Capacity to Pay
I
WHEN M. Caillaux left the United States early in October, a sadder but a wiser man after the failure of his debt negotiations in Washington, many tongues — some great, some small — posed the question: ‘Has the United States assumed the rôle of a Shylock among the nations?’ And a chorus of voices from far and wide, large in volume but not impressive, was raised to answer, ‘Aye.’ Yet no sooner had the Italian debt settlement been announced than a new note was sounded. This time it was: ‘Has the United States suffered a change of heart? Is it so eager to avoid a repetition of the French failure that it is allowing itself to be fleeced?’ And again: ‘Has the door now been opened so that France may expect easier terms ? ‘ The answer to those questions is not simple, but the key to their unlocking lies in an analysis of the policies consistently followed by the American Debt Commission.
When that Commission, properly termed the World War Foreign Debt Commission of the United States, was created by Congress, there were imposed upon it certain specific limitations. It was forbidden to cancel any part of the capital sum of any debt; it could not negotiate an interest rate lower than 4¼ per cent; it could not extend payments beyond a given length of time; and it could reach no agreement that was not subject to ratification by Congress. Some modification of these restrictions was made at a later date when Congress increased the size of the Commission from the original five members to nine, in order that representatives of the Democratic Party might sit in on its deliberations; but this modification was unimportant except as it indicated that Congress might later be willing to ratify agreements which for good and sufficient reason did not meet the minimum specifications prescribed.
The Commission, in its present form, is the best assurance the American taxpayer could have that his interests are being properly looked after. With Secretary Mellon as chairman, and with experienced men like Secretaries Hoover and Kellogg, Senator Smoot, and Congressman Burton as active members, there is assured as expert a financial, economic, and political guidance as could be assembled in any group. These men have not only a profound grounding in economics but a wealth of experience in practical business and governmental affairs. Domestic politics are a negligible quantity in their calculations, and, rumors to the contrary notwithstanding, their conferences have been remarkably free from dissension on any essential facts.
What is the direct interest which the taxpayer has in the debt settlements? During the war the American Government issued bonds bearing 4¼ per cent interest, and from the money so raised it made loans to various European Governments. Ever since, the taxpayer has been supplying the money to meet not only the 4¼ per cent interest payments but also the amortization charges on the bonds. In other words, the total burden which he has carried because of foreign debts has corresponded to the total amount of the Liberty bonds issued to care for them plus the interest paid on them up to the moment of a debt settlement. His criterion of the measure of a debt settlement, then, is the extent to which that settlement relieves him of his burden; or, put in another way, his forced contribution to each foreign nation is the difference between the 4¼ per cent he is paying to-day on the American bonds and the amounts which are paid by that nation toward reducing its debt. All of which leads to the conclusion that the only honest way of determining the generosity or the rapacity of the American Government in the debt settlements is by figuring the present value of those settlements.
Let us take first the British accord. At the time that agreement was reached the British Government had borrowed from the American taxpayer, in terms of Liberty bonds and interest, about $4,600,000,000. That sum represents the present value of the total debt. Yet, if the British taxpayer were to invest to-day (speaking as of the day of the settlement) in Liberty bonds to the amount of $3,792,350,000, such bonds would over the same length of time yield a total sum equal to the payments which the British Government has pledged itself to make over a period of sixty-two years. In other words, the United States has forgiven — or, to use a stronger term, canceled — 18 per cent of the total debt, calling on Great Britain to pay only 82 per cent. Eighteen per cent measures the extent of American generosity, 82 per cent American rapacity.
Applying the same method of calculation to the Belgian debt settlement, we find that 46 per cent represents the extent of American generosity, and 54 per cent American rapacity. Yet in this case the figures do not tell the whole story, because the American Government waived in favor of Belgium a sum of money which, under the Dawes Plan, was set aside from German reparations to meet the pre-Armistice debt owed the United States by Belgium. The present value of that sum, assuming that Germany pays the full amount of reparations provided for by the Dawes Plan, comes to about $80,000,000. As a result, through the combined working of the Dawes Plan and the generosity of the American taxpayer, Belgium is called on to pay less than one third of her obligations to the United States.
The total Italian debt was about $2,040,000,000. The present value of the payments, as arranged in the schedule agreed to on November 2, 1925, is only $530,000,000. Consequently the American taxpayer will carry 75 per cent of the burden of the loans made to Italy, while the Italian taxpayer carries but 25 per cent. Similar calculations could be made covering the other agreements already reached. Finland, Lithuania, Hungary, Poland, Czechoslovakia, Latvia, and Esthonia, all have received substantial concessions, not only in the interest rate, — which, together with the schedule of payments, corresponds very closely to the British settlement, — but in the computation of the capital sum.
If these figures do not refute the accusation of ‘Shylock,’ then I have not made myself clear. There still remains, however, the question: Has our Government allowed itself to be fleeced? The answer can best be found by examining the factors which entered into the calculations of the American Debt Commission.
II
Obviously one principle has been maintained in every settlement — the integrity of the capital sum borrowed. In each case provision is made for the repayment of that sum in annual installments over a period of sixty-two years. The annual payments begin with comparatively small amounts and are graduated upward to reach their maximum after perhaps fifty years. There is practically no variation in this formula, and any subsequent agreements that are made can be counted on to follow it. The period of years may be extended or the annuities may be varied somewhat, but the fundamental idea of the sacredness of the capital amount of an international debt will surely be maintained.
A second principle, and perhaps the most important one, is that, once the capital sum has been determined, negotiations should be confined entirely to the rate of interest to be paid, and that this rate of interest should be based upon the capacity of each nation to pay. Here the Commission was obliged to depart from the limitations set upon it by Congress, trusting that a full review of the facts might later ensure Congressional ratification. In judging the capacity to pay, two questions dominate: first, the ability of the debtor country to raise the essential money by taxation; second, the possibility of transferring the money once raised into the necessary foreign exchange. To estimate the first requires an examination into the fiscal system of a country, into the prospect of reducing expenditures and increasing taxes, and into the prospect of increasing national wealth which would produce additional tax revenue without increasing the burden on individuals.
The transfer question brings up such matters as the balance of trade, whether more commodities are exported than imported, the character of the situation with respect to such so-called invisible items as immigrant remittances, tourist expenditures, shipping services, interest on other loans, and so forth. In every case the Commission must determine how large an amount can be actually transferred without affecting the stability of the debtor nation’s currency, once the latter has been stabilized.
A third element likewise entered into the calculations of the American Commission. During the past century the trade of the world has doubled in value every twenty-five years. It is a reasonable assumption that this increase will continue, and, inasmuch as the settlements cover a period of sixtytwo years, the Commission was fully justified in basing on this factor the size of payments to be made in the future.
With these points in mind let us see just how the Commission applied them in actual practice. At the time the British settlement was reached the American Commission estimated that the payments agreed on would represent an increase of about three per cent in British taxation. They also estimated that through economies in government the British could reduce their taxes by considerably more than three per cent and that, as a consequence, payment of the American debt could be carried out without imposing any additional tax burden upon the individual. All of these estimates have proved correct. As far as the transfer problem was concerned, the Commission recognized that, whereas the payment of the annuities required only about $160,000,000 a year, the credit balance in favor of England from both visible and invisible items came to nearly $500,000,000. In other words, the members of the Commission were convinced that payments could be made without depreciating the value of the pound, and the shrewdness of their judgment has been borne out completely. Whereas the pound was selling at a considerable discount when the settlement was made, it has now reached par in spite of regular payments to the United States, In fact, the actual process of making payments on given days has yet to stir a ripple in financial circles or attract more than a line in the financial press.
The experience with the British settlement has been a startling surprise to those learned theoretical economists who proclaimed the impossibility of England’s being able either to raise the funds by taxation or to transfer them to the United States once they were raised. It has also proved a boomerang to the economists who predicted that the payment of this debt, the largest of all our foreign debts, would be accompanied by such a flood of foreign goods that it would throw hundreds of thousands of American workmen out of work. Since the day of the settlement American labor has been fully employed. The predictions may still come true, but no indication in support of them can yet be seen.
In estimating Belgium’s capacity to pay, the Commission took into account the facts that Belgium had recently raised her taxes to the maximum and that economies, while possible, could not be counted on for a number of years. It also recognized that payments during the first ten or fifteen years could be adjusted so as to absorb only a fraction of Belgium’s reparation receipts and thereby necessitate no additional taxation. Besides these factors, in Belgium’s case the transfer problem was rendered difficult by an unfavorable visible and invisible balance of trade, while the assurance given by President Wilson in regard to the pre-Armistice debt supplied another motive for leniency. However, in the larger payments exacted for later years the element of increasing world-trade was patently taken into consideration.
In determining capacity to pay, the case of Italy presented the greatest difficulties. Italy had taxed her people to the maximum that industry could endure. She had balanced her budget and very considerably reduced her military expenditure. She had little relief to hope for from reparations. Her population was growing without a corresponding increase in economic productivity. Her complete lack of essential raw materials — such as iron, coal, cotton, copper, and foodstuffs — threw her balance of trade heavily on the debit side. Even the large items of emigrant remittances and tourist expenditures were not sufficient to affect the unfavorable balance. Therefore initial payments of only $5,000,000 a year, increasing slightly during the first twenty-five years, were finally determined upon. Yet, even in reaching this sum, the Commission had to count on a continuation of the rejuvenation in industry and economic life which has occurred in the past two years, and to some extent on the anticipation of a peaceful and progressive world.
III
A consideration of the French situation I have purposely left till the end because it is the one over which the greatest misunderstanding has arisen and in which the human and political equations have played a very confusing part. France is economically sound. Her people are thrifty and prosperous. She suffers from no unemployment. Her production is high and her standard of living is high. Being an agricultural country, she is independent of any need to import foodstuffs. She has large supplies of coal and iron, which, together with abundant waterpower, give her possibilities of a vastly increased industrial development. In territory she has regained AlsaceLorraine and received a mandate over vast regions in Asia Minor and Africa. She has a visible favorable tradebalance of $100,000,000 a year, and in addition she realizes at least $150,000,000 from American tourists every season. Her reparation receipts will run to about $400,000,000 per annum, so that the question of transferring funds which she might set aside for the repayment of her debt to us does not present great difficulties. Her assets, then, are very great.
