers of their goods. And over the long term, taxation degrades the productive capabilities of a nation by diverting the profit of productive activity to nonproductive and wasteful uses. Much of this has been considered at length some chapters previously.
As such, states regularly turn to another "juggling trick" to reduce their debts: debasing their currency, as a means to repay borrowed funds in the original amount agreed upon with money that has lesser value. A debt incurred on an amount of currency that originally held a value of four ounces of silver could then be repaid by new currency that holds a value of less than two.
The practice of debasement dates back to the Roman empire - Smith provides an account when, after the Punic wars, currency was suddenly reduced to a sixth of its previous value - and in Smith's own time was common in all the nations of Europe. What is not common, and in fact entirely unknown, was any instance in which a state ever sought to amend debasement and restore the value of its currency.
As with most swindles, this tends to be highly effective until the moment it is discovered: once the state has repaid one installment of debt with debased coin, it will find its creditors unwilling to renew outstanding debt without a significant increase in the rate of interest to compensate for the debasement of the currency, and thus begins a cycle in which interest rates constantly increase and the value of money constantly decreases.
What strikes Smith as curious is that this is often done without any public objection. Were a private bank or mint to suddenly declare that it would repay its outstanding debts with bills that were a fraction of the value of those they had borrowed, there would surely be a calamity upon all the creditors they had defrauded. When the same is done by the state, there is seldom any public outcry, which leads them to the conclusion that it is an effective and acceptable method of raising funds, and to be not at all discouraged in the practice.
Exploitation of Colonies to Repay Debt
For a state to become liberated from debt, it must necessarily discover a method for augmenting its revenue or decreasing its expense by a "very considerable" degree. This drives states to constantly seek to devise ways to constantly raise taxes, and constantly reduce public services. And it cam expect that a body of subjects, both burdened and neglected, will be sorely vexed. The solution to this quandary has generally been to place the burden of taxation on subjects in remote locations, such as colonies.
The primary problem of collecting taxes from colonies is the utter lack of precious metals. Colonial territories tend to be very wealthy in terms of resources other than minerals - consider the sugar-producing islands of the Caribbean, where there is great productivity and wealth by means of trade, but no domestic source of precious metal.
The Americans, meanwhile, have no gold or silver money and carry out their interior commerce by a form of paper currency. The European nations "already get all the gold and silver" produced in their colonies, so there isn't any to be had of them. And while the balance of trade is skewed in the favor of the mother country, what they receive are crude materials, not any form of money such is in use in Europe.
(EN: Smith stops short of pointing out the obvious - that burdening colonists with taxes while neglecting their need of services led to their rebellion against the crown, and instead suggests that taxation of colonies was "not contrary to justice" as the debt of Britain was, in some part, necessary to their establishment and cultivation. He further suggests it is just that England should be exploitive of Scotland and Ireland. But again, I expect this is propaganda to avoid prosecution for treason on the basis of what is clearly implied.)
However, Smith does conclude with the notion that fiscal responsibility is necessary to restore the wealth of Great Britain: the expansion of the British empire has been a costly endeavor, and one that has not resulted in the wealth of precious metals for which it was undertaken. In short, Britain should consider whether such endeavors have any prospect of becoming profitable - and in the case that it is not, it should be given up. If they are not the solution to the problem, they only worsen the situation, and the Europe should become more introspective in its consideration of a solution to the problem of its present circumstances.