If banks create money by lending, that power has two faces at once: it funds growth, and it makes your deposits depend on confidence. Here's both.
You deposit $100. The bank keeps a fraction in reserve and lends the rest. That loan gets spent, redeposited, and lent again. Step by step, a single deposit supports a much larger pile of money. Watch it happen, then notice what's quietly assumed.
Set how much each bank holds back, then run the chain.
"The Federal Reserve creates all the money."
The central bank creates base money and sets the rules — but most of the money in your economy is created by ordinary commercial banks when they make loans, as the chain above shows. The Fed influences how much, through interest rates and regulation; it doesn't directly mint most of it. Understanding this is the difference between blaming one building in Washington and seeing a whole system of incentives.
It's tempting to call money-creation-by-lending a trick. It isn't — it's a genuine tradeoff, with a real upside and a real downside that come bundled together.
Credit lets an economy fund things before the money exists — a business expands, a family buys a home, an idea gets capital. Money supply can grow with real economic activity instead of being capped by how much metal has been dug up. Used well, this is how investment and growth get financed.
The same system means your "money in the bank" is mostly a promise. Banks hold only a fraction of deposits as cash. If too many people want their money at once, the bank can't pay — even a healthy one. Confidence becomes load-bearing.
Defenders argue this fragility is a price worth paying. Elastic credit smooths over shocks, funds productive investment that rigid money can't, and — paired with deposit insurance and a lender of last resort — has made catastrophic bank runs rare in developed economies. On this view, the 2008 and 2020 rescues are evidence the safety net works, not that the system is broken. Hold that argument; section 6 puts it directly against the alternative.
This system works only while most people leave their money in place. Push the other way and you get a bank run — the failure mode that has recurred for centuries, most recently at Silicon Valley Bank in 2023.
A healthy bank with a 10% reserve. Watch what happens when withdrawals exceed what it holds.
So credit banking gives an economy flexibility and gives savers fragility, held together by confidence — and by whoever stands behind that confidence when it cracks. Who is that, what tools do they use, and how much power does it give them? That's the control room, next.