Book V, Chapter III, 1

ON PUBLIC DEBTS.

In the rough state of society before commerce spreads and manufactures develop, when the costly luxuries that only commerce and manufactures can introduce are wholly unknown, a person with a large revenue can, as I have tried to show in the third book of this Inquiry, spend or enjoy it only by supporting nearly as many people as it can support. A large revenue may always be described as command over a large quantity of the necessities of life. In that rough state, it is commonly paid in a large quantity of those necessities: the materials of simple food and coarse clothing, grain and cattle, wool and raw hides. When neither commerce nor manufactures offer the owner anything for which to exchange most of what remains after his own consumption, he can do nothing with the surplus but feed and clothe nearly as many people as it will feed and clothe. Hospitality without luxury, and generosity without ostentation, are then the chief expenses of the rich and powerful. But these, as I have also tried to show in the same book, are expenses by which people are seldom ruined. There is perhaps no selfish pleasure so frivolous that pursuing it has not sometimes ruined even sensible men. A passion for cockfighting has ruined many. Yet instances of people ruined by hospitality or generosity of this kind are, I believe, uncommon, though luxurious hospitality and ostentatious generosity have ruined many. The long periods for which estates remained in the same families among our feudal ancestors sufficiently demonstrate a general tendency to live within one's income. The rustic hospitality constantly practiced by great landowners may now seem inconsistent with the order we tend to regard as inseparable from sound management; yet we must surely grant that they were frugal enough not ordinarily to spend their entire income. They generally had an opportunity to sell some of their wool and raw hides for money. Perhaps they spent some of that money on the few objects of vanity and luxury available in their age; but it seems they commonly hoarded some of it. Indeed, there was little else they could do with whatever money they saved. Trade was disgraceful for a gentleman, and lending money at interest, then regarded as usury and prohibited by law, would have been more disgraceful still. In those violent and disorderly times, moreover, a reserve of money was useful: if driven from home, they could carry something of recognized value to safety. The same violence that made hoarding useful made concealment equally useful. The frequency of treasure-trove—treasure discovered with no known owner—sufficiently shows how often people both hoarded and concealed their hoards. Treasure-trove was then considered an important source of sovereign revenue. Today, perhaps, all the treasure-trove in the kingdom would scarcely be a significant source of income for a private gentleman with a good estate.

The same tendency to save and hoard prevailed in sovereigns as in their subjects. Among nations little acquainted with commerce and manufacturing, the sovereign, as observed already in the Fourth book, is placed in circumstances naturally inclining him to the frugality required for accumulation. In such circumstances even a sovereign's expenses cannot be governed by a vanity that delights in the gaudy finery of a court. The ignorance of the age provides few of the trinkets of which that finery consists. Standing armies are not yet necessary; thus even a sovereign, like any other great lord, can spend scarcely anything except on generosity to his tenants and hospitality to his retainers. Generosity and hospitality seldom lead to extravagance, whereas vanity almost always does. Accordingly, as already observed, all the ancient sovereigns of Europe possessed treasures. Every Tartar chief today is said to possess one.

In a commercial country rich in every kind of expensive luxury, the sovereign, like nearly all the great landowners in his dominions, naturally spends much of his revenue purchasing those luxuries. His own country and its neighbors supply him abundantly with all the costly trinkets that make up a court's splendid but insignificant pageantry. To sustain a lesser pageantry of the same sort, his nobles dismiss their retainers, make their tenants independent, and gradually become as insignificant themselves as most wealthy townsmen in his dominions. The frivolous passions governing their conduct govern his as well. Why suppose him the only rich man in his dominions untouched by such pleasures? Even if he does not do what he very likely will—spend so much of his revenue on them that he seriously weakens the state's defenses—we can hardly expect him not to spend on them everything beyond what those defenses require. His ordinary expenses come to equal his ordinary revenue, and he is fortunate if they do not frequently exceed it. He can no longer be expected to amass treasure; when extraordinary needs demand extraordinary expenditure, he must call upon his subjects for extraordinary assistance. The present and the late king of Prussia are the only great European princes supposed to have amassed any substantial treasure since the death of Henry IV. of France, in 1610. The frugality that leads to accumulation has become almost as rare in republics as in monarchies. The Italian republics and the United Provinces of the Netherlands are all in debt. The canton of Berne is the only European republic to have amassed any substantial treasure; the other Swiss republics have not. A taste for some kind of pageantry—splendid buildings, at least, and other public adornments—often prevails as strongly in the seemingly sober senate house of a small republic as in the extravagant court of the greatest king.

