All right, I’ve never studied economics, have no professional training or interest in fiscal or monetary matters, and before last year thought derivatives were entry-level calculus, not a scheme to spread risk until it disappeared.
But I’ve often wondered where money comes from. I mean, there’s more money now than there was 1,000, or 100, or 10 years ago, right? But not more than there was 1 year ago! So, what is money and where does it come from? Any why does the amount of money change over time?
The root of money is our collective faith in the future. Faith, specifically, that several things will happen. First, the coiners of money (previously, kings and such; now, central bankers) will gradually make more amounts of it. Second, that populations will grow. Third, that the velocity of monetary exchange will increase. And fourth, that people who borrow will be successful in convincing other people to part with things of value, so the borrower can pay back the loan with interest.
So, number one, inflation. Whatever the currency of the time – clam shells, animal skins, gold coins, greenback dollars, T-Bills – it is a tangible item which can be freely passed from one party to another, with an agreed upon, somewhat stable value. Meaning, a dollar will buy a quart of milk today and next month. If the coiners of these units of exchange increase the money supply faster than the supply of goods/services to be purchased increases, than the value of the coin goes down – inflation. This is one source of new money, but it is not the original source.
Second, an increase in the number of people producing, and exchanging goods and services will feed the money tree. This increase can come about either through population growth within the territory covered by a specific monetary unit, or through broadening the population base through trade.
But what are those people doing that might affect the amount of money extant? The ones who do something which others will pay money for – hamburgers at McDonald’s, appendectomies at the hospital, cars from Detroit, insurance coverage from Hartford – are the actors. They are taking something, say beef, flour, mayonnaise and pickles which cost $1, and improving it so that someone else will pay $2 for it. One individual person – the producer/provider – has increased his own personal money supply. Collectively, as all these transactions take place, the overall money supply is increased. But again, it seems as if something is being created out of nothing. We are not yet at the root source of money
Money can be increased if the speed with which it is exchanged can be increased. Selling 10 hamburger a day produces more money for the individual than selling five hamburgers a day. But again, only if the money supply is somehow being increased elsewhere.
So where is that elsewhere? The next to last stop on the road is credit. Credit is the faith that the person to whom money is being loaned will convince others to buy goods or services at a price higher than it costs the lender. Part of this value increase can then return to the lender in the form of interest, as well as pay off the original amount.
So, let’s call the lender a bank. The bank is in essence creating the new money through the phenomenon of leverage. Leverage means that the bank loans more money than it actually possesses. Currently, most banks loan out about 9 times more money than they actually have on hand. To stay in business, they have to hope that more than 9 out of ten times they loan they will be paid back in full and on time.
It is that hope of repayment that is the ultimate source of new money in our world, the reason that there is now more money than there was 10 years ago. And, of course, the increase in the absence of hope is the reason there is now less money than there was a year ago. Our economic success is basically a giant Ponzi scheme, grounded on the faith that people will continue to want to produce and purchase things and services, faith that there will be more people to do that (through increases in either local population, or increases in the amount of interchange between populations – international trade), faith that coiners will continue to gradually make more money, and, ultimately, faith that the receivers of “new” money (loans) will be able and willing to pay bank the loans with interest.
If something breaks down anywhere along this scheme, the system falters, and we see money (or actually, the promise of money) disappear.
Economists try to put all of this into mathematically formulae, which work when the system is in stasis. So they are able to analyze inflation, the numbers of workers, changes in intra and international trade, and the amount of loans outstanding and assets held by banks quite well. What they can’t do is analyze hope and faith.
Apparently, it is a loss of faith (euphemistically called a “crisis of confidence” by our secular press and leaders, who prefer not to see capitalism for the religion it is) that has cost millions their jobs, and even more Americans to fear their personal financial futures. There is no longer a faith that loans will be repaid, and so fewer new loans are made. Fewer new loans means fewer resources for developing and sustaining new enterprises. And the future – which is based on that faith of repayment – therefore appears different. One with less money.
I am not concerned here with how to “solve” this current problem, if it indeed is one. I am just trying to figure out where new money comes from, and where it goes when it disappears. Since the money was never there to begin with – after all, faith is intangible – its loss is just as ephemeral.
I would suggest there is some amount of hope in all this. First, more people will have longer careers. Instead of retiring at 55 or 62, more people will work well into their sixties and even 70s. This will be good for them, and good for funding Social Security and Medicare. And sustained wisdom in the work force will be good for all of us.
Second, once people start returning to work – when we once again are creating more new jobs than we destroy – the relative wealth among Americans will change. The biggest losers have those with the biggest portfolios. I suspect we will see a compression of wealth again, with the upper ten percent holding relatively less than the bottom 90.
So two problems which have been raised in the last decade or so – how to fund entitlement programs in the future, and how to counter to increasing concentration of wealth in the richest parts of the population – have been solved for the foreseeable future in the last 3 months or so. All because some people realized the money they were creating wasn’t really there after all.