How banks create money (with your money)

Let's say NewBank just opened its first branch. They start off with $0 in customer deposits. You walk into the bank with a big sack of cash with $100K in it and the bank manager says, "Hey, it looks like we have our first customer!"

You open an account and now the bank has $100K. The bank manager wants to make money, and for some reason you decide you wanna borrow from the bank and stick the money in your account. You ask the bank manager "how much can I borrow?" to which the manager replies, "you can borrow up to 90K".

There's now 190K in your account. Wait a minute, the bank has only accepted 100K in deposits, and yet your bank account now has 190K. WTF? Where did the 90K come from? Simple, the bank created it!

Here's what happened:

  1. You lent the bank 100K.
  2. The bank lent you 90K.
  3. You and the bank have borrowed from each other!

OK, so now you want to take your money out:

  • You: "How much can I withdraw?"
  • Manager: "100K"
  • You: "OK, give me 100K"
  • Manager: "Sure, but you still owe us 90K"
  • You: "OK, fine, here's 90K"
  • Manager: "Thank you sir. Would you like to withdraw your last 90K?"
  • You: "Yes please"

Money creation is the bank lending out your money:

  1. You have 100K, the bank has $0.
  2. You make a deposit, now you have $0 and the bank has 100K.
  3. The bank lends you 90K, now your account shows 190K.
  4. The bank only has 10K in reserves but owes you 190K.
  5. The money supply just went from 100K to 190K.
  6. That extra 90K? The bank created it out of thin air.
  7. When you repay the 90K loan, that money disappears. It wasn't real money, it was debt.

In summary, if you wanna go further down the rabbit hole, here's a video by Money & Macro that explains it in more detail.