The question naturally arises as to what disposition shall be made of a public debt after it has been contracted. The answer which ordinarily occurs to American students is that the debt will be canceled at the earliest convenience. The American people have shown little sympathy with the policy of perpetuating a debt. Most other countries, to a greater or less degree, do not share this attitude. England, to some extent, assumes the American viewpoint, while the countries of Latin origin generally show little concern in regard to the extinction of their indebtedness. Since these two viewpoints are prevalent, it is of importance to note the reasons advanced for the adoption of each policy.
Reasons for Extinguishing Debts. - A factor of primary importance in the consideration of debts is the burden placed upon the citizens of a country, and it is upon this phase, largely, that the policy of debt extinguishment differs. The payment of a debt necessarily means heavier taxation with a corresponding burden upon industry. If the principal is allowed to stand, however, the burden can gradually be decreased by the natural expansion of industry, and gradual increase of the social income and wealth. With this development the burden of an interest charge gradually becomes less because the financial ability of the citizenship has been increased. In England, for example, in 1815, the interest charge of the public debt was slightly less than 10 per cent of the annual social income. By 1880 the same interest charge represented less than a 3 per cent burden upon the social income. The same situation is, of course, true in many other countries.
The tendency for money to depreciate in value also lessens the burden of indebtedness. In periods when the value is appreciating, as following 1873, however, the opposite effect will ensue. When the present indebtedness of most countries is taken into account, however, it is too much to hope that currency depreciation will make any appreciable diminution in the burden. Debts are frequently contracted at times when currency is at the peak of depreciation - in periods of war inflation - and the chances are that the subsequent changes in the value of the currency will enhance, rather than decrease, the burden of indebtedness.
The burden which the extinction of a debt will place upon the industry of a country has often been overemphasized. It is true that the state has no independent source of capital out of which to pay the bondholders. It must resort to taxation, and taxes are paid from the capital or income held by the citizenship. What the state does is to collect a fund from one class of citizens, the taxpayers, and turn it over to another class - the bondholders. In order that nothing be lost by the transfer, the second class must use the funds as efficiently as the first class would have used them. It is not at all unlikely that they may be used more efficiently. If taxes are so contrived that they take funds for the state that otherwise would have been squandered, then productive capacity may actually be increased by the payment of debts.
The productive capacity of a country would be decreased, of course, if its debts were paid when the security holders lived in another country. This is usually true to such a small extent as to have little influence in shaping the course of action. Cancellation of debts may have a further wholesome effect upon industrial workers, in that their minds are relieved from the thought that a part of the products of their exertions is going to the class of bondholders, and perhaps is assisting to maintain them as an idle class.