Us dollar

Where does money come from?

Cutting through the veil of lies, invented complexities and deceit.

In the event that you ever took a course in economics at university, there is a reason why you don’t know that commercial banks create the vast majority of the money supply: you have been lied to. As an example, Gregory Mankiw’s Macroeconomics, the most widely used introductory textbook in the United States, continues a falsehood first perpetrated by Samuelson’s textbook in 1948. These textbooks teach that the national government creates money, as well as the money multiplier theory of money creation; they do not reveal that banks create credit money themselves, through their own loan process.[1]

Standard economics textbooks teach that banks lend out existing deposits of savings. They state that the collective actions of the banking system then can create additional money supply, as loans from one bank then become deposits of other banks, up until a ceiling imposed by a central bank (called the reserve requirement). So, in textbooks, the reserve requirement is crucial to the amount of money in an economy and banks don’t create money themselves.

The money multiplier theory explained
The money multiplier theory

Here is a little science experiment. Most textbooks teach that money is created collectively by the banking system, controlled by a money multiplier, imposed by the central bank’s reserve requirement. So, a reserve requirement is a necessary component of money creation, right? Well, what about countries like Canada, Australia, the United Kingdom, Sweden, etc. where there is no reserve requirement? How do the textbooks explain that? Well, they can’t. Regardless, empirically, there is a weak correlation between reserve requirements (where they do exist, like in the United States[2]) and money creation in an economy. Similarly, there is a weak correlation between savings and money creation.[3]

You may be asking yourself: if changes in the money supply (which impact inflation and cause excess variance in the business cycle, both bad news) don’t really come from savings or from this money multiplier concept, then how does this impact bank regulation? If banks create the vast majority of money in an economy and they do it by themselves, based mainly on their own estimates of future value, how are they regulated? We are going to get to that in a minute. As advance warning, you probably don’t want to know.

An even more ridiculous theory taught in economics classes is that banks are just financial intermediaries and that they don’t create money; this theory states that only the national government creates money. This theory is taught alongside the money multiplier/fractional reserve model mentioned above. Banks are just simply channeling savings to productive use. So nice and helpful of them.

Banks as financial intermediaries theory explained
Banks as financial intermediaries

Here is an interesting quote about why this quite misleading information is taught to the public, from an economist who wasn’t afraid of telling the truth.

“The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it. The process by which banks create money is so simple the mind is repelled. With something so important, a deeper mystery seems only decent.”

John Kenneth Galbraith.[4]

The only significant living economist who has actually done an honest, empirical investigation into the mechanics of bank money creation, who has really gotten his hands dirty doing actual banking work, is Dr Richard Werner, a professor in the UK with a doctorate from Oxford.[5] He has compared scientifically the three main theories of money creation (money multiplier, banks as intermediaries, and credit money creation).[6] He is able to disprove the two standard theories taught in economics: the money multiplier and banks as intermediaries. They are demonstrably false. The credit money creation theory matches with what banks actually do in the real economy and cannot be disproved.

The credit money creation theory explained
The credit money creation theory

Yet, despite this, most well-known economists still continue to support theories that are disproved by evidence and by admissions from central banks themselves. Why is that? There are a few reasons, including: mainstream economists don’t include banks and money very much in their explanations for how the overall economy works; they are so wedded to their axioms of banks as neutral agents in an economy, simply allocating capital, that, intellectually, it requires an exceptionally strong effort to be genuinely self-critical of what you have learned; not a single one of them has actually worked as a banker, as far as I can find[7]; and, the vast majority, directly or indirectly, benefit financially from continuing to support the party line and avoiding biting the hand that feeds them. For others, in a world where you can see that the emperor has no clothes on, it takes a lot of guts to speak up and tell the truth. Guilds and their enablers don’t change from the inside.

In fact, like most things to do with modern banking, the situation isn’t black and white. There is a (small) element of the truth in banks acting as financial intermediaries and fractional reserve/the money multiplier does play a role in money creation. However, the vast majority of money creation comes from the banks’ own credit processes. What the banking industry and their enablers do, however, is point to the (relatively) less harmful theories (intermediaries, money multiplier effect of the system), while intentionally remaining silent about the largest contributor: that individual banks create FV money through the lending process, which is then co-mingled with PV money (money where the value has already been created) so that the two “monies” are indistinguishable from each other.

Does bank credit money come from nothing? Is it created by the stroke of a pen?

It is sometimes suggested that banks can create credit money out of thin air. This idea can, perhaps, be dated to a comment from one of the founders of the Bank of England. “The bank hath benefit of interest on all moneys which it creates out of nothing.”[8] The phrase “out of nothing” sounds very common, so economists translate it into Latin to make it sound better: ex nihilo.

