The Real Economy And The Financial Economy
A tale of two economies
As we hurtle towards increasingly volatile and uncertain times, it’s helpful to understand how the real economy interacts with the financial one as a lot of the things that we are experiencing now like high inflation can be explained by these interactions.
The real economy
The real economy refers to our ability to produce things that people need and want such as food, clothing, shelter, societal infrastructure, machinery, computing, etc. It’s more or less a function of the amount of workers there are and how much capital (machines, technology, etc.) they can bring to bear on their work — all other things equal, the more that both of these increase, the more the economy is able to produce what it needs to sustain itself and thrive.
The financial economy
On the other side is the financial economy. A real economy where transactions can only be completed with hard currency (e.g. gold) is pretty constrained. That’s because the supply of currency depends on how much gold has been mined (or gained from trading with other countries) — so if the real economy’s ability to produce outpaces the amount of gold, the value of goods goes down relative to the value of the money, a.k.a. deflation.
