In the year 2014, an economics professor spent months convincing a small bank in Germany to let him observe something that nobody outside the banking system had ever witnessed before. He wanted to sit inside the bank while a real loan was approved. Eventually, the bank agreed.
They opened their books, opened their systems, and allowed him to see exactly where the loan money came from.
The professor was Richard Werner, a banking economist from Germany. What happened next was about to make accounting far more exciting than accounting has any right to be. He watched the bankers step-by-step create brand new money out of absolutely nothing.
Not from deposits. Not from reserves. Not from someone else’s savings account.
Money that simply did not exist one moment existed the next. And he became the first person in history to document the process from inside a real commercial bank.
Shortly afterward, the Bank of England effectively admitted the exact same thing in one of their own official publications. A link to the paper is available in the video description, in case you think I have accidentally wandered into conspiracy theory territory. The official confirmation from a major central bank was a crucial moment for transparency.
Now, here is the problem. Your brain hates this explanation. Mine did, too.
We have all grown up believing money must be far more complicated than that. Surely something this important must involve vaults, gold bars, and men in expensive suits nodding at spreadsheets. Apparently not.
In reality, it is almost insultingly simple.
Every time a bank approves a loan, they do not go looking for someone else’s savings. They do not open Linda’s retirement account and say, “Sorry, Linda, we are temporarily borrowing your pension so Jason can finance a jet ski and a midlife crisis.” Nope, that is not what happens.
Instead, they open a computer, type numbers into your account, and in that exact moment, money that did not exist a second earlier suddenly exists and can be spent immediately.
If you are sitting there thinking there is absolutely no way that is true, you are in good company. When researchers ask people who creates money in their country, most answer the government, the central bank, or the treasury. Almost nobody answers commercial banks.
Even though that is where the overwhelming majority of money is actually created. And yes, the government creates some. The central bank creates some.
But private banks create most of it.
To understand why, you first need to understand that not all money is the same. There are basically three different types of money. The first type is central bank reserves.
Normal people never see this money. Banks use it to settle payments with each other. Think of it like a VIP lounge your debit card is not invited to.
The second type is cash. Notes, coins, the $14 living permanently in your car’s cup holder. This money is created by the central bank.
But surprisingly, cash makes up only a tiny percentage of all money in the economy.
Which brings us to the third type, commercial bank money. This is the big one. Your salary, your mortgage, your savings account, your emergency fund that somehow became a holiday fund.
This is digital money created by commercial banks, and it makes up the overwhelming majority of money in the economy today. Which raises a fairly important question. How exactly is this money created?
Most of us were taught the same story. You deposit money. The bank keeps some and lends out the rest.
That money gets deposited somewhere else. The process repeats. Simple, neat, elegant.
Unfortunately, it is not really how modern banking works. Think about it. If banks genuinely needed your deposits in order to lend, they would be desperate to attract them.
They would offer 12% savings accounts, free holidays, free iPhones, anything to get your cash. Instead, they offer savings rates that inflation finds genuinely hilarious. Why?
Because deposits are not the thing limiting lending.
So, where does the loan money come from? Short answer, nowhere. Banks operate using something called double-entry bookkeeping, which sounds boring because it is.
But it also runs the entire financial system. Let me explain. Every transaction gets recorded twice on the bank’s balance sheet.
Once on the asset side and once on the liability side. Let us say you borrow $20,000. The bank writes down, “This customer owes us $20,000.”
That is an asset, because your future repayments belong to them. Then they write, “We owe this customer $20,000.” That is the deposit now sitting in your account.
That is their liability. One entry on the left, one entry on the right. Both increase by $20,000.
And just like that, money is created. No vault opened. No cash moved.
The bank was not recording money that already existed. The act of creating the accounting entries was the act of creating the money. That is the mechanism.
If you are waiting for the catch, the moment where the bank manager finally says, “Right, now let us go find the actual money,” because surely banks need to hold at least a 10% reserve before making a loan, you are about to be very disappointed. In reality, reserve requirements in many countries are extremely low or even zero. As in, none.
Which means the question is not, “Do banks have enough money to lend?” The question is, “Do banks want to lend to you?”
Let us assume you have accepted this strange new reality. The bank typed money into existence. You spent it.
You bought the car, renovated the kitchen, purchased the espresso machine that now judges you every morning. What happens next? This is where things get really interesting, because every loan is actually two things wearing a trench coat pretending to be one thing.
The principal and the interest. Suppose you borrowed $20,000. Over the life of the loan, you might repay another $4,000 in interest.
As you repay the principal, that money slowly disappears from the economy. Deleted. Removed.
Gone. The same keyboard that created the money effectively destroys it. But not all of it disappears.
The only thing left behind is the $4,000 in interest you paid along the way. The principal appeared. The principal disappeared.
The interest stayed behind.
Before you ask, no, banks cannot create unlimited amounts of money. They still need borrowers who can repay. They still need enough capital to satisfy regulators.
And they still need to believe they will make money on the loan. But within those constraints, banks still get to make one incredibly important decision. Who gets the new money first?
Because where banks lend determines where new money enters the economy.
Imagine you are running a bank. Person A asks for $80,000 to open a restaurant. But restaurants have an unfortunate habit of occasionally turning into empty buildings with motivational quotes still painted on the walls.
Terrifying. Another asks for $700,000 to buy a house. The house does not disappear.
If repayments stop, the bank takes the house. Which loan feels safer? Exactly.
So if you are a bank, where does most lending naturally go? Mortgages, property, existing assets. And once you see where credit flows, house prices start making a lot more sense.
Every mortgage approval creates new purchasing power. More money, same houses, higher prices. And when that process repeats millions of times over decades, house prices do not just rise, they accelerate.
You do not need a PhD in economics to know that this is not really a housing problem. Housing is just where the money problem shows up first.
Now, before we finish, I want to zoom out for a second. Because beneath all the economics, all the accounting, all the banking jargon, this conversation is really about something much simpler. Your time.
Every early alarm. Every commute. Every overtime shift.
Every Monday meeting that absolutely could have been an email. You are trading pieces of your life for money. Money is your labor frozen in digital form.
Hours of your life converted into numbers on a screen. Which means understanding money is not really about understanding finance. It is about understanding the exchange rate between your life and the world around you.
You do not need to become an economist. You do not need to become a banker. But if you do not understand credit, you do not understand money.
And if you do not understand money, someone else gets to write the rules for you. That is a dangerous position to be in, because whether you realize it or not, the financial system affects almost every major decision you will ever make. The house you can afford.
The business you can start. The risks you can take. The freedom you have.
Understanding the system does not magically fix it, but it does something important. It means you stop playing the game without knowing the rules. And that is usually where winning starts.
