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 essential to the conduct of the administration in accordance with its idea of the services which that administration ought to render to the inhabitants.

Whether Governments should raise debts at all is a question that might very easily be argued were it not that they have so long and so vigorously done so that the argument would be futile. They do so in order to carry on war, to finance public services such as transport systems, and to make good a gap between revenue and ordinary expenditure. In the bad old past, loans have been much too freely granted by the lending centres, especially London and Paris, to irresponsible Governments without sufficient inquiry as to how the money was to be spent, or even as to how much of it was ever going to reach the Treasury of the borrower, after all the cormorants on both sides of the water had been satisfied, who thought that they had claims to pickings out of the transaction. The consequence has been a series of defaults for which the citizens of the defaulting country have little real responsibility, and a very ugly blot on the history of International Finance, in its first century. Such things could hardly happen again, and in the present dearth of capital for investment there is no need to fear that weak borrowers


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 will be allowed to have funds of which they are going to make bad use. But as the present dearth is not going to last for ever, it is well that issuing houses and investors should make up their minds about the principles on which money should be lent to Governments, and determine to stick to them.

Lending for war purposes is evidently not a matter to which any economic rules can be applied. One lends to one's own Government when it is at war, because one wants to do everything to help it to win; it chooses to get money from its citizens by loans, and so one subscribes if one can even though one may be convinced that less loans and more taxes would be a sounder and much cheaper way of financing war and that the notion that we can make posterity pay is a pure delusion, even if it were right or wise to do so. If we lend to other Governments when they are at war, we do so because we want to help them to win, and at the same time believe that they will at any rate end the war not too much impoverished to meet the service of the debt. None of these sentiments are amenable to financial reasoning since they depend almost entirely on patriotism or political fancy.

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 Lending to foreign Governments for public purposes requires the most careful scrutiny. It is really only desirable when the public purpose is a railway or a harbour or an irrigation scheme which can be shown to be as certain as is humanly possible to bring in a revenue that will fully cover the service of any loan that is to be spent on it; and even then there is always the doubt whether the scheme would not be likely to be more successfully handled, from every point of view, by a judicious combination of local and foreign capital working under a concession that is fairly drawn and fairly administered in the interests of the concessionaires and of the community.

Moreover, the scheme must not only produce a revenue big enough to meet the service of the loan, it must also, by means of improved transport facilities or production of some article that is in demand abroad, increase the export trade of the borrowing country and so enable it to meet the "invisible import" of demands for interest and redemption. A foreign loan that merely enables the citizens of a country to take in one another's washing with greater ease and mutual profit will be a burden on its exchange each half year as remittances have to be made to New York and London to meet interest and sinking fund, and there is no increase in goods


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 going abroad to be turned into dollars and pounds. It may be that schemes, such as road making, may be shown to be going to produce, indirectly, a great increase in revenue and in exports without actually themselves putting any money into the hands of the local Finance Minister, and it would be absurd to deny that these beneficent results might follow in some instances. Nevertheless, very exacting scepticism on such a point is certainly to be encouraged because foreign money is such an expensive luxury for a borrower and the ease with which it is sometimes raised is so great a temptation to slack and wasteful administrators that it is much safer to confine its use to public works in which it will pay for itself.

Foreign money is an expensive luxury to the borrower because its effect is essentially different from that of money borrowed at home. Domestic loans redistribute the income of the citizens, by transferring interest from the pockets of the tax-payers to those of the, but do not reduce the income of the nation as a whole. They have awkward economic and social effects because the charge for them is to a great extent taken from industry and enterprise and handed over to who may be mere idlers; but when taxation is soundly imposed and only falls on


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 industry when it earns profits (as in the example of a well-administered income tax) the burden of a home debt, if it is not too big, is easily borne and the pages of our historians are full of prophecies of England's ruin made by distinguished statesmen and economists after great additions to her debt by wars, followed by the triumphant refusal of England to be anything but more prosperous than ever. Foreign loans, on the other hand, pour a flood of money, that has not been earned in the country, into the pockets of its citizens as they are spent by the borrowing Government and so produce a short-lived spell of artificial and unwholesome prosperity, and then are followed by a half-yearly drain (unless, as often happens, the drain is met by "another dose of the same") which means that the inhabitants as a whole have to consume so much less, because a sufficient value in their goods has to be sent abroad and so provide the foreign currency in which the debt charge has to be met.

Borrowing to meet Budget deficits, caused because the Government has spent too much and taxed too little, is evidently unsound finance and especially so when loans are raised abroad. When it is done at home, occasionally and on a small scale, there is no great harm in


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 it; and it may go on for years without damaging a country's credit, as was shown by France before the war. But if the Government of a foreign state borrows in London instead of making its citizens pay for the normal expenses of administration, the result is a serious check on the vigilance with which its expenditure is watched, and the natural tendency to official extravagance is encouraged, and in all subsequent years the check on home consumption and the adverse effect on the exchange that are involved by foreign debt are penalties for the extravagance.

It may be contended that all these considerations are the concern of the borrower rather than of the lender and that if the investor thinks that a foreign security is good enough to hold he need not bother his head about the purpose for which it was raised or the way in which the money was originally spent. Within limits this is true, but bad financial habits are so easy to contract and so hard to reform that when a country's foreign debt has been chiefly raised for purposes that have not helped to increase its revenue and its export trade, it is likely to find the service of it increasingly difficult to meet.

We find then that the real security behind a Government debt is an extremely elusive


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104Rh Professor Chamberlain points out how little reverence there was for the Mikado until some time after the Restoration:—

This last sentence, though it states sober historical fact, is scarcely credible to those who only know twentieth-century Japan. The spread of superstition has gone pari passu with the spread of education, and a revolt against the Mikado is now unthinkable. Time and again, in the midst of political strife, the Mikado has been induced to intervene, and instantly the hottest combatants have submitted abjectly. Although there is a Diet, the Mikado is an absolute ruler—as absolute as any sovereign ever has been.

The civilization of Japan, before the Restoration, came from China. Religion, art, writing, philosophy and ethics, everything was copied from Chinese


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 article. It cannot be a matter of real assets owned by the debtor because we have already seen that the United States and England, whose credit stands highest, have practically none; but then the United States owe nothing abroad and the British Government likewise, until during the war it borrowed abroad in order to finance its Allies; it is even now possible that out of Reparations and payments of interest and debt by Allies the British Government may be able to cover the service of its debt to America; and if nothing should be received from these sources, the net income from the foreign investments of British citizens is now estimated at £250 millions, or nearly eight times as great as the yearly sum required for the service of their Government's debt to the United States. It thus appears that countries which have no foreign debt, which is only another way of saying countries that have wealthy inhabitants, are those which enjoy the highest credit, which is a dismally platitudinous conclusion to reach, and not very helpful; because the wealth of a country is nearly as difficult a matter to estimate as the readiness of its citizens to pay taxes rather than allow its Government to default.

The mere fact, however, that a country has to borrow abroad may be taken as an indication


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 of poverty for the time being, though it may be compatible with the possession of great potential resources. The latter condition has evidently been present in our Dominions and in countries such as Brazil, Argentina and Chile. It should be noted, however, that the United States, though still a borrowing country up to the time of the war, held all its own Government debt and only did its borrowing by issues of railroad and industrial bonds and stocks. Evidently the financial position of the Governments of our Dominions and of the foreign countries that are chronic borrowers abroad would have been much stronger if the funds necessary for development purposes had been raised by private enterprise, according to the American pattern.

The comparatively severe burden imposed on a country by a debt raised abroad has already been shown, and it is clear that the debts of those countries which are continually adding to this burden become increasingly unattractive to the prudent investor. For the time being repeated issues of external debt relieve the burden because the interest on the existing loans is paid not by a reduction of the consumption of the inhabitants but out of the pockets of investors in some other country who find the fresh money. But there comes a time


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 when the process of meeting external interest charges by external borrowing has to stop, and then the full weight of the burden is suddenly laid on the shoulders of those who are really responsible for carrying it, and unless their wealth has in the meantime grown as rapidly as the debt, the process is very unpleasant. But this is unlikely, since otherwise why should additions to external debt have continued?

Nevertheless there have been examples of countries with a considerable external debt, which have been able, through the industry and thrift of their inhabitants, to bring the debt home and so relieve themselves of the burden of external debt charge. France borrowed heavily abroad to pay the German War Indemnity after 1871, but quickly took the debt home, and it is likely that we shall see Germany do the same with the loan issued for her in 1924. It will be remembered also that italy in the years before the war was able to take home most of the italian Rentes that were once freely dealt in in Paris and London, being enabled to do so largely by the wealth that was poured into her by her citizens who went abroad and worked and saved, especially in North and South America, and sent their savings to italy.

France's rapid recovery after 1871, and


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 Italy's growing wealth, which improved the credit of both of them so rapidly, were thus accompanied and marked by a reduction of external Government debt, the absence of which has already been noted as a feature of the financial position of the wealthiest countries with the highest credit. And it thus seems safe to conclude that one test of the soundness of overseas debts, as investments, is the pace at which the debtors have been increasing external liabilities America's example has shown that it is possible for a country to expand its resources and development with amazing speed and with the help of foreign capital, without any necessity for its Government to issue loans abroad, and for a country to be using this form of financing its development is clearly an indication of financial weakness—one might almost say moral weakness, were not the word so overworked.

Exception has evidently to be made in the case of dependent countries with an alien administration and a backward population, such as India and the Dutch East Indies. With them there is clearly much more reason for development by means of Government debts, but for' self-governing countries with a number of rich inhabitants, continuous borrowing abroad is a symptom that needs explanation.


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 Those then who are considering an investment in any oversea public debt have to decide or make guesses about:—

1. The risk of war with the debtor, because in war there is no interest and the security is probably unsaleable.

2. The extent of the debtor's external debt and the rapidity of its growth as compared with

and, since (a) and (b) are largely a matter of estimate.

3. The proportion that its total debt charge bears to its total expenditure.

4. Its habits with regard to balancing its budget.

5. The stability of its currency.

The risk of war is evidently guesswork, and so also to an extent that will surprise any conscientious investor who tries also to be an investigator, are the facts, or what ought to be the facts, included under 2 and 3. Even the matter of the amount and growth of the external debt is by no means always made clear from official statements, because at times when


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 monetary conditions are unfavourable to a new loan in the open market it is possible that temporary credits may be arranged in a foreign centre and included under some heading such as floating debt, which does not give the information needed.

Whether any country balances its Budget—or rather, in most cases, the extent to which it fails to do so—is a matter that is as difficult to guess as we shall find it on later pages difficult to know what is the real profit or loss that an industrial company has made. We believe in England that our Government balances its Budget and we hope that we are right because a sum of £45 to £50 millions, yearly devoted to debt redemption, gives us a handsome margin on which to come and go. But if we tried to be exact, how much do we know about the arrears of taxation carried over each year? The sum of these arrears must be enormous, and variations in it might make a substantial difference to a year's accounts.

On the subject of 4 there is a definite record that tells one the actual facts about the exchange value of a country's currency not furnished by its official documents but by the dealings in it on the exchange markets of the world. We can really find out exactly what the rupee or the franc or the milreis has been


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 worth in sterling yesterday or a year ago or ten or fifty years ago. And these facts are sometimes really some guide as to what the probable value of any country's currency may be in a year's time; though the extent to which shrewd people may be misled about exchange movements was shown by the readiness with which they went on buying German marks until the value of the mark went out of sight.

In the midst of this mirage of doubts and possibilities those who invest in oversea Government debts work largely on impression and instinct, a hazy knowledge of the financial past of the debtor and the summary of the shrewd judgment of the Stock Exchange which is supplied to them by their brokers. They think and feel and find that Capel Court agrees that "Argentina (or whatever the country may be) is all right" and there you are. In this example there is at least a record to work on, but how can anyone make a guess concerning the probable performance of the frisky European three-year-olds who have lately made their appearance? Of them, however, it can at least be said that they were introduced at a time of great difficulty and under august auspices. The need for care was so evident that we may be certain that as much


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 as possible was exercised by the issuing houses which fathered them. Probably investors follow a trusting faith in the issuing house and perhaps after all this is the safest guide with foreign issues, for those who really know the records of the issuing houses. Still I must confess a preference for a mature vintage not only in foreign debt but in industrials. A debtor who has paid and a company that has earned for half a century or even for twenty years, and has stood the shock of 1907 and the cataclysms of 1914 and 1921 has an aroma, like a bottle that is whiskered with honourable cobwebs.

When we come to the detailed points to be desired in any particular form of oversea public debt that we may be considering they will evidently be the same as those mentioned in discussing Home Public Debts, with one important addition. We shall want either a definite date of repayment or regular redemption by drawings or purchase, so that so much of the loan is definitely cancelled every year, or else possibly, in the case of a highly favoured borrower, a perpetual debt. What we do not want is a loan which carries an option in favour of the debtor, so that it may be repaid, after a certain date, if and when it suits his convenience, which it will only


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 do at a time when it will be inconvenient to the investor to be repaid.

Besides these obvious requirements we shall want the interest, drawn bonds and bonds due on maturity to be paid in sterling money or else in American dollars, or some currency in the stability of which we have the most complete confidence. It may be asked why, if this proviso is to be insisted on, the stability of the debtor's currency was, a few pages ago, put down as a matter to be investigated—why does it concern the investor if he is to be paid in sterling or dollars? Because if the currency is unstable in which most of the debtor's revenue is collected, the debtor Government will evidently have more difficulty in providing the dollars or pounds in which the debt charge has to be paid; and in so far as its revenue is collected "in gold," the tax-payer will have the more difficulty in paying it. When the Brazilian milreis fell from 1s. 4d. to 5d. in exchange value, the Brazilian tax-payer had to produce more than three times as much in local currency in order to put down pounds in London for the service of the English loans, which thus involved a greater effort on the part of the debtor country and impaired the creditor's security without increasing his income.


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 In fact the danger that is run by those who lend to foreign debtors who are cursed with an unstable currency is so great that ingenious efforts are made by issuing houses to secure, as a collateral pledge, some asset which is sure of a market abroad and so is equivalent to so much foreign currency. This device has been successfully carried out in the case of loans to the State of San Paulo and to the Brazilian Government secured on holdings of coffee which had been taken over from the growers in order to prevent its price being wrecked by sales at a time when the market was gorged. The coffee was gradually sold as consumption overtook supply and the proceeds were used to meet interest and redeem the loans. But the circumstances under which any foreign debtor is in a position to pledge such a "sterling asset" are evidently rare, and a system by which Governments undertake such wholesale purchases of commodities is not one to be encouraged, even though it provides a convenient form of collateral, if the operation is well and successfully thought out and concluded.

As to other forms of liens and pledges, such as special assignations of the Customs duties, or the profit of a tobacco monopoly or the revenues of railways, the limitations on their


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 value have already been noted. But they are a popular feature with the Stock Exchange and with the investing public which it educates, especially when the assigned revenues are periodically paid over to the agents of the bankers to the loan; and loans so fortified are likely to be more tenderly treated by a Finance Minister than those which have no special security attached. The mere fact of their being given, however, is a symptom of financial weakness.

In some cases, when the borrower is a weak or backward Government, they are a very real advantage. The Chinese loans secured on the Maritime Customs duties paid at the treaty ports and handled only by the foreign officials of the Customs Board are certainly made safer by the fact that the funds needed for their service are collected on the seashore and do no go inland at all. But such an arrangement as this is obviously exceptional.

State debts—that is to say the debts of the provinces that make up the Federated nations, such as the German Empire, Argentina, Brazil, etc.—should be tasted by the investor with a very long spoon indeed. The German States in pre-war days enjoyed, and with good reason, first-rate credit, which was only smashed by the cataclysm inflicted on


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105Rh models. Japanese history begins in the fifth century, whereas Chinese history goes back to about 2,000 , or at any rate to somewhere in the second millennium This was galling to Japanese pride, so an early history was invented long ago, like the theory that the Romans were descended from Æneas. To quote Professor Chamberlain again:—

This question of fictitious early history might be considered unimportant, like the fact that, with us, parsons have to pretend to believe the Bible, which some people think innocuous. But it is part of the whole system, which has a political object, to which free thought and free speech are ruthlessly sacrificed. As this same pamphlet says:—

Shinto, a primitive nature cult, which had fallen into discredit, was taken out of its cupboard and dusted. The common people, it is true, continued to place their affections on Buddhism, the popular festivals were Buddhist; Buddhist also the temples where they buried their dead. The governing


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 them by the madness of the Imperial Government assisted by that of its neighbours; but when a State's credit is not first-rate—and if it is it seldom needs to borrow abroad—it is likely to be a dangerous debtor because of its limited powers of taxation. The Australian States, of course, having been in existence before the Federation, are in a class by themselves.

Municipal debts abroad and such issues as the Port and Harbour Trust securities produced by India and the Dominions often have a more solid appearance than the debts of the Central Governments, because less subject to the shifting gusts of politics and free from the economic waste of expenditure on armaments which eats into the financial strength of all Central Treasuries. It is easy to persuade oneself that whatever may happen to the Government of a country its principal cities must go on and its great ports must be thronged with ships, which will pay harbour dues.

I still lie awake o' nights sometimes because many years ago a City of Moscow loan came out and friends of mine who had a little money to invest asked me what I thought of it and I answered very much in the terms of the above paragraph. Experience has now


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 taught us that, if a central Government falls altogether to pieces and is succeeded by one that repudiates its obligations, or even if (as in the German example) a central Government divides the value of the currency by a sufficient number of millions, the most attractive-looking municipal loan will be found to have no health in it. Nevertheless, their finances being on a smaller scale and covering a smaller area, can be more closely watched by the citizens who suffer if they are ill administered; on the other hand, municipal extravagance is often a source of profit to local contractors and land jobbers and where politics are corrupt, the street corner corruption of local politics is likely to be especially corrosive and disgusting. And the judicious investor, before he handles such securities on his own judgment, ought to know a good deal more than he is likely to find out about the system of taxation from which foreign or even colonial municipalities collect their revenues, and whether it suffers from the defects which we found in the rating system in England.

