Trace the chain from a bank loan to a higher price.
A bank approves a £200,000 mortgage. Where do those pounds come from?
Yes.A loan and a deposit are created in the same keystroke: the bank now owes you £200,000 and you owe the bank £200,000. Both sides appear at once.
Not quite.This is what most people picture, and banks encourage it. But a bank that could only lend what savers brought in would have to turn you away on a quiet week, and none ever does.
Not quite.Notes are a small tail of the money supply — under 5% in most rich countries. The rest is numbers in accounts, and those are made by lending.
A loan makes a deposit. That is the main way new money enters the world — not a printing press, but a bank agreeing that somebody is good for it.
Put the chain in order: how one mortgage adds pounds to the economy.
Tap them in order — first to last.
Bank agrees the loan→New deposit appears→Borrower pays the seller→Seller holds new pounds
New money enters at the moment of agreement, not at a printing press.Yes.Nothing was moved from anywhere. The pounds began as an agreement about the future and ended up in a stranger's account.
New lending has to go somewhere. Slide to change how much of it buys things that already exist — houses, land, shares — rather than paying for something new to be built.
20%50%80%
Building new things80% of new lending
Buying what already exists20% of new lending
20%Most of the money pays wages and materials. New things get built, and there is more to buy as well as more money.
Building new things50% of new lending
Buying what already exists50% of new lending
50%Half the new money is bidding for a fixed number of houses. House prices climb; the shops feel calm.
Building new things20% of new lending
Buying what already exists80% of new lending
80%Almost all of it is chasing the same assets. Prices there rise fast, and the official inflation figure barely moves.
Lending is booming and the shopping basket is barely dearer. What is the most likely reason?
Yes.House prices are not in the shopping basket. Money can pour in and the official figure stays quiet, because it is measuring somewhere else.
Not quite.It affects the prices of whatever it is spent on. The question is always which prices, not whether.
Not quite.Shops absorb a squeeze for a season at most. A boom that lasts years cannot hide in margins that thin.
Move the control to see what changes.
The borrower repays £1,000 of the loan itself — the principal, not the interest. What happens to that £1,000?
Yes.The deposit is cancelled against the debt. Both numbers shrink by £1,000, and the money that was created by the loan stops existing.
Not quite.The interest is the bank's income. The principal is the unwinding of the loan itself — it pays for nothing and buys nothing.
Not quite.There is nothing sitting there to lend. The bank's power to lend again comes from its capital and its judgement, not from this repayment.
New lending (money created)£500bn
Principal repaid (money destroyed)£470bn
Two huge flows. What matters to prices is the gap between them.
In a year, a country's banks make £500bn of new loans and borrowers repay £470bn of principal. By how many billions did the money supply grow?
£bn
Yes.Lending creates, repayment destroys, and the money supply is the difference. This is why lending can be enormous and the money supply almost flat.
A central bank raises interest rates. Which link does that pull first?
Yes.The rate is a price on borrowing. It works by making the agreement less attractive — which is slow, and why the effect on prices takes a year or more to arrive.
Not quite.It has no such power, and no central bank has ever had it. It sets a price and waits.
Not quite.That is price control, a different tool with a different history. A rate rise instructs nobody.
Lesson complete
Most new money is a bank loan, and repaying it takes that money back out.