Best Answer: Well first off you need to understand how the 1913 Federal Reserve Act changed how we use money.
Prior to the Fed Act, Money was Gold. All paper issued was a 1 to 1 relation to Gold. If you find old US Bills, you'll see that they say redeemable in Gold. That ment inflation couldn't exist in an economy unless new Gold was found. Because Inflation is too many dollars chasing too few goods. And if you don't have new money, you'll never have inflation. A $1 today will buy you the same stuff 100yrs from now if Gold is money.
The Fed Act changed all that. It gave the Fed the power to create and destroy money. Paper Money. Backed by nothing. Not Gold, just faith. Called Fiat Money.
So here is how it works. The Central Bank (ie: The Fed) creates new money and distributes it into the economy. That distribution method is by way of debt. So for instance, the Congress needs $5/million dollars,
so it issues T-Bills. The Central Bank buys those T-Bills with the money it created. The Fed holds the paper, the Govt holds the Money. Now the Govt spends the money and it ends up in the hands of the people. Ta-Da, the money supply is born.
Its simple, but you get the jist. Now as for new money having to be created, its a mandatory. The reason is do to several factors, but the simplest is population growth and economic growth. As the population grows, the money supply must grow, else more and more people will exist and there won't be enough money in the economy to make it work. Thus spawns deflation. Think about it, what would the economy look like if the money supply was capped at $1,000,000 and we have 300/million people? Hell, you might be able to buy a house, plane, and boat with $1.00. lol
In any case, I could ramble on, but you should understand now.
Alby · 7 years ago