Public debts as investments are very much the same problem whatever be the country from which they are issued. All over the world the income that is behind them, on which the soundness and value of the security ultimately depend, comes from the taxable capacity of the inhabitants of the area involved, whether the borrower be a Government or a State or a municipality. The only difference is that the difficulty of arriving at anything like an exact estimate of the extent of that taxable capacity—which we found to be considerable at hone—becomes much greater when we have to send our minds on a sea voyage, and try to imagine how the average Pole or Brazilian or Chinaman regards the question of the sanctity of financial contracts entered into by his Government or his municipality. The war showed us that a nation which is ready to pay taxes for a cause that it thinks to be worth the sacrifice can draw on its resources to an extent which would have been thought to be incredible until it was tried. But we are still in the dark as to whether any body of tax-payers would make sacrifices in order to preserve its country's solvency, to anything like the same extent as for securing victory in war; and it is upon the temper of the tax-payer that taxable capacity in the last resort depends. We are also profoundly ignorant about political conditions in other countries. There was a time when Mexican securities were thought to be first rate, of their class. But they depended on the maintenance of the dictatorship established by President Diaz. When he went the country fell back into anarchy and bankruptcy.
Though the basis of security be the same, however, a very important difference between home and foreign investments has been introduced by the war, and the ungentlemanly manner in which it was waged. Some of us are old enough to remember the confidence that used, in the remote Victorian age, to be felt by British investors in Russian Government securities because of a tradition which told them that all through the Crimean War British investors in Russian bonds punctually received the interest due to them. But in the late war the Governments fought with every possible weapon, and among them the financial one was perhaps the most important, after the naval and military. They not only did not pay their own debts to belligerents, but did not allow their citizens to do so; and under modern conditions they were evidently quite right. And so anyone who buys the securities of any foreign Government or public body does so with the certainty that if we should go to war with the debtor he would not pay us a shilling's worth of interest as long as the war lasted. The "war risk" attached to all foreign investments is thus a very real factor, as long as the possibility of war lasts; and it is obviously one which is extremely difficult to calculate.
This is the consideration which gives to investments in our own Dominions an advantage over those in all other countries, though the degree of war risk varies very greatly between one foreign country and another.
Apart from it, we have a feeling that the countries of our own race and language are likely to think and act more or less as we should in making sacrifices if necessary to defend their Government and public authorities against default. And the fact that they, nearly all of them, use currencies identical with ours, not only eliminates an element of possible difficulty in making payments, but makes it easier for the conscientious investor to study with intelligence any official statements that may be published concerning the financial position of the borrower.
Debts of some Dominion and Foreign Governments have one advantage over that of ours, in the shape of tangible assets, some of which produce a revenue and some even a revenue that more than suffices to meet the interest on the money spent on them. This is the retort that is always, and most rightly, hurled by the Australians at anyone who hints that Australia has borrowed rather rapidly in London. Nearly the whole of the British debt, as was shown above, represents money shot away in the course of wars, some of which have only happened because, as subsequent statesmen have told us, we "put our money on the wrong horse." Australia's debt is offset by the possession of a railway system, and national ownership of railways may be said to be the general rule, except in the United States, England and Argentina. So it happens by a curious paradox that the two countries whose credit stands highest have least to show as revenue producing assets to set off against their debts.
This fact seems to indicate that it is easy to attach too much importance to the possession of such assets, and it is clear that a creditor, who relied on them to come to his rescue if the general revenue of a country failed to supply his interest, might be uncomfortably disappointed, even if the railways or State forests or whatever the asset might be were definitely pledged to the service of the loan. State management of railways is often extravagant and bad, but even if the Government were willing to sell or lease its transport system to a body representing foreign creditors, and give it power to carry out reforms in order to produce a larger revenue, it would be extremely difficult to make such reforms effective.
The real advantage, from the point of view of the investor, of Government debts is the fact that behind them is the whole wealth of all the inhabitants of the country, in so far as the said inhabitants can be induced to part with it for public purposes; and the existence of particular assets and sources of revenue, even if definitely pledged and assigned to the service of debt, is a certain protection to the investor and makes a loan look safer, and may even sometimes make the borrower more careful in expenditure; but if the worst happens, Government has to be carried on, or thinks so, and the first charge on every item in every country's revenue, whatever arrangements may be made to the contrary, is ultimately the amount that, in its opinion, is essential to the conduct of the administration in accordance with its idea of the services which that administration ought to render to the inhabitants.
