Where does money come from? How does an economy keep getting more money – what is the origin?
In: Economics
It’s fake money that is only believed to exist. Of course, all fiat money is fake so it’s a moot point.
Banks convert the money you put in them into non liquid assets like land and things like that, and also loan it out to other people. That’s how bank runs happen; they don’t actually have the money on them
Banks create money through loans. And to be clear, it has nothing to do with the federal reserve or fractional reserves. There are regulations in place to meter the banks, so they don’t game the system, like what happened leading to the 2008 crash. Banks have to be profitable, meaning they have to bring in revenue – they can’t just make their own loans and pay themselves.
Money is an agreement. Everyone agrees that this piece of paper (or shells, pieces of ivory, bronze coins) has a specific value. This allows people to buy and sell things without having to barter and end up with things you don’t want (like trading wheat for sheep).
The argument comes in when people don’t agree on the value of a good or service or that I want to get Paid more, or there was a flood and all of the crops in Kansas were wiped out. The government has tools available to stabilize the value of the money it issues. The more stable the value of the money, the more people will trust it and use it.
A good example of a currency that does not have stabilization controls (among other things, including the fact the ledger can be spoofed and by design the currency has an artificial scarcity) is BitCoin. Because of its instability, larger companies are not willing to use it. Since people cannot predict what the value of bitcoin will be in a couple of months, it becomes very difficult for any kind of long term planning.
Tightly controlled currencies with stable economies (and the economy has to be stable to maintain a stable currency) behave in stable predicable ways, the federal reserve is trying to maintain an inflation rate around 2% so everyone has a good idea what their dollars will be worth in a year. Note that the federal reserve can control lending rates, it does not directly control the value of the dollar (which leads to currency trading).
money came about as a representation of debt. early societies didnt use barter significantly (despite the classic ‘money replaced barter’ story, there is no evidence that any society in history was ever based on barter), instead using ‘gift’ based economies where i give you what you need freely because i know you have my back too. which really comes down to labyrinthine networks of unspoken obligations and debts. premodern societies also usually have really high homicide rates, cant imagine why.
the base form of government is basically a group of bandits who realize they can extract value from their victims indefinitely if they keep them alive. early governments developed money as a token representing your tribute. i can demand you give me your food each year, but if i make tokens and demand my tribute in those, then you have to participate in my economy to exchange your food for tokens. by creating currency and only accepting tribute in it, stationary bandit governments pull their subjects into their economy, enforcing dependence and making themselves even more power.
haters will say im wrong, but its easy to see that modern government is just a more developed, less malignant evolution of this structure
Banks *generate* money via loans. Money is created out of thin air when banks do this. They can do this because they’re usually sending only some of the money they hold in their vaults out at a time. They may be liable for $1 million in loans, but at any given moment, their clients are only asking for $100,000 in payments. So as long as they have at least $100,000 in their reserves, they’re fine, they can stay in business. And more money is always coming in as people pay off their loan that the bank lent them, and people make deposits. This is called [*fractional-reserve banking*](https://en.wikipedia.org/wiki/Fractional-reserve_banking).
Lending is the *origin* of money. Money is a *representation* of debt. For the most part, in a modern economy, this is where all new money in the system comes from.
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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