Where Does New Money Come From?

Ask someone where new money comes from, and you'll usually hear one of two answers. “The government prints it.” Or, a little more sophisticated: “The Federal Reserve creates it.” Both answers describe a real thing that happens — but together, they account for a small fraction of the money in circulation. The vast majority of new dollars are created somewhere else entirely.

They're created by commercial banks. Every time a bank approves a loan.

That's not a metaphor or a simplification. It's a description of the actual mechanics, confirmed by the central banks themselves.

To put a number on it: the total amount of physical cash in the United States — every bill in every wallet, register, and mattress — is roughly $2.3 trillion. The total M2 money supply — the standard measure of dollars in circulation, including bank deposits — is roughly $21 trillion. Physical cash is about 11% of the total. The other 89% exists as numbers in bank accounts. And most of those numbers were created by the process described below.

Once you see how it works, a lot of things that seem mysterious — why the money supply keeps growing, why housing prices keep rising, why inflation is structural rather than accidental — start to make sense.

The version you might have learned in school

If you took an economics class, you probably learned something called fractional reserve banking. It goes like this.

A customer deposits $1,000 in a bank. The bank is required to keep a fraction in reserve — say, 10% — and can lend out the rest. So it keeps $100 and lends $900 to someone else. That person spends the $900, and the recipient deposits it in their bank. That bank keeps $90, lends out $810. The next bank keeps $81, lends out $729. And so on.

Through this chain of deposits and loans, the original $1,000 turns into roughly $10,000 of total deposits across the banking system. Economists call this the money multiplier. If you've heard the phrase “fractional reserve banking,” this is what it refers to: banks hold a fraction of deposits in reserve and lend out the rest, multiplying money through the system.

It's a clean, intuitive model. Most economics textbooks still teach it this way. And the basic insight — that banking multiplies money beyond the original deposit — is real.

But the sequence is backwards. The textbook says deposits come first, then loans. The reality is the opposite.

How money is actually created

In 2014, the Bank of England published a paper in its Quarterly Bulletin that said, plainly, what bankers already knew but textbooks hadn't caught up to:

“Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower's bank account, thereby creating new money.”
— Bank of England, “Money creation in the modern economy,” Q1 2014

Read that again. The bank doesn't take money from one account and move it to another. It doesn't lend out deposits it already has. It creates a new deposit — new money — at the moment it approves the loan.

Here's what that looks like in practice. Say you apply for a $300,000 mortgage and the bank approves it. The bank doesn't go to a vault, count out $300,000 in cash, and hand it to you. It doesn't withdraw $300,000 from other customers' accounts. It opens a new entry on its books: you owe the bank $300,000 (that's the loan — an asset for the bank), and simultaneously, $300,000 appears in your account (that's the deposit — a liability for the bank). The two sides of the ledger balance. And $300,000 that didn't exist five minutes ago now does.

When you use that money to buy the house, it moves to the seller's account. Now it's circulating in the economy. New money, created from a lending decision. Not printed. Not transferred. Created.

This happens millions of times a day, at every bank in the country. Car loans, business lines of credit, credit cards, student loans — each one adds new dollars to the money supply at the moment of approval.

And when loans are repaid, the process reverses: the money is destroyed. Your monthly payment reduces your account balance and cancels a matching slice of the bank's loan — the two ledger entries that were created together are erased together. The money supply is the net result of all the money being created through new lending minus all the money being destroyed through repayment. As long as new lending exceeds repayment — which in a growing economy, it almost always does — the money supply expands.

The Bank of England isn't alone in describing it this way. The German Bundesbank published a similar explanation in its April 2017 Monthly Report: banks create money through lending. The textbook model — deposits first, then loans — has the sequence reversed.

So what's the difference?

The textbook says: deposits come first, and banks lend out a portion. Money creation is limited by the reserve ratio.

The reality says: loans come first, and deposits are the byproduct. Money creation is limited by different things entirely.