But, as has already been hinted, perhaps the really judicious investor in Foreign Public Debts is he who makes no attempt to investigate all the incalculable and elusive details that make up a sound security of this


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 class, but relies on his faith in the issuing house, which is much more easily able to arrive at something like truth on the subject. But how many private investors know much about the facts which ought to guide them to confidence in an issuing house?

And perhaps, after all, the chronic inability of weak Governments to make both ends meet is the soundest reason for expecting that they will meet their debt obligations, if they possibly can. They know that they are always wanting to borrow, and that they cannot borrow unless they pay.


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the ordinary investor this chapter might be put into one word, "Don't." We have seen in Chapter V that investments in "real or heritable securities," by which I understand that real property and mortgages thereon are meant, are permitted under the Trustee Act; but such investments have been in the past a fruitful source of loss to beneficiaries under trust deeds, when trustees, on their own responsibility or under the advice of solicitors, have put funds into mortgages on house property that has declined in value, as house property is liable to do without the process being evident to anybody but the keenest observer.

This is the essential difference between real property and Stock Exchange securities, that the latter have a quotation—sometimes more or less nominal it is true, but at least a quotation and a record indicating business done in them,


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 that can be studied in the daily papers. With house property there is no such facility for watching the value of the investment, and this lack, among other things, makes it quite unsuitable for an investor, unless he is confident that his interests are being guarded, with unceasing vigilance, by a solicitor or other agent, who gives close attention, and brings real knowledge, to the matter. Investments in Building Societies suffer from the same disadvantage, and an investment that cannot be watched is not one to be looked at.

Even ground rents, which rank as a gilt-edged security—and with good reason when they are good—inevitably suffer from the same lack of a free public market, and can only be indulged in on the most competent technical advice.

Anyone who buys houses outright and hopes to receive from them an income, after he has collected the rents and paid all outgoings, is indulging in a frankly speculative form of investment.

It may come right just as a purchase of shares in an oil-field that has not yet sruck oil may come right, but it requires so much technical knowledge or so much good luck, that it is outside the range of the present inquiry, which seeks to light a candle by which the ordinary


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 citizen may invest his money with reasonable safety and with a reasonable chance of increasing it. The owner of house property—the " landlord" as he is so often described—is very lucky if he gets an average net yield from it which is better than what he could have secured on the Stock Exchange with much less anxiety and trouble; and, owing to his general unpopularity and the subservience of modern Governments to the prejudices of the multitude, he is likely to be treated with the gravest injustice at times when the service that he provides for the public is most essential and costs most to increase or reproduce.

The man who buys a house to live in is evidently in a quite different position. He has a good tenant, who will not be exacting about repairs—in fact the owner-tenant is likely to go wrong in the other direction and forget that houses wear out. If he has chosen a good neighbourhood and paid a reasonable price, he may do well by his investment.

But landlords are at all times especially hard hit by a general rise in prices because of the comparatively long terms for which they dispose of the use of their property. An owner who lets a house on a seven years' lease may have the greater part of his net income wiped out by a rise in prices which adds 10 per cent. or 20


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 per cent. to the cost of structural repairs, and to the prices of all the commodities which he has to buy out of the income from the lease. This is a risk that he has to take, and in normal times it is balanced by the consequent addition to the money value of his property. But by the Rent Restriction Act of 1915 the Government, having first made the position of landlords difficult and unprofitable by debasing the currency (which perhaps it could not avoid), proceeded to forbid them to raise rents, so inflicting serious injustice on a class of investors who provide the public with the essential service of shelter, at a time when providers of and dealers in food and coal and munitions were earning peerages by making fortunes out of the nation's need. And at the expense of the unfortunate landlord a very comfortable benefit was conferred on the tenant, who was probably earning a larger money income than ever before and made hay while the sun shone by taking in lodgers. A class that is faced by great difficulties and anxieties in normal times, and in abnormal times is sacrificed to the prejudices of its customers and the opportunism of Governments, is not one that any prudent investor will join unless he knows the ropes so well that he is absolutely certain that he is not making a mistake.


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 An investor who confines himself to mortgages on real property is in a stronger position, being, or hoping that he is going to be, not an owner but a creditor, with all the advantages that we have seen to be attached to that position, with the addition that in the matter of real property the right of foreclosure that goes with a watertight mortgage is more practical and valuable than we shall find it to be when we come to consider the question of industrial debts.

Foreclosure means the right, if the debtor does not pay interest or repay the debt if it be demanded, to sell the property over his head and repay oneself out of the proceeds, the balance, if any, going to the debtor. This right is more practical and valuable with regard to houses and land, because they are articles that are wanted to a certain extent on their own account and have some sort of a price whatever be the circumstances of those who live in or on them, whereas a factory or the building in which a great multiple shop is carried on, or a railway station, might, if the enterprise that uses it is a failure, be quite unsaleable and a mere encumbrance to anybody that seized it for the payment of a debt, who would have to begin by spending money on rebuilding it before it could be sold.


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106Rh class determined to change all this. They insisted on the Shinto doctrine that the Mikado descends in direct succession from the native Goddess of the Sun, and that He himself is a living God on earth who justly claims the absolute fealty of his subjects. Such things as laws and constitutions are but free gifts on His part, not in any sense popular rights. Of course, the ministers and officials, high and low, who carry on His government, are to be regarded not as public servants, but rather as executants of supreme—one might say supernatural—authority. Shinto, because connected with the Imperial family, is to be alone honoured.

All this is not mere theorizing; it is the practical basis of Japanese politics. The Mikado, after having been for centuries in the keeping of the Tokugawa Shoguns, was captured by the clans of Satsuma and Choshu, and has been in their keeping ever since. They were represented politically by five men, the Genro or Elder Statesmen, who are sometimes miscalled the Privy Council. Only two still survive. The Genro have no constitutional existence; they are merely the people who have the ear of the Mikado. They can make him say whatever they wish; therefore they are omnipotent. It has happened repeatedly that they have had against them the Diet and the whole force of public opinion; nevertheless they have invariably been able to enforce their will, because they could make the Mikado speak, and no one dare oppose the Mikado. They do not themselves take office; they select the Prime Minister and the Ministers of War and Marine, and allow them to bear the blame if anything goes wrong. The Genro are the real Government of Japan, and will presumably remain so until the Mikado is captured by some other clique.

From a patriotic point of view, the Genro have shown very great wisdom in the conduct of affairs.


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 This advantage, however, is only one of degree, because even houses that are too elaborate for a declining neighbourhood often have to be converted into flats or "maisonettes" before they can produce a revenue; and in spite of it, mortgages on house property seem to me to be nearly as unsuitable for the private investor as outright ownership.

If he indulges in mortgages he lends money to the owner of house property or to the owner of a lease, usually up to what is believed to be two-thirds of the value of the freehold or the lease. The owner pays him interest, half-yearly or quarterly as may be arranged, and is usually bound to repay the amount of the loan at any time, on receipt of such notice as is provided by the contract. The lender can at any time transfer the mortgage to any buyer to whom he chooses to sell, and in case of default by the debtor can exercise the right of foreclosure already described.

At first sight one might well ask, What more by way of security could Shylock or Master Dumbleton require than property which is worth half as much again as the amount lent, with a right to demand repayment at any time, and seize the property if the debtor fails to pay? And in fact those wise and wary investors, the insurance companies, habitually place enormous


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 sums in mortgages on freehold and leasehold property. Why should you and I fear to tread where these angels rush in? Because the insurance companies, making these investments on a magnificent scale, and deriving from them a princely revenue, can afford to expend upon them the funds necessary to secure the professional vigilance that is necessary in the case of property whose value has to be constantly watched, and watched by an eye that can detect symptoms of decay, because there is no market quotation. With this safeguard, the application of highly qualified expert knowledge, mortgages are a very pleasant form of debt to an investor who can afford it.

Without it, you and I would be in danger of lending £1,000 on property valued at £1,500—or not only valued but known to have changed hands yesterday at that figure—and then finding in ten years' time, either because we ask the debtor to repay it and he cannot do so, or because we cannot get him to pay the interest, that our attempt to get our money back by foreclosure is a dismal failure, because the property is not worth £500. If we are very ignorant and unjust we may call the valuer bad names and threaten him with proceedings; he will say, with perfect justice, that all he said was that the property was worth £1,500 ten


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 years ago, not that it was going to stay there till the crack of doom.

