Where Money Actually Comes From

Most people assume money comes from the government. Mostly, it doesn’t. Notes and coins are government-made, but they’re a small slice of all money, on the order of a few pence in every pound.¹ Most of the rest is created by ordinary high-street banks, chiefly when they lend.² New money is typed into existence when a bank lends, and deleted from existence when the loan is repaid.³ Behind them all is the central bank, which anchors the price of borrowing. It creates some of the money directly, and in the years it was buying bonds that was a large amount.⁴ And it creates money when the system needs rescuing. That’s the machine.

The three kinds of pounds

Cash is the notes and coins the state puts into circulation, a tiny fraction of the total.

Bank deposits are the numbers in your current account, and they’re what almost all “money” is, an IOU from your bank to you. When you feel like you have £5,000, you hold a bank’s promise to pay you £5,000.

Then there are reserves [electronic balances that banks hold at the central bank]. You and I never touch these, and banks use them to settle up with each other, so when you pay a plumber who banks elsewhere, your bank transfers reserves to the plumber’s bank behind the scenes.

So “where does money come from” is a question about bank deposits.

The engine: a loan creates money, repayment destroys it

Say a bank approves you for a £200,000 mortgage. It doesn’t go to a vault and count out £200,000 of other people’s savings. It writes £200,000 into an account and writes a £200,000 debt against you.⁵ The bank’s books balance. Your promise to repay is what it now owns, and the new deposit is what it now owes. Nobody anywhere lost £200,000. The money is new. Before the loan it didn’t exist. Now it does, and it’s out in the economy being spent.

You don’t need to take that from me. In 2014 the Bank of England published a paper called “Money creation in the modern economy” that says it plainly.⁶ Banks don’t lend out savers’ deposits, lending creates deposits. The Bank is describing itself.

Repayment runs the film backwards. The principal you pay back is deleted the same way it was created. It reaches no saver, and only the interest survives as the bank’s income. You owe more than was created. The loan wrote £200,000 into existence, and you’ll repay £200,000 plus interest that nobody wrote. It comes out of the wider pool of deposits, money other people’s loans made, and the bank pays it back out as wages and dividends, so it circulates rather than disappearing. What it can never do is escape the pile of loans, because the pool it circulates in is made of them. Let the pile shrink and the pool shrinks with it. If every household, firm, and government repaid every debt tomorrow, nearly all the money would vanish with it. Our money supply is the running total of debts not yet repaid.

People call this fractional reserve banking [holding far less in reserve than the total claims outstanding], and the name fits the shape. But the modern engine runs the opposite way round from the textbook story of collecting deposits and lending a fraction out. Banks lend first, creating deposits, and sort out reserves afterwards, because the central bank stands behind the payment system and will supply the reserves it needs to keep settling, at a price it sets.⁷ The vault isn’t the binding constraint. What limits a bank is whether the borrower looks good for the money, what the regulator demands it hold as a safety buffer of its own capital [the bank’s own funds that absorb losses first, not the reserves it settles with], and whether the loan is profitable at the interest rate on offer. A single bank still has to hold a stock of easily sold assets set against the money that could leave in a month, and when it borrows from the central bank it has to pledge something the central bank will accept.⁸

Where this design came from

The design grew by accident, a piece at a time.

For thousands of years, the money that lasted was something scarce you dug up, gold and silver.⁹ Gold was heavy, risky to move, and risky to store, so people left it with goldsmiths and traded the paper receipts instead. The receipts worked as money. And issuers noticed that hardly anyone came for the metal at the same time, so they wrote more receipts than they held gold. That’s where the shape we still live with starts, with claims multiplying on top of a scarce base.

It came with a built-in way of breaking. Banks competed by holding thinner and thinner reserves. Every so often confidence cracked and everyone demanded the metal at once, a run. After enough of those, the state stepped in with a central bank as lender of last resort [a backstop that creates money to rescue failing institutions]. The losses landed on the public, the borrowing stayed high, and the next crack was bigger.

Then, again and again, the gold promise was tested and the rules changed. In 1933 the United States banned private gold holding, and repriced the dollar against gold the year after.¹⁰ In 1971 it stopped exchanging dollars for gold.¹¹ Since that day no major currency has been exchangeable for anything scarce at a fixed price. What a pound or a dollar is worth is set by the decisions of the people who manage it, and for a currency tied to another one, by the decisions of the people who manage that one.

Occasionally you see that in the open. Nigeria’s central bank had been setting what a dollar cost, and by June 2023 it was calling that about 470 naira. Then it stopped setting the number, and within nine days a dollar cost 770. Nearly 40% of the naira’s official value was gone. Seven months later it fell again, to about 1,450. Imports jumped in price, wages didn’t move, and people were poorer. Nobody voted on that. It’s the loud version of a process that runs unnoticed, at around 2% a year, in countries that manage it more smoothly.