The reserve ratio — that 10% the textbook talked about — was the supposed hard limit on how much money banks could create. But in March 2020, the Federal Reserve set the reserve requirement to zero. Not reduced it. Eliminated it. Banks in the United States are no longer required to hold any fraction of deposits in reserve. The textbook constraint is gone.

What actually limits money creation?

If banks can create money by lending and there's no reserve requirement, what stops them from creating unlimited money?

Four things.

Capital requirements. Banks must hold a minimum amount of their own equity relative to the loans they make. If a bank's equity runs low, regulators restrict new lending. This is the real hard limit — not reserves, but capital.

Interest rates. The Federal Reserve sets the rate at which banks borrow from each other overnight. When the Fed raises this rate, borrowing becomes more expensive, fewer loans are profitable, and banks create less money. When the Fed lowers the rate, borrowing gets cheaper, more loans make sense, and banks create more money. This is how the Fed actually controls the money supply — not by deciding how many dollars to create, but by making lending more or less attractive.

Demand for loans. A bank can't force someone to borrow. If businesses don't see profitable investments or households don't want new mortgages, lending slows and money creation slows with it. This is why recessions reduce money growth — not because the Fed turns off a switch, but because fewer people want to borrow.

Regulation and risk appetite. Banks make lending decisions based on credit risk, collateral, and their own assessment of whether the borrower will repay. Tighter regulation or a more cautious banking sector means fewer loans and less new money.

The key insight: the money supply isn't set by a central planner. It emerges from millions of individual lending decisions, shaped by interest rates, regulation, and economic conditions. The Federal Reserve influences it. It doesn't dictate it.

Why this matters for the prices on the clock

Every item tracked by Satoshi's Clock — from a month of rent to a cup of coffee — is priced in a currency whose supply grows every time a bank approves a loan.

The M2 money supply — the broadest commonly used measure of dollars in circulation — has grown at roughly 6 to 7% per year on average over the past several decades. That growth is driven by bank lending, which is driven by interest rates, which are set by the Federal Reserve.

That growth rate is why the clock's methodology uses M2 expansion as the terminal growth rate for Bitcoin's logistic model. Nobody sets a target for M2 growth — it's an emergent result of millions of lending decisions under the Fed's interest-rate policy. But it has been remarkably consistent, and the clock uses it as the baseline speed at which dollars lose purchasing power.

Consider housing specifically. Mortgages are the single largest category of bank lending. Every mortgage creates new money. That new money bids up the price of the house, which raises the value of nearby homes, which supports larger mortgages on those homes, which creates more money. The lending and the prices reinforce each other. This helps explain why housing costs have outpaced wages for decades. Restricted supply and zoning constraints play a role too — but the money supply expanding through the mortgage market creates a persistent upward pressure that those factors alone don't account for.

A currency that expands every time someone takes out a loan is a currency that loses value over time. That's not a flaw — it's a feature of the system's design. The question is whether you want all of your savings denominated in it.

Bitcoin's answer to that question is a fixed supply: 21 million coins, enforced by code. No bank creates new bitcoins by lending. No central bank adjusts the rate of issuance. The supply schedule was set in 2009 and hasn't changed since.

Whether that's a better design is an open question. That it's a fundamentally different design is not.

The takeaway

Most new money isn't printed by the government or created by the Federal Reserve. It's created by commercial banks, every time they make a loan. The loan creates the deposit. The deposit is new money.

This isn't a fringe theory. It's how the Bank of England, the Bundesbank, and the Federal Reserve describe their own system.

The practical consequence: the money supply grows as long as lending grows. And lending, by design, almost always grows — because interest rates are set to encourage it, because the economy rewards borrowing to invest, and because the entire banking system is built around the idea that credit expansion is normal and healthy.

Every price on the clock reflects that expansion. Every year, more dollars chase roughly the same number of goods. Every year, each dollar buys a little less. The mechanism isn't mysterious once you see it. It's a loan.