Item Creation

Items are created through three primary mechanisms.

1) Players skilled in manufacturing can create them.
2) They can be created by NPC shopkeepers out of thin air.
3) They are created as treasure carried by the monsters and become available when the monster is killed. This "loot" mechanic is the method by which the majority of items are created.

Item Destruction

Items are also destroyed though various means. For example, using a sword slowly causes irreparable wear and it will eventually break, disappearing from the world.
The most common way for an item to leave the world is through "garbage collection" – when an item is left on the ground, it is deleted automatically by the server within a few minutes to ensure that the world does not accumulate junk.

Crafting resources into goods
Crafting Failure
Consumables
Durability
Expiration Timers
Spoilage
Recipes
Trash Cans
Trash for token bag
Recycle/Exchange

Quote from UO Designer Raph Koster:

Another fascinating bit: He reminds the reader that while in the real world, we find it acceptable that making wooden foozles may not make money, but in a virtual world, players will literally file bug reports when there’s no market for their craftables. After all, why would a dev put it in the game to be made if it was worthless?

Item Drains

There are five primary ways in which items are removed from the economy.

1)Botched manufacturing is the result of inexperienced player manufacturing.

2)Degradation is simple wear and tear; for example, as a character uses a sword it loses durability and eventually breaks.

3)Decay is garbage collection – if items are left on the ground, they will be reclaimed by the server within a few minutes to prevent the world becoming littered with junk. This is very common after someone is "killed".

4)Degradation also covers consumables such as reagents which are destroyed when used.

5)Selling to NPC shopkeepers can remove items from the world if they choose to destroy the item.

Gold leaves the economy in two principle ways:

1)NPC shopkeepers take gold when they sell goods to players. The large sums paid for house deeds are a very significant component of this.

2)Rent charged by vendors. 

The original design focused heavily on macroeconomic rules: the closed resource flow, the mechanics of supply from NPCs, and the drain rules

Thus players, in the process of training, produce huge numbers of item regardless of whether there is a market for them. This, combined with the effects of macroing create over-production

Complicating this oversupply problem in UO is that the players expect to make a profit for their labor regardless of whether or not there is a market for it. A tailor may create a large number of shirts and then take them to an NPC shopkeeper to sell. The shopkeeper, already storing a pile of identical shirts which he can’t sell, refuses to buy more.

The addition of software like UORazor and UOSteam could create complex macros which could auto-create even more junk that can not be sold