The very old roots of sound finance.

Feb.14 2006 The doctrine of always balancing the budget and ignoring the difference between the capital budget and the current expenditure budget goes back a long way in history. One can trace the roots of this debate to the ancients. James Macdonald in a Free Nation Deep in Debt:the Financial Roots of Democracy, (New York: Farrar, Strauss and Giroux, 2003) traces some aspects of the doctrine to the Greeks and ancient Romans.for example, the first recorded public loan occurred in 404 BC at the end of the Peleponnesian War. The Spartan sponsored oligarchy that replaced the defeated Athenian democrats who fled Athens borrowed 100 talents from the Spartans to fund an anti democratic campaign. When the democrats returned to power a vote was held whether to honour the debt of their oligarchic predecessors by levying a tax. The citizens decided to do so. This first loan was followed in the next 150 years by a series of other loans essentially to finance wars. In 360 BC the Ionian city of Clazomenae sold devalued drachmas made from iron rather than silver forcibly to their wealthier citizens to finance the payoff of a loan of 20 talents at 20 % interest to their mercenaries. (p.37-38, Macdonald) A variety of other debt financing strategies including life annuities,foreign borrowings and interest free or low interest loans were already present in the classical world of the ancients. Much later in the fourteenth century the Italian city states engaged in deficit finance and sold low interest bonds called the monte comune to finance their expenditures.By the early 1400s 2/3 of Florentines held public bonds that financed the public debt. This was also true in Venice and Genoa. (p. 82 Macdonald) By the time of the English civil war the two doctrines sound finance versus deficit finance as techniques of economic management were relatively well established in the literature and in practice. St. Thomas Aquinas, the theologian 1225-1274 was an exponent of balanced budgets and strongly opposed to loans. The French philosopher and political writer Jean Bodin(16th century)believed that state revenues should be limited to the public domain,conquest,gifts, annual contributions of allies, customs duties and taxes.(Alvin Hansen, Fiscal Policy and Business Cycles, p.109) But the great English philosopher Thomas Hobbes believed that sometimes borrowing was justified and necessary to finance great ventures. Adam Smith disagreed arguing that overspending in good times caused ther shortfall in bad times and believed much like our contemporary fiscal conservatives that borrowing was the road to ruin. David Hume as well. This debate continued between Ricardo and Malthus. Ricardo argued that public investment was a net subtraction from private investment which contemporary economists call crowding out.The British called it the Treasury view which R.F.Kahn showed to be faulty in his famous article on the multiplier.Adrian Ham has written the best guide to the Treasury in which he as a former insider expresses his exasperation with how the Treasury insisted on trying to sabotage Keynesian policy. Malthus to his everlasting credit disagreed and called attention to the problem of inadequate aggregate demand. (He is buried incidentally in Bath Cathedral. The day I went the doorkeeper told me I was one of the only persons in close to 20 years who was a visitor and knew this).(See Samuel Hollander's excellent work Classical Economics as well as Keynes' General Theory. Keynes , of course famously wrote to George Bernard Shaw before the General Theory appeared that he was writing a work that would dethrone the Ricardian basis of classical economics ) But the reality was that the growth of the state and the increasing wealth and economic development of capitalist societies was fuelled by and faciltated by the growth of the financial industries which increasingly bankrolled the process. Alvin Hansen puts it clearly. ``The development of credit institutions made possible the financing of wars in a manner which added stimulus to the economy through the net additions of purchasing power injected into the community through the use of credit.`` (p.111)How much better it would have been if the rise of these credit institutions would have been used to finance peaceful expansion of civil society and not war. But it would take until the twentieth century until that principle was firmly established. However, even in the nineteenth century credit institutions like the Barings Bank financed the economic development of Canada and the development of the vast transportation infrastructure that was essential to building the country. The boom in government securities was paralleled and even supplanted by the boom in private securities issued by the great corporations during the latter half of the nineteenth and early twentieth century.