And even if all goes well and the debtor is solvent and the property keeps its value, the irregularity with which the interest on mortgages is habitually paid, makes them compare very unfavourably, for an investor who wants to receive his income on certain dates, with Stock Exchange securities. The great majority of public debts and company debts and preferences pay, if at all, on the due date as punctually as the sun rises. The mortgagor pays after such interval as suits his convenience, and usually after having his memory jogged by the mortgagee or his agent.

Land and houses, in spite of the fact that they are real and solid and "cannot run away," and their owners and the owners' creditors can go and look at them and see that they are there, are liable to enormous fluctuations in value both upwards and downwards.

And land and houses are nearly always what the Stock Exchange calls an "all one way market"—either all buyers or all sellers—and consequently difficult and awkward to deal in. A few years ago industrious agents were plastering England with titles to urban freehold plots in the neighbourhood of Canadian cities that were going to rival the growth of Los Angeles


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 and New York, and some of the buyers, who were quick enough in turning round and selling, made mouth-watering plums out of the gamble. Those who did not are still waiting for the growth of those modern El Dorados, and in the meantime look ruefully at a tin-box full of unsaleable title deeds.

But there is no need to go abroad to see big fluctuations in real property values. Some of us can remember the time when ground near Hindhead fetched less than £10 an acre as heathy and indifferent grazing. Since Hindhead became a health resort and an opulent suburb the price per acre ranges up to £2,000. Contrariwise, streets of what were formerly fashionable mansions in certain parts of London are now dwelt in by a precarious population of weekly lodgers and are little better than slums.

Such are fluctuations which the investor in mortgages has to face. But if the fluctuation be upward he is paid off and has to find another investment. If it be downward, he loses his money or some of it, after a host of worries and legal technicalities and expenses. For you and me, it is a case of "no bid." As Dante says, "let us not speak of them, but look and pass."


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the investor turns from public debts to enterprise, he walks out of a mist into twilight. We have seen how much guesswork and obscurity surrounds the question of the solvency of a Government or a public body, and how much faith and sentiment is needed by those who put money into the debts of the best of them, in the hope that it will be safe for twenty years or so. When we come to examine the question of the earning power of a company, we are faced by the baffling cryptogram of the balance-sheet, more interesting as a puzzle than informing as a statement of fact, and the apparently more illuminating record of the profit and loss account, which, however, merely tells us what the directors, usually in the best of good faith, think that the company has earned. But profit, as Mr. Wells says, "is the economic riddle that still puzzles us to-day."

Concerning the efficiency of balance-sheets


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 in misleading—"lying in every line" as he puts it—language much stronger than I should care to use has been employed by Sir Josiah Stamp; as a leading official of the Inland Revenue office and the director and secretary of a great industrial company with interests in many others, he has had unique opportunities for judging figures as exponents of facts. Usually a restrained writer, fond of the apt and judicious rather than the emphatic phrase, he holds the loud pedal down hard when he deals with the balance-sheet. As witness:—

"Our modern fetish of a 'safe' or 'sound' balance-sheet . . . lies in almost every line and yet is approved professionally because it overstates no assets and understates no liabilities, while it has valuable premises written down to negligible figures and reserves hidden in innumerable places, or profits 'held up' and 'tucked away.' 'The truth, the whole truth and nothing but the truth' cannot be derived from the modern balance-sheet so vaunted for its prudence; but prudence is just as possible without departing from what a balance-sheet ought to be—a faithful record of the employment of the total capital invested in the business, whether as an original outlay or retained profits, from which the true rate of profit on invested capital can be determined.


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 Has the shareholder, who wishes to sell his holding, no rights as to some real knowledge of the value of what he is selling? . . . If it is said that all we are concerned with in the balance-sheet is that it is a final clear up of the accounts, I have nothing more to say. If you say two balance-sheets of the same concern can be quite different and yet both be equally accurate and true and desirable, I have nothing to say. When I was a surveyor of taxes, I often had people coming to me with sheets of paper and saying, 'Well, I do not keep much of accounts, but I have made up that for the bank manager, and it puts the best face on things.' One day I was talking to a bank manager friend, and he said that people often came to him with accounts and said, 'Here is a thing I had to prepare for the tax people, and so I am at least as right as that.' To one it was to be a maximum, to the other a minimum. Ought the balance-sheet to be a thing you can pull this way and that? If that is our idea, it may well be that it is destined to be radically changed in the next generation. Now, why the financial community should acquiesce in a condition of things in which a balance-sheet can be almost anything I cannot imagine. Auditors' certificates refer not merely to it being corect accord-


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107Rh There is reason to think that if Japan were a democracy its policy would be more Chauvinistic than it is. Apologists of Japan, such as Mr. Bland, are in the habit of telling us that there is a Liberal anti-militarist party in Japan, which is soon going to dominate foreign policy. I see no reason to believe this. Undoubtedly there is a strong movement for increasing the power of the Diet and making the Cabinet responsible to it; there is also a feeling that the Ministers of War and Marine ought to be responsible to the Cabinet and the Prime Minister, not only to the Mikado directly. But democracy in Japan does not mean a diminution of Chauvinism in foreign policy. There is a small Socialist party which is genuinely anti-Chauvinist and anti-militarist; this party, probably, will grow as Japanese industrialism grows. But so-called Japanese Liberals are just as Chauvinistic as the Government, and public opinion is more so. Indeed there have been occasions when the Genro, in spite of popular fury, has saved the nation from mistakes which it would certainly have committed if the Government had been democratic. One of the most interesting of these occasions was


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 ing to the books, but truly and faithfully representing the condition of the business."

This exposure of the value of a balance-sheet as a guide to investors and shareholders is all the more significant and suggestive, in that it was uttered in the course of an address delivered at an annual conference of the Society of Incorporated Accountants and Auditors.

Nevertheless, it is the only guide, with or without a profit and loss account which is based on it, that is vouchsafed to the public by a large number of very important companies and it cannot be left out altogether, much as Sir Josiah's words would tempt one to save time, space and patience by leaving the balance-sheet buried under the heap of contumelious epithets that he has piled upon it.

When one picks up a balance-sheet one sees two lists of things with figures against them on one side and the other of a sheet of paper, usually with a dividing line down the middle. The left side, in English practice, is headed Liabilities, or Dr. (signifying debtor) and the right side Assets, or Cr. = Creditor. It thus shows on one side what the Company owes, on the other what it is owed or has got. The difference between the value put on the assets


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 and that of the liabilities is the balance, which is profit, and is available for distribution as dividend or allocation to reserve, or to be carried forward to next year. It is added to the figures of the liabilities to make the two sides agree. If the company has made a loss, the assets are less than the liabilities in value, and the balance appears on the assets side.

It is sometimes disconcerting to the uninitiated to find the company's capital and reserves among its liabilities, because they think that these are items which it must have got and must possess and that therefore they ought to be among the assets. But a moment's thought makes it clear that the capital is the money subscribed by the original shareholders and is consequently owed, and has to be accounted for by the company to them, which it does by showing assets on the other side, in which the money has been sunk; and likewise the reserve fund has been built up out of sums reserved out of profits, or received by the issue of shares at a premium, and similarly is owed to the shareholders.

The sum put down under capital sometimes includes shares that have been issued, not against money subscribed, but in part payment for the business acquired, if the company bought an existing business, or for services


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 rendered in starting the enterprise; but this is a complication that need not detain us. The stock or shares have been issued against "value received "or thought to have been received, and so their owners are part proprietors of the company to whom it has to account for the sums credited to them.

After this preliminary survey let us look at the details of a comparatively simple balance-sheet and see how much it tells us that would be a trustworthy guide to a shareholder or to anybody who was considering a purchase of part of its debt or share capital. Here is the slightly simplified balance-sheet, as on June 30, 1925, of Messrs. Bass Ratcliff and Gretton, famed as brewers wherever the English language is spoken, and in a few other places besides:—


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 It is a nice strong, mellow balance-sheet, worthy of the generous beverage that has built it up. Looking at the liabilities first, let us note the most important feature on the debit side of this and every other balance-sheet. It has been said that the capital and reserves of a company are owed by it to its shareholders. Such a debt is evidently on a different plane from debts owed to outsiders, and the first thing to be noted is the proportion of outside debt to shareholders' claims.

The outside claimants (debenture holders and creditors) against Messrs. Bass are owed £3,843,000 out of a total of over £8,613,000 millions; so that if the company went into liquidation and the assets realized the values placed on them, there would be £4,770,000 to be divided among the shareholders. The preferred shareholders having been paid off at par, there would be £3,410,000 for shareholders, the face value of whose claim is only £2,040,000, giving them an apparent bonus of £1,370,000 among them. This increment, however, is by no means "unearned," being exactly accounted for by the Reserve Fund, accumulated out of past profits, and the Profit and Loss balance of £420,000 which belongs to the shareholders on the assumption that there were, at the date of the balance-sheet,


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 no arrears of interest or dividend due to debenture holders or preference shareholders.

