It vice versa where’s it coming from when the economy is booming?
When the economy is bad, it feels like there’s not enough money to go around, but when it’s good there’s plenty.
In: Economics
It’s still there, it’s just not being spent as often. “The economy” is people trading things for other things, like dollars, bananas, and foot massages. If I spend a dollar for a banana, the fruit seller can then spend that dollar for a foot massage, and the foot masseuse can give that same dollar to me when I beg on the bus. Three “dollars” spent but it’s one dollar. Then if we do the same thing again it’s six dollars, etc. It’s less about how much money there is and it’s more about how much money is moving around.
For common people, it gets hoarded. People hold onto their money and don’t spend it. Which in turn means businesses make less money and often increase prices to compensate and/or let staff go to stay profitable. Which means people lose jobs and can’t afford to buy things, which means less money back to businesses and it repeats.
There is a whole load of complicated things to do with businesses with changing interest rates and such that can have an impact too, but that’s beyond ELI5: The true answer really is:
The money doesn’t go anywhere, it just gets spread around less.
Less being spent, less wages being paid, less loans being paid off, more defaulting, more unemployment, in a big vicious circle until something breaks.
Money is not as significant as the goods and services in the economy.
Money is simply how we measure goods and services.
An economy has issues when there are changes to the goods and services being produced.
There are a few things that can change the quantity of goods and services in an economy. Some of them are short term shocks to the system. Others are due to misallocations.
At a very basic level we can have an example.
The economy only has two things in it. Home builders and food producers.
They use money to pay each other. The population is growing so more food needs produced and more homes need built. Food producers pay home builders to build more homes and home builders buy food from the food producers.
But then people stop having babies. And so now over time there are fewer homes that are needed built. “We already have enough home as the population is not growing. Young adults will not take homes from those who die from old age.”
So now the home builders stop Producing. They stop building homes because they stop being paid to build them.
Now the economy contracts. There are fewer goods and services in the economy.
The dollars still exist. The same number of dollars are there. But what they are buying changes.
This happens all the time. And usually the industry that gets smaller is replaced by something that is growing. So there isn’t too much issue.
But if a lot of industries contract at the same time or expand at the same time you can have issues.
So money is just an allocation system for goods and services. Every time money is transacted, goods or services are being acquired by someone. If you and I had a $100 bill and we took turns exchanging that bill for something, we would be increasing the economic output of our little ecosystem. For example, if you gave me the $100 so I could do some landscaping for you and then I give you back $100 so I could buy a kitchen appliance from you and then you gave me back the $100 so you could buy my old comic books, etc…
If we did this 20 times, our little economy has the GDP of $2000. There was still only ever one $100 bill, but we exchanged it 20 times and each performed a service or exchanged property. in the end, money is meaningless if it’s not usable and using it is what generates an economy. Between each other, we fixed our landscaping and got more desirable items for our homes. We’re both better off because we exchanged that money back and forth.
Now if we exchange it less, we’re in a recession now. There’s still the same amount of money, just the one bill, but we aren’t exchanging it as often, there are fewer goods and services in our economy. In essence, we are now poorer because our lifestyle has gone down despite having the same amount of money.
Basically a way to think of it is that in a booming economy, more money is changing hands more rapidly and, in a recession, it’s not happening as much. The real measure of the wealth of a population is how many goods or services they acquire/create.
It doesn’t go anywhere, it just trades hands more slowly. That is called velocity of money, and during a recession it slows as people slow spending because they’re been laid off or fear it, businesses spend less.
Much of it gets pent up in assets that holders don’t want to sell, but also part of the issue is that new money isn’t being *created* through the process of banks making loans.
Maybe it helps to think of investment money like stocks and real estate and collectibles as potential energy, (vs the money that people spend and earn from their jobs, which is like kinetic energy).
If there’s a recession and the value of things like real estate drops, that’s just a drop in potential.
It’s much simpler of you replace real estate with a silly trend like Beanie Babies. The Beanie Baby market crash didn’t wipe out any actual money or real products, it just adjusted the potential of what your stuffed animals were worth.
Money can “disappear” during a recession when real goods like houses and oil or virtual-but-valuable things (like contracts, debt, stocks, crypto-currency, personal data about consumers etc) are wildly overvalued and the market suddenly “corrects” and tries to assign a more accurate value. You bought something for $100 and suddenly it’s worth just $20. The “missing” $80 was just a guess as to how much your stuff was worth. The actual dollar bills kept moving and being spent.
This can be a big problem if you need a loan to keep your business going. Last year banks were happy to loan you money because your stuff was worth $100 and you could use that as collateral, now it’s only worth $20 they won’t loan you anything. You still need to pay back your loans from last year AND you don’t have the money you need to keep your business running AND sales are down because everyone is suddenly in the same situation and doesn’t have extra money to spend.
Saving, safer investments that don’t return as much.
Basically money is created by carefully loaning out money. People collectively deposit $100 into a bank and that bank can lend $110 to businesses or home buyers or whoever. They use that money, including the $10 extra dollars that didn’t exist before, to do productive things.
Although this sounds (and can be) precarious, it’s a really underrated aspect of the US economy. We’re able to grow because _relative_ to other places we’re eager for risk and reward without overdoing it.
Here’s a analogy that explains what you see. Think of money like cars. They can be parked in the garage or they can be driving around on the street. If you look at the street, with some traffic monitoring device and publish how much traffic there is, you’re not really measuring how many cars there are. If the government makes more cars and gives them away, then there are more cars, so you might expect to see more cars on the street. But even if the number of cars remains the same but when more opportunities to get some good stuff if you drive to get it arise you’ll also see more cars on the road.
This is how the economy works. The “opportunities to get some good stuff” are an example of a healthy economy rewarding people for doing work (or at least driving to work). Government stimulation, giving away cars, provides the measurement of a good economy, lots of cars on the road, without it meaning the same thing.
When politicians do stuff to make the stock market go up, not only are they lining their pockets (and their rich supporters pockets) they are also messing with the measurement you might use to understand if the economy was good or bad.
Latest Answers