Whether Governments should raise debts at all is a question that might very easily be argued were it not that they have so long and so vigorously done so that the argument would be futile. They do so in order to carry on war, to finance public services such as transport systems, and to make good a gap between revenue and ordinary expenditure. In the bad old past, loans have been much too freely granted by the lending centres, especially London and Paris, to irresponsible Governments without sufficient inquiry as to how the money was to be spent, or even as to how much of it was ever going to reach the Treasury of the borrower, after all the cormorants on both sides of the water had been satisfied, who thought that they had claims to pickings out of the transaction. The consequence has been a series of defaults for which the citizens of the defaulting country have little real responsibility, and a very ugly blot on the history of International Finance, in its first century. Such things could hardly happen again, and in the present dearth of capital for investment there is no need to fear that weak borrowers will be allowed to have funds of which they are going to make bad use. But as the present dearth is not going to last for ever, it is well that issuing houses and investors should make up their minds about the principles on which money should be lent to Governments, and determine to stick to them.
Lending for war purposes is evidently not a matter to which any economic rules can be applied. One lends to one's own Government when it is at war, because one wants to do everything to help it to win; it chooses to get money from its citizens by loans, and so one subscribes if one can even though one may be convinced that less loans and more taxes would be a sounder and much cheaper way of financing war and that the notion that we can make posterity pay is a pure delusion, even if it were right or wise to do so.[1] If we lend to other Governments when they are at war, we do so because we want to help them to win, and at the same time believe that they will at any rate end the war not too much impoverished to meet the service of the debt. None of these sentiments are amenable to financial reasoning since they depend almost entirely on patriotism or political fancy.
Lending to foreign Governments for public purposes requires the most careful scrutiny. It is really only desirable when the public purpose is a railway or a harbour or an irrigation scheme which can be shown to be as certain as is humanly possible to bring in a revenue that will fully cover the service of any loan that is to be spent on it; and even then there is always the doubt whether the scheme would not be likely to be more successfully handled, from every point of view, by a judicious combination of local and foreign capital working under a concession that is fairly drawn and fairly administered in the interests of the concessionaires and of the community.
Moreover, the scheme must not only produce a revenue big enough to meet the service of the loan, it must also, by means of improved transport facilities or production of some article that is in demand abroad, increase the export trade of the borrowing country and so enable it to meet the "invisible import" of demands for interest and redemption. A foreign loan that merely enables the citizens of a country to take in one another's washing with greater ease and mutual profit will be a burden on its exchange each half year as remittances have to be made to New York and London to meet interest and sinking fund, and there is no increase in goods going abroad to be turned into dollars and pounds. It may be that schemes, such as road making, may be shown to be going to produce, indirectly, a great increase in revenue and in exports without actually themselves putting any money into the hands of the local Finance Minister, and it would be absurd to deny that these beneficent results might follow in some instances. Nevertheless, very exacting scepticism on such a point is certainly to be encouraged because foreign money is such an expensive luxury for a borrower and the ease with which it is sometimes raised is so great a temptation to slack and wasteful administrators that it is much safer to confine its use to public works in which it will pay for itself.
Foreign money is an expensive luxury to the borrower because its effect is essentially different from that of money borrowed at home. Domestic loans redistribute the income of the citizens, by transferring interest from the pockets of the tax-payers to those of the debt-holders, but do not reduce the income of the nation as a whole. They have awkward economic and social effects because the charge for them is to a great extent taken from industry and enterprise and handed over to debt-holders who may be mere idlers; but when taxation is soundly imposed and only falls on industry when it earns profits (as in the example of a well-administered income tax) the burden of a home debt, if it is not too big, is easily borne and the pages of our historians are full of prophecies of England's ruin made by distinguished statesmen and economists after great additions to her debt by wars, followed by the triumphant refusal of England to be anything but more prosperous than ever.[2] Foreign loans, on the other hand, pour a flood of money, that has not been earned in the country, into the pockets of its citizens as they are spent by the borrowing Government and so produce a short-lived spell of artificial and unwholesome prosperity, and then are followed by a half-yearly drain (unless, as often happens, the drain is met by "another dose of the same") which means that the inhabitants as a whole have to consume so much less, because a sufficient value in their goods has to be sent abroad and so provide the foreign currency in which the debt charge has to be met.
