The outstanding objection to the use of fiat money as a means for meeting an emergency is that the inflation of the currency causes a higher price level, which not only enhances the cost of the war - since the government must buy at the new level - but places a burden upon all who purchase goods. It is possible that borrowing will cause an inflation of purchasing power, and consequently an increase in prices, but just to what extent it is difficult to determine. Under the modern system of exchange a vast amount of purchases is made with credit, and to the extent that borrowing manufactures credit instruments which can be used directly or indirectly as purchasing power, a rise in prices will result. In so far as bonds are purchased with funds which would otherwise enter the market and command goods, this effect is not felt. The government has simply substituted itself as purchaser for the individual from whom the funds were secured.

Causes Expansion of Credit. - The expansion of credit from borrowing is likely to come through the institution of the modern bank. Individuals, spurred on by patriotic zeal, may secure credit accommodation which would not otherwise be considered, and turn this over to the government in exchange for bonds. The banks themselves have been relied upon extensively as aids to the government. The percentage of reserve has been decreased, frequently, in order to extend credit to the government. The government, in order to help the banks lend assistance to itself, has made deposits of specie on the implied condition that aid would be given. With this specie as a basis, several times as much credit could be extended in the purchase of bonds or certificates of indebtedness. The use of the obligations of the government, moreover, as the basis for the issue of bank notes, forms another means for the increase in purchasing media. The issue of the Federal Reserve Bank notes, based upon certificates of indebtedness, forms a good example of this form of transaction.1

From the nature of the case it is impossible to calculate just how much purchasing power exists because of the issue of evidences of indebtedness, which would not otherwise be found. Even if this could be accurately determined, to calculate the precise effects on prices would still be more or less of a conjecture because of the derangement in the production of commodities caused by the war. The fact remains, however, that it is quite likely that government borrowing will cause a perceptible expansion of purchasing power, and with it a consequent increase in the general price level.

Effects of Increased Price. - To the extent that borrowing increases prices, the effect is much the same as the issue of fiat money. The burden is increased to the government and, in varying degrees, to the citizenship. The materials for war are, to a large extent, purchased in the open market, and the inflated prices must, of course, be paid. While this burden may not be insignificant, it does not compare to that felt by the citizens, since they too must buy at the higher price level. Wages do not rise as rapidly as prices, thereby entailing a burden upon the laboring classes which often brings about a derangement of industry because of the increased prevalence of strikes. Individuals and institutions whose income is fixed, encounter the most severe difficulties. Industries such as public utilities fall in this class. The rates for their services are fixed, while expenses mount with the price changes.

Some industries, on the other hand, reap benefits from the situation. Manufacturers who are paying wages and buying raw materials at one price level, and selling finished

1 See p. 499 for statistics showing the increase in purchasing media during the Great War.

products at a higher price level at a later period, find a larger differential to go to the profit account. Enterprisers in the extractive industries, such as farming, mining, and lumbering, usually find that increased expenses do not absorb the increased returns. The interest secured from the increased expansion of bank credit tends to make the situation a profitable one for banking institutions. The net result of borrowing, then, in so far as it increases prices, is to saddle a burden upon the citizenship by necessitating greater government expenditure, and by causing a greater expenditure by individuals to secure the same commodities.

The interest charge, moreover, is no small item in the total cost when the length of time which government securities usually run is taken into consideration. Suppose, for instance, that a war were entirely financed by the issue of twenty-five-year 4 per cent bonds. The cost in this case would be doubled, since the interest charge would amount to as much as the principal. Even if there were no effect on prices, the interest charge which results from borrowing necessarily makes a war more costly.