CHAPTER XIII

CENTRAL AMERICAN PUBLIC FINANCE

Sources of Revenue--Defects of the Fiscal Systems--Floating Debts--Brief History of the Bonded Debt in Each Republic--Depreciation of the Currency Systems--The Monetary Situation in Each Country--Need for Financial Assistance from the United States.

Few factors have done more to retard the economic progress of the Central American republics than the defects of their fiscal systems. The inability of the governments to meet the current expenses of efficient administration or to discharge their obligations to foreigners, and the demoralization of the monetary systems which has resulted from attempts to make the depreciation of the currency a source of revenue, have been a serious drawback to the investment of capital and the development of commerce in the Isthmus, and have involved some of the five countries in rather serious diplomatic complications. This financial weakness has been due partly to the nature of the governments’ incomes, partly to defects in administration, arising from ignorance or dishonesty, and partly to general economic and political conditions.

Each of the five republics obtains its revenues principally from customs duties, on exports and imports, and from the rum monopoly. Other sources of income, of which the most important are tobacco and powder monopolies and stamp taxes, amount to very little as compared with these two great items. Direct property taxes, the introduction of which has at times been attempted in Guatemala, Nicaragua, and Costa Rica, have met with very little success, and have been very unpopular.

This fiscal system has many bad features. The duties upon imports, upon which the chief reliance is placed, are so high that they seem in many cases to discourage commerce. This is especially true in regard to the cheap textiles and other articles used by the working classes, for the imposition of the duty according to the gross weight of the package, and the failure to make adequate distinction between different qualities of the same category of articles, raises the prices of some goods to a point where consumption is materially lessened. There are still stronger objections to the second great source of revenue, the manufacture and sale of _aguardiente_, or rum, for as in other countries where similar monopolies have existed the temptation to stimulate the consumption of the liquor has in some cases proved stronger than consideration for the welfare of the community. In view of the relation between drink and vice and crime, which is nowhere more directly evident than among the working classes of the Isthmus, it is hard to understand how the public authorities can not only permit but encourage the unrestricted sale of what is little more than a low grade of alcohol. Some of the governments, indeed, have endeavored by raising the price of the _aguardiente_ to check its consumption, and have done so without materially decreasing their own income, but with the majority the object has seemed to be to sell a large amount at a low price rather than the opposite.

The following table shows the revenues of each of the five republics in 1913, the last year before the general financing disorganization caused by the European war:

Revenues in 1913. (Approximate equivalent in American gold.)

Source of revenue Guatemala Honduras Salvador Nicaragua Costa Rica

Import duties 1,930,000 1,130,000 2,900,000 1,680,000[78] 2,500,000

Export duties 1,275,000 88,000 600,000 112,000

Liquor and other monopolies 450,000 775,000 1,200,000 1,368,000 1,150,000

State owned railways, telegraphs, postal service, etc. (Gross income) 200,000 140,000 285,000 500,000

Miscellaneous 325,000 377,000 615,000 317,000 208,000 --------- --------- --------- --------- --------- Total revenues 4,180,000 2,500,000 5,600,000 3,355,000 4,470,000

The way in which the Central American governments spend their income has already been described. The heaviest outlays are those for military purposes and for the service of the foreign debt. The following table shows roughly the division of the expenditures between the different departments of the administration:

Expenditures in 1913. (Approximate equivalent in U. S. gold.)

Department Guatemala Honduras Nicaragua Salvador Costa Rica _Gobernación_ 220,000 320,000 208,000 860,000 380,000 Public works 130,000 287,000 902,000 600,000 695,000 Public instruction 180,000 152,000 159,000 354,000 635,000 War and marine 520,000 720,000 410,000 1,600,000 627,000 Finance and public credit 475,000 185,000 385,000 2,150,000 1,320,000 Charities * * 9,600 500,000 80,000 Judiciary * 70,000 127,000 280,000 325,000 Miscellaneous 695,000 26,000 2,800,000 126,000 211,000 --------- --------- --------- --------- --------- Total expenditures 2,320,000 1,750,000 4,809,000 6,470,000 4,273,000

* Not specified.

Note. The miscellaneous expenditures include items of nearly $500,000 for “exchange,” i. e. for buying drafts on foreign places, in Guatemala, and of $1,680,000 for paying claims arising from recent revolutions in Nicaragua.

