International Finance

by Hartley Withers

"He also on the 18th of June, 1872, obtained £173,570 by delivering to the trustees ... 5042 bonds of the 1870 loan, at £75 Per bond and 33,000 bonds of the 1869 loan at 104 francs per bond, and retaking them at the same time from the trustees at £50 and 104 francs per bond respectively. Mr. L---- had contracted to pay for these bonds and they had been issued to him at the prices of £75 and 104 francs respectively, and the remission in the price therefore amounted to a gift to him of £173,570 ... out of this portion of the loan of 1869, and the loan of 1870, Mr. L----has received in cash, or by the remission of his contracts, £955,398."

It is little wonder that Honduras has been in default on these loans ever since. In its Report the Committee commented severely on the action of Don C---- G----, the London representative of the Republic. "He sanctioned," it says, "Stock Exchange dealings and speculations in the loans which no Minister should have sanctioned. He was a party to the purchase of the mahogany cargoes, and permitted the public to be misled by the announcements in relation to them. By express contract he authorized the 'additional drawings.' He assisted Mr. L---- to appropriate to himself large sums out of the proceeds of the loans to which he was not entitled." Very likely he had not a notion as to what the whole thing meant, and only thought that he was doing his best to finance his country along the road to wealth. But the fact remains that by these actions he made his Government a party to the proceedings that were so unfortunate for it and so ruinous to the holders of its bonds.

After its examination of these and other less sensational but equally disastrous issues the Committee made various recommendations, chiefly in the direction of greater publicity in prospectuses, and ended by expressing their conviction that "the best security against the recurrence of such evils as they have above described will be found, not so much in legislative enactments, as in the enlightenment of the public as to their real nature and origin."

If the scandals and losses involved by loan issues were always on this Gargantuan scale, there would be little difficulty about disposing of them, both on economic and moral grounds, and showing that there is, and can be, only one side to the problem. But when it is only a question, not of fraud on a great scale but of a certain amount of underhand business, such as is quite usual in some latitudes, and a certain amount of doubt as to the use that is likely to be made by the borrower of the money placed at its disposal, it is not so easy to feel sure about the duty of an issuing house in handling foreign loans. At a point, in fact, the question becomes full of subtleties and casuistical difficulties.

For instance, let us suppose that an emissary of the Republic of Barataria approaches a London issuing house and intimates that it wants a loan for 3 millions sterling, to be spent half in increasing the Republic's navy, and half in covering a deficit in its Budget, and that he, the said emissary, has full power to treat for the loan, and that a commission of 2 per cent. is to be paid to him by the issuing house, which can have the loan at a price that will easily enable it to pay this commission. That is to say, we will suppose that the Republic will take 85 for the price of its bonds, which are to carry 5 per cent. interest, to be secured by a lien on the customs receipts, and to be redeemed in thirty years' time by a cumulative Sinking Fund working by annual drawings at par, or by purchase in the market if the bonds can be bought below par. If the Republic's existing 5 per cent. bonds stand, let us say, at 98 in the market, this gives the issuing house a good prospect of being able to sell the new ones easily at 95, and so it has a 10 per cent. margin out of which to pay stamps, underwriting and other expenses, and commission to the intermediary who brought the proposal, and to keep a big profit to themselves. From the point of view of their own immediate interest there is every reason why they should close with the bargain, especially if we assume that the Republic is fairly rich and prosperous, and that there is little fear that its creditors will be left in the lurch by default.

From the point of view of national interest there is also much to be said for concluding the transaction. We may, with very good ground, assume that it would also be intimated to the issuing house that a group of Continental financiers was very willing to take the business up, that it had only been offered to it owing to old standing relations between it and the Republic, and that, if it did not wish to do the business, the loan would readily be raised in Paris or Berlin. By refusing, the London firm would thus prevent all the profit made by the operation from coming to England instead of to a foreign centre. But there is much more behind. For we have seen that finance and trade go hand-in-hand, and that when loan-houses in the City make advances to foreign countries, the hives of industry in the North are likely to be busy. It has not been usual here to make any express stipulation to the effect that the money, or part of it, raised by a loan is to be spent in England, but it is clear that when a nation borrows in England it is thereby predisposed to giving orders to English industry for goods that it proposes to buy. And even if it does not do so, the mere fact that England promises, by making the loan, to hand over so much money, in effect obliges her to sell goods or services valued at that amount as was shown on an earlier page.[^[6]] On the Continent, this stipulation is usual. So that the issuing house would know that, if they make the loan, it is likely that English shipbuilders will get the orders on which part of it is to be spent, and that in any case English industry in one form or another will be drawn on to supply goods or services to somebody; whereas if they refuse the business it is certain that the industrial work involved will be lost to England.

