Historically, governments have fostered and encouraged credit expansion to a great degree. They have done so by weakening the limitations that the market places on bank credit expansion. One way of weakening is to anesthetize the bank against the threat of bank runs. In nineteenth-century America, the government permitted banks, when they got into trouble in a business crisis, to suspend specie payment while continuing in operation.

With the establishment of fiat money by a State or by a World State, it would seem that all limitations on credit expansion, or on any inflation, are eliminated. The central bank can issue limitless amounts of nominal units of paper, unchecked by any necessity of digging a commodity out of the ground. They may be supplied to banks to bolster their credit at the pleasure of the government. No problems of internal or external drain exist.

Inflation, in recent years, has been generally defined as an increase in prices. This is a highly unsatisfactory definition. Prices are highly complex phenomena, activated by many different causal factors. They may increase or decrease from the goods side—i.e., as a result of a change in the supply of goods on the market. They may increase or decrease because of a change in the social demand for money to hold; or they may rise or fall from a change in the supply of money.

In chapter 11, we depicted the workings of the monetary system of a purely free market. A free money market adopts specie, either gold or silver or both parallel, as the “standard” or money proper. Units of money are simply units of weight of the money-stuff. The total stock of the money commodity increases with new production (mining) and decreases from wear and tear and use in industrial employments. Generally, there will be a gradual secular rise in the money stock, with effects as analyzed above.

We have already seen in chapter 8 what happens when there is net saving-investment: an increase in the ratio of gross investment to consumption in the economy. Consumption expenditures fall, and the prices of consumers’ goods fall. On the other hand, the production structure is lengthened, and the prices of original factors specialized in the higher stages rise.

In the previous section we have presented the basic process of the business cycle. This process is often accentuated by other or “secondary” developments induced by the cycle. Thus, the expanding money supply and rising prices are likely to lower the demand for money. Many people begin to anticipate higher prices and will therefore dishoard. The lowered demand for money raises prices further.