Failure to save in peacetime makes borrowing necessary in wartime. When war arrives, the treasury holds no more money than is needed for the ordinary expenses of the peacetime establishment. War requires an establishment costing three or four times as much to defend the state, and consequently a revenue three or four times the peacetime revenue. Even supposing the sovereign possessed, as he almost never does, the immediate means to raise his revenue in proportion to his expenses, the proceeds of the taxes that must supply the increase would not begin to enter the treasury until perhaps ten or twelve months after their imposition. Yet the moment war begins—or rather, the moment it seems likely to begin—the army must be enlarged, the fleet fitted out, and garrisoned towns prepared for defense; army, fleet, and garrisons must all be supplied with arms, ammunition, and provisions. Great expense must be incurred immediately in the face of immediate danger; it cannot await the slow, gradual receipts from new taxes. In this emergency the government has no recourse but to borrow.

The same commercial condition of society that, through moral causes, thus compels a government to borrow gives its subjects both the ability and the inclination to lend. If it commonly brings the need to borrow, it also brings the means of doing so readily.

A country rich in merchants and manufacturers must also have many people through whose hands pass not only their own capitals but those of everyone who lends them money or entrusts them with goods. These sums pass through their hands as often as, or more often than, the income of a private man living on his income without trade or business passes through his. Such a man's income can ordinarily pass through his hands only once a year. But the whole capital and credit of a merchant engaged in a trade with very rapid returns may sometimes pass through his hands two, three, or four times a year. A country rich in merchants and manufacturers thus necessarily has many people able, whenever they choose, to advance a very large sum to the government. Hence the ability of subjects in a commercial state to lend.

Commerce and manufacturing can seldom flourish long in a state without a regular administration of justice, where people feel insecure in their property, where contracts are not upheld by law, and where the state's authority cannot be counted on to compel those able to pay their debts to do so. In short, they can seldom flourish without some confidence in the justice of government. The same confidence that ordinarily leads great merchants and manufacturers to entrust their property to a particular government's protection leads them, on extraordinary occasions, to entrust it with the use of that property. By lending to the government, they do not diminish their ability to carry on trade and manufacturing even momentarily; they commonly increase it. The needs of the state generally make the government willing to borrow on terms extremely advantageous to the lender. The security it gives the original creditor can be transferred to another creditor and, because confidence in the state's justice is widespread, generally sells in the market for more than its original price. The merchant or moneyed man profits by lending to the government and increases rather than diminishes his trading capital. He therefore generally considers it a favor when the administration admits him to the first subscription for a new loan. Hence the inclination of subjects in a commercial state to lend.

The government of such a state is very likely to rely on its subjects' ability and willingness to lend on extraordinary occasions. Foreseeing how easily it can borrow, it excuses itself from the duty of saving.

In a rough state of society there are no large commercial or manufacturing capitals. Those who hoard whatever money they can save, and conceal their hoards, do so because they distrust the government's justice: they fear that, if their hoard and its location became known, they would soon be robbed. In such circumstances few could lend money to the government in an emergency, and nobody would willingly do so. The sovereign understands that he must save to meet such emergencies, for he foresees that borrowing will be impossible. This foresight further strengthens his natural inclination to save.

The enormous debts now weighing upon, and probably destined in the long run to ruin, all the great nations of Europe have followed a fairly uniform course. Nations, like individuals, have generally begun by borrowing on what might be called personal credit, without assigning or mortgaging a particular fund to pay the debt; when that resource failed, they proceeded to borrow against assignments or mortgages of particular funds.

What is called Great Britain's unfunded debt is contracted in the first of these ways. It consists partly of debt bearing, or assumed to bear, no interest, resembling a private person's debts incurred on account; and partly of interest-bearing debt resembling what a private person contracts on a bill or promissory note. Debts due for extraordinary services, or for services either not provided for or not paid for when performed—part of the extraordinary expenses of the army, navy, and ordnance, unpaid subsidies to foreign princes, unpaid seamen's wages, etc.—usually constitute the first kind. Navy and exchequer bills, issued sometimes to pay part of such debts and sometimes for other purposes, constitute the second kind: exchequer bills bear interest from their issue date, and navy bills from six months after their issue. The bank of England sustains the value and facilitates the circulation of these bills either by voluntarily discounting them at their current value or by agreeing, for certain considerations, to circulate exchequer bills on behalf of the government—that is, to accept them at face value and pay the interest due on them. It thereby often enables the government to contract a very large debt of this kind. In France, where there is no bank, state bills (billets d'etat [See Examen des Reflections Politiques sur les Finances.]) have sometimes sold at a sixty and seventy per cent. discount. During the great recoinage in king William's time, when the bank of England chose to suspend its usual transactions, exchequer bills and tallies are said to have sold at discounts of twenty-five to sixty per cent. This was due partly, no doubt, to doubts about the stability of the new government established by the Revolution, but partly also to the lack of support from the bank of England.

When this resource is exhausted and money can be raised only by assigning or mortgaging a particular part of public revenue to pay the debt, governments have done so in two ways. Sometimes the assignment or mortgage has lasted only a short time—a year or a few years, for example—and sometimes forever. In the first case, the fund was thought sufficient to repay both principal and interest within the specified term. In the second, it was thought sufficient to pay only the interest, or a perpetual annuity equal to the interest, while the government remained free to redeem the annuity at any time by repaying the principal borrowed. Money raised by the first means was said to be raised by anticipation; by the second, by perpetual funding, or simply funding.

On Public Debts.

Before commerce spreads and manufacturing improves, people do not know the costly luxuries those activities bring. As I tried to show in the third book of this Inquiry, someone with a large revenue then has almost no way to spend it except to support as many people as it can support. A large revenue always means having access to a large amount of life's necessities. In that early condition, people usually receive their revenue in necessities: basic food and rough clothing, grain and cattle, wool and raw hides. Without commerce or manufacturing, an owner cannot exchange most of what remains after personal consumption for anything else. The only thing to do with the surplus is feed and clothe as many people as it can support. Hospitality without luxury and generosity without display are the main expenses of the rich and powerful in these circumstances. But, as I also tried to show in that book, these are not expenses that often ruin people. Almost any trivial selfish pleasure has sometimes ruined even sensible people. Cockfighting has ruined many. Yet I believe few have been ruined by this kind of hospitality or generosity, although luxury in hospitality and generosity practiced for show have ruined many. Estates stayed in the same families for a long time among our feudal ancestors. That is strong evidence that people generally lived within their means. The constant, country-style hospitality of great landowners may not seem compatible with what we now think of as orderly financial management. Still, we must grant that they were thrifty enough not usually to spend their whole income. They could generally sell some wool and raw hides for money. They may have spent part of that money on the few luxuries and status goods available at the time, but they appear generally to have saved part of it. In fact, they had little choice but to store whatever money they saved. Trade was considered beneath a gentleman, while lending at interest was considered usury, forbidden by law, and even more disgraceful. In those violent and disorderly times, it was also useful to keep money ready. If driven from home, they could carry something of recognized value to safety. The violence that made saving useful also made it useful to hide their savings. Treasure-trove—treasure found without a known owner—was common enough to show that both saving and hiding money were common. The sovereign then regarded treasure-trove as an important source of revenue. Today all the treasure-trove in the kingdom would perhaps barely count as significant revenue for a private gentleman with a substantial estate.

The sovereign shared the subjects' tendency to save and accumulate money. As already noted in the Fourth book, a ruler of a nation unfamiliar with commerce and manufacturing is naturally placed in circumstances that favor the restraint needed to accumulate wealth. Even a ruler cannot then spend money on the vanity of an ornate court: the period offers few of the decorative goods that make one possible. Standing armies are not yet needed. The ruler, like another great lord, can spend almost nothing except on generosity toward tenants and hospitality toward retainers. Such generosity and hospitality seldom lead to extravagance, though vanity almost always does. Accordingly, as already noted, all Europe's ancient sovereigns kept treasures. Every Tartar chief today is said to keep one.

In a commercial country full of costly luxuries, the ruler, like nearly every large property owner in the country, naturally spends much of his revenue buying them. His own country and nearby countries supply the costly ornaments that create a dazzling but empty court spectacle. For a smaller spectacle of the same sort, nobles dismiss their retainers, allow their tenants to become independent, and gradually become as unimportant as most wealthy town merchants. The same shallow desires affect the ruler. Why assume that he alone among his country's wealthy people feels no attraction to such pleasures? He may well spend so much on them that he seriously weakens the state's defenses. Even if he does not, we can hardly expect him not to spend everything left after paying for those defenses. His usual spending comes to equal his usual revenue, if it does not often exceed it. He can no longer be expected to accumulate treasure. When exceptional needs bring exceptional costs, he must call on his subjects for extra help. Since Henry IV. of France died in 1610, only the present and previous kings of Prussia, among Europe's major princes, are believed to have accumulated much treasure. The thrift that makes accumulation possible has become almost as rare in republics as in monarchies. The Italian republics and the United Provinces of the Netherlands are all in debt. The canton of Berne is the only European republic that has accumulated a substantial treasure. The other Swiss republics have not. A taste for impressive displays, at least for fine buildings and other public decorations, often prevails in the apparently sober senate of a small republic as much as in the pleasure-loving court of the greatest king.

Failing to save during peace makes borrowing necessary during war. When war arrives, the treasury holds no more than is needed for normal peacetime spending. Defense in wartime requires spending three or four times as much, and therefore revenue three or four times the peacetime level. Suppose the ruler had the means to increase revenue at once to match spending, which he almost never does. The proceeds of the new taxes might still take ten or twelve months to reach the treasury. Yet as soon as war begins—or even appears likely—the army must grow, the fleet must be fitted out, and fortified towns must be prepared for defense. They all need weapons, ammunition, and provisions. Danger demands a large payment immediately; it cannot wait for the slow arrival of new tax receipts. Government has no choice then but to borrow.

Commercial society creates this need for government borrowing through its effect on behavior. It also gives subjects both the means and the desire to lend. Along with the need to borrow comes the ease of borrowing.

A country with many merchants and manufacturers has many people who regularly handle not just their own capital but also the capital of people who lend to them or supply them with goods on credit. This money can pass through their hands as often as, or more often than, a private person's income passes through the hands of someone living on that income without doing business. Such a person's income normally passes through their hands only once a year. But a merchant in a business with quick returns may handle the whole amount of their capital and credit two, three, or four times a year. Thus a country rich in merchants and manufacturers has many people who can, if they choose, advance a very large sum to the government at any time. This is why subjects of a commercial state are able to lend.

Commerce and manufacturing rarely thrive for long without reliable justice, secure property, legal protection for contracts, and a government expected to enforce payment by people able to pay their debts. In short, they require some confidence that the government will act justly. The confidence that makes major merchants and manufacturers entrust their property to a particular government in ordinary times also makes them willing to let it use their property in extraordinary times. Lending to the government does not even briefly reduce their ability to conduct business; it usually increases it. The state's needs generally lead the government to borrow on very favorable terms for the lender. The claim it gives the original lender can be transferred to another creditor and, because people generally trust the state's integrity, can usually be sold for more than the lender paid. Merchants or people with money thus profit from lending to the government, increasing rather than reducing their business capital. They commonly see it as a favor to be included among the first subscribers to a new loan. This explains the willingness of subjects in a commercial state to lend.

Such a government is likely to rely on its subjects' ability and willingness to lend when unusual needs arise. Knowing it can borrow easily, it excuses itself from saving.

In an early society, there are no large merchant or manufacturing capitals. Individuals save and hide whatever money they can because they do not trust the government's justice. They fear that if anyone learned about the money and where it was hidden, they would soon be robbed. Few could lend money to the government in an emergency, and nobody would want to. The ruler knows borrowing is impossible and must save for emergencies. This knowledge strengthens the ruler's natural tendency to save.

The enormous debts now weighing down Europe's great nations, and probably destined eventually to ruin them, have developed in much the same way. Like private individuals, nations first borrow on what might be called personal credit, pledging no particular source of revenue to pay the debt. When that no longer works, they borrow against specifically assigned or mortgaged revenue.

Great Britain's so-called unfunded debt is incurred in the first way. Part of it bears no interest, or is supposed to bear none, like a private person's running account. The rest bears interest, like a private person's bill or promissory note. Debts for extraordinary services, or for services not budgeted or paid for when performed, usually make up the first kind. They include some exceptional army, navy, and ordnance expenses, overdue subsidies to foreign princes, unpaid sailors' wages, etc. Navy bills and exchequer bills, issued partly to pay such debts and partly for other purposes, make up the second kind. Exchequer bills earn interest from their issue date; navy bills begin earning it six months after issue. The bank of England supports the value and circulation of these bills in two ways. It may voluntarily discount them at their current value, or it may agree with the government, in exchange for certain benefits, to circulate exchequer bills by accepting them at face value and paying any interest due. This often lets the government incur a very large debt of this type. In France, which has no bank, state bills (billets d’etat [See Examen des Reflections Politiques sur les Finances.]) have sometimes sold at discounts of sixty and seventy per cent. During the major recoinage under king William, the bank of England stopped its normal transactions. Exchequer bills and tallies then reportedly sold at discounts ranging from twenty-five to sixty per cent. That was partly, no doubt, because people doubted the stability of the new government established by the Revolution, but also partly because the bank of England no longer supported them.

Once this way of borrowing runs out, the government must assign or mortgage a particular part of public revenue to raise money and repay the debt. It has done so in two ways at different times. It might pledge that revenue for a short period, such as a year or several years, or pledge it forever. In the first case, the revenue was expected to pay both principal and interest within the stated period. In the second, it was expected to pay only interest, or an equivalent yearly payment forever. The government remained free to end that yearly payment at any time by repaying the original principal. The first way of raising money was called anticipation. The second was called perpetual funding, or simply funding.