Borrowing to meet Budget deficits, caused because the Government has spent too much and taxed too little, is evidently unsound finance and especially so when loans are raised abroad. When it is done at home, occasionally and on a small scale, there is no great harm in it; and it may go on for years without damaging a country's credit, as was shown by France before the war. But if the Government of a foreign state borrows in London instead of making its citizens pay for the normal expenses of administration, the result is a serious check on the vigilance with which its expenditure is watched, and the natural tendency to official extravagance is encouraged, and in all subsequent years the check on home consumption and the adverse effect on the exchange that are involved by foreign debt are penalties for the extravagance.
It may be contended that all these considerations are the concern of the borrower rather than of the lender and that if the investor thinks that a foreign security is good enough to hold he need not bother his head about the purpose for which it was raised or the way in which the money was originally spent. Within limits this is true, but bad financial habits are so easy to contract and so hard to reform that when a country's foreign debt has been chiefly raised for purposes that have not helped to increase its revenue and its export trade, it is likely to find the service of it increasingly difficult to meet.
We find then that the real security behind a Government debt is an extremely elusive article. It cannot be a matter of real assets owned by the debtor because we have already seen that the United States and England, whose credit stands highest, have practically none; but then the United States owe nothing abroad and the British Government likewise, until during the war it borrowed abroad in order to finance its Allies; it is even now possible that out of Reparations and payments of interest and debt by Allies the British Government may be able to cover the service of its debt to America; and if nothing should be received from these sources, the net income from the foreign investments of British citizens is now estimated at £250 millions, or nearly eight times as great as the yearly sum required for the service of their Government's debt to the United States. It thus appears that countries which have no foreign debt, which is only another way of saying countries that have wealthy inhabitants, are those which enjoy the highest credit, which is a dismally platitudinous conclusion to reach, and not very helpful; because the wealth of a country is nearly as difficult a matter to estimate as the readiness of its citizens to pay taxes rather than allow its Government to default.
The mere fact, however, that a country has to borrow abroad may be taken as an indication of poverty for the time being, though it may be compatible with the possession of great potential resources. The latter condition has evidently been present in our Dominions and in countries such as Brazil, Argentina and Chile. It should be noted, however, that the United States, though still a borrowing country up to the time of the war, held all its own Government debt and only did its borrowing by issues of railroad and industrial bonds and stocks. Evidently the financial position of the Governments of our Dominions and of the foreign countries that are chronic borrowers abroad would have been much stronger if the funds necessary for development purposes had been raised by private enterprise, according to the American pattern.
The comparatively severe burden imposed on a country by a debt raised abroad has already been shown, and it is clear that the debts of those countries which are continually adding to this burden become increasingly unattractive to the prudent investor. For the time being repeated issues of external debt relieve the burden because the interest on the existing loans is paid not by a reduction of the consumption of the inhabitants but out of the pockets of investors in some other country who find the fresh money. But there comes a time when the process of meeting external interest charges by external borrowing has to stop, and then the full weight of the burden is suddenly laid on the shoulders of those who are really responsible for carrying it, and unless their wealth has in the meantime grown as rapidly as the debt, the process is very unpleasant. But this is unlikely, since otherwise why should additions to external debt have continued?
Nevertheless there have been examples of countries with a considerable external debt, which have been able, through the industry and thrift of their inhabitants, to bring the debt home and so relieve themselves of the burden of external debt charge. France borrowed heavily abroad to pay the German War Indemnity after 1871, but quickly took the debt home, and it is likely that we shall see Germany do the same with the loan issued for her in 1924. It will be remembered also that italy in the years before the war was able to take home most of the italian Rentes that were once freely dealt in in Paris and London, being enabled to do so largely by the wealth that was poured into her by her citizens who went abroad and worked and saved, especially in North and South America, and sent their savings to italy.
France's rapid recovery after 1871, and Italy's growing wealth, which improved the credit of both of them so rapidly, were thus accompanied and marked by a reduction of external Government debt, the absence of which has already been noted as a feature of the financial position of the wealthiest countries with the highest credit. And it thus seems safe to conclude that one test of the soundness of overseas debts, as investments, is the pace at which the debtors have been increasing external liabilities America's example has shown that it is possible for a country to expand its resources and development with amazing speed and with the help of foreign capital, without any necessity for its Government to issue loans abroad, and for a country to be using this form of financing its development is clearly an indication of financial weakness—one might almost say moral weakness, were not the word so overworked.
Exception has evidently to be made in the case of dependent countries with an alien administration and a backward population, such as India and the Dutch East Indies. With them there is clearly much more reason for development by means of Government debts, but for' self-governing countries with a number of rich inhabitants, continuous borrowing abroad is a symptom that needs explanation.
