# Where Money Actually Comes From Nearly all money is created by ordinary high-street banks at the moment they lend, and destroyed again when the loan is repaid. Where money actually comes from, why the machine can't idle, and the one money that isn't born as debt. - Date: 2026-07-15 - Canonical: https://thenaturalstate.org/essays/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. Nearly all the rest is created by ordinary high-street banks. New money is typed into existence when a bank lends, and deleted from existence when the loan is repaid. Behind them all is the central bank, which sets the price of borrowing and creates money itself 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. 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. 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. 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. ## 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. 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. In 1971 it stopped exchanging dollars for gold. Since that day the major currencies have had nothing behind them but policy. The answer to "what backs the pound" is the decisions of the people who manage it. Occasionally you see that nakedly. When Malawi devalued the kwacha by roughly 44%, a national supermarket chain shut for a day to relabel the goods, and nobody got a 44% pay rise to match. Prices jumped across the board, wages didn't move, and people were poorer overnight, by decree. 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. That anchors the price of borrowing across the economy. It doesn't set how much banks lend. Banks and borrowers do that. It decides how expensive borrowing will be. 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. 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. 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 2019 the entire corporate profit pool of the United States was about 2.25 trillion dollars. Covid-era money creation ran at roughly 5 trillion dollars a year. You could have taxed every corporation at 100% and not covered half of it. Whatever the public story, money creation is now the main funding tool of the modern state. 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. So if prices and wages broadly fall, debts take a bigger bite of everyone's income, yours, your employer's, the bank's, the government's. Push that far enough and defaults cascade through the chain of promises. 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. 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 2008 even fully collateralised trade finance froze for days because no bank would trust another bank's promise. That's why the central banks of the rich world target rising prices of about 2% a year, forever. Falling prices kill a machine built out of debt, and that machine is what the target protects. But technology is pushing the other way, harder every year. It keeps making things cheaper to produce, which is the natural state of a market, prices falling toward the cost of making one more unit. So to keep prices rising 2% while the natural drift is down, credit has to grow faster than the deflation it's fighting, and the deflation compounds. That's why the numbers look deranged. In the two decades to about 2020, the world added roughly 185 trillion dollars of new debt to buy about 46 trillion dollars of growth. 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 making the money worth less so the debts shrink against what money actually buys. That route has a polite name, inflation. It's a default paid by whoever holds the currency. ## Who gains and who pays New money doesn't arrive everywhere at once. It enters somewhere specific, through banks, asset markets, governments, and their contractors. 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 Alice the nurse 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 Alice's effort changed. The money changed, and it moved value from her side of the table to the other one. 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 I say inflation is wage deflation. Her real pay [what her wages actually buy] fell while the number on her payslip rose. 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 needs inflation is the debt structure, not human exchange. ### "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 1930s were. 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 sits one policy mistake away, and that's the indictment. We built money that can't survive 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 in 2008, trillions in 2020, and markets now wobble at the hint of support being withdrawn. 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." Innovation runs on savings and equity, people backing founders for a share of what they build. It doesn't need the marginal new pound of bank credit. 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, either by issuing a fresh promise or by writing more claims than there was metal. There's now one exception. Every pound is born as someone's debt. Every bitcoin is born as someone's cost. 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]. The issuance runs on a fixed schedule, halves roughly every four years, and stops at 21 million. 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]. All of it holds on one condition, that bitcoin stays decentralised and secure. There's no loan behind it, no promise, no committee. Its supply answers to physics and code rather than to policy. With the two answers side by side, the rest of the thesis follows on its own. Money that's born as debt must expand or die, so it swallows the price falls technology keeps trying to hand you. Money that's born as cost can simply sit still and let prices fall. Today we print money and not goods. The world we're heading into prints goods and not money.