17. Two Additional Considerations

On various historical occasions credit expansion has been used as an instrument to help finance the national budget deficit. This can occur in two ways: either banks may be instructed to acquire treasury bonds with part of their credit expansion, or the government may borrow money directly from banks. Though technically these are examples of credit expansion, here it does not directly influence the loan market, but rather acts as a perfect substitute for the creation of money. In fact in this case, credit expansion amounts to the simple creation of money to finance the public deficit and leads to the traditional effects of any inflationary process: an initial redistribution of income similar to that which follows any inflationary process; and a distortion of the productive structure, to the extent the government finances expenditures and public works which temporarily modify the productive structure and later cannot be permanently maintained via economic agents’ current spending on consumer goods and services. At any rate it is necessary to distinguish true credit expansion, which gives rise to an artificial boom and to the business cycle, from the mere creation of new money and the placing of it in the hands of the state, a procedure which exerts the effects typical of an inflationary tax.⁷⁹

Another final consideration relates to the international nature of business cycles. Economies as internationally integrated as modern ones usually are initiate credit expansion processes simultaneously, and the effects spread rapidly to all the world's markets. While the gold standard prevailed, each country's capacity for domestic credit expansion was automatically limited, and this limit was determined by the invariable outflow of gold from the relatively more inflationary economies. With the abandonment of the gold standard, the arrival of flexible exchange rates and the triumph of monetary nationalism, each country became able to freely adopt credit expansion policies, triggering an inflationary contest which pitted all countries against all others. Only a very large and integrated economic area comprising various nations which have renounced credit expansion and maintain among themselves fixed exchange rates will be able to free itself, relatively speaking (not completely), from the damaging effects of a general expansion of credit initiated outside its borders. Nevertheless the effects of inflation may be felt even inside this area if a flexible exchange rate is not established between it and the countries outside of it which suffer a process of monetary expansion. It is true that fixed exchange rates act as an (imperfect) substitute for the limits the gold standard set on each country's ability to independently expand its money supply in the form of loans. However this is consistent with the fact that the negative effect external expansion has on nations with more prudent monetary policies can only be lessened by the establishment of flexible exchange rates.

In any case the definitive elimination of economic crises will require a worldwide reform of the monetary system. Such a reform is outlined in the ninth and final chapter of this book.