An Essay on Capital Economics

Let’s take a detour from technology for a short while…

I have often mused over how the money supply grows.

It stands to reason that when the amount of “stuff” (i.e. production output) changes then the money supply must also change in lock-step, in order to avoid any destabilisation from significant & unwanted amounts of inflation or deflation. Total money supply is in essence an abstract (technological) representation of total “stuff” supply (i.e. products, goods, and services) that make up the surplus by which Economics exists, to lay out a just mechanism for distribution to the populace at large (without surplus there is no Economics).

Concider the main actors in the economic system: 1) Soverign, 2) Government, 3) Central Banks, 4) Retail Banks, 5) Businesses (surplus providers) & individuals (surplus consumers).

The authorities (Soverign, Government, Central Bank) say to their Retail Banks:

You can have the power to create brand new money out of thin air in the form of loans, however you must be able to attract that money back – with interest – to show that the recipient of the loan created new value for the economy (i.e. the societal surplus). This way, money supply should grow in-line with production output.

And remember, each currency unit added to the money supply will reside in bank accounts, and so, due to fractional reserve banking, will be multiplied many times over (to account for screwges in the system that hoard wealth). Thus, demand is amplified and circling back to the original loan, this was to increase supply; they both were able to grow together.

The ultimate purpose of this capitalistic economic mechanism, or system, is to move society away from scarcity and towards abundance.

But what of the profit motive? This is simply a means to utilize the greed of the individual in a way that helps rather than harms the society around them. The deal is: individuals can have more of the surplus of society but in return they must also be adding back into the surplus in a net positive way, by putting in more extra value than they are taking out by consuming stuff (products & services). Therein lies the genius of capitalisim; aligning personal greed with societal improvement.

If, for a period of time, supply has not kept up with demand (e.g. a supply chain shock), then here enters a second way to increase money supply. The Central Bank is empowered by the Government/Sovereign to offer increased interest rates to banks who store their on-hand deposits overnight with them. If Central Bank base rates are high enough then banks will elect to keep their money with the Central Bank rather than using it to tether a higher dept to equity ratio (remember banks can only be leveraged on their deposits by up to a certain ratio, usually by law). The net effect is banks lend less to the public, but also earn interest which is actually a net addition to the money supply (put into the wiser resource-allocating hands of the bankers, of course 😉 ).

Finally, we have Quantitative Easing (QE) & Quantitative Tightening (QT). This is another way to increase money supply but with the notable difference that an account, or balance, is kept of exactly how much money – usually in the form of government or company bond purchases – has been added into the system. QE has the effect of stimulating demand by increasing liquidity throughout the system. This includes demand for assets such as property and securities (stocks), making asset prices go upwards, and asset owners feel richer and therefore more likely to spend. QT has the opposite effect; liquidity is pulled out of the system thereby decreasing demand.

In conclusion, balance has to be maintained between supply and demand forces whilst, over time, the economy is grown. This is how we achieve prosperity through abundance for all. And – rather excitingly for technologists – the author believes technology plays an every increasing role in this beautiful process, as society becomes more and more advanced.

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