The revenues are decreased, and the expenditures are increased, in some countries to an alarming degree, by inefficiency and corruption in their administration. The control of the public funds is almost entirely in the hands of the President and his subordinates, for the voting of taxes and of the budget by Congress is a very perfunctory matter even in those countries which have most nearly attained constitutional government in other respects. The income is derived from sources which remain much the same from year to year, and its disposition is subject to little control by the Congress, because the annual financial legislation does not always appropriate specific sums for specific purposes, but simply divides the estimated expenditure between the various departments. The administration, moreover, does not seem to regard itself as bound to keep within the general limits laid down if it can obtain funds for additional outlays. The Congress, which is rarely in a position to oppose itself to the wishes of the executive in this or in other matters, usually ratifies excess expenditures or proposed changes in the budget with little question.

In some of the countries, there is undoubtedly a large amount of corruption in the management of financial affairs. The traditions of the public service encourage rather lax conduct on the part of the officials, for custom and public opinion tolerate many practices which are now considered improper in countries which have had a longer experience in self-government, and those who are unscrupulous are aided in defrauding the government by the inadequate provision which is made for the supervision of accounts. The commonest forms of graft are those which imply a rather loose standard of official morality rather than actual theft or dishonesty, but it cannot be denied that there are many officials, some of whom occupy the highest positions in their respective countries, who have enriched themselves during their tenure of office by means which nothing could excuse. Few such men, fortunately, occupy positions of power in the five republics at the present time.

The chief fault of Central American public finance is the indifference shown in regard to the balancing of revenues and expenditures. The governments frequently pay salaries and other obligations with receipts rather than with money. This practice gives rise to many abuses, for often the receipts can be cashed only by persons having influence with the authorities of the treasury department, and thus become a source of graft. Certain governments, indeed, make it a practice to buy their own promises to pay at a discount, after depreciating them by refusing to redeem them at their face value. The floating debt, which ordinarily bears a very high rate of interest, is always an indefinite but steadily increasing quantity, comprising a great variety of obligations. It includes claims for salaries and for supplies furnished to the government, for damage to property during revolutions, for violated concessions and contracts, and other demands of every degree of validity. Some of these are paid off from time to time as the condition of the treasury permits, but no provision is made for the service or amortization of the internal debt as a whole.[79]

Each of the five republics has also a bonded debt, held for the most

## part in England. In most cases this dates back to the loan of £163,000

contracted in London by the officials of the first Central American Federation. Costa Rica and Salvador paid off their share of this after they became independent, but the other states, after defaulting for several years, eventually made arrangements for refunding the bonds with new loans. At the same time, further issues were made, chiefly for the construction of railways, during the period of prosperity and inflation which accompanied the first development of the coffee plantations in the seventies and eighties. These were often accompanied by fraud, in which both the officials of the Central American governments and the companies which floated the bonds participated, and which in some cases reached immense proportions. The service of the foreign debts became very difficult when the coffee prices fell, and when the decline in the price of silver, upon which the monetary systems of the Isthmus were based, greatly increased the amount of the debt in terms of the national currency without proportionately increasing the national revenues. During the decade 1890-1900, nearly all of the republics found it impossible to maintain regular payments of interest. New arrangements were therefore made with the creditors, who were forced to accept successive reductions of their claims, amounting in some cases to a large proportion of the total, in order to obtain any payment at all. These readjustments, with the partial repudiation which they involved, naturally injured severely the credit of the five countries.

Guatemala has until very recently been involved in almost continuous difficulties with her creditors. Her share of the debt of the Central American Federation remained in default until 1856, when it was refunded with the accrued interest into a new five per cent loan of £100,000. In 1869 another loan of £500,000, issued at 70¹⁄₂ and bearing interest at six per cent, was issued through a London banking house. Both loans went into default in 1876. They were refunded in 1888 by a bond issue of £922,700, bearing four per cent interest, and another issue was made at the same time to consolidate the internal debt. The Republic again failed to meet its obligations to its creditors in 1894, and the latter were forced to accept a further reduction of their claims. By an arrangement made in 1895, both the external and internal bonds were refunded by a new issue of £1,600,000, at four per cent, secured by a special tax of $1.50 gold on each bag of coffee exported. These bonds now constitute the principal foreign debt of the Republic. The government soon violated the terms of the agreement under which they were issued, for the coffee export tax was reduced in 1898 and 1899, and its proceeds were used for other purposes than the service of the loan. Payments of interest were suspended from 1898 to 1913. After several fruitless attempts to reach an agreement, the bondholders finally secured the resumption of payments through the energetic diplomatic intervention of the British government, and the interest has been met regularly since 1913. The principal, on December 31, 1915, amounted to £2,357,063.[80]

