F. The Ultimate Limit: The Runaway Boom

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. And if there existed a World State, or a co-operating cartel of States, with a world bank and world paper money, and gold and silver money were outlawed, could not the World State then expand the money supply at will with no foreign exchange or foreign trade difficulties, permanently redistributing wealth from the market’s choice to its own favorites, from voluntary producers to the ruling castes?

Many economists and most other people assume that the State could accomplish this goal. Actually, it could not, for there is an ultimate limit on inflation, a very wide one, to be sure, but a terrible limit that will in the end conquer any inflation. Paradoxically, this is the phenomenon of runaway inflation, or hyperinflation.

When the government and the banking system begin inflating, the public will usually aid them unwittingly in this task. The public, not cognizant of the true nature of the process, believes that the rise in prices is transient and that prices will soon return to “normal.” As we have noted above, people will therefore hoard more money, i.e., keep a greater proportion of their income in the form of cash balances. The social demand for money, in short, increases. As a result, prices tend to increase less than proportionately to the increase in the quantity of money. The government obtains more real resources from the public than it had expected, since the public’s demand for these resources has declined.

Eventually, the public begins to realize what is taking place. It seems that the government is attempting to use inflation as a permanent form of taxation. But the public has a weapon to combat this depredation. Once people realize that the government will continue to inflate, and therefore that prices will continue to rise, they will step up their purchases of goods. For they will realize that they are gaining by buying now, instead of waiting until a future date when the value of the monetary unit will be lower and prices higher. In other words, the social demand for money falls, and prices now begin to rise more rapidly than the increase in the supply of money. When this happens, the confiscation by the government, or the “taxation” effect of inflation, will be lower than the government had expected, for the increased money will be reduced in purchasing power by the greater rise in prices. This stage of the inflation is the beginning of hyperinflation, of the runaway boom.128

The lower demand for money allows fewer resources to be extracted by the government, but the government can still obtain resources so long as the market continues to use the money. The accelerated price rise will, in fact, lead to complaints of a “scarcity of money” and stimulate the government to greater efforts of inflation, thereby causing even more accelerated price increases. This process will not continue long, however. As the rise in prices continues, the public begins a “flight from money,” getting rid of money as soon as possible in order to invest in real goods—almost any real goods—as a store of value for the future. This mad scramble away from money, lowering the demand for money to hold practically to zero, causes prices to rise upward in astronomical proportions. The value of the monetary unit falls practically to zero. The devastation and havoc that the runaway boom causes among the populace is enormous. The relatively fixed-income groups are wiped out. Production declines drastically (sending up prices further), as people lose the incentive to work—since they must spend much of their time getting rid of money. The main desideratum becomes getting hold of real goods, whatever they may be, and spending money as soon as received. When this runaway stage is reached, the economy in effect breaks down, the market is virtually ended, and society reverts to a state of virtual barter and complete impoverishment.129 Commodities are then slowly built up as media of exchange. The public has rid itself of the inflation burden by its ultimate weapon: lowering the demand for money to such an extent that the government’s money has become worthless. When all other limits and forms of persuasion fail, this is the only way—through chaos and economic breakdown—for the people to force a return to the “hard” commodity money of the free market.

The most famous runaway inflation was the German experience of 1923. It is particularly instructive because it took place in one of the world’s most advanced industrial countries.130 The chaotic events of the German hyperinflation and other accelerated booms, however, are only a pale shadow of what would happen under a World State inflation. For Germany was able to recover and return to a full monetary market economy quickly, since it could institute a new currency based on exchanges with other pre-existing moneys (gold or foreign paper). As we have seen, however, Mises’ regression theorem shows that no money can be established on the market except as it can be exchanged for a previously existing money (which in turn must have ultimately related back to a commodity in barter). If a World State outlaws gold and silver and establishes a unitary fiat money, which it proceeds to inflate until a runaway boom destroys it, there will be no pre-existing money on the market. The task of reconstruction will then be enormously more difficult.

• 128Cf. the analysis by John Maynard Keynes in his A Tract on Monetary Reform (London: Macmillan & Co., 1923), chap. ii, section 1.
• 129On runaway inflation, see Mises, Theory of Money and Credit, pp. 227–31.
• 130Costantino Bresciani-Turroni, The Economics of Inflation (London: George Allen & Unwin, 1937), is a brilliant and definitive work on the German inflation.