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127



National Monetary Commission

the market value. Thus the note circulation of the country
was made to depend largely on the amount of the national debt.
After the Spanish war, instead of providing a new basis for note
circulation the Government extended a large part of the ma-
turing debt for thirty years. In 1900 by an act of Congress
the 3, 4, and 5 per cent loans were converted into 2 per cent
bonds at par, to run thirty years. Up to this time, says Mr.
White, "it had always been the policy of the Government to
pay its interest-bearing debts as soon as possible in order to
avoid unnecessary burdens upon the taxpayers. Thus the 5-20
bonds issued during the war were made redeemable at any time
after five years, but payable at the end of twenty years. Under
this system the Treasury could use its surplus revenues to pay
bonds at par instead of buying them in the market at a premium.
* * * Now nearly $550,000,000 of the public debt was put
beyond the chance of extinction for nearly a quarter of a cen-
tury, except by purchase in the open market. The Government
paid a bonus of nearly $50,000,000 on the old bonds, of which
it recovered less than $2,000,000 as premium on the new ones."*^

Mr. White adds that the loss was enormous. For example, a
surplus of $240,000,000 in 1907 might (but for the refunding)
have been applied to the extinction of debt, and thus annulled
the interest on that amount. "The excuse for this kind of
financiering was that if the Government's interest-bearing debt
were paid, there would be a shortage of bonds to be held as
security for national-bank notes."

A law of 1902 provided for the issue of $130,000,000 2 per
cent bonds, interest payable quarterly in gold, the bonds re-
deemable in 1 91 6 and payable in 1936 in gold. These were for
the Panama Canal expenditure, and a first issue in 1906 of
$30,000,000 took place.

o White: Money and Banking, p. 405.



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The panic in the autumn of 1907, followed by a general bank
suspension for two months, demonstrated the dangers of an
inelastic and artificial currency. During the course of the
panic the Treasury, on November 17 offered to issue $50,000,000
of Panama Canal bonds and $100,000,000 of one-year certificates
of indebtedness. This, of course, involved borrowing money
from a market which already could not meet the demands upon
it. The idea was that the offer of 3 per cent interest would
attract hoarded money and that the increase of 2 per cent bonds
would increase the amount of national bank notes. Doubt was
thrown on the legality of the issue of certificates, and the banks
feared to deplete their reserves still further by buying bonds.

To meet this it was arranged that 75 per cent of the certificate
subscriptions and 90 per cent of those for the Panama bonds
should remain in the vaults of the subscribing banks. On this
inducement $25,000,000 of bonds and $30,000,000 of certificates
were sold. Bankers generally held that the Government's
intervention had been the reverse of helpful.

The interest-bearing debt of the United States in 1908 was
thus divided:

At 4 per cent $118, 490, 000

At 3 per cent 78, 132, 000

At 2 per cent 700, 882, 000

Total 897, 504, 000

The variations in the funded debt since 1870 have been as

follows :



1870.
1875-
1880-

i88s-
1890.
1895-
1900.
1907.



Funded debt.



%2, 046, 000, 000
I , 722, 000, 000

I, 724, 000, 000

1 , 196, 000, 000

725, 000, 000

716, 000, 000

I , 023, 000. 000

89s. 000, 000



Interest.



S119, 000, 000
97, 000, 000
80. 000. 000
47, 000, 000
29. 000, 000
29, 000, 000
3i. 000, 000
22, 000,000



129



National Monetary Commission

In 1889 the yield of the 4 per cent bonds was 3.13, it then
rose till it was 3.58 in 1893, and between 1892 and 1895 was
occasionally higher than the German and Dutch 4 per cent.
From 1896 the 4 per cent 1925 bonds fell constantly until the
yield in 1901 was 2.90 and American paper was the highest
valued in the world. The yield has risen since then, and has been
generally about equal to French rentes and higher than consols.
In 1907 it was 3.17 — the lowest yield of Government stock next
to consols.

The following table gives details of the fluctuations:

1891-1894 4 PER CENT 1907 BONDS.



1891.
1892.
1893-
1894-



Highest.