Some brilliant minds have repeated this. Niall Ferguson mentions this in Ascent of Money. Ray Daglio does the same in his video How the Economic Machine works.

However, this isn’t correct. Banks don’t create credit money from nothing, with the stoke of a pen. It is quite close to being true, though. The reason that most people cannot believe it, and why most economists therefore have not been able to accept the credit money creation theory, is that it sounds silly. Probably, instinctively, something based on common-sense inside you says: something from nothing isn’t very likely. You cannot create gold from nothing.

However, what banks create isn’t gold.

It is the IOU.

Formerly, this IOU was linked to gold, to a memory of value created by effort in the past. Today, it is linked to a loan asset, which is expected to bring in a future revenue stream. Really, banks are monetisation entities.

Commercial banks today create credit money. This credit money has purchasing power and is indistinguishable from a real deposit of value into a bank account. This use of funds for loans isn’t created out of thin air; it is created by using the confidence capital of the bank, their reputation. Of course, you have to be a bank as well; other actors in the economy cannot just create credit money. It requires a banking license. This license from the government essentially grants power from the nation state to a commercial bank to create credit money. Most of the money supply creation power in an economy is granted to the private banking sector, which creates money based on their views of their own profit potential. In no country is this power to create money directly regulated. Nor is the use of these created funds regulated at all.

Most people don’t see the reality of how money is created. Others see, but seek to mislead. A few see clearly. Here are some quotes from those who see.

“If the American people ever allow private banks to control the issue of their currency … the banks … will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered …. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.”

Thomas Jefferson[9]

“A great industrial nation is controlled by its system of credit. Our system of credit is concentrated in the hands of a few men. We have come to be one of the worst ruled, one of the most completely controlled and dominated governments in the world — no longer a government of free opinion, no longer a government by conviction and vote of the majority, but a government by the opinion and duress of small groups of dominant men.”

Woodrow Wilson[10]

“It is well enough that people of the nation do not understand our banking and money system, for if they did, I believe there would be a revolution before tomorrow morning.”

Henry Ford[11]

“Thus, our national circulating medium is now at the mercy of loan transactions of banks, which lend, not money, but promises to supply money they do not possess.”

Irving Fischer[12]

“In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. Deficit spending is simply a scheme for the ‘hidden’ confiscation of wealth.”

Alan Greenspan[13]


[1] So, it is a little embarrassing when other central banks, like the Bank of England, actually state clearly that, no, central banks don’t create most of the money supply. Most of the money supply comes from commercial banks in an economy by making loans. But, the textbooks never change, never reveal the truth about money creation, even when central banks themselves state it clearly. Why could that be?

[2] On 26 March 15 2020, the Federal Reserve Board reduced reserve requirement ratios to zero percent for all depository institutions.

[3] You can measure total savings (which would be incorrect) or available savings depending on changes in the interest rate paid on savings deposits; it doesn’t matter. Both correlations are weak.

[4] JK.Galbraith, Money: Whence it came, where it went, Princeton, Princeton University Press, 1975, p.22.

[5] He isn’t a banker and he doesn’t fully seem to understand the workings that you would know if you were an insider, but he actually did field research!! It is incredible, as the biggest sin in being an economics professor seems to be actually applying your trade, getting your hands dirty with commerce. You won’t find that with any Nobel prize winners.

[6] R. Werner, ‘A Lost century in economics: Three theories of banking and the conclusive evidence’, International Review of Financial Analysis, vol. 46, pp. 361–379.

[7] Economics is one of the few professions where you can be an expert without actually ever having worked in your area of expertise. I mean, if you want to be a golf pro, it helps if you have swung a golf club. Not so with economists who “teach” about banking. Yet, when these same economists go to the doctor, you can be pretty sure that they select someone who has real experience, not just someone who has read about how medicine works and has developed grand theories.

[8] William Paterson, founder of the Bank of England, from contemporary sources, 1694.

[9] Quoted by contemporaries. Letter to John Taylor, 1816. Letter to John Wayles Eppes, 1813.

[10] W. Wilson, The New Freedom, New York, Doubleday, Page & Co., 1913. Also quoted by contemporaries.

[11] H. Ford and S. Crowther, My Life and Work, New York, Doubleday, Page & Co., 1922. Also quoted by contemporaries.

[12] I. Fisher, ‘100% Money and the Public Debt’, Economic Forum, April — June 1936, pp. 406–420.

[13] A. Greenspan, ‘Gold and Economic Freedom’, Objectivist newsletter, 1966.

Most of the money supply creation power in an economy is granted to the private banking sector, which creates money based on their views of their own profit potential.
Robert Sharratt

Robert Sharratt

A former banker who has had enough of disparities in financial opportunities. Working to leave the world a better place than he found it, writing while doing it.