How does money supply work?

[hardcore_gamer]

EDIT: Thread title changed.

While I consider myself fairly knowledgeable about economics, I admit this is one area where I don't really understand that much. Just how exactly does money supply work? By that I mean is how is it decided how much money exists in society at any given moment in time? I know banks give out money and I have heard that if the state wants to increase or decrease the money supply it can do this via interest rates, but this doesn't tell me everything I want to know.

For example, let's say that I and a thousand other people got stranded on a desert island without any real hopes of escape, and that we decided to construct our own society and economy from grounds-up using only whatever goods we had with us and whatever new stuff we could find and/or build on the island, and that stones would be used as money (let's just ignore the fact for a moment that anybody could pick up new stones). How would it be decided how many stones to issue into the economy? And would everybody get the same amount of stones? How does this work?

And what if for whatever reason the people start being able to trade with other people who sail passed them who accept their stones in exchange for goods? Would the island just run out of stones?

[fraggle]

http://www.theguardian.com/commentisfree/2014/mar/18/truth-money-iou-bank-of-england-austerity

[Tarnsman]

hardcore_gamer said:

While I consider myself fairly knowledgeable about economics, I admit this is one area where I don't really understand that much.

So you are fairly knowledgeable in a field you don't understand the core principle of? Someone post the clapping Orson Welles from Citizen Kane gif for me.

[pavera]

Pssh. Stranded on a desert island and you decide to make rocks into currency? Why not trade in grains of sand? Then you can all be billionaires.

[AD_79]

Tarnsman said:

Someone post the clapping Orson Welles from Citizen Kane gif for me.

[Obsidian]

It's times like these that make me wonder if Hardcore_gamer has actually looked up the word fáviti yet.

[Tarnsman]

Thank you AD.

To answer your question Hardcore_Gamer (even though I shouldn't). Trade is how money works. Money is inherently nothing. Currency has no value beyond what we give it. The only purpose of currency is to facilitate trade as goods for goods based commerce is not a viable method of prolonged mass trade. Imagine if in order to buy a TV from Best Buy you had to give them goods of equal value. It wouldn't work for both parties, it's not logistically feasible for you to carry around the required goods for trade and the party you're trading with might not have a need for the goods you do have.

Thus currency is born so that parties can trade using things with a globally accepted value that are easier to exchange and offer a wider variety of uses. Let's say you have two kids. Omar and Sayaka. Sayaka gets socks for Christmas. Omar gets a bedazzled handbag. Sayaka wants the bedazzled handbag and offers to give Omar her socks for it, Omar refuses because he doesn't need socks. Now imagine if Sayaka's parents loved her and gave her money instead of socks. She goes to Omar and Omar trades her the bag because he can then use money to purchase what he does want.

How does money get its value? Consumers. Money has no real tangible value, even if it's tied to a real resource like gold, it's just "we say it's worth this much" which is why the US Government can still print money and have that money have value even being trillion dollars in "debt". As long as consumers generally agree to pay X for Y, then money's value exists, which is why when severe economic crashes happen and people stop buying things you see crazy shit happen with the value of money.

So lets go to your desert island scenario. Stones would work if they were special stones anyone couldn't just pick up, and they'd only work as currency only if your island allowed for the currency to function. If your island doesn't have a broad enough production of goods then money will be thrown aside for direct goods for goods trade.

[geo]

I once wondered who gets the money made by the mint.

[40oz]

http://www.theonion.com/article/us-economy-grinds-to-halt-as-nation-realizes-money-2912

[Cupboard]

As usual, if it can't be explained with rock n roll, it ain't worth explaining.

[Inkie]

geo said:

I once wondered who gets the money made by the mint.

At least in the US, it goes from the mints to the Federal Reserve, who controls how much money is in circulation. They distribute the money to banks, but also can take from them. They also give loans of sorts to the Government.

[Koko Ricky]

I love that Dire Straits song.

[Doomkid]

hardcore_gamer said:

I consider myself fairly knowledgeable about economics

how exactly does money work?

Dude, this seriously is comedy gold

There's nothing wrong with not fully understanding how money works - especially in theory VS in practice, if we're being honest economics is not only finicky but also ever changing, but this is just the most blatantly self-contradictory quote I've seen on DW in ages!

I consider myself a pro at Doom

how do you use frags?

[Kontra Kommando]

All I know about money is that the more you have of it, the better off you'll be. So save as much of it as you can, and invest wisely to ascertain even more.

[hardcore_gamer]

I should probably have worded the question differently. I know what money is for, but I don't know how the money supply is handled. I should have asked "how is the money supply managed" instead of "how does money work". Yea I agree I worded this in a manner that was stupid, but I do in fact understand how money works, except for the organizing of the money supply.