122

US
116



116

114
108
112K



Average.



118. 76
116. II
112.27
11451



Real
Yield.



3.38
3.46
3.58
3SI



1895-1907 4 PER CENT 1925 BONDS.




In 1862, 1864, and 1878 the Government issued in all some
$64,000,000 of 6 per cent bonds on behalf of the Pacific railways,
but these were redeemed by 1900 and most of these railway
loans have been paid back to the United States Government by
the railways.

An article in the London Economist (November 13, 1909)
explains the existing situation. The value of the 2 per cent



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United States bonds is artificially high, because the national
banks have to hold them. They are always higher than 3 per
cent rentes or 2^2 per cent consols, sometimes even than 3 and
4 per cent United States bonds. They act (i) as the basis for
the note circulation, (2) as a guaranty for the government
deposits in the national banks, (3) as a means of raising money
for federal needs. As a result of the act of 1900 many state
banks took the opportunity of becoming national banks, of
receiving bond-secured government deposits and issuing bond-
secured notes. In eight years the capital of the national banks
rose by 50 per cent and their circulation by 100 per cent.



Circulation.



2 per cent bonds
held by banks.



1900
1902
1904
1906
1908



5331,693.000
380, 476, 000
457, 281, 000
S83, 172,000
665, 845, 000



5270, 007, 000
320, 738, 000
416, 973, 000
S06, 653, 000
593. 259,000



103
109
105
104
104



The reduction of interest from 4 to 2 per cent drew the
securities out of the hands of the public, and a reduction of
one-half per cent in taxation made it cheaper for the banks to
hold 2 per cent than 4 per cent bonds. In November, 1909, the
2 percents for the first time fell below par. The prospect of
fresh issues for the Panama Canal, the lessened demand for
currency and the expectation of banking reform were factors in
this decline. When the price is below par the national banks
have to make good the deficiency in their guaranty deposit by
buying fresh bonds, and thus lose their profit.

II. Sinking Fund and Dkht Reduction.

The systematic reduction of debt began in 1790 with the ap-
plication of any surplus revenue from the tonnage fees and im-
ports to the purchase of public bonds. In 1792 the bonds pur-



131



National Monetary Commission

chased were made the basis of a definite sinking fund, the in-
terest on them to continue and to be paid to a commission for
the future purchase of bonds. In 1795 the commissioners were
allotted certain revenues to be applied to the purchase of definite
portions of the debt. Hamilton has been accused of following
Price's compound interest fallacy in his plan for debt reduction;
but Professor Dunbar considers that Hamilton's scheme was
based on the expectation of a surplus, and that its failure
resulted from an unanticipated growth of expenditure.

Gallatin formulated the true principles of debt reduction in
1800 in a debate upon the sinking fund, when he observed
(with a side reference to Hamilton) :

"I know but one way that a nation has of paying her debts,
and that is precisely the same that individuals practice, 'spend
less than you receive,' and you may then apply the surplus of
your receipts to the discharge of your debts. But if you spend
more than you receive, you may have recourse to sinking funds,
you may modify them as you please, you may render your ac-
counts extremely complex, you may give a scientific appearance
to additions and subtractions, you must still necessarily increase
your debt."

Still he did not abolish the old sinking fund, but increased the
annual appropriations. In 1791 the debt had been $75,400,000.
This old debt was reduced by Hamilton to $72,700,000 by 1801,
but in the same period new loans had been made, mostly at 8
per cent, so that Jefferson's Government inherited $83,000,000.
Gallatin's sinking fund extinguished $46,022,810 between 1801
and 1 8 1 1 , while the purchase of Louisiana added 1 1 X millions of
new debt. On January i, 181 2, the debt was $45,154,189, or 31
millions less than the original revolutionary debt. In fairness
to Hamilton we must remember that his sinking fund enabled
some conversions to be made, which reduced the charge. The



132



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Credit of Nation



following table shows details of debt reductions between 1801
and 1812 : "





1801.


1804.


1812.