Salvador had paid off her share of the federal debt in 1860, by a compromise with the holders of the bonds. In 1899, a loan of £300,000 at six per cent and in 1892 another of £500,000 at six per cent were obtained from bankers in London for the purpose of extending the railway line from Acajutla to Santa Ana and San Salvador. These were secured by mortgages on the railway. In 1894 the service of the loans was assumed by the Central American Public Works Company, which took over the railway for eighty years in return for a promise of an annual subsidy from the government and a guarantee of a minimum annual profit. In 1899 this company entered into another contract with the Republic, by which it agreed to retire on its own account all of the 1889 and 1892 bonds, converting them into five per cent mortgage debentures of the Salvador Railway Company, which had been formed to take over the concessions held by the Public Works Company. The Railway Company was to receive a fixed annual subsidy of £24,000 for eighteen years. In this way the bonds ceased to be obligations of the Republic. The only foreign bonded debt of Salvador at the present time is the issue of six per cent sterling bonds secured through two London banks in 1908. On January 1, 1916, £756,900 out of the original £1,000,000 were still outstanding. The service of these was suspended after the outbreak of the European war, but an arrangement was made with the bondholders by which the coupons from August, 1915, to August, 1919, were to be funded into new bonds bearing seven per cent interest.

Costa Rica, which had paid off her share of the Central American debt in full immediately after the dissolution of the Federation, contracted two loans in London,--one of £1,000,000 at six per cent in 1871, and the other of £2,400,000 at seven per cent in 1872,--during the first years of General Guardia’s administration. From the two, it is said that the Republic received a total sum of £1,158,611, 18 s, 5 d,[81] the rest being kept by the speculators who arranged the transaction. The service of the debt was suspended in 1874. In 1885 a new arrangement was made through Mr. Minor C. Keith, by which the old bonds were refunded at one half their face value by a new issue of £2,000,000 at five per cent. The interest was to be paid by Mr. Keith until 1888, in return for concessions in regard to the railroad which he was building, and after that date by the government. The service of the debt was suspended from 1895 to 1897, when a new agreement was made by which the rate of interest was reduced and the unpaid coupons were exchanged for certificates at forty per cent of their face value. Payments were resumed and were maintained until October, 1901, when a financial crisis caused by high rates of exchange and falling coffee prices again forced the government to suspend them. For nearly ten years the bondholders were put off, usually on the ground that the Republic was unable to pay as much as its creditors asked. Each administration made an effort to settle the matter by securing a reduction of the debt, but refunding contracts made with Speyer and Company in 1905 and with the National City Bank of New York in 1909 were rejected by the Congress. Finally, however, the pressing need for refunding the internal debt, which bore ruinous rates of interest and was increasing alarmingly every year, led the government to make a new contract with Mr. Minor Keith in 1911. This provided for a bond issue of £1,617,200, bearing four per cent interest for the first ten years and five per cent thereafter, to refund entirely the principal and the unpaid interest of the old debt, which, even with the numerous previous reductions, amounted to £2,710,293 by the end of 1910. The creditors accepted the arrangement, and the bonds were taken by an international syndicate, formed by bankers in New York, London, Hamburg, and Paris. The interest was secured by the customs revenues, the administration of which was to be taken over by the syndicate in case of default. As soon as the Congress had ratified this agreement, another loan of 35,000,000 francs at five per cent, issued at eighty, and secured by a mortgage on the _aguardiente_ monopoly, was arranged in Paris for the payment of the internal debt. Since 1911, the service of these obligations has been maintained with scrupulous regularity. The total foreign debt of the Republic on December 31, 1915, was 31,478,392.27 colones, or $14,641,112.68 American gold.[82]

In Nicaragua, £285,000 in six per cent bonds secured by a mortgage on the National Railway had been issued in 1886. Payments were suspended on these in 1894, and an arrangement was made in 1895 by which the interest was reduced to four per cent. In 1904, another six per cent loan, to the amount of $1,000,000 gold, was negotiated with Mr. Weinberger of New Orleans. Both of these debts were paid in 1909 by means of an issue of £1,250,000 at six per cent contracted for by the Ethelburga Syndicate of London. The interest on the Ethelburga loan was reduced to five per cent in 1912, through the good offices of the two New York banking firms which had undertaken the reorganization of the currency, on condition that these firms continue to administer the customs revenues of the Republic, by which the bonds were secured. The total foreign debt of Nicaragua on December 31, 1915, was as follows:[83]

Ethelburga bonds (£1,179,620) $5,740,131 Debt to Brown Brothers and Seligman 1,060,000 ---------- Total $6,800,131

