Monetary Plumbing
How money actually gets created, expanded, and distributed in the modern system. Most of it has nothing to do with printing presses.
How Money Is Created
Most people assume that money is created by the government running a printing press. In reality, the vast majority of money in a modern economy is created by commercial banks when they issue loans. When a bank approves a mortgage, it doesn't reach into a vault and hand over someone else's savings — it creates new deposit money from nothing. The central bank sets the rules and the reserve requirements, but the commercial banking system does the actual expanding.
This process is called fractional reserve banking. Each bank holds only a fraction of its deposits as reserves and lends out the rest. That loan becomes someone else's deposit at another bank, which then lends most of it out again. One real deposit multiplies through the system into many times its original value.
How One Deposit Becomes Many
Follow $10,000 as it moves through the banking system. Each bank holds a fraction as reserves and lends the rest — creating new money with every cycle.
The reserve requirement is the fraction of each deposit a bank must hold. The rest can be lent out. The Fed sets this rate. Before 2020, it was 10%. It is currently 0%.
Initial Deposit: $10,000
You deposit your paycheck at First National Bank. This is real money — earned from work. Everything that follows is created by the banking system.
Deposit In
$10,000
Held as Reserves
$1,000
New Loan Created
$9,000
Sarah borrows $9,000. This money didn't exist before the loan was approved. The bank created it.
System Totals After 1 Round
Original Cash
$10,000
Total Deposits
$10,000
Total New Money
$9,000
Money Multiplier
1.0x
With a 10% reserve requirement, the theoretical maximum money multiplier is 10.0x — meaning $10,000 could eventually become $100,000 in total deposits across the banking system.
The key insight:
Only the original $10,000 was real money earned from productive work. Everything above that was created by the banking system through lending. Each loan creates a new deposit, which enables another loan, which creates another deposit.
The borrowers all owe real debt with real interest — but the money they borrowed was created at the moment the loan was approved. This is how the modern money supply expands: not through printing presses, but through the banking system's ability to create credit.
At 10%, which was the U.S. requirement before March 2020, one dollar of deposits could theoretically support ten dollars of total money in the system. The Fed dropped the requirement to 0% during COVID — meaning there is no legal limit on this expansion.
Why This Matters for Prices
When the banking system can multiply deposits by 10x, 20x, or even more, the total money supply grows far beyond what was originally earned through productive work. All that new money competes for the same pool of real goods and services. The result: prices rise — not because goods got scarcer, but because money got more abundant.
And this is just one channel of monetary expansion. Government deficit spending, central bank asset purchases (quantitative easing), and the shadow banking system all add additional layers of money creation on top of this basic mechanism.
Topics Still to Come
- Quantitative easing — the Fed buying assets with newly created reserves
- Government deficit spending and Treasury issuance
- The repo market and shadow banking
- How new money enters the economy unevenly (the Cantillon Effect)
- Why the reserve requirement being 0% since 2020 matters
Content forthcoming
Detailed explainers covering each of these mechanisms — with data and historical context — are under development.