Those then who are considering an investment in any oversea public debt have to decide or make guesses about:—
1. The risk of war with the debtor, because in war there is no interest and the security is probably unsaleable.
2. The extent of the debtor's external debt and the rapidity of its growth as compared with
(a) its wealth,
(b) its trade balance,
and, since (a) and (b) are largely a matter of estimate.
(c) its internal debt, and
(d) its total expenditure.
3. The proportion that its total debt charge bears to its total expenditure.
4. Its habits with regard to balancing its budget.
5. The stability of its currency.
The risk of war is evidently guesswork, and so also to an extent that will surprise any conscientious investor who tries also to be an investigator, are the facts, or what ought to be the facts, included under 2 and 3. Even the matter of the amount and growth of the external debt is by no means always made clear from official statements, because at times when monetary conditions are unfavourable to a new loan in the open market it is possible that temporary credits may be arranged in a foreign centre and included under some heading such as floating debt, which does not give the information needed.
Whether any country balances its Budget—or rather, in most cases, the extent to which it fails to do so—is a matter that is as difficult to guess as we shall find it on later pages difficult to know what is the real profit or loss that an industrial company has made. We believe in England that our Government balances its Budget and we hope that we are right because a sum of £45 to £50 millions, yearly devoted to debt redemption, gives us a handsome margin on which to come and go. But if we tried to be exact, how much do we know about the arrears of taxation carried over each year? The sum of these arrears must be enormous, and variations in it might make a substantial difference to a year's accounts.
On the subject of 4 there is a definite record that tells one the actual facts about the exchange value of a country's currency not furnished by its official documents but by the dealings in it on the exchange markets of the world. We can really find out exactly what the rupee or the franc or the milreis has been worth in sterling yesterday or a year ago or ten or fifty years ago. And these facts are sometimes really some guide as to what the probable value of any country's currency may be in a year's time; though the extent to which shrewd people may be misled about exchange movements was shown by the readiness with which they went on buying German marks until the value of the mark went out of sight.
In the midst of this mirage of doubts and possibilities those who invest in oversea Government debts work largely on impression and instinct, a hazy knowledge of the financial past of the debtor and the summary of the shrewd judgment of the Stock Exchange which is supplied to them by their brokers. They think and feel and find that Capel Court agrees that "Argentina (or whatever the country may be) is all right" and there you are. In this example there is at least a record to work on, but how can anyone make a guess concerning the probable performance of the frisky European three-year-olds who have lately made their appearance? Of them, however, it can at least be said that they were introduced at a time of great difficulty and under august auspices. The need for care was so evident that we may be certain that as much as possible was exercised by the issuing houses which fathered them. Probably investors follow a trusting faith in the issuing house and perhaps after all this is the safest guide with foreign issues, for those who really know the records of the issuing houses. Still I must confess a preference for a mature vintage not only in foreign debt but in industrials. A debtor who has paid and a company that has earned for half a century or even for twenty years, and has stood the shock of 1907 and the cataclysms of 1914 and 1921 has an aroma, like a bottle that is whiskered with honourable cobwebs.
When we come to the detailed points to be desired in any particular form of oversea public debt that we may be considering they will evidently be the same as those mentioned in discussing Home Public Debts, with one important addition. We shall want either a definite date of repayment or regular redemption by drawings or purchase, so that so much of the loan is definitely cancelled every year, or else possibly, in the case of a highly favoured borrower, a perpetual debt. What we do not want is a loan which carries an option in favour of the debtor, so that it may be repaid, after a certain date, if and when it suits his convenience, which it will only do at a time when it will be inconvenient to the investor to be repaid.
Besides these obvious requirements we shall want the interest, drawn bonds and bonds due on maturity to be paid in sterling money or else in American dollars, or some currency in the stability of which we have the most complete confidence. It may be asked why, if this proviso is to be insisted on, the stability of the debtor's currency was, a few pages ago, put down as a matter to be investigated—why does it concern the investor if he is to be paid in sterling or dollars? Because if the currency is unstable in which most of the debtor's revenue is collected, the debtor Government will evidently have more difficulty in providing the dollars or pounds in which the debt charge has to be paid; and in so far as its revenue is collected "in gold," the tax-payer will have the more difficulty in paying it. When the Brazilian milreis fell from 1s. 4d. to 5d. in exchange value, the Brazilian tax-payer had to produce more than three times as much in local currency in order to put down pounds in London for the service of the English loans, which thus involved a greater effort on the part of the debtor country and impaired the creditor's security without increasing his income.
