The Hidden Circuit of U.S. Money Creation
From Congressional Deficits to Bank Lending
We hear a lot of talk of blaming the fed about why we are in the place we are but that’s not entirely true. First the fed controls the overnight rate, and Powell has 12 governors who vote with him, so he has no true authority when there is voting held, granted most side with the chairman there is still dissent. The excess fiscal comes from the congress, yet no one calls them out and the treasury issues the bonds. The banks issue debt from fractional banking, but yet we have this whole boogeyman syndrome. It’s ridiculous. Right wrong or indifferent we are going to teach you how this really works, because in this world we speculate too much and look for the boogeyman. Subscribe and share. Or don’t we really don’t care. This is to help you and your family so have a good day. Remember the fed chair must be approved by congress and testify to congress.
The United States operates the world’s largest fiat currency system, one in which the supply of money is not constrained by any physical commodity but is instead expanded through a coordinated interplay of fiscal policy, government borrowing, central bank operations, and private-sector credit creation. This mechanism, often misunderstood or oversimplified in public discourse, begins not with the Federal Reserve printing money at will but with decisions made in Congress, where spending authorizations routinely exceed tax revenues, producing deficits that must be financed through borrowing. That borrowing, in turn, injects reserves into the banking system, enabling commercial banks to multiply the money supply many times over through the ordinary process of making loans. The result is a self-reinforcing cycle in which persistent fiscal deficits drive both public debt accumulation and private money growth, with gradual currency debasement as the long-term consequence.
The Congressional Budget Office plays a pivotal but understated role as the official scorekeeper of this process. Charged with producing independent, nonpartisan projections under current law, the CBO effectively signals to markets, policymakers, and the public what the fiscal trajectory will be if no changes are enacted. Its February 2026 Budget and Economic Outlook paints a picture of unrelenting deficit expansion, with primary deficits driven by built-in growth in entitlement programs and secondary deficits compounded by rising interest costs. By assuming continuation of existing statutes, the CBO’s baseline becomes a de facto endorsement of ever-larger debt issuance, conditioning investors to expect that Treasury will remain a permanent and growing borrower in global capital markets.
Over the coming decade, the CBO projects cumulative deficits exceeding $24 trillion, pushing federal debt held by the public from roughly 99% of GDP at the end of 2025 to approximately 120% by 2036. These figures are not alarmist scenarios but the mathematical consequence of current-law spending commitments outpacing revenue growth. Annual deficits begin at $1.9 trillion in fiscal 2026 about 5.8% of GDP and widen steadily, reaching $3.1 trillion by the end of the projection window. Such numbers reflect structural rather than cyclical imbalances, meaning they persist even in an economy assumed to be operating near potential. The principal forces behind this trajectory are mandatory spending programs chiefly Social Security, Medicare, and Medicaid whose outlays rise automatically with demographics and health-care cost inflation. Social Security benefits grow as the baby-boom cohort retires fully into the system; Medicare and Medicaid costs escalate both from enrollment growth and from per-beneficiary spending increases that consistently outpace general inflation. Added to these is the explosive growth of net interest expense: the CBO forecasts interest payments surpassing $1 trillion annually as early as 2026 and more than doubling to $2.1 trillion by 2036, as higher post-pandemic interest rates compound on an ever-larger debt stock.
When Congress enacts appropriations and entitlement laws that produce deficits, the U.S. Treasury Department becomes the operational arm that translates those fiscal decisions into marketable securities. Authorized by statute and subject to the debt ceiling (periodically suspended or raised), Treasury issues bills, notes, bonds, Treasury Inflation-Protected Securities (TIPS), and Floating Rate Notes in volumes calibrated to cover both maturing debt and new borrowing needs. The issuance schedule is announced quarterly and refined weekly, providing predictability to investors while allowing flexibility to respond to cash-flow variations. Treasury auctions represent one of the most liquid and transparent debt markets in the world. Conducted electronically through the TreasuryDirect platform and the Fed’s TAAPS system for institutional bidders, auctions are managed by the Federal Reserve Bank of New York acting as Treasury’s fiscal agent. Primary dealers roughly two dozen large banks and securities firms are obligated to submit meaningful bids at every auction, ensuring demand even in stressed conditions. Competitive bids determine the clearing yield or price, while non-competitive bids from retail investors and foreign official institutions are filled at the resulting average rate.
The auction process is deliberately structured to minimize borrowing costs while maximizing participation. Most securities are sold via multiple-price auctions, in which each winning bidder pays the price it bid, but Treasury has long used uniform-price formats for certain bills and inflation-protected securities to encourage more aggressive bidding. The overwhelming majority of new debt often 90% or more is absorbed initially by primary dealers, who then distribute it to end investors ranging from money-market funds and pension funds to foreign central banks and sovereign wealth funds. By law, the Federal Reserve is barred from purchasing newly issued Treasury securities directly at auction, a prohibition rooted in historical fears of uncontrolled debt monetization. Instead, the Fed influences the market through open-market operations conducted exclusively in the secondary market (HYG, TLT). When the Federal Open Market Committee decides to expand its balance sheet, the New York Fed’s trading desk buys existing Treasuries or agency mortgage-backed securities from primary dealers and other counterparties, crediting their reserve accounts with newly created central-bank money.
