A country's economy in principal works just like a household, or, to include all the business terms, like a farm. In adtition, the farm constitutes one of the basic forms of the economy. The farmer takes a resource, land, adts labor, and exchanges the harvest for other products which he doesn't produce.
During this process he might need to buy lifestock or seeds before he reaps the benefits of that purchase. He will need to borrow the funds through credit or bonds. Hopefully, his income from this investment will be higher than the cost of the funds (=interest).
Business Investment
Our farmer buys a cow with the plan to continuously sell the milk or, at a later time at an appreciated price, the whole
cow.
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Stock
For dividends: a "shareholder" buys a part ownership (=share) in the cow and hopes to make a profit from his
share of the milk sales.
For appreciation: in the future someone will buy the share of the cow for more than what it cost today.
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Bond
The farmer gives me an IOU ("I owe you") in exchange for cash to buy more cows. At an agreed time he will pay back my cash
plus some agreed upon interest.
If the cow dies before the farmer pays me back, he most likely will go broke and I lose my money.
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Trading Bonds
If I want my cash before maturity, I will offer it to the highest bidder (at a stock exchange) who will pay just as much so she
will realize a little profit once she has received the interest.
If in the meantime a farmer next door issues an IOU at a higher interest rate, my original bond will be worth less: a buyer
will rather buy the other farmer's bond with a higher interest rate.
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Treasury Notes (t-notes)
When the US. treasury borrows money, it also issues IOUs which we call "Treasury Notes." The government uses these funds to
build roads, buy weapons, finance bank bailouts. the government usually pays a lower interest rate than our farmer because we
assume that the US. Government default rate is lower than the farmer's.
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A Common Misconception
After loosing money in the stock market I stay in the market to win my money back.
This is similar to the roulette player who just lost $500 and keeps playing in order to recover the money she just lost . .
. or loose even more.
A more rational way of looking at this scenario: the money she has lost is not hers anymore (although she would love to think
so). Any future round of gambling is a new beginning with the same odds as the previous rounds.