From the point of view of the creditors the position is different, but quite comfortable. They rank first, but, naturally, only to the extent of their claim. All that concerns them taken as a whole is to be sure that out of assets valued at over 8½ millions, their aggregate debt of £3,843,000 will be met in full, and the margin is surely large enough to satisfy the most exacting, especially when they notice that debtors, investments, cash and bills receivable come to £3,723,014, almost enough to satisfy them, without disposing of any of the freehold brewery site and buildings, or the tied houses, or the stock of materials and beer made and in the making, to say nothing of that elusive and incalculable item, the goodwill.

Creditors, as need hardly be said, are not an aggregate all on the same basis, and anyone contemplating a purchase of Bass Debenture stocks would have to be careful to see in what order they rank in priority of claims and how much power the directors have to put claims ahead of them in borrowing money for the purposes of the business. But when all this has been investigated it will appear that the position is as sound as a straightforward


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108Rh the conclusion of the Treaty of Portsmouth, after the Sino-Japanese war, which deserves to be told as illustrative of Japanese politics.

In 1905, after the battles of Tsushima and Mukden, it became clear to impartial observers that Russia could accomplish nothing further at sea, and Japan could accomplish nothing further on land. The Russian Government was anxious to continue the war, having gradually accumulated men and stores in Manchuria, and greatly improved the working of the Siberian railway. The Japanese Government, on the contrary, knew that it had already achieved all the success it could hope for, and that it would be extremely difficult to raise the loans required for a prolongation of the war. Under these circumstances, Japan appealed secretly to President Roosevelt requesting his good offices for the restoration of peace. President Roosevelt therefore issued invitations to both belligerents to a peace conference. The Russian Government, faced by a strong peace party and incipient revolution, dared not refuse the invitation, especially in view of the fact that the sympathies of neutrals were on the whole with Japan. Japan, being anxious for peace, led Russia to suppose that Japan's demands would be so excessive as to alienate the sympathy of the world and afford a complete answer to the peace party in Russia. In particular, the Japanese gave out that they would absolutely insist upon an indemnity. The Government had in fact resolved, from the first, not to insist on an indemnity, but this was known to very few people in Japan, and to no one outside Japan. The Russians, believing that the Japanese would


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 balance-sheet can make it, with an article of world-wide consumption and fame behind it.

But now let us see what a sour, jaundiced, liverish critic—and it is in this spirit that the prudent investor will scan every financial statement put before him—can say against the attractions of the Bass balance-sheet.

He will begin by pointing out, with perfect truth, a defect that is common to nearly all balance-sheets—all, it may be said, except those in which the assets consist of nothing but cash in hand or at a first-class bank, and securities quoted, and actively dealt in, on the Stock Exchange. This defect is that whereas the liabilities give you figures which are certain facts, the assets are expressed in figures which are, with the exception of the cash and investments mentioned above, to a certain extent a matter of guesswork. The figures may be too high or too low (our liverish friend, of course, will assume that they are too high), but it would be a miracle if any of them proved to be exactly correct if the assets were sold.

Cash is a definite and known amount; securities quoted on the Stock Exchange may reasonably be expected to be sold at or near the prices at which they have lately changed hands. But when we come to half-brewed beer in vats, and still more when we come to


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 bricks and mortar in the form of breweries and public houses, the difference between what they may be expected to be worth and what they may actually fetch may be very considerable.

To point his moral and adorn his tale, he might cite the recent reconstruction of Vickers, Ltd., in the course of which it was found necessary to write more than ten millions off assets standing at 22¼ millions, and further to provide 2¼ millions to meet "contingent and other liabilities expected to accrue." (Economist, December 12, 1925.)

After this general denunciation of all balance-sheets, the critic would proceed to dilate in detail on the one before us. First of all, he would say that even assuming the figures of the assets to be correct, the position only represents the present situation of a business which is a highly prosperous member of a trace which many people believe to be doomed, because the consumption of alcoholic liquor is alleged to be diminishing; nearly the whole of the North American Continent is already (or is supposed to be) dry; and some prophets tell us that in a decade or two the social and economic results of the American experiment will be so overwhelming that the rest of the world will be driven perforce on to the water


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 wagon. In that day Messrs. Bass, if still existing, will be brewing ginger beer.

In the meantime there would be a bad time of dwindling demand to go through, and on the assumption of this bad time the critic will proceed. Cash, he will say, looks very nice at half a million and more, but if bad times came and it were necessary for the brewers to fight for the diminishing thirst of the public there would not be nearly so much of that cash before the fight had gone far. The same thing can be said of investments. It is an imposing total, but even supposing that they can be sold to realize the price—and we all remember days in 1914 when very few securities could be sold at all—would the total still be as imposing after a few years of depression in the drink trade?

And these are the plums in the assets pudding, because their value does not depend on that of beer; the jaundiced critic would only begin to enjoy himself when he proceeded to deal with the others. Debtors and bills receivable, he would say, are, or may be, very good assets as long as brewing and selling beer is a prosperous business, but if it were afflicted by misfortunes that affected Messrs. Bass, their debtors—the trade connections who have been supplied on credit—would almost certainly be affected even more severely, and who knows


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 how much they could pay? And stocks, brewery premises and tied houses are inevitably all in the same beer-logged boat. The sort of critic we are imagining might even be guilty of making a bad pun about assets being sometimes too liquid, when liquor is out of fashion.

But when he comes to goodwill, he will really open his shoulders and slog. For he will tell us, which is true, that goodwill is an item never seen in the sort of balance-sheet that is produced by the elect of the financial world, the banks and insurance companies, and will go on to say, what is much more doubtful, that it has no right to be in any balance-sheet at all, but ought to have been written off years ago out of profits; and that this is a case in point because the value of the Bass goodwill depends entirely on the fame of their beer, and if the public gives up drinking beer, this value becomes a vanishing quantity.

Finally such a critic might add that any balance-sheet is worse than useless as a guide to the position of a company, because the people who draw them up, and the authorities whose business it is to examine them, have not yet made up their minds on the very important question as to what a balance ought to show, whether it should set out to display the way in which the company's money has been spent, or


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109Rh not give way about the indemnity, showed themselves generous as regards all other Japanese demands. To their horror and consternation, when they had already packed up and were just ready to break up the conference, the Japanese announced (as they had from the first intended to do) that they accepted the Russian concessions and would waive the claim to an indemnity. Thus the Russian Government and the Japanese people were alike furious, because they had been tricked—the former in the belief that it could yield everything except the indemnity without bringing peace, the latter in the belief that the Government would never give way about the indemnity. In Russia there was revolution; in Japan there were riots, furious diatribes in the Press, and a change of Government—of the nominal Government, that is to say, for the Genro continued to be the real power throughout. In this case, there is no doubt that the decision of the Genro to make peace was the right one from every point of view; there is also very little doubt that a peace advantageous to Japan could not have been made without trickery.

Foreigners unacquainted with Japan, knowing that there is a Diet in which the Lower House is elected, imagine that Japan is at least as democratic as pre-war Germany. This is a delusion. It is true that Marquis Ito, who framed the Constitution, which was promulgated in 1889, took Germany for his model, as the Japanese have always done in all their Westernizing efforts, except as regards the Navy, in which Great Britain has been copied. But there were many points in which the Japanese Constitution differed from that of the German Empire. To begin with, the Reichstag was elected by manhood suffrage,


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 should try to indicate the sum that the assets might, if sold, be expected to fetch.

This criticism is unfortunately true. If you look back a few pages at Sir Josiah Stamp's observations with which this chapter began, you will see that even this very clear-sighted examiner of balance-sheets expresses himself with a certain inconsistency. He tells us very clearly what a balance-sheet ought in his opinion to be—namely a "faithful record of the employment of the total capital invested in the business, whether as an original outlay or retained profits." This surely can only mean that what should be shown is all the money that has been spent in purchasing the assets and in making provision against the inevitable decline, owing to depreciation by wear and tear and "obsolescence," in their value. In other words the full amount charged against depreciation of wasting assets: (such as machinery, plant, etc.) and against provision for doubtful debts, declining value of investments and other such precautionary expenditure, should be clearly shown either by being put down as written off certain assets or included in a depreciation fund among the liabilities, the assets being left at the sums that they cost.

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 balance-sheet which would clearly represent some quite important facts. It would be contrary to the general practice, by which directors do not state the full amount that is taken from revenue for this purpose, with the result that there are, as Sir Josiah says, "reserves hidden in innumerable places," and in the case of ill-financed companies, there are undisclosed losses in equally numerous spots.

But then, if this be what a balance-sheet ought to be, it will break down under the next demand that Sir Josiah makes upon it. "Has the shareholder," he proceeds to ask, "who wishes to sell his holding no rights as to some real knowledge of the value of what he is selling?" And this surely must mean that the balance-sheet ought to show not what has been spent upon the assets, but what they ought to be expected to fetch, if sold; or to cost, if they had to be replaced. If this be the true basis of a balance-sheet, a company would not only be entitled, but obliged, in times of rapidly rising prices, to write up the value of those assets which had risen in price.

