New on FinoLib · Volume I: Global Economy
My latest article is now live on FinoLib, the free finance library I write: How Is Currency Created and What Determines Its Value?, from Volume I: Global Economy. Read the summary below for the substance of the topic, then continue to FinoLib for the complete treatment.
0.9 How Currency Is Created Today — and How Much Is Too Much
The idea in plain words
Central banks create only notes, coins and bank reserves. Ordinary banks create most of the money by lending: a new loan credits a new deposit in the borrower’s account. Lending is held back by capital rules, liquidity rules, willing borrowers and the policy rate, not by a reserve multiplier.
Key points
■When a bank lends a household $300,000, it credits $300,000 to the borrower’s account; no saver’s balance is reduced to fund it.
■The US reserve requirement has been zero since March 26, 2020, and the Fed pays interest on reserves, so it can hold a large stock of reserves and still control short-term rates.
■Currency is about 10.6% of US M2 ($2.48 trillion of $23.34 trillion), so roughly nine of every ten dollars exist as account entries.
A closer look
In the modern fiat system, currency creation is more complex than a government simply “printing money.” Money exists in several distinct forms, which economists categorize by how liquid they are — how easily and immediately they can be used for transactions.
Under the hood
Under the Hood: Where the $300,000 Goes
The borrower does not keep the new $300,000 deposit for long: it goes to the seller of the house, who banks elsewhere. The borrower’s bank sends the payment, and the two banks settle it by moving $300,000 of reserves across their accounts at the central bank. The seller now holds the deposit, and the total amount of money in the economy is unchanged by the transfer: payments move money between banks; only new lending, repayment and central bank purchases or sales change the total, while a cash withdrawal merely changes its form from deposits to notes.
Recap
The central bank creates notes, coins and bank reserves; commercial banks create most money by lending, because a new loan credits a new deposit, and repayment destroys it. Lending is limited by capital, liquidity rules, willing borrowers and the policy rate, not by a reserve multiplier, and QE creates reserves and deposits together.
0.10 How a Currency’s Value Is Determined — and Who Does It
The idea in plain words
A floating currency’s value is set by no one. It comes out of the foreign exchange market, where interest rates, inflation differences, trade, growth, politics, speculation and central bank action all push on it. The impossible trinity says a country can keep only two of three: a fixed exchange rate, open capital flows and its own interest rates.
Key points
■The FX market traded about $9.6 trillion a day in April 2025, with the US dollar on one side of roughly 89% of trades.
■A 10% fall in the rupee makes gasoline dearer for Indian families, because oil is priced in dollars, but makes Indian software exports more competitive.
■At end-March 2026, India’s banknotes in circulation were worth ₹41,23,995 crore (about ₹41.2 lakh crore), up 11.9% in a year, and ₹500 notes were 85.5% of that value.
A closer look
In today’s floating exchange rate system, no single authority sets the value of a currency. Its value emerges from the continuous interaction of millions of buyers and sellers in the global foreign exchange (FX or forex) market — the largest financial market in the world, trading an average of about $9.6 trillion per day in April 2025, with the US dollar on one side of roughly 89% of all trades.
A worked example
Worked Example: How a Carry Trade Pays, and How It Unwinds
Illustrative round numbers, not market quotes. A fund borrows ¥1,600,000,000 for three months at 0.25% a year, converts it at 160 yen per dollar, and buys US Treasury bills yielding 5% a year. Its broker requires $1,000,000 of margin. Step Formula Result Dollars raised ¥1,600,000,000 ÷ 160 $10,000,000 Yen owed after 3 months ¥1,600,000,000 × (1 + 0.25% × 0.25) ¥1,601,000,000 Dollars after 3 months $10,000,000 × (1 + 5% × 0.25) $10,125,000 Repay if the rate stays at 160 ¥1,601,000,000 ÷ 160 $10,006,250 → profit $118,750 Repay if the yen strengthens to 145 ¥1,601,000,000 ÷ 145 $11,041,379 → loss $916,379 A move from 160 to 145 is a yen rise of 160 ÷ 145 − 1 ≈ 10.3%, and…
Recap
A floating currency’s value is set in the FX market, about $9.6 trillion a day in April 2025 with the dollar on one side of roughly 89% of trades, and moved by rates, inflation, trade, growth, politics, speculation such as the carry trade, and intervention.
What the full article covers
In the full article I take you through these sections:
■0.9 How Currency Is Created Today — and How Much Is Too Much
■0.10 How a Currency’s Value Is Determined — and Who Does It
It includes worked examples, a look under the hood at the mechanics, a recap, a reveal-on-click quiz and the official sources behind every figure.
Volume I: Global Economy
Read the full article on FinoLib
The complete article, How Is Currency Created and What Determines Its Value?, with every worked example, diagram, quiz and source, is free to read in Volume I, Global Economy on finolib.com.
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