[Maes]

You simply print as much as you need. As long as everybody is happy to accept your colored sheets of paper, things are A-OK.

https://udumakalu.files.wordpress.com/2014/12/0dc07-0.jpg?w=470




BTW, I wonder why our government didn't do this simple trick: banknotes are tracked, have a unique serial number and can be rendered void, but coins do not, thus we could have minted a fuckton of 1 and 2 euro coins and silently slip them into circulation, by e.g. paying 5% or 10% of each public employee's salary exclusively in Euro coinage. TA-DAH! A 5%-10% savings on public expenses suddenly realized ;-)

There's some ECB rule somewhere that euro coins are legal tender only up to payments of 50 euros at a time (or 50 coins at a time, I'm not sure), perhaps foreseeing something like this. In theory, this means that someone could refuse getting paid with "too many" coins...but once the "extra" euros are circulating, how could anyone physically remove them from circulation, short of banning all coins?

[Bucket]

Printing tons of money to handle an economic crisis is a bad idea. Not doing it is a worse idea.

[raymoohawk]

american money is a god given institution that jesus hand delivered to the founding fathers. also money that other countries have becomes of the devil, unless they do business with the blessed and righteous top 1% of america, wich converts it to jesus money. converting all currency to christ endorsed money is the ultimate manifest destiny of the holy god kingdom of america. if you deny this absolute overwhelmingly objective bible-backed truth (or you happen to be poor) you will totally burn in hell

amén

[hardcore_gamer]

Bucket said:

Printing tons of money to handle an economic crisis is a bad idea. Not doing it is a worse idea.

I fail to see how printing money to solve an economic crisis does anything else than creating inflation. Germany tried it in the 1920's, and do did Zimbabwe. It did not end well.

EDIT: I have changed the thread title and bits of the OP to make it more accurate for the question I was asking.

[SYS]

[fraggle]

A small amount of inflation is a good thing. It's uncontrolled, runaway hyperinflation that's bad.

[Maes]

What about negative inflation, which seems to be the "trend" in commie pinko Yurope?

Also, I never understood how/why per-country inflation is still calculated for countries in the Eurozone, or more generally, for countries in a monetary union. Since there's only one booty-daddy of the money supply (the ECB) of the single currency, how can there be regional-scale inflation? Is there e.g. a separate per-state inflation in the USA?

Is "inflation" in monetary unions a different aspect than wages/prices/cost of living disparities?

hardcore_gamer said:

I fail to see how printing money to solve an economic crisis does anything else than creating inflation. Germany tried it in the 1920's, and do did Zimbabwe. It did not end well.

Only that those cases spiraled out of control also due to other factors, like international pressure, loser status in a major war or 3rd world shithole-factor. Most historical inflationary/devaluation policies were much more moderate in effect, though I remember that e.g. a copy of Mickey Mouse would cost 50 Drachmas when I was 6, and it had gone to 120-130 when I was 11, and nearly 400 when I was 16 (BTW, at that time $1 was about 250 Drachmas).

OTOH, our "good neighbor" Turkey was still struggling to achieve 3-figure inflation in the 90s, and at some point they simply cut off 4 or 5 zeros out of their Turk Lira and called it Yeni (New) Turk Lira. *rolleyes*

Again, it all depends on how much others (especially foreign traders and Guardians of the Good Money) value your newly printed colored pieces of paper. If they think they can be used to buy good value, real estate, business etc., then they will be happy to trade some of their own colored pieces of paper (of a Superior Currency, of course, of course) for a fairly determined price (in your inferior currency, of course). If not...well...they will ask you to print many, many more of them, which is really a polite way of telling you "fuck you".

A side effect of living in a country with a devalued currency, which many Europeans have forgotten, is that while you can have a relatively good standard of living within your own country, travelling abroad is usually a crash landing, financially speaking.

Imported goods are also ridiculously overpriced (such is e.g. the situation in Brazil, Russia and Bulgaria: I visit Bulgaria often, and while their housing, food etc. costs are literally half those of Greece's, so are their wages, and imported good such as cars, electronics and even fuel cost practically as much (if not more) as in Greece.

[Inkie]

hardcore_gamer said:

I have changed the thread title and bits of the OP to make it more accurate for the question I was asking.

MV=PQ

M=Supply of money

V=Velocity of money (in other words, how much people spend money as opposed to just saving it)

P=Price of Goods

Q=Quantity if goods

Fiat money (such as rocks) is valued from the demand for it, against its supply. As you may know, something that is low in supply tends to be valued or priced higher. Inversely something of high supply tends to be at a low price.

The demand for money is due to convenience. Since modern money is typically federally backed (legal tender), it is a common medium of exchange. Instead of directly trading what you produce, you convert it to a common measure of value by selling it for money, that you can use to buy whatever you need, even if the seller didn't want the product you originally wanted to trade.

There is now real "right" answer to exactly how much money you would need. But typically a stable value with a slight inflation is considered "healthy," but most markets tend to slowly fluctuate in a cycle.