The state’s part: the central bank and the Treasury

The Bank of England sets Bank Rate, the interest it pays on reserves.¹² That anchors the price of borrowing across the economy. It doesn’t write the loans. Banks and borrowers do that. But it isn’t a bystander on how much gets lent, because it sets the price of borrowing, stands behind the system, and can cap lending directly. Those three set the room inside which banks and borrowers decide the quantity.

When it wants to push prices up harder, it creates money directly. That’s quantitative easing [QE], and the central bank creates new money and uses it to buy bonds, mostly the government’s own, which raises their prices, pushes interest rates down, and weakens what the currency buys.¹³ Strip the acronym away and the loop is stark. The government funds itself by selling gilts [the IOUs the UK government issues to borrow]. Pension funds and insurers buy them. And the Bank of England creates money and buys them itself, close to £900 billion of bonds by the end of the QE years.¹⁴ One arm of the state issues IOUs, another arm creates the money that buys them. That’s the logic at the end of that road. If nobody wants your IOU at the price you need, you start buying your own IOU.

In 2020 the before-tax profits of every company in the United States came to about 2.5 trillion dollars.¹⁵ In the first year of the pandemic response the country’s stock of money, cash and bank deposits together, grew by about 4 trillion dollars.¹⁶ You could have taxed every company’s profit at 100% and not covered two thirds of it. Money creation isn’t presented as a tax and doesn’t show up as revenue, but it works as a hidden tax, because it takes purchasing power from whoever holds the currency. It bridges the gap between what the state promises and what tax raises, and in a rescue it moves sums tax couldn’t reach. Tax is the part you can see.

Why the machine can’t idle

Almost every debt is fixed in pounds, and that one fact connects this machine to everything else. Your mortgage payment doesn’t shrink because prices fall. A system built on those debts can take a slow fall that comes with better tools. In that fall it’s the cost of making things that drops, and pay drifts down slowly behind it, so the money to meet a fixed payment is still there. What it can’t take is a sudden fall in the prices credit pushed up, houses first, because then the losses spread through the banks. In that fall it’s the lending that has stopped, so incomes and the house fall together and at once, and the fixed payment is hit from both sides in the same year. Houses come first because people buy them with borrowed money. The debt takes a bigger bite of every income, yours, your employer’s, the government’s. And where the loan was written against a house, the house is worth less too, so the bank stands to lose more on that loan. Push that far enough and defaults cascade through the chain of promises.

And a fall like that makes itself worse. Money is destroyed when a loan is repaid. In a downturn, new lending dries up while old loans keep being repaid, so the money supply itself starts shrinking.¹⁷ Defaults bite from the other side, eating the bank’s own capital until it can lend less still. That drops prices further, which makes the remaining debts heavier still. The system spirals. In late 2008 some fully backed trade guarantees between banks froze for days, and containers sat on the docks, because banks stopped trusting each other’s promises. Across the whole of trade, banks wrote fewer letters of credit [a bank’s promise to pay for shipped goods] and lent each other less, but most of it kept moving.¹⁸ So every time a sudden fall in the prices credit pushed up threatens, the system is rescued with new money, and the rescues keep getting bigger.

In between the rescues, the central banks of the rich world target rising prices of about 2% a year, forever.¹⁹ They publish why they aim there. They want room to cut interest rates in a downturn, they know wages resist falling, and they say the official measure of prices overstates the rise.²⁰ Those are the reasons they give, and the debts aren’t among them.²¹ The debts show up in the rescues, not in the everyday 2%.

But technology is pushing the other way. Under a money nobody can add to, the natural direction of prices is down, because people keep getting better at making things and competition passes the saving on. So when a central bank targets 2% inflation, it doesn’t need two points of push. It first has to cancel whatever better tools would have taken off prices that year, then add two on top. How big that fall would be is about how fast output per hour of work grows, which is what the productivity figures measure. On the published figures that’s a point or two a year.²² No statistic records that fall, because it never happened. And the push behind that fall keeps getting stronger, because the tools are improving faster than they did, so what policy has to cancel out keeps getting bigger. The yearly pace of new money hasn’t trended up. What the record shows growing is the stock of debt and the size of each rescue. That’s why the numbers look deranged.

Between 2000 and early 2018, the world added roughly 185 trillion dollars of new debt to buy about 46 trillion dollars of growth.²³ That’s four new units of debt for one of output, and each new unit buys less than the last. The total stock of claims runs into the hundreds of trillions of dollars. It won’t be repaid in full in honest money, because it can’t be. The remaining choices are to default openly, or to default quietly, by holding the interest that lenders are paid below the rate prices rise, so the debts shrink against what money buys. That route has a polite name, financial repression. It’s a quiet default on every pound and on every claim fixed in pounds, so the loss falls on what a person holds in pounds. Whether a particular person ends up worse off also depends on what they owe.