This reserve creation directly expands the monetary base currency in circulation plus reserves held at the Fed. Although the Fed is not formally designated a “buyer of last resort,” its quantitative easing programs have repeatedly served that function in practice. Between 2008 and 2014, and again from 2020 to 2022, the Fed’s holdings of Treasury securities ballooned from less than $500 billion to nearly $6 trillion, absorbing a significant share of net issuance during periods when private demand might otherwise have been insufficient at low yields. Even after the initiation of quantitative tightening in 2022, the Fed remains by far the largest single holder of Treasury debt, with its portfolio rollover providing a steady bid that caps upward pressure on long-term yields. This accommodation effectively bridges the gap between Treasury supply and private-sector demand, allowing deficits to be financed smoothly without immediate market disruption.
The true multiplier of the money supply, however, resides not in the central bank but in the commercial banking system. Banks create the vast majority of money used in daily transactions demand deposits, checking accounts, and other components of M2 simply by extending loans. When a bank approves a mortgage, business line of credit, or credit-card advance, it simultaneously creates a new asset (the loan receivable) and a new liability (the borrower’s deposit), expanding both its balance sheet and the broader money stock. Although reserve requirements were set to zero percent in March 2020, banks still hold substantial reserves for settlement, liquidity, and regulatory purposes. In the current ample-reserves framework, the binding constraints on lending are capital requirements, risk appetite, loan demand, and profitability rather than reserve availability. Large money-center banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo dominate this process, originating trillions in new credit annually.
The classic textbook description of fractional-reserve banking still applies conceptually: an initial injection of reserves allows a chain of lending and redepositing that amplifies the money supply. In practice, the multiplier has become more variable and less predictable since the shift to floor-based interest-rate targeting and abundant reserves, but the fundamental principle remains new bank credit equals new money. Overnight funding markets facilitate this system by allowing banks to borrow and lend reserves seamlessly. The federal funds market secured overnight repurchase agreements (repos), and the Fed’s standing repo facility together ensure that temporary reserve surpluses or shortages do not disrupt lending. The Fed influences the cost of this short-term funding by setting the interest on reserve balances (IORB) and the overnight reverse repo rate, anchoring the federal funds rate within its target range.
Fiscal deficits interact intimately with bank money creation. When the government disburses spending whether payrolls to federal employees, benefit checks to retirees, contracts to defense firms, or transfers to households (Cantillon Effect) the funds flow through the Treasury’s account at the Fed into commercial bank reserves and private-sector deposits. This simultaneous increase in reserves and deposits provides banks with both the raw material and the customer base for further lending. Persistent large deficits therefore act as a continuous stimulus to private credit growth. Historical episodes of rapid M2 expansion such as the post-2020 surge following massive pandemic relief packages illustrate how fiscal injections can supercharge bank balance sheets when monetary policy is accommodative.
Critics of this arrangement argue that sustained deficit financing, when ultimately absorbed by domestic credit creation rather than foreign saving, inevitably debases the currency. Inflation is not merely a transitory phenomenon but the long-run consequence of money growth systematically exceeding the economy’s productive capacity. The CBO’s own projections implicitly acknowledge this risk by forecasting steadily rising debt-service costs that crowd out other budget priorities and increase vulnerability to interest-rate shocks. Higher debt also raises the probability of a sudden loss of investor confidence, though the dollar’s reserve-currency status and the unparalleled depth of the Treasury market have so far prevented such an outcome. Markets have accommodated record peacetime debt issuance with remarkable equanimity, supported by the absence of near-term inflation pressures and the Fed’s credible commitment to price stability. Foreign official holdings, once dominant, have declined as a share of total debt, meaning domestic institutions and the central bank itself have absorbed the bulk of recent supply growth.
The American money-creation circuit is thus a closed loop: Congress authorizes spending beyond revenues → Treasury issues securities → primary dealers and investors purchase them → the Fed provides liquidity and, when needed, direct demand → banks receive reserves and deposits → banks extend new loans, multiplying money → increased economic activity generates tax receipts that lag spending → larger deficits ensue. Breaking this loop would require either drastic spending restraint or substantial revenue increases options that current-law projections deliberately exclude. Whether this system can continue indefinitely without triggering higher inflation, forced austerity, or a more severe crisis remains the defining macroeconomic question of the era. The CBO’s 2026–2036 outlook offers no reassurance on that score, instead presenting a future in which debt compounds, interest burdens mount, and the need for ever-greater borrowing becomes structurally embedded. In the absence of political consensus to alter course, the machinery of money expansion will keep turning, driven by the same fiscal impulses that set it in motion. If you made it this far thank you.
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The DOOM cycle is what it is NOW !