Old debt:

Funded


$57, 000, 000

2, 800, 000

12, 400, 000

7, 200, 000

3, 200. 000


$Sj. 500. 000

I, 800, 000

7, 700, 000

7, 200, 000

900, 000

n , 200, 000
3, 700, 000


$33, 200. 000


Unfunded






Previous time loans








Louisiana:

Debt
















Total - - .


82, 600, 000


86, 000, 000


45, 200, 000





During the war of 181 2 the operation of the sinking fund
was suspended. At its close (in 181 7) the arrangement of the
sinking fund and debt account was much simplified by an enact-
ment that all certificates of the public debt when redeemed
should be destroyed. At that time there were 14 types of
stock, bearing 7 different rates of interest. In the years follow-
ing the war a series of large surpluses favored debt reduction,
although the fixed periods for which loans had been contracted
proved an inconvenience. In 1824 $9,500,000 of 6 per cents
were converted to4j^ per cents redeemable in eight or nine years.
Other attempts at refunding were not markedly successful, as
too low interest was offered. By 1835 the debt was almost paid
off, and the sinking fund was transferred from the management
of the commissioners to that of the Secretary of the Treasury.

During the civil war the law of February 25, 1862, enacted
that a sinking fund should be created by the surplus from
import duties after they had been used to pay the interest on
the debt. The surplus was to be used to buy i per cent of the
debt each year, and this was to be set apart as a sinking fund,
the interest on which was likewise to be applied to debt reduc-
tion. The residue of the customs receipts (if any) was to be

a Dewey: Financial History, p. 125.
133



National Monetary Commission

paid into the Treasury. There were no surpluses during the
war, nor were the above provisions observed after it was over,
but the debt as we have seen was redeemed with amazing rapidity
by means of annual surpluses. The history of the refunding
of the civil-war debt has already been related.

III. Debts of thk States, Cities, and Other Locae Bodies.

During the first half of the nineteenth century many of the
Northern States borrowed for internal improvements, such as
railroads and canals. The States in the South and West also
raised loans for state banks, and in the West for various com-
mercial enterprises. These undertakings were often unremuner-
ative, and the newer States sometimes failed to meet the obli-
gations which they had incurred. For example, in 1838
Mississippi invested $5,000,000 in a bank which broke. The
governor recommended that the bonds should be repudiated, on
account of certain irregularities, and a legislature elected on
this issue carried out the repudiation. Florida acted in much
the same way. Foreigners who invested in state securities
found that under the Constitution the Federal Government
had no power over defaulters. It was during this period that
The Times called the States "one vast swindling shop." Even
Sidney Smith, an admirer of America, was provoked by these
scandals to unaccustomed bitterness.

In 1843 it was proposed that Congress should assume the
state debts. This course was not adopted, and American
credit continued to suffer for the dishonesty of some and the
incompetence of other States. Owing to these experiences
amendments were gradually introduced into many state con-
stitutions imposing restriction on public borrowing, as, for
instance, that the loans must be temporary and that the
amount of each must not exceed a certain sum varying from
$50,000 to $1,000,000. In 17 States loans must be accom-



134



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n s



panied by legal provision for redemption, and in i6 every act
proposing a fresh loan must be referred to a popular vote.

The civil war caused a large increase in state debts, but they
have lately been reduced. In 1902 their total amount was
$235,000,000, as against the $925,000,000 of the federal debt.
The burden per head was $9.15 in 1870, $5.48 in 1880, $3.37 in
1890, and $2.99 in 1902. Thirty-one States in 1902 were below
this average, and only a few markedly above it — Nevada with
an average of $14.70, Arizona $23.86, and Massachusetts $22.87.

The rate of interest on state debts in 1902 varied from 3 per
cent to 7 per cent. In 1902 the amounts were thus distributed —

At 3 per cent $90, 000, 000

At 3.5 per cent 60, 000, 000

At 4.5 per cent 30, 000, 000

At 6 per cent 35, 000, 000

At 7 per cent 20, 000, 000



235,000,000
The service of the debt for states, cities, and smaller local au-
thorities in 1902 claimed $78,900,000, or 7.1 per cent of their
total expenses. But against this it is to be remembered, espe-
cially in the municipalities, that a considerable part of the cap-
ital debt (whose total in 1902 stood at $1,864,900,000) is applied
to productive purposes, the revenue from which covers about 70
per cent of the service of the debt.