Who gains and who pays

New money doesn’t arrive everywhere at once. It enters somewhere specific, usually through bank loans and central bank bond purchases, so it goes first to houses, shares, and bonds, and into the accounts of whoever sold them. The first receivers spend it at today’s prices. By the time it has passed through enough hands to reach a payslip, prices have already moved, so say a physiotherapist gets a 3% rise and calls it progress while her rent and food bills rise 8%, and the house she rents is worth more to her landlord than it was. Nothing about the worker’s effort changed. The money changed, and it moved value from her side of the table to the other one. Part of the saving from better tools does reach her as higher pay, late and unevenly.²⁴ The rest goes to whoever got the new money first, through house and share prices. That early-receiver advantage has a name, the Cantillon effect [those closest to new money benefit first, before prices adjust for everyone else], and the issuer’s own cut has a name too, seigniorage [the profit made by whoever creates the money]. It’s why inflation is wage deflation. Her real pay [what her wages actually buy] fell while the number on her payslip rose. It’s the same coin, read from the worker’s side.

What’s said in the machine’s defence

“A little inflation is healthy. We need it or people won’t spend.”

People buy phones, food, and winter coats even though next year’s version will be cheaper or better, because they need them now. The claim underneath is “if we don’t erode your savings, you won’t participate”, and it answers itself. Growth comes from productivity, from getting better at making things. Borrowing to put up an empty showroom counts as growth too, in the figures, but nobody got better at making anything. What can’t take a sudden fall in the prices credit pushed up is the debt structure, not trade between people. The reasons the central banks publish for the target are other ones, and the debts aren’t among them.²⁵

“Deflation is a catastrophe. Look at the depressions.”

Two animals share the word. Deflation from a credit collapse, wages and prices falling against fixed debts, is lethal, and it’s what the early 1930s were.²⁶ Deflation from productivity, things getting cheaper because we got better at making them, is the reason your phone is a miracle. Inside this system the first kind of deflation, from a credit collapse, is one policy mistake away. A policy mistake is only one of many triggers that could start it, because the fragility sits in the system itself. That’s the indictment. We built money that cancels the thing technology naturally does.

“It’s managed by experts. They can steer it.”

Each rescue has been bigger than the last, hundreds of billions of dollars of government spending and bond-buying in 2008 and trillions in 2020, and markets now wobble at the hint of support being withdrawn.²⁷ Support can be pulled back part of the way for a time, as it was from 2022 to 2024, when rates rose and bond holdings shrank.²⁸ But each place the pull-back strained got new support within days, the Bank of England’s in September 2022 and the Federal Reserve’s in March 2023, and the promise to step in was never withdrawn.²⁹ A system that needs a larger dose each round to get less effect is doing the steering.

“Without elastic money we’d lose credit and innovation.”

Early-stage innovation runs on savings and equity, people backing founders for a share of what they build, so the extra pound of bank credit isn’t what starts it. Where a firm is young and has little to pledge, a fall in local bank lending does cut its research spending and its patents, so the extra pound changes how fast and how widely innovation spreads.³⁰ Credit would still exist under hard money. It would just be priced honestly and used more carefully.

The one money that isn’t born as debt

So the question about any money is where it comes from and who can make more of it. Every money before this one has given the same answer. Someone could always make more, and the route varied with the money. Some issued a fresh promise.³¹ Some wrote more claims than there was metal. Some made the coin for less than the value stamped on it and kept the difference.³² And where the money was metal that nobody could print, the route ran through the vault that held it, where the claims could be multiplied. Whoever controlled the vault could then suspend the promise to hand the metal over when those claims came due.³³ There’s now one exception. Every pound is born as someone’s debt. Every bitcoin is born as someone’s cost.³⁴

New bitcoin comes only from mining [computers spending real electricity to win the right to add the next batch of transactions, collecting the new coins as the prize]. There’s no loan behind it, no promise, no committee. The issuance runs on a fixed schedule, halves roughly every four years, and stops at 21 million.³⁵ Those rules are enforced by everyone who runs a node [software that checks every transaction against the rules and rejects any coin created outside them]. Bitcoin’s supply answers to a rule counted in blocks, kept by the people who run nodes, rather than to policy. Energy is what a new coin costs to win and what makes the record expensive to rewrite. It isn’t what sets how many coins there are. All of that holds on more than one condition. The rules have to stay beyond any one party’s reach, the network has to stay costly to attack, and bitcoin has to come into use as money rather than only be held. And staying costly to attack is work that has to keep being paid for, not a state the network sits in.³⁶

With the two answers side by side, the rest of the thesis follows on its own. Money that’s born as debt keeps expanding, so the price falls technology keeps trying to hand you never reach you as lower prices. Money that’s born as cost puts no requirement on the system to expand, so prices can fall and nothing has to push them back up. Whether they fall quietly depends on how much credit gets written on top of it and on whether those lenders are rescued when they fail. Today we print money and not goods. The world we’re heading into prints goods and not money.