Where does money come from? How does an economy keep getting more money – what is the origin?
In: Economics
It depends on your money system.
If money is some physical thing like gold (“commodity money”), it’s simple. There’s more gold when people go and dig up gold out of the ground, or learn new mining techniques, or go to new places where all the easy-to-get gold hasn’t been gotten yet (like America 500 years ago, or space in the next 100 years).
If money is pieces of paper printed by the government (“fiat money”), it’s also simple. New money is printed when the government prints it. If the government’s irresponsible and prints way too much, you get ridiculous situations involving needing a wheelbarrow full of money for a loaf of bread. And then you get a wrecked economy, lots of ruined businesses and unemployed people. This can make things really bad, with problems like political instability, war, riots, genocide, etc.
Many countries today use a particular strategy to avoid this. They set up a system where only one part of the government (the “central bank”, in the US the “federal reserve” or “The Fed”) can print money. They then have that part of government run by technical experts who print the right amount of money to keep prices spiraling out of control in either direction, and encourage businesses to employ as many people as possible.
The politicians who decide the government should spend money can’t just order new money to be printed, they’ve given away the authority to print money to the central bank experts. So the politicians either have to raise taxes to get the money now, or sell government bonds (IOU’s) to investors, who give the government money now in exchange for a promise to get more money later.
It’s seriously expensive and inconvenient to ship around large truckloads of printed pieces of paper. So the Fed has a computer system, every US bank has an account (“Fed account”) on this computer system. Each Fed account tracks how many pieces of paper each bank *could* get if they ask for them. Then if you’re a bank, and you need to send a billion dollars to another bank, you don’t need to pay for a fleet of armored trucks to drive across the country, make some team of employees count and load 10 million pieces of paper, and have a small army of heavily armed security guards make sure nobody steals the money. Instead you just use your computer to ask the Fed’s computer to subtract $1 billion from your Fed account balance and add it to the other bank’s Fed account balance.
Ordinary citizens and businesses don’t have Fed accounts though. That’s only for banks. Instead we have a checking account, savings account, or CD with a bank. A bank account balance isn’t money. It’s an IOU from the bank. The bank does have lots of money in the form of pieces of paper in teller drawers, safes and vaults, plus a Fed account balance they can immediately redeem for officially printed money. A bank’s almost always able to give actual money to anyone who comes in and wants to make a withdrawal, that is, turn some/all of their account balance into money. But the amount of money in the bank is much less than the sum of the balances of people with bank accounts there. That’s because the bank loaned it out for things like mortgages and government bonds. Which you can think of as the bank buying IOU’s from people. So in addition to the Fed account and the stack of bills, the bank also has a stack of IOU’s. Which will eventually be worth money later, as the people who wrote those IOU’s get around to paying up. And they might be worth money now, if the bank can find some other bank or an investor willing to buy them.
Most of what we think of as “money” isn’t money at all. It’s an IOU from someone. Pay for something with a check? You’re actually paying with an IOU from your bank. Use a credit card for a $20 restaurant meal? You’re basically writing a personal IOU and passing it to the credit card company, if you only make minimum payments, you might pay off $1 at a time over your next 30 credit card payments or so. The credit card company passes *another* IOU to the restaurant. The credit card company sends the restaurant a check at the end of the month for $20 to settle its IOU — but the check is another IOU, this time from the credit card company’s bank. The restaurant owner deposits the check…but he doesn’t get money. Instead his account balance goes up — he now has an IOU from *his* bank.
The amount of the economy that’s IOU’s sounds scary, and in some ways it is pretty unsettling. But bank IOU’s are fairly safe in the US, since banks must pay for government-run insurance (FDIC) that will reimburse people for up to $200k in bank IOU’s if the bank gets in a situation where it doesn’t have enough money to pay for its IOU’s.
[This video](https://www.youtube.com/watch?v=PHe0bXAIuk0) explains things pretty well.
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