How Money Actually Works

Money is a collective agreement — a shared technology that makes trade and cooperation possible at scale. It is not backed by gold (that ended in 1971). It is not guaranteed by nature. It has no intrinsic value. It is useful precisely because everyone agrees it is useful, and it is managed by institutions — governments and central banks — that have their own interests and incentives. Understanding money as a social technology rather than a natural resource changes how you think about its value, its stability, and its future.

Most people believe money is printed by governments. The reality is more interesting. Approximately 97% of money in circulation is created by commercial banks when they make loans. When a bank approves your mortgage, it does not transfer existing money to the seller — it creates new money by crediting your account. When you repay the mortgage, that money is destroyed. The money supply expands and contracts based on lending activity, not government printing presses. This is why interest rate changes have such powerful economic effects — they change the cost of borrowing, which changes the rate of money creation.

Fiat currency — currency backed by government decree rather than a physical commodity — has no fixed supply. Governments and central banks can create more of it when circumstances require. This is not inherently sinister. It allows the economic system to respond to crises — the 2008 financial crisis, the pandemic — in ways that a gold standard could not. But it does have a structural implication: over time, more money chasing a roughly similar quantity of real goods and services means each unit of money buys less. The direction of travel for all fiat currencies, historically, is toward less purchasing power.

When new money enters the economy, it does not arrive evenly distributed to everyone simultaneously. It arrives at specific points first — typically financial institutions and large asset owners — and spreads outward from there. By the time it reaches wage earners and small savers, prices have already risen. This dynamic, named after the 18th century economist Richard Cantillon, means that money creation systematically benefits those closest to the source of new money and disadvantages those furthest from it. It is one of the structural reasons why wealth inequality tends to increase during periods of monetary expansion. Understanding it is not a conspiracy theory — it is textbook economics.