On the other side of the account there are plenty of good reasons against the business. In the first place the terms offered are so onerous to the borrower that it may safely be said that no respectable issuing house in London would look at them. In effect the Republic would be paying nearly 6 per cent, on the money, if it sold its 5 per cent. bonds at 85, and the state of its credit, as expressed by the price of its bonds in the market, would not justify such a rate. The profit offered to the issuing house is too big, and the commission demanded by the intermediary is so large that it plainly points to evil practices in Barataria. It means that interested parties have made underhand arrangements with the Finance Minister, and that the Republic is going to be plundered, not in the fine full-flavoured style that ruled in earlier generations, but to an extent that makes the business too disreputable to handle. Any honourable English house would consider that the terms offered to itself and the conditions proposed by the emissary were such that the operation was suspicious, and that being mixed up with suspicious business was a luxury that it preferred to leave alone.

On other grounds the loan, well secured as it seems to be, is not of a kind to be encouraged. We have supposed its purpose to be, firstly, to meet a deficit in a Budget, and secondly, to pay for naval expansion. Neither of these objects is going to improve the financial position of the Republic. Covering a deficit by loan is bad finance in any case, but especially so when the loan is raised abroad. In the latter case it is most likely that the borrowing State is outrunning the constable, by importing more goods than it can pay for out of current production.

If it imports for the purpose of increasing its productive power by buying such things as railway material, then it is making a perfectly legitimate use of its credit, as long as the money is well spent, and the railways are honestly built, with a prospect of opening up good country, and are not put into the wrong place for political or other reasons. But if this were so, the money would not be wanted to balance a Budget, but on railway capital account. When a balance has to be filled by borrowing it can only mean that the State has spent more than its revenue from taxes permits, and that it is afraid to cut down its expenses by retrenchment or to increase its revenue by taxing more highly. And so it chooses the primrose path of dalliance with a moneylender.

As to naval expenditure, here again we have bad finance writ large over the proposal. It is not good business for countries to borrow in order to increase their armies and navies in time of peace, and the practice is especially objectionable when the loan is raised abroad. In time of war, when expenditure has to be so great and so rapid, that the taxpayers could not be expected to have it all taken out of their pockets by the tax-gatherer, there is some excuse for borrowing for naval and military needs; though even in time of war, if we could imagine an ideal State, with every citizen truly patriotic, and properly educated in economics and finance, and with wealth so fairly distributed and taxation so fairly imposed that there would be no possibility of any feeling of grievance and irritation among any class of taxpayers, it would probably decide that the simplest and most honest way of financing war is to do so wholly out of taxation. In time of peace, borrowing for expenditure on defence simply means that the cost of a need of to-day is met by someone who is hired to meet it, by a promise of interest and repayment, the provision of which is passed on to the citizens of to-morrow. It is always urged, of course, that the citizens of to-morrow are as deeply interested in the defence of the realm that they are to inherit as those of to-day, but that argument ignores the obvious fact that to-morrow will bring its own problems of defence with it, which seem likely to be at least as costly as those of the present day. Another objection to lending economically backward countries money to be invested in ships, is that we thereby encourage them to engage in shipbuilding rivalry, and to join in that race for aggressive power which has laid so sore a burden on the older peoples. The business is also complicated by the unpleasant activities of the armament firms of all countries, which are said to expend much ingenuity in inducing the Governments of the backward peoples to indulge in the luxury of battleships. Here, again, there is no need to paint too lurid a picture. The armament firms are manufacturers with an article to sell, which is important to the existence of any nation with a seaboard; and they are entirely justified in legitimate endeavours to push their wares. The fact that the armament firms of England, Germany, and France had certain interests in common, is often used as a text for sermons on the subject of the unpatriotic cynicism of international finance. It is easy to paint them as a ring of cold-blooded devils trying to stimulate bloodthirsty feeling between the nations so that there may be a good market for weapons of destruction. From their point of view, they are providers of engines of defence which they make, in the first place, for the use of their own country, and are ready to supply also, in time of peace, to other nations in order that their plant may be kept running, and the cost of production may be kept low. This is one of the matters on which public opinion may have something to say when the war is over. In the meantime it may be noted that unsavoury scandals have occasionally arisen in connection with the placing of battleship orders, and that this is another reason why a loan to finance them is likely to have an unpleasant flavour in the nostrils of the fastidious.