Equally confusing to the layman, who endeavours to cull wisdom from the sayings of these learned authorities, are the observations of Mr. Pixley in his Duties of Auditors that has


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 gone through so many editions. In his chapter on the Credit side of Balance-sheets, he begins by insisting that there are strong reasons for not calling it the Assets side, and says the "professional accountants, who themselves used the term for many years, have lately been impressed at the meaning endeavoured to be put upon it, it never having previously occurred to them that anyone could truthfully assert that they believed that the amounts opposite the items on the credit side of a balance-sheet were their realizable actual value."

But this actual realizable value seems to be just what Sir Josiah Stamp thinks that a shareholder ought to be able to see. Moreover, Mr. Pixley himself, on the very next page, says that "at the same time it must not be understood that an auditor has simply to ascertain that the amounts taken credit for in the balance-sheet in respect of property or assets are merely their book values. Prior to the auditor commencing his duties, the figures to be inserted in respect of these items have, of course, to be settled by the directors, and the groundwork upon which they have to arrive at the figure to be taken credit for in respect of each item is, of course, the balances of the Ledger Accounts. This is also the basis from


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 which the auditor starts in his endeavour to satisfy himself that the amount finally decided upon by the directors is, or is not, correct." He starts from the book values, but the use of this word evidently implies that he does not stop there. Where does he go next, and where does he arrive finally, and by what test does he satisfy himself that the figure finally decided upon by the directors is, or is not, "correct"?

If the realizable value of the assets is what ought to be shown, it is evidently a matter of guesswork because the realizable value of anything, except a very few securities and commodities in which there is a quoted price and a really free market, can only be known by taking it into the market and selling it. Moreover there will be a very great difference in the guesses that we shall make at it, according as we decide whether realizable value is to be old iron, scrap-heap value, or value as a going concern. If, by a great effort of the imagination, one could conceive the Bass brewery as a derelict failure, the value of its site, buildings, machinery, plant, book debts would be x; the value of these items as parts of a great concern that is earning a profit of nearly half a million pounds a year, is, or may fairly be argued to be, x multiplied by something considerable. But


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 as to what this "something considerable" should be, is a matter in which opinions will differ enormously. And the question is all the more complicated because it will clearly depend on the rate of profit being earned, and the rate of profit depends on the view that is taken concerning the value to be placed on the assets.

For if the figures of the assets, or the items on the creditor side, need to be reduced or raised in order to be a "correct statement," the difference between the assets and the liabilities will be altered, and this difference is what makes profit.

Let us see by means of a very much simplified example, how the process works of arriving at profit. Let us suppose a little company starting with a balance-sheet like this:

At the end of its first year it has worked up its stock and sold it for £100,000, paid £20,000 in wages, taxes and all other expenses and replaced its material at a cost of £50,000. It has (in order to simplify) worked entirely on a cash basis and so has received £100,000


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 and paid out £70,000 and its position will be stated thus when the directors come to draw up the balance-sheet for public issue.

The amount of net profit finally shown will depend entirely on the view that the directors take about the figures to be put into the final balance-sheet against the items on the credit side apart from cash, which is a known quantity. Material may have fallen in value since they bought it and there may be much discussion as to whether it ought to be written down by io per cent., by 20 per cent. or by nothing at all. The machinery and plant, being brand new, some will argue that there is no need to write them down at all, while the more prudent will urge that their ultimate destiny is the scrap-heap, that the mere fact that they have done a year's work takes about 50 per cent. off their value for selling purposes and that a start ought to be made at once with the writing down process.

If compromise is finally reached on the basis of a 5 per cent. all round reduction in


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 the doubtful assets, the balance-sheet will be drawn up thus:

If no writing down is decided on, the profit will remain at the original £30,000; if 10 per cent. is taken off the doubtful items, it will come down to £10,500.

This simplified example shows us that the profits shown as earned by all profit-earning concerns, depend ultimately on what the directors think about the figure to be set upon those assets in the balance-sheet, the value of which cannot from their nature be definitely ascertained, without the expensive and tedious process of expert valuation which also is liable to error. The opinion of the directors is subject to comment by the auditors and criticisms by the shareholders, but, as a general rule, their decision is final. As has been shown, the problem that they have to consider lends itself to argument, and is open to wide differences of opinion on the part of people who are honestly trying to do the right thing; and the conclusion of these honest, but fallible, gentlemen decides the profit that is earned.


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 It may be said that their decision can only modify the amount of profit shown, and could not make a loss into a profit. Ultimately and in the long run, this is certainly true, for bad finance brings its day of reckoning; but the day is often delayed, and in the meantime book-keeping agility can perform wonderful feats.

Moreover it must be noted that a particularly clear and simple balance-sheet was chosen as the specimen for examination. In those of the great industrial combines, whose assets consist largely of securities of other companies, all the doubts and difficulties that have faced us are many times multiplied.

What is the practical conclusion to be drawn by the investor? It seems to me to be this, that since the value placed on most of the assets of a balance-sheet is, to a great extent, a matter that can only be guessed at, and is actually arrived at by the opinion of the Board of Directors, the most important asset that a company can possess, after, and perhaps even before, the technical efficiency in production that its business requires, is an honest and prudent Board. Fortunately this asset is possessed by the great majority of companies, because without it they would very soon perish. But there are degrees, and the personality of


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 the Board and the traditions under which they conduct what may be called the balance-sheet side of the business is not only of the highest importance, but is also a matter on which the ordinary investor is likely to have even less information than upon the conditions and prospects of any enterprise in which he is interested.

Having thus bewildered and puzzled ourselves by trying to discover what a balance-sheet is meant to convey and finding that on its credit it consists chiefly of figures that may be too low or may be too high, but are almost certain to be an inadequate guide to the value of the business, let us go back to the Bass balance-sheet and see what sort of reply the Board would make to the observations of the ultra-critical critic which were set forth above.

They would probably admit

(1) That the figures set against most of the assets can only be arrived at by taking their cost price and writing off from it whatever sums the Board thinks right to deduct for depreciation and that consequently these figures are a matter of the Board's opinion. Nevertheless they would say


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 (2) That a good and honest Board, such as most companies possess, assisted by the highly trained skill of the auditors, does its best to make full and sufficient provision for depreciation and is in fact likely to err on the side of providing too much rather than too little, with the result that they are flayed by Sir Josiah Stamp for having "hidden reserves" and "profits tucked away";

(3) That since there can be no certitude, it is surely better to understate rather than overstate the value of doubtful assets; and that a good balance-sheet should try to state them at, or below, their realizable value.

(4) That all the dismal vaticinations of the imaginary and imaginative critic about the day when England will be dry and Bass will be brewing ginger beer, and all the present breweries, tied houses, plant, stock, goodwill and book debts will be of problematical value, is beside the mark; because a balance-sheet is not meant to be a prophecy showing what the business is going to be doing in twenty years' time, but a picture of its condition to-day and that all that a


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 Board can do is to draw that picture as accurately as it can.

(5) That as to goodwill, the balance-sheet might easily have been made prettier in the eyes of many critics, if instead of amassing a Reserve of £950,000 the Board had written off, as they could evidently have easily done, the whole of the £800,000 at which goodwill is valued. But that nevertheless under modern conditions of industry selling power is almost, if not quite, as important as power to make a good article, that a Bass label on a bottle has a quite miraculous power as a seller, and in short that if there be any enterprise in the world that has a right to set out its goodwill as a valuable asset, that enterprise is Bass's brewery.

After which the chastened investor, having discovered that the soundness of a balance-sheet depends chiefly on that of the Board, as to which he is largely in the dark, and that he cannot expect it to tell him the future, which is what he really wants to know, may well ask whether nothing can be done to make balance-sheets more informing, and, if not, what other


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 test he can take if he tries to judge for himself concerning the prospects of a company. Before we try to answer these questions let us see what light is thrown on the question by the Profit and Loss Account.


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the year ending June 30, 1925, Messrs. Bass, whose balance-sheet has already been the subject of our study, published the profit and loss account on page 131, which was attached to the balance-sheet and the directors' report.

On one side we see the receipts of all kinds, less certain expenses, plus the balance brought forward from the previous year; on the other, the payments that have been made, including interim dividend on ordinary shares, and the provisions made for depreciation, etc.; and the two sides tally by the addition to the payments and provisions of the sum that is left over to be carried to the balance-sheet.

A profit and loss account thus shows us the process by which the figures of the balance-sheet are produced, by giving us, among other things, the sums deducted from the book values of property, investments and debts due;


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110Rh whereas in Japan there is a property qualification which restricts the franchise to about 25 per cent of the adult males. This, however, is a small matter compared to the fact that the Mikado's power is far less limited than that of the Kaiser was. It is true that Japan does not differ from pre-war Germany in the fact that Ministers are not responsible to the Diet, but to the Emperor, and are responsible severally, not collectively. The War Minister must be a General, the Minister of Marine must be an Admiral; they take their orders, not from the Prime Minister, but from the military and naval authorities respectively, who, of course, are under the control of the Mikado. But in Germany the Reichstag had the power of the purse, whereas in Japan, if the Diet refuses to pass the Budget, the Budget of the previous year can be applied, and when the Diet is not sitting, laws can be enacted temporarily by Imperial decree—a provision which had no analogue in the German Constitution.