Frances liabilities consist in a fundamental unwillingness to tax her people to a point which, considering her economic strength, would compare favorably with the efforts put forth by either great Britain or Italy. She is carrying on two wars and maintaining an armament far greater than that of 1914 in spite of the fact that her principal enemy has been disarmed. Her fiscal system cannot stand the strain, and no Finance Minister whom she has put in office since the war has succeeded in balancing her budget. Incompetence in the handling of finances is her besetting danger. These liabilities may seem overwhelming at the moment, but on a cool appraisal all can be shown to be transitory. If they were not, her extinction as a Great Power would be certain. No one who knows the great ingenuity and capacity of the French people, and the economic strength of the nation, can have any doubts as to her survival. Sometime she must attain financial stability. No debt commission that attempted to negotiate an agreement with her covering a period of sixty-two years could assume another hypothesis. And, acting upon such an assumption, no debt commission could allow the American taxpayer to carry in the future the burden of present French financial incompetence.
The failure of France to reach a settlement with the American Debt Commission in Washington was not the fault of the latter. Every criterion applied by the Commission to the other nations with which it had dealt was applied to France. Her debt amounted to about $4,020,000,000. The American Commission was willing to settle on a basis which would have ensured easy payments in the first few years, and, figured at present value, would have been equivalent to a 32 per cent cancellation. This offer was refused point-blank.
When M. Caillaux appeared in Washington, hailed as a miracle man of finance, he still felt the flush of success as the result of his negotiations with Winston Churchill in England. The tentative agreement for a settlement of the Anglo-French debt had been advertised as a triumph for Caillaux. In reality it committed France to large payments in the next ten years, at a time when France could least afford to pay, while the concessions in her favor were on later payments. Taken as a whole, it appeared to be a good settlement for the French people, but analyzed in detail it was full of unpleasant ‘jokers.’ Yet M. Caillaux’s idea was to force the United States into a settlement which would conform with this agreement. He even went so far as to intimate to the press that, unless the United States signed on the dotted line, he would return at once. And then what happened? The American Commission dissected M. Caillaux’s proposal for him, stating just what that proposal would mean for France: —
‘We find that the principles of these arrangements (Anglo-French), if applied to the debt of the United States, would imply a larger obligation upon the part of France to the United States than that contained in our proposal below. . . . The net result of the application of these principles to the American debt would bring about that France should pay to the United States an annual amount of $161,000,000 for the first twenty years, and $61,000,000 thereafter for forty-two years. These payments would be altered if the annuity of $61,000,000 were deferred for the first seven years and added to the subsequent period, as discussed in London. It seems to us that those principles of repayment are infeasible to France in the application of its indebtedness to us.’
The only interpretation that can be given to this statement is that the American Commission refused to consider M. Caillaux’s principle of settlement as properly interpreted, because it considered that offer beyond France’s present capacity to pay.
The basis of the negotiations was then changed and M. Caillaux gave consideration to the American proposal, which followed closely the lines of the Anglo-American agreement as to the capital sum, but suggested interest payments to begin at only one half of one per cent, mounting to 3½ per cent in thirteen years. The offer was rejected, several modifications of it were rejected, and M. Caillaux forced a suspension of further negotiations by insisting in the final French proposal that any payment by France must be dependent on reparation receipts — a proviso that the American Commission had flatly and very properly held to be out of the question from the beginning. A five-year modus vivendi was finally agreed to, whereby France promised to pay the sum of $40,000,000 per year, — an amount which Caillaux stated to be within her capacity to pay, — and whereby negotiations were to be resumed at the end of that period. Even that temporary settlement has been refused approval by the Finance Committee of the French Chamber. This may be accounted for as a vote of lack of confidence in Caillaux, but it is more probably the effect of the failure of a definite agreement on French credit in the money marts of New York and London. France will probably be looking for a final settlement soon. That she can ever get from the present Debt Commission easier terms than those which were offered her this year, provided that the principle of capacity to pay is maintained, I very much doubt. The American taxpayer will make sacrifices — even 75 per cent sacrifices, as in the case of Italy — if he can be convinced by some such body as the Debt Commission that the sacrifice is just as well as generous; but. he will not be bludgeoned into surrendering what is rightly his when the debtor is able-bodied, productive, and fundamentally solvent.
This whole discussion is based on realities, and all sentimental considerations have been scrupulously avoided. That the latter may loom large in the minds of many people cannot be denied, but one essential fact should never be forgotten. The American Debt Commission was created by Congress as a collection agency; it assumed a solemn trust to act on behalf of the American taxpayer, and to lighten so far as possible the burden he has been carrying. In the fulfillment of that mandate, capacity to pay — a straightforward, businesslike, unsentimental estimate of capacity to pay — is the only sound criterion. Voices will always be raised accusing the United States of being rapacious on the one hand and a shorn lamb on the other, but those voices will have to await the passing of many years before a judgment can be reached as to whether their echo rings true.