The payments for interest are as follows :



states

Towns over 25,000 inhabitants. .
Towns under 25,000 inhabitants

Counties

Other divisions



$9, 560. 000

42, 770. 000

7, 180, 000

9, 610, 000

9, 770, 000



79, 090. 000



Per cent
of total.



The total indebtedness of the United States for certain years
from 1870 to 1902 is classified in the table on the next page.



135



National M o n e t ar y Com m i s s i o n







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136



The Credit of Nations

In 1887 Adams (Public Debts °) remarked of the States that
they had no financial standing and never appeared on the market
as large borrowers, because of the restrictions on their adminis-
trative capacity. Some of their original functions, such as
banking, have been taken over by the Federal Government, and
others, such as railway management, by private corporations.

During the last forty years, in fact ever since the conclusion
of the great civil war, the credit of the American States and
cities has advanced rapidly and steadily. As in all parts of the
civilized world the standards of civic life, and consequently of
communal expenditure, have risen very rapidly. In respect of
lighting, sanitation, water supply, and transit the American
city, like its European rival, has been transformed. The move-
ment for municipalization of natural monopolies has, however,
not gone so far in the United States as in England or Germany;
and this fact, together with the severe restrictions imposed by
state legislatures, accounts for the generally lower ratio of
municipal debt to population in the New as compared with the
Old World. In spite of the loud and too often just complaints
of extravagant waste and even corruption American municipal
credit is good, and the bonds of the chief cities find a ready
market, if not a free market, in the English or German sense.
The market for city bonds in the United States has been
described by a recent financial writer as "sufficiently close for
the investor's purpose," except as regards minor municipalities.
These smaller issues are generally taken over by private banking
houses, mainly in New York or Boston, who then distribute the
bonds among their clients at a good profit. The table on the
next page shows the growth of municipal indebtedness in the
United States in the last ten years for twelve of the largest
cities .

a P. 303.



137



National Monetary Commission



Grcnulk of American Municipal Debts, 1898-1908.



Cities.



New York

Chicago

Philadelphia-.

St. Louis

Boston,

Baltimore

Cleveland

San Francisco

Cincinnati

Buffalo

Pittsburg

New Orleans.



Net debt, January i.



1899-



Dollars.

244. 220,435

15, 104,636

36, 380, 082

13.924. 278

55.084, 172

12,408, 434

8, 139.003

68, xos

25. 169.532

II, 286,397

9. 172,956

14,009. 137



Dollars.
672, 019, 244
24, 844, 400
79.635.020
19, 966, 000
74,099,388
22, 507.048
22,567,077
3. 787. 725
29, 242, 667
13,258,863
12, 118,987
26, 126, 600



Debt per capita.



1898. 1908.



68.79

7- 74

29- 33

26. 50

109.31

23- 65

20.34

• 19

65- 37

29. 70

30. 57
50. 94



156.82

8.73

53 40

26.48

122. 01
39- 67
42.98
9.46
68.81
33- 14
30.39
74- 64



New York City has suffered much for its extravagance; in
the crisis of 1907 it was glad to sell 4}^ per cent bonds at very
little above par, and again in March, 1910," it issued a loan for
$50,000,000 in 4.^4 per cent bonds at par. At the beginning of
1910 a survey of the credit of twenty-four cities showed yields
varying from just under 3^ per cent in the case of Detroit to
just over 4 per cent in the case of Portland.

The conditions governing the credit of American municipali-
ties may be realized by a selection of typical instances. Let me
take Cleveland, Ohio, where one may follow the researches of a
careful student.'' The city debt was insignificant before the
civil war, with the exception of half a million dollars borrowed

« Copenhagen was borrowing in the same week on a 4 per cent basis.

&The Finances of Cleveland (Columbia University Studies in History,
Economics, and Public Law. \'olume XXV, number 3), by Charles C.
Williamson, Ph. D. New York. The Columbia University Press. Lon-
don, P. S. King & Sons, 1907. See Chapter VI and Appendix D.