Honduras is now the only one of the Central American republics which has not effected some adjustment of its foreign debt. This country, on January 1, 1916, owed to foreign creditors the immense sum of £25,407,858,[84] arising from loans contracted in London and Paris in the years 1867-70. Bonds to a nominal value of £5,398,570, and bearing from five to ten per cent interest, were issued at that time for the construction of an interoceanic railroad from Puerto Cortez to the Gulf of Fonseca. The greater part of the money received from the investors in these securities seems to have been divided between the officials of the Republic and the promoters, with the result that the sum which finally found its way into the national treasury was sufficient only to build ninety kilometers of the railroad. The payments of interest, which until that time had been made out of the principal of the loan, were suspended in 1872, and the quotation of the bonds on the European exchanges dropped rapidly from 85¹⁄₂% to 1¹⁄₄% of their face value.[85] A few half-hearted efforts to enter into negotiations with the bondholders have been made during the years which have since intervened, but the Republic has shown little inclination to make good its obligations, and there have even been occasional propositions to repudiate the debt altogether, because of the fraud which accompanied its flotation. Meanwhile the government has been unable to make arrangements for the extension of the National Railway into the interior, because of the lien held by the bondholders upon the line, and it has also been unable to obtain new loans for carrying out other internal improvements. The foreign debt has thus been one of the principal factors which have retarded the Republic’s economic advance.

Early in 1909, a plan for the settlement of the debt was arranged by the British minister in Central America, but its consummation was prevented by the protest of the United States, which insisted that provision must at the same time be made for the adjustment of certain American claims. An arrangement suggested by J. P. Morgan and Company was therefore substituted for the British scheme. The New York bankers agreed to purchase the old bonds at the rate of £15 in cash for each £100 of the old bonds with their accrued interest, on condition that the United States government be a party to the agreement under which this was done. After some delay, a treaty was signed on January 10, 1911, by Secretary of State Knox and the Minister of Honduras at Washington, in accordance with which the United States was to assist Honduras in obtaining a loan secured by her customs duties, which were to be administered, until the bonds were paid, by a collector general nominated by the State Department. The treaty was rejected by the Honduranean Congress on January 31, 1911.[86] After the Bonilla revolution, another attempt was made to arrange for the loan, but there was such strong opposition to the treaty in the American Senate that nothing could be accomplished. In February, 1912, J. P. Morgan and Company withdrew from the negotiations, and a syndicate of New Orleans bankers took their place. The treaty, however, was never ratified, and the plan for a new loan was finally abandoned.

At the Pan American Financial Conference in May, 1915, the delegates from Honduras announced that their government was ready to increase the customs duties and the banana export tax to a point where they would yield an additional sum of $410,000 gold each year, which might be set aside for the service of the foreign debt. As the holders of the bonds have indicated their willingness to negotiate upon this basis, there seems to be reason to hope that an adjustment will eventually be brought about which will place the credit of the Republic on a sound basis.[87] Until this is done, it will be impossible to build railroads or to carry out the other internal improvements which are indispensable for the development of the country.

The failure of the Central American governments to fulfill their obligations to foreign creditors is not due entirely to a listless sense of national honor, for in many cases there has been serious doubt whether these obligations should be regarded as entirely valid. The circumstances under which the majority of the public debts were contracted were such that the governments have felt a strong reluctance to recognize their duty to repay them in full. The bonds, bearing heavy rates of interest, were usually purchased in the first place at a considerable reduction from their face value, and the speculators who floated them took advantage of the ignorance or the cupidity of the agents with whom they negotiated to defraud the borrowing governments of large sums. A large part of the product of the issue, in fact, seems in many cases to have been retained by the underwriters or divided by them with the Central American officials. Subsequent administrations were naturally unwilling to repay sums from which the country as a whole had never received the benefit, especially as the service of the loan involved a heavy and in some cases intolerable burden upon the impoverished treasury and deprived the government of resources which were sorely needed for the maintenance of order and the promotion of internal improvements.

One of the influences which have most disastrously affected the government finances and the credit of the Central American republics during the last generation has been the depreciation of their currencies. Until the last decade of the nineteenth century, the money of the Isthmus had been based upon the silver dollar, subdivided into eight _reales_ or one hundred cents. Each of the five countries had its own coinage, but foreign money, especially from other Latin American states, was ordinarily accepted at its face value. When the market price of silver declined, as it did with great rapidity after 1890, there was a serious disturbance both of the foreign commerce and of the finances and credit of the five governments, and this disturbance was intensified by a further depreciation of the currency, in Guatemala, Costa Rica, and Nicaragua, by the issue of irredeemable paper money. For a number of years, rates of exchange fluctuated widely, with a general upward tendency, and it became increasingly difficult for merchants to pay their bills in foreign countries and for the governments to meet the service of their loans. Costa Rica, and later Nicaragua, succeeded in establishing a currency on a gold basis, but in the other republics the situation grew more and more difficult until the outbreak of the European war in 1915. This catastrophe caused the rate of exchange upon New York to rise from 25 to 100 per cent in each of the five countries, and made necessary a suspension of payments upon the foreign debt in two of them.