In fact the danger that is run by those who lend to foreign debtors who are cursed with an unstable currency is so great that ingenious efforts are made by issuing houses to secure, as a collateral pledge, some asset which is sure of a market abroad and so is equivalent to so much foreign currency. This device has been successfully carried out in the case of loans to the State of San Paulo and to the Brazilian Government secured on holdings of coffee which had been taken over from the growers in order to prevent its price being wrecked by sales at a time when the market was gorged. The coffee was gradually sold as consumption overtook supply and the proceeds were used to meet interest and redeem the loans. But the circumstances under which any foreign debtor is in a position to pledge such a "sterling asset" are evidently rare, and a system by which Governments undertake such wholesale purchases of commodities is not one to be encouraged, even though it provides a convenient form of collateral, if the operation is well and successfully thought out and concluded.
As to other forms of liens and pledges, such as special assignations of the Customs duties, or the profit of a tobacco monopoly or the revenues of railways, the limitations on their value have already been noted. But they are a popular feature with the Stock Exchange and with the investing public which it educates, especially when the assigned revenues are periodically paid over to the agents of the bankers to the loan; and loans so fortified are likely to be more tenderly treated by a Finance Minister than those which have no special security attached. The mere fact of their being given, however, is a symptom of financial weakness.
In some cases, when the borrower is a weak or backward Government, they are a very real advantage. The Chinese loans secured on the Maritime Customs duties paid at the treaty ports and handled only by the foreign officials of the Customs Board are certainly made safer by the fact that the funds needed for their service are collected on the seashore and do no go inland at all. But such an arrangement as this is obviously exceptional.
State debts—that is to say the debts of the provinces that make up the Federated nations, such as the German Empire, Argentina, Brazil, etc.—should be tasted by the investor with a very long spoon indeed. The German States in pre-war days enjoyed, and with good reason, first-rate credit, which was only smashed by the cataclysm inflicted on them by the madness of the Imperial Government assisted by that of its neighbours; but when a State's credit is not first-rate—and if it is it seldom needs to borrow abroad—it is likely to be a dangerous debtor because of its limited powers of taxation. The Australian States, of course, having been in existence before the Federation, are in a class by themselves.
Municipal debts abroad and such issues as the Port and Harbour Trust securities produced by India and the Dominions often have a more solid appearance than the debts of the Central Governments, because less subject to the shifting gusts of politics and free from the economic waste of expenditure on armaments which eats into the financial strength of all Central Treasuries. It is easy to persuade oneself that whatever may happen to the Government of a country its principal cities must go on and its great ports must be thronged with ships, which will pay harbour dues.
I still lie awake o' nights sometimes because many years ago a City of Moscow loan came out and friends of mine who had a little money to invest asked me what I thought of it and I answered very much in the terms of the above paragraph. Experience has now taught us that, if a central Government falls altogether to pieces and is succeeded by one that repudiates its obligations, or even if (as in the German example) a central Government divides the value of the currency by a sufficient number of millions, the most attractive-looking municipal loan will be found to have no health in it. Nevertheless, their finances being on a smaller scale and covering a smaller area, can be more closely watched by the citizens who suffer if they are ill administered; on the other hand, municipal extravagance is often a source of profit to local contractors and land jobbers and where politics are corrupt, the street corner corruption of local politics is likely to be especially corrosive and disgusting. And the judicious investor, before he handles such securities on his own judgment, ought to know a good deal more than he is likely to find out about the system of taxation from which foreign or even colonial municipalities collect their revenues, and whether it suffers from the defects which we found in the rating system in England.
But, as has already been hinted, perhaps the really judicious investor in Foreign Public Debts is he who makes no attempt to investigate all the incalculable and elusive details that make up a sound security of this class, but relies on his faith in the issuing house, which is much more easily able to arrive at something like truth on the subject. But how many private investors know much about the facts which ought to guide them to confidence in an issuing house?
And perhaps, after all, the chronic inability of weak Governments to make both ends meet is the soundest reason for expecting that they will meet their debt obligations, if they possibly can. They know that they are always wanting to borrow, and that they cannot borrow unless they pay.
- ↑ See Our Money and the State, by H. Withers, Chapter II.
- ↑ Macaulay, History of England, Chapter XIX.