The Constitution having been granted by the Emperor of his free grace, it is considered impious to criticize it or to suggest any change in it, since this would imply that His Majesty's work was not wholly perfect. To understand the Constitution, it is necessary to read it in conjunction with the authoritative commentary of Marquis Ito, which was issued at the same time. Mr. Coleman very correctly summarizes the Constitution as follows :—

Article I of the Japanese Constitution provides that "The Empire of Japan shall be reigned over and governed by a line of Emperors unbroken for ages eternal."

"By reigned over and governed," wrote Marquis Ito in his Commentaries on the Constitution of Japan, "it is meant


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 {| style="text-align: left; font-size: 92%; margin: auto; padding: 2em;" ! colspan="2" style="text-align: left; font-variant: small-caps;" | Dr. ! colspan="2" style="text-align: right; font-variant: small-caps;" | Cr.
 * + Balance Sheet as at June 30, 1924
 * To rents, rates, taxes, insurance and compensation fund || £197,387
 * By sales of ale, stout, and sundry products, less manufacturing and cooperage expenses, excise duty, brewing licences, and carriage || £1,267,630
 * To repairs and renewals of premises and plant || 98,388
 * By sundry rents, interest and dividends || 259,298
 * To depreciation of freehold and leasehold premises, licensed property and plant || 62,591
 * By transfer fees || 168
 * To salaries, travelling and agencies expenses, advertising, show cards, labels, stationery, law charges, retiring allowances, subscriptions, gifts, directors’ and auditors’ remuneration and sundries || 543,343
 * By balance brought forward, June 30, 1924 || 93,429
 * To interest || 7,058
 * To bad debts, reserve for doubtful debts, and depreciation of investments || 81,661
 * To interest on mortgage debenture stocks || 80,800
 * To dividends on preference stock || 68,000
 * To interim dividend of 3 per cent. on ordinary shares || 61,200
 * To balance carried to balance-sheet || 420,097
 * colspan="2" style="text-align: right;" | £1,620,525
 * colspan="2" style="text-align: right;" | £1,620,525
 * }
 * To interest on mortgage debenture stocks || 80,800
 * To dividends on preference stock || 68,000
 * To interim dividend of 3 per cent. on ordinary shares || 61,200
 * To balance carried to balance-sheet || 420,097
 * colspan="2" style="text-align: right;" | £1,620,525
 * colspan="2" style="text-align: right;" | £1,620,525
 * }
 * colspan="2" style="text-align: right;" | £1,620,525
 * colspan="2" style="text-align: right;" | £1,620,525
 * }
 * }


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 those sums are deducted out of the revenue of the company, in order to provide for depreciation of property through wear and tear and obsolescence, for decline in the prices of investments, and for default, whole or partial, on the part of debtors. The result of the process is that the figures at which the assets affected stand in the balance-sheet are reduced and so the margin between liabilities and assets, which constitutes the balance available for distribution, is reduced likewise.

This one shows the imposing total of over a million and a quarter of gross profit, from sales of the company's product, less the cost of producing and conveying it and the charges made by the Inland Revenue for excise duty and brewing licences. A curious inquirer would have liked to see a little more—to have been told what was the sum of the gross sales and how much was taken off under each of the headings into which the expenses were divided. The answer of the Directors would no doubt be that they cannot be expected to give away information which might be valuable to their rivals. This answer must be accepted under present conditions. Perhaps the day will come when the growing curiosity of Labour concerning the nature and extent of profit, and the emphasis now laid on profit sharing


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 schemes as a solution for industrial unrest, will oblige all employers to publish really full and informing accounts, observing definite and accepted rules for the treatment of depreciation. But that is another story.

Rents, interest and dividends (presumably from the licensed premises and investments owned by the company) bring in £259,000 odd and with the trifle received on transfer fees (charged by the company for registering transfers of its stocks and shares from one owner to another in its books) and the carry forward from the previous year, £93,429, the total receipts to be accounted for come to £1,620,525.

Looking at the other side of the account we find that what may be called inevitable charges under the headings

(1) rents, rates, taxes, insurance and compensation fund,

(2) salaries and all the other items bunched up with them (though subscriptions and gifts may perhaps be called optional),

(3) interest (presumably to creditors) and interest on debenture stocks,

absorb in all £828,588.

What may be called optional items—those about which the opinion of the directors as to


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 how much should be spent or allowed is the deciding factor—are

(1) repairs and renewals of premises and plant,

(2) depreciation of freehold and leasehold premises, licensed property and plant, and

(3) bad debts, doubtful debts and depreciation of investments.

These come to a total of £242,640.

It is in exercising their judgment on the reservation and allocation of this sum, which is enough in this case to pay nearly 12 per cent. on the company's ordinary capital, that the directors have to perform what is perhaps their most responsible duty. In their decision about it, and in parallel decisions which have to be made by all Boards of companies engaged in production, transport and commerce and in nearly all forms of finance, prudent Boards set aside sums that err on the side of over provision for depreciation of property and investments and for doubtful debts, and on the side of excessive lavishness in repairs and renewals so that the property may be always rather more than up to date.

Thereby they act in the best interests of the


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 property, the business, the shareholders and themselves; but their excess of virtue lays them open to the charge of putting away hidden reserves, tucking away profits and so forth. Of shareholders, who feel aggrieved on this score, one can only say, as the unwillingly sober sinner said of his completely incapacitated comrade, "I wish I 'ad 'alf 'is complaint."

Imprudent Boards hope for a more favourable opportunity for making fuller provision; fraudulent Boards, which are happily rare, deliberately make provision that they know to be insufficient; and so the amount of the profit that is carried to the balance-sheet is increased at the expense of the efficiency of the business and of the profits of future years, and to the ultimate undoing of the shareholders, and of the directors themselves if they were merely imprudent and in the end we may hope, though it is not safe to bet on it, even if they are fraudulent.

But surely there must be a middle course—a policy that will not write off too much or too little, but will give us the truth, the whole truth, and nothing but the truth?

What is Truth?' quoth jesting Pilate, and paused not for an answer." Who can say what is the strictly correct amount to spend


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111Rh that the Emperor on His Throne combines in Himself the Sovereignty of the State and the Government of the country and of His subjects."

Article 3 of the Constitution states that "the Emperor is sacred and inviolate." Marquis Ito's comment in explanation of this is peculiarly Japanese. He says, "The Sacred Throne was established at the time when the heavens and earth became separated. The Empire is Heaven-descended, divine and sacred; He is pre-eminent above all His subjects. He must be reverenced and is inviolable. He has, indeed, to pay due respect to the law, but the law has no power to hold Him accountable to it. Not only shall there be no irreverence for the Emperor's person, but also shall He neither be made a topic of derogatory comment nor one of discussion."

Through the Constitution of Japan the Japanese Emperor exercises the legislative power, the executive power, and the judiciary power. The Emperor convokes the Imperial Diet, opens, closes, prorogues, and dissolves it. When the Imperial Diet is not sitting, Imperial ordinances may be issued in place of laws. The Emperor has supreme control of the Army and Navy, declares war, makes peace, and concludes treaties; orders amnesty, pardon and commutation of punishments.

As to the Ministers of State, the Constitution of Japan, Article 55, says: "The respective Ministers of State shall give their advice to the Emperor and be responsible for it."

Ito's commentary on this article indicates his intention in framing it. "When a Minister of State errs in the discharge of his functions, the power of deciding upon his responsibilities belongs to the Sovereign of the State: he alone can dismiss a Minister who has appointed him. Who then is it, except the Sovereign, that can appoint, dismiss, and punish a Minister of State? The appointment and dismissal of them having been included by the Constitution in the sovereign power of the Emperor, it is only a legitimate consequence that the power of deciding as to the responsibility of Ministers is withheld from the Diet. But the Diet may put questions to the Ministers and demand open answers from them before the public, and it may also present addresses to the Sovereign setting forth its opinions.

"The Minister President of State is to make representations to the Emperor on matters of State, and to indicate,


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 on repairs and renewals or to provide for depreciation of investments that have no quotation, or for the doubtfulness of doubtful debtors? If you are going to answer that companies ought not to invest in securities that have no quotation, or lend money to debtors, who are doubtful, then you are putting a drag upon enterprise, which would make business on its present scale impossible. "Wise Venturing," wrote the great Lord Halifax, "is the most commendable Part of human Prudence. It is the upper Story of Prudence, whereas perpetual caution is a kind of underground Wisdom that doth not care to see the Light."