Several causes have contributed to the disorganization of the Central American currencies. The fallacies which have at times caused unfortunate experiments with the monetary systems of other countries have been as attractive in Central America as elsewhere, and every financial or commercial depression has seen demands, which have usually been acceded to, for an increase in the circulating medium. The banks, whose notes form the larger part of the currency in each state, have been subject to little effective regulation, and have in some cases been abetted by the governments in flooding the country with worthless paper money. By unscrupulous speculation in foreign exchange, moreover, they have often done much to cause unnecessarily violent fluctuations in the premium on gold. At the present time, laws relieving the banks of their obligation to exchange their notes for gold or silver are in force in Guatemala, Salvador, Nicaragua, and Costa Rica. The factor which has done most to disorganize the monetary systems of the five republics, however, has been the inability of the authorities to resist the temptation to use the depreciation of the currency as a source of revenue. There is no easier method of raising money for pressing needs than the issue of government paper or the granting of special privileges to the banks in return for loans; and few of the countries have as yet learned that such a policy in the long run does far more harm than good.

The worst currency system of the Isthmus is that of Guatemala, where silver coin has entirely disappeared from the circulation within the last twenty years. On assuming office in 1898, President Estrada Cabrera found himself confronted by serious financial difficulties arising from the extravagance of his predecessor and the business depression from which all of the Central American countries were at the time suffering. In order to provide funds, the new administration resorted to what was practically an issue of unsecured paper money. In return for a large loan, drawn in part from the reserves which guaranteed their circulation, the banks were relieved of their obligation to redeem their notes in silver, and a large issue of new notes, guaranteed solely by the claims of the banks against the government, was made at the same time through the so-called _Comité Bancario_. Subsequent decrees made all debts payable in paper even though the contracts expressly provided for payment in silver. The redemption of the bank-notes has never been attempted, and further issues have been made from time to time until the amount in circulation, on January 1, 1916, was more than $160,000,000.[88] The money depreciated rapidly. Just before the outbreak of the European war, the paper _peso_ was worth about five cents in gold, but in August and September, 1914, the difficulty of obtaining drafts on foreign countries forced the rate of exchange from 20 to 1 to 40 to 1. It has remained approximately at this point since that time, although it has fluctuated considerably, sometimes rising or falling as much as thirty per cent within a few weeks.

The circulating medium is now in a very bad condition. The notes of the smaller denominations are dirty and torn almost beyond recognition, and in quantity they fall far short of supplying the necessities of commerce. The subsidiary coinage, which consists of nickel and copper pieces of 12¹⁄₂ and 25 cents, is also insufficient in quantity, and it is supplemented in ordinary transactions by tokens issued by business houses and municipalities, tram-car tickets, and postage stamps. This state of affairs naturally causes great inconvenience to persons engaged in commerce on a small scale.

The fluctuations in the rate of exchange make business transactions very difficult, for merchants who handle imported goods must change their prices from day to day if they are to avoid loss, and must at the same time face the greatly decreased purchasing power of the masses of the people when the money in which wages and salaries are paid depreciates. There is a growing tendency to quote prices and make transactions in United States currency, of which there is a large amount in circulation.

Proposals for reforming the currency have been made from time to time, but none of them have been taken up by the government. The reintroduction of a metal standard, in fact, has been opposed by one of the most influential classes in the community. The coffee planters and other employers of labor have benefited greatly by the rising rate of exchange. Despite the depreciation of the currency, they have raised the wages of their employees comparatively little, and the latter, bound by contracts from which the decline in their earning power made it more difficult than ever for them to escape, have been unable to protest. The result has been an enormous increase in profits, for wage costs have been reduced, while the coffee has continued to be sold for gold in the European and North American markets. The government also benefits by the present situation, for the revenues from the customs houses are received in gold, and the employees are paid in paper, with the result that there is a yearly increasing surplus in favor of the treasury. The effect of this condition on the morality of the underpaid officials has already been mentioned.

In Nicaragua, monetary conditions were much similar to those in Guatemala before the reform carried out by the New York bankers in 1912. President Zelaya had driven the silver out of circulation early in his administration by the issue of legal tender treasury notes, and the value of the _peso_, after his fall, had sunk to about five cents gold. The establishment of a new currency, under the 1911 treasury bills agreement, has been described in