Deep Dive: How Money Is Created

🤔 Guiding Question for This Lab

"If new money always enters at specific points,
who gets the advantage and who pays the price?"

🧪 Welcome to the Money Creation Lab

Most people picture a money printer in a basement.
In real life, new money enters through two layers.

Layer 1 is the government and central bank.
Layer 2 is the commercial banks that you and I use.

Both layers create money. They just do it in different ways.

🏛️

Step 1

Where money is born

🎛️

Step 2

How the Fed moves the levers

🌍

Step 3

What the rest of the world feels

Step 1: The Two-Layer Money Fountain

Most people think governments "print" all the money. In reality, modern money flows from two connected layers — the government & central bank (Layer 1), and the banking system (Layer 2).

Layer 1: Base Money (Government + Central Bank)

When the government spends more than it collects in taxes, it borrows by issuing Treasury bonds.
Banks and investors buy those bonds using existing dollars.
The Federal Reserve can later purchase those bonds from banks, paying with newly created digital reserves—the foundation of the monetary system.

Base money = physical cash + bank reserves at the Fed.

Layer 2: Credit Money (Commercial Banks)

Commercial banks use those reserves as a foundation to make loans.
When a bank lends, it creates new deposits—money that didn't exist before.
When loans are repaid, those deposits disappear.

Over 90% of the money we use is this credit money.

Key Insight

The government creates IOUs.
The central bank creates reserves.
Banks create deposits.
Each layer adds leverage—and debt.

That's why every dollar starts as someone's promise to repay.

When you see this, a simple question appears:

If every dollar starts as someone's promise to repay,
what happens when too many promises are made at once?

Want to see the full chain from one deposit to many loans?

🔬 Open the Fractional Reserve Lab →

Interactive Visualization

Adjust the reserve requirement to see how Layer 1 (base money) multiplies into Layer 2 (credit money)

Reserve Requirement: 10% (Banks must keep this % in reserve, can lend the rest)

5% (High Multiplier) 25% (Low Multiplier)

Layer 1: Central Bank

(Base Money / Reserves)

$100B

×10

Layer 2: Commercial Banks

(Total Money Supply)

$1,000B

Central Bank Money

10%

Commercial Bank Money

90%

Key Insight: Over 90% of the money supply comes from commercial bank lending, not from central banks. Central banks create the base, but commercial banks multiply it through the lending process.

🎛️ Step 2: The Fed Control Room

Now look inside the main control room.
This is the balance sheet of the central bank.
On one side we see what it owns.
On the other side we see who it owes.

Federal Reserve Balance Sheet

📊 Assets ($T)

U.S. Treasuries $5.0T

Debt of the government that the Fed holds

Mortgage-Backed Securities $2.5T

Bundles of home loans

Other Assets $0.5T

Short-term loans and positions with other banks and central banks

💰 Liabilities ($T)

Currency in Circulation $2.3T

Physical cash that people hold

Reserve Balances $3.2T

Deposits that banks keep at the Fed

Reverse Repo Facility $1.8T

Short-term parking lot for cash from big financial players

Treasury Account $0.7T

The main bank account of the government at the Fed

💧 Global Liquidity Meter

Tight Neutral Abundant

🎯 What Each Lever Does

Quantitative Easing: The Fed buys more Treasuries or mortgage bonds → Assets go up → Reserves of banks go up → The fountain has more base money

Quantitative Tightening: The Fed lets bonds mature or sells them → Assets go down → Reserves of banks go down → The fountain has less base money

Cut Rates: Loans become cheaper → Banks want to lend more → Layer 2 grows faster

Raise Rates: Loans become more expensive → Banks lend less → Layer 2 grows slower

🎚️ Interest Rates: The Faucet Handle

Lower rates → cheaper borrowing → more credit → faster money growth.

Higher rates → costlier loans → slower money creation.

Central Bank Interest Rate: 5%

0% (Easy Money) 5% (Moderate) 15% (Tight Money)

⚖️ Moderate Credit Flow

Borrowing is affordable. Lending is steady. Economy balanced.

💭 Reflection: How powerful should one small committee be if it can expand or shrink the money supply for everyone?

🌍 Step 3: What the Rest of the World Feels

When the Fed pushes more reserves into the system and keeps rates low:

Bond yields tend to fall
Stocks often rise
The dollar can weaken compared to other currencies
Scarce assets like Bitcoin often catch a wave of new demand

When the Fed drains reserves and raises rates:

Bond yields tend to rise
Stocks can struggle
The dollar can become stronger
Risk assets and weak firms feel the squeeze

🎯 Interactive Missions

Mission 1: Spot the Fountain

Go back to Step 1. You start with $100B in base money and a 10% reserve requirement.

Set reserve requirement to 10%
Note the total money supply
Now move the requirement to 5%
What happened to the size of the fountain?

Ask: Who benefits when the money multiplier increases?

Mission 2: Extreme Easing

Go back to Step 2. In the Fed Control Room:

Click the "Quantitative Easing" button
Watch the asset sliders and global liquidity meter
Observe what happens to the liquidity level

Ask: Who benefits when money becomes cheap and plenty? Who loses?

Mission 3: Sudden Tightening

Run the opposite experiment:

Click the "Quantitative Tightening" button
Then click "Raise Rates"
Observe the liquidity meter

Ask: What happens to bank lending? Asset prices? People who already have a lot of debt?

⚖️ The Trust Balance

Central banks don't print most of the money—but they set the rules that decide how much private banks can create.

The system stays stable only while people trust that money will hold value tomorrow.

⚖️ The Trust Seesaw

Adjust the money creation rate and watch how trust tips

Money Creation Rate: 5%/year

0% (Deflation) 15% (High) 30% (Crisis)

Money
Creation

🏦

Public
Trust

✅ Balanced System

Moderate inflation keeps economy stable. Trust remains high.

💭 If trust breaks… the fountain stops flowing.

🎯 Mission 4: Trust and Growth

Connect back to the Trust Seesaw above. After you play with easing and tightening in Step 2, return here and adjust the money creation rate.

Notice how a fast-growing money supply can push the trust meter down for people who save in that currency.

💡 Key Takeaway

When rules are set by a small group, the fountain can grow or shrink in ways most people do not see.

Bitcoin will appear later in this path as a system with very different rules.

First you need this map of how fiat money works today.