It’s called “Fractional Reserve Banking”. The bank only needs to have about 10% of a loan on hand.

If a bank has $100, they can write a loan for $1,000; effectively putting $900 more into circulation. When that is spent, it gets deposited into a bank, which can then loan it out amplified again.

This could create infinite money, as I understand it. Since there is not infinite money, there must be a gap in my understanding somewhere.

I like Geoff Mann’s description: “When money is released into general circulation by a bank or a state, it is always issued via the process of debt creation. Which is to say, even though it is hard for many of us to believe, that much if not most of the money in circulation is produced when someone or some institution goes into debt. (Remember it need not be physical currency to circulate; currency represents a very small fraction of circulating money.) For example, when someone borrows money from a bank, it is not as if the bank has that money in bills and coins in a safe in the basement, nor does it have it in "digital" form. Instead, by lending money to the borrower (and thereby fulfilling its obligation to the debt contract), the bank basically "creates" that money. It simply creates a big hole in its own accounts, with a "minus" sign beside it. The debt contract stipulates that the borrower's obligation is to fill the hole by a set date. The money loaned does not need to pre-exist the debt contract. Which means that the debt contract literally creates the money, because the big hole the bank placed in its own accounts is mirrored by an equally large "pile" in the borrower's account. The borrower spends that money in the economy, and, in addition to the interest that is the price of using this money, slowly pays the bank back to fill the hole. The money produced via the loan is issued to the borrower who is then indebted, and the money represents the means of settling that debt.

The debt in this example is obviously private (be-tween a borrower and a private bank), but money produced by the creation of their credit-debt contract can circulate generally in the public realm-if you borrow to pay your tuition, the money you borrow is not special money only you can use. Your school can use it to pay instructors and buy office furniture, instructors can use it to buy groceries, and so on. The money is a product of your indebtedness, and you can transfer it to whomever you please- it is transferable debt. Now, in theory, a bank cannot go on creating money in this way without limit. Modern banking systems have regulated "capital requirements"; some portion of a banks money-loan portfolio must be covered by reserves of cash or cash-like assets. But the ratio in most capitalist nation-states is only around 10 percent, often even less.

Thus, at least in theory, unless all banks are simultaneously maxed out on their lending— unlikely, and even if it did happen, the banks merely have to go raise some more money to add to their reserves— the money supply can change size in response to demand for loans without direct state involvement.

Similarly, when the state creates money via spend-ing, "printing," borrowing, etc., the money issued is a form of state debt. State-issued money is a claim on the state by the holder of the money, and it circulates among all the other private bank-issued debt-money: transferable debt. So, for example, when you come to settle your account with the state (pay your taxes, say), the state must accept its own credit-issue as legitimate means of redemption. The money is transferable debt that must be accepted as equivalent to the abstract unit of account.“

The money supply grows because banