I hear a lot of people talking about economic growth, as in over time there is more value in the economy. For example, index funds like SP500 are growing consistently over decades a. On the other hand, economy is just buying stuff from other people with money they got from another person they produced stuff for, which he then sold to other people for money, like a closed loop. If that’s the case how is more money added to the system? how can the market as a whole grow instead of some companies profiting on the expansion of others?
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This topic gets tricky because IOU’s are a huge part of the economy, and IOU’s act a lot like money. If you have $10,000 in the bank, you say “I have $10,000 of money in the bank.” But this isn’t quite true. You don’t have $10,000 of money. You have effectively an IOU from the bank, a piece of paper that says “IOU $10,000 — Bank of Bob.”
And the bank has money in its vault, but actually most of the stuff in the bank’s vault is… IOU’s. Pieces of paper that say stuff like “IOU $10,000 a year for 30 years from 2022 to 2052 — Harry Homebuyer”
One thing about IOU’s is that.. Any two people in an economy can create an IOU on their own.
So the amount of IOU’s that exist is ultimately the combination of the decisions and situations of every person and company in the economy — whether they borrow more, repay more, or go bankrupt. And their decisions about how much they trust IOU’s right now (and just as important, *whose* IOU’s they trust), vs. how much cold hard cash money they want to have ready, just in case they need it.
So what about money? Money’s created when the Central Bank prints money. (In the US, the Central Bank is called the Federal Reserve, or “The Fed” for short.)
The Central Bank is a government department, but it’s also sort-of independent from the main part of the government. The Central Bank’s job is to print (or burn) money to try to keep the system in balance. It’s supposed to be a non-political entity staffed by a crew of technical experts who use math and data to decide how much printing or burning’s needed to keep as many people employed as possible and prevent prices from spiraling out of control in either direction.
Right now there’s “inflation” which means prices are spiraling upward a lot faster than is healthy. Too many IOU’s have flooded the system, and the amount of money plus money-like IOU’s is starting to get a bit out of whack with what the economy can actually produce (partly because supply chain problems and the war in Ukraine are causing production issues).
So the Fed’s burning money (quantitative tightening) and raising the interest rates banks pay each other for certain transactions (rate hikes).
Where does the Fed get money to burn? Well, in earlier years, The Fed printed a whole bunch of money and used it to buy IOU’s — normally they only buy IOU’s from The Treasury (another government department) but they also bought a bunch of mortgage IOU’s from regular homeowners. As those IOU’s are paid off, The Fed burns some of that money (and uses some to buy more IOU’s, as too much burning shocks the system).
There’s a really excellent YouTube video called [How the Economic Machine Works](https://www.youtube.com/watch?v=PHe0bXAIuk0) that explains this really well.
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