That cash in your wallet won't last forever, so what happens to it when it needs to be replaced?
Think about money being created. A furiously spinning printing press might come to mind. Now imagine money being destroyed. Do you think of a three-story shredder, a bonfire, a wide blue recycling bin?
You might have noticed that it's pretty hard to find any cash printed much earlier than the 1990s in circulation. Just as more money is constantly being created, it's also constantly being destroyed. Who are the destroyers of money, and how do they do it?
In order to explain money destruction, we have to define what we mean by money destruction. For example, are we talking about money being eliminated, its very presence disappearing from the economy? Or are we talking about when money is physically destroyed but replaced with newer, crisper currency? Let's consider both questions.
When Money Disappears
You probably know that the Federal Reserve controls the money supply, the technical term for the amount of money in the economy. When the money supply expands, money flows into the financial system. When the money supply contracts, money drains out of the financial system. But how does the money actually disappear?
In 2010, 2.6 billion $1 bills were destroyed.
The Fed expands the money supply through a couple of methods. For simplicity, let's consider "security purchasing." When the Fed wants to expand the money supply, it buys a security -- let's call it Asset A -- from a bank. Then it electronically transfers money to that bank. There is now additional money in the financial system that the bank can use to provide loans.
The nice part about being the Fed is that it doesn't actually need to mail a box of dollar bills to pay for these securities. Instead, it creates a "reserve balance" liability on its balance sheet. The transaction is completely electronic. No hard currency changes hands.
Then, when the Fed is ready to reduce monetary supply, it sells Asset A. This puts the security back into the financial market and reduces money in the system, again electronically. Is that money destroyed?
On the one hand, the money no longer exists in the financial system. On the other hand, it was only there temporarily in the first place. When the Fed gets that money back, it merely reduces the size of its reserve balance liability. In a sense, money is only "created" during an expansionary cycle electronically, through an accounting mechanism. It's then "destroyed" in a similar, but opposite, accounting entry.
When Currency Is Physically Destroyed
Obviously, not all money is electronic. Just look at your wallet. Bills and coins are destroyed every day. There are three destroyers of money, and they're the same ones who create and regulate it.
(1) The Bureau of Engraving and Printing and (2) The U.S. Mint