138



The Credit of Nations

for the erection of water works. Yet in 1 843 Cleveland's finances
were "embarrassed," largely owing to the practice of issuing
orders recklessly on the treasury. In 1847 the total debt was
$22,000, of which $8,000 were treasury orders, worth about 62.5
cents on the dollar. Thus the city had to pay in its own depre-
ciated currency of treasury orders from 25 per cent to 33 per cent
more for labor and materials than the cash prices, and it became
necessary to fund part of these orders and bring the rest to par.
But "funded debt" does not appear in the city accounts till
1856. After 1 86 1 floating obligations accumulated and were
periodically refunded. Even current charges, such as interest or
lighting expenses, were allowed to run for some time and then
funded into interest-bearing debt. In 1872 30 per cent of Cleve-
land's indebtedness was due to such charges, and for several
years later over one-third of the interest was paid on bonds to
meet current expenses. Bonds were issued for the building of a
viaduct, for water works, and other special improvements.
Between 1871 and 1877 $9,500,000 was raised by loans. Cleve-
land was only following in the steps of other cities. From 1 866
to 1875, while the population of 15 of the principal cities of the
United States increased by nearly 71 per cent, their indebtedness
increased by 271 per cent. In the same period the increase in
Cleveland's population was 72 per cent and the debt rose by 355
per cent, although in i860 her mayor had warned the city that
"such a policy (of loaning) is unwise and to be deprecated." We
may note, however, that in the earlier period it was not easy to
attract investors. After the civil war city bonds gradually came
into favor with investors, and this has been an important factor
in the growth of municipal indebtedness. There have been few
cases of repudiation or composition in the history of cities of
any standing in the United States. Pittsburg for a time refused
to pay interest on some street-improvement bonds that were



139



National Monetary Commission

issued in 1879. Memphis once compounded with its share-
holders after the fever epidemic of 1878, and Galveston scaled
down its debt after being nearly wiped out by a fiood.

At first the increase of Cleveland's debt was obscured by a
division into "general" and "special" indebtedness, the latter
incurred for local improvements and paid for by special
assessments on the property benefited. From 1 870-1 875 this
"special" debt was almost quadrupled and amounted to nearly
$3,000,000, while the general debt increased by only 50 per cent.

Opposition arose to these bond issues on the ground that they
were controlled by private interests, especially by land specu-
lators. Various irregularities were discovered, for example, a
method of paying contractors not in cash, but in interest-bear-
ing bills or "certified estimates" which the treasurer would
discount at from 3 to 5 per cent.

From 1870 to 1880 a wave of borrowing afflicted American
towns. Municipal indebtedness in the State of Massachusetts
increased from $34,800,000 to $80,427,000 between 1870 and
1874. This expansion led to limitations being imposed by
various States upon the borrowing powers of their cities.
Pennsylvania (1873) limited municipal debts to 7 per cent of
the tax valuation, Maine (1877) limited them to 5 per cent, and
in 1 88 1 Indiana forbade any municipal debts in excess of 2 per
cent of the valuation. In 1874 Ohio limited the debt of her
cities and towns to 5 per cent of their tax valuation, but this
maximum has since been raised more than once. Between
1878 and 1 89 1 the debt of Cleveland decreased by $500,000, but
in 1 89 1 the net indebtedness was very near the 5 per cent limit,
although the waterworks debt was not included in the maxi-
mum. Of late the city of New York has also reached its maxi-
mum, and leading financiers have expressed grave anxiety as
to the financial outlook unless strong measures of retrench-
ment arc adopted.



140



The Credit of Nations

In 1896 in connection with a new scheme of municipal im-
provement the mayor of Cleveland brought forward arguments
for the extension of the debt limit. No American city of the
same class (he pointed out) had so small a debt, except San
Francisco and Detroit, and (according to his calculation) the
debt of Cleveland in proportion to population "was anywhere
from a sixth of to something less than merely equal to the
debt of a dozen of fifteen other large cities." Real and personal


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