The book values of what may be called the arguable assets are originally the sums paid for land, buildings, machinery, plant and investments and the price of goods sold to buyers who were not in a position to make immediate payment for them. A sum paid for a piece of property is something definite to put down in an account, though within five minutes after it has been paid, and before the ink on the cheque is dry, the buyer may know in his heart that he has paid too much and that he has no right to credit himself with his asset at this figure if he is really making an estimate of what he is worth. It has probably


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 happened to most of us to fall in love with a house or a picture or a something and to have paid hastily the sum asked for it lest someone else should snap it up, while one is quite conscious that it would be very difficult to sell it again at anything like the same figure, unless one were fortunate enough to find an equally eager buyer.

In business such individual whims do not often exert much influence, but trade competition sometimes produces startling results, as for example when some years ago the breweries were bidding against one another for the possession of licensed premises which they wanted to acquire and confine to the sale of their own products by making them "tied houses."

If, then, original cost even in the year when the sum is paid for property is not always a figure that can be set against in a balance-sheet that aims at truth—if truth means realizable value—who shall say at what pace it ought to be written down in the years that follow or what is the figure to which it should finally be brought by the process of annual reduction? Evidently there is a great difference in this respect between one item and another. Of land, Mr. Leake says definitely that "for accounting purposes" it "should be


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 stated at cost, because the capital outlay thereon does not expire as it does in the case of wasting assets"; and again on a later page "Freehold land is not a wasting asset." Here at last we have a bedrock fact on high authority; and yet a heretic might suggest that freehold land is an asset which though it may not waste, very often changes in value. To say nothing of the land owned by a mining company, which exhausts it before it has done with it, because this is evidently an exceptional case, even a factory site may have its value seriously affected by the development of improved transport facilities elsewhere, or by a dozen other influences.

Leasehold land is an item which can be definitely calculated because it is known that so much has been paid for the use of it during so many years, at the end of which it will revert to the owner. Here then the directors and auditors have a question of simple arithmetic to work on, and all that they have to do, or to see done, is the setting aside of an annual sum which will wipe out the book value of leasehold land by the date of the expiry of the lease. But even here there is nearly always a necessity for provision, to an extent which is a matter of opinion rather


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 than of certainty, for possible liabilities and expenses at the termination of the lease.

Buildings are a difficult problem. At first sight it would seem that as long as they are well maintained in good working order and all necessary repairs are carried out, they are as good as new, and rather better, for the purposes of the business, because they and the business have grown used to one another and "found" themselves like the ship Dimbula in Mr. Kipling's story. But a business is not put away to mature like wine in a bottle—and even wine needs re-bottling at intervals. A business has to grow and its buildings seem to shrink like a schoolboy's clothes. At the present moment the Bank of England is rebuilding itself, and its determination, for artistic reasons, to preserve its old outside walls is probably adding considerably to the cost of the process.

As to rapidly wasting assets, such as machinery and plant, there is no doubt that they have to be written down fast because in a less or greater number of years they will be worn out; in some cases it is even possible to calculate the life of a machine with some approach to accuracy. But even then the question of obsolescence has to be considered. In some up-to-date works it is boasted that


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 no machine has ever been known to wear out because it has always been superseded by a better one, and sent to the scrap-heap long before it had ceased to work efficiently.

As to unquoted investments a rough value can be arrived at from the income received from them, though there may always be room for much argument as to the basis on which this income should be capitalized; and it may often happen that a holding of shares on which no dividend at all is received may bring indirect business advantages which should rightly figure in a balance-sheet which aims at truth. But the sum at which they ought to figure is a matter which may cause very wide differences of opinion.

And when we come to doubtful debtors, hope pulls one way and fear pulls the other, and who is to decide between them? Trade possibilities and the psychology of the debtor reacting on and confusing one another make them in some ways the most difficult problem of all. Yet Mr. Leake says that "it is comparatively easy to estimate the value of book debts, or of stock-in-trade, because such assets are likely to be turned into money within a short period of time." But the mere fact that provision has to be made not only for


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 doubtful debts but for definitely stated bad debts, seems to indicate that Mr. Leake's likelihood is not always a certainty.

Stock-in-trade should be capable of fairly close calculation if it be estimated on the basis of cost of materials plus cost of work put into it; but there is probably a considerable difference in the practice of one management and another in the care and caution with which these estimates are made.

Mr. Pixley, indeed, says that "The amount to be taken credit for in respect of stock is of supreme importance in many companies, as it is no exaggeration to state that it is frequently possible to double or treble the apparent profit, where the directors and manager together, or even the latter alone without the knowledge of the former, succeed in deceiving the auditor, and consequently the shareholders. The auditor cannot, of course, be held responsible for the value assigned to this stock, as it is manifestly impossible that he should, even if he were qualified, be able to take or to check the actual measurement or counting of stocks, whether of raw materials or manufactured articles, either by number, weight, or otherwise, but he must use reasonable discretion, when the valuation of the stock is handed to him in satisfying


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112Rh according to His pleasure, the general course of the policy of the State, every branch of the administration being under control of the said Minister. The compass of his duties is large, and his responsibilities cannot but be proportionately great. As to the other Ministers of State, they are severally held responsible for the matters within their respective competency; there is no joint responsibility among them in regard to such matters. For, the Minister President and the other Ministers of State, being alike personally appointed by the Emperor, the proceedings of each one of them are, in every respect, controlled by the will of the Emperor, and the Minister President himself has no power of control over the posts occupied by other Ministers, while the latter ought not to be dependent upon the former. In some countries, the Cabinet is regarded as constituting a corporate body, and the Ministers are not held to take part in the conduct of the Government each one in an individual capacity, but joint responsibility is the rule. The evil of such a system is that the power of party combination will ultimately overrule the supreme power of the Sovereign. Such a state of things can never be approved of according to our Constitution."

In spite of the small powers of the Diet, it succeeded, in the first four years of its existence (1890–94), in causing some annoyance to the Government. Until 1894, the policy of Japan was largely controlled by Marquis Ito, who was opposed to militarism and Chauvinism. The statesmen of the first half of the Meiji era were concerned mainly with introducing modern education and modern social organization; they wished to preserve Japanese independence vis-à-vis the Western Powers, but did not aim, for the time being, at imperialist expansion on their own account. Ito represented this older school of Restoration statesmen. Their ideas of statecraft were in the main derived from the Germany of the 'eighties, which was kept by Bismarck from undue adventurousness. But when the Diet proved


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 himself that it has been arrived at in a systematic manner. . . . In some cases it is desirable to ascertain whether much of the stock has been on hand for a long period; as it may lead the auditor to form the opinion that the price taken credit for should be reduced, either owing to depreciation in the goods themselves, or to the inability of the manufacturer to sell at former prices."

Incidentally it may be observed that all these endeavours recommended by Mr. Pixley to the auditor seem to be designed to secure that this asset shall be stated at the "realizable" value, which, as we saw above, was maintained by him as not being the true meaning of the figures set against the items on the credit side of a balance-sheet.

Everyone, however, will agree that the auditors cannot possibly be expected to value the whole property of the company every year before they certify the balance-sheet. We can expect them to verify the cash and check the prices of the quoted securities. Beyond that, although their skill and discretion and experience may be of immense service to shareholders, we cannot expect more from them than what they claim to have done in the usual


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 form of certificate; that is, to have examined the balance-sheet and obtained all the information and explanations that they required, and decided that the balance-sheet is "properly drawn up so as to exhibit a true and correct view of the state of the company's affairs according to the best of our information and the explanations given to us, and as shown by the books of the company."

As to goodwill, opinion concerning the value of this item in a balance-sheet varies from the austere severity which argues that it ought to be written off altogether because there is nothing tangible behind it, to the more lenient judgment which considers that, however intangible, goodwill, which represents the reputation and popularity of a business and its products, is in some ways the most valuable possession that an enterprise can build up or acquire. Volumes might be written on the subject. Here it is enough to remind those who lay stress on the value of goodwill that this value, great as it undoubtedly is as long as the business is successful and the product is popular, dwindles very fast if the wind of popular favour shifts.

Enough has been said to show the investor that if he hopes by the scrutiny of balance-sheet and profit and loss account to arrive at


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 conclusions concerning the position of an industrial company, he is only examining a set of figures, many of the most important of which merely express the opinion of the Board and management, subject to examination necessarily limited in scope by the auditors.

It may be possible to check the value of the Board's opinion by looking up its members in the Directory of Directors, seeing what are the other companies that they help to rule and investigating their prosperity. Investors are often advised to cultivate this system and it certainly has its value. But it does not take us very far because the best directors are often those who confine their attention to one or two companies, the affairs of which they understand thoroughly, and consequently have no extended record to show whether they are consistent winners. If, nevertheless, the investor determines to use the balance-sheet as a guide he should be careful to study it in comparison with its predecessors; and to facilitate this comparative study balance-sheets might all be drawn up, as some are now, to show the figures of yesteryear, side by side with those of to-day.

It is true that by this method the student may be multiplying the possibility of error, because the policy of the company in the treatment of its arguable assets may have