Part I — The Basics · Lesson 10 · How The System Works

Where money comes from

Banks create it by lending

The Bank of England published a paper in 2014 titled "Money creation in the modern economy" that explicitly corrected the textbook story. The textbook says: people deposit money, banks lend out a fraction of those deposits. This is wrong. What actually happens: a bank approves your loan, types $400,000 into a new line on its books labeled "loan asset" and types $400,000 into another line labeled "your deposit." Both numbers exist where neither existed before. That's not metaphor — that's accounting.

Watch it happen. Click "Approve loan" below to see a bank's balance sheet expand in real time.

What this means

Three things follow from this and they are profound:

One: every dollar of money in the modern economy started its existence as someone's debt. M2 (the broad money supply) and total private debt move almost in lockstep, because they're two sides of the same accounting entry. If everyone paid off their debts, the money supply would collapse to almost nothing. We literally need debt to have money.

Two: the people who get to decide what new money is created for have enormous power. Right now those people are bankers, and what they decide to fund is mostly: real estate (mortgages), corporate finance (LBOs, buybacks), and existing assets. Almost none of new money creation goes to direct productive investment in new infrastructure, new industry, or households who would spend it. That's a political choice baked into the structure.

Three: when central banks "print money" via QE, they're not directly funding the government. They're crediting bank reserves, hoping banks will lend more. From 2008-2021 that hope failed — banks parked reserves rather than lending — which is why QE produced asset price inflation but very little consumer price inflation until COVID broke supply chains.

The textbook lie: Most economics textbooks still teach the "money multiplier" model where banks lend out fractions of deposits. The Bank of England, the Bundesbank, and the Federal Reserve have all published papers saying this is wrong. The textbooks haven't updated. An entire generation of economists, policymakers, and voters operates on a model that the central banks themselves rejected.
If a bank approves your $300,000 mortgage, where does that money come from?
Correct. The bank doesn't transfer money from elsewhere — it creates a new deposit by writing it into existence on its balance sheet, balanced by a loan asset. The constraint is capital and credit risk, not whether deposits exist.

What you just learned

Money is debt. Banks create it. The decision of who gets to borrow — and therefore who gets to bring new money into existence — is one of the most important political decisions in any economy, and almost nobody talks about it as political.