Temporary but unforeseen deficits may prop erly be met by the issue of short-term obliga tions in anticipation of the next tax levy. It may be impossible or undesirable to disturb existing tax rates, and, unless there is a surplus on hand, it is preferable to borrow than to permit a floating indebtedness to be created. Such loans, however, are for short periods and for relatively small amounts.
Much more important is the second group, that designed to care for serious emergencies such as war. In such a case the government cannot wait for the slow increase in revenues increased ncreased taxation; it must have the money at once. The only alternative method of guarding against such a contingency is the so-called guarding policy* of Prussia, ac cording to which that kingdom amassed a quantity of precious metals amounting to $60,000,000 and securities for use in case of war. How inadequate such a resource is be comes evident when it is. noted that this sum was spent in the first three or four months of the Great War. Only by the use of public credit, perhaps to the breaking point, is it pos sible for modern nations to meet the cost of war.
The third occasion for public borrowing arises when a government wishes to undertake a scheme of public investment, such as the build ing or purchase of a railway, a waterworks sys tem, an electric-light plant, etc. If the business is a commercial one it will itself provide the means of repayment, and it is, therefore, un necessary as well as undesirable to saddle it upon the taxpayers. Moreover, from an en gineering point of view, it is desirable to have the whole amount of capital necessary for the enterprise on hand at the start, so that no de lays may occur. Debts for this purpose should not, if the business is well conducted, impose any additional burden upon the taxpayers.
There is no magic in government borrow ing; it means simply a postponement of the unpleasant necessity of paying one's debts to the next generation. One of the first and most obvious effects of public borrowing is an in crease in the tax rate, for the interest must be paid even if the principal is not. If the sums borrowed by the government have been large this lessens the amount of capital available for private industry and consequently raises the rate of interest. Various social and political
effects may also be noted, such as the creation of a district bond-owning class, as in France, or the lessened control of our legislatures over the disposal of public funds when existing debts absorb large amounts of revenue.
The technique of public borrowing will be discussed in another place. (See article Drzrs, PUBLIC). It is sufficient to point out at this time that in selling bonds the Minister of Finance must in general appeal to the same motives as the ordinary seller of commercial paper, ex cept that in times of emergency like war the patriotism of the people may lead them to accept somewhat worse terms than they ordi narily would. In fact loans are classified by numerous writers into the three classes of forced loans (such as the issue of irredeemable paper money), patriotic, and voluntary loans, but the last two can really be considered to gether, as they are both contractual rather than forced.
It frequently happens that when the emer gency which forced the government to borrow possibly at very high rates is past, the rate of interest falls. Then, if the government has the right of repayment of the principal, it can avail itself of this opportunity to sell new bonds at a lower rate of interest and to pay off the holders of the old bonds with the proceeds. This is called conversion or refunding. By this process, without any extinction of the prin cipal, the burden of the interest charge on a given amount of debt was steadily reduced for the nations of Europe during the 19th century.
But while conversion may reduce the inter est charge it leaves the principal untouched, and states, like individuals, are faced at last with the unpleasant problem of debt payment. As yet it must be said that this problem has not been squarely faced by modern govern ments. Except for the United States and to a lesser degree Great Britain, almost none of the civilized nations has attempted to pay off its national debt. And yet a sound financial policy requires that this be done as rapidly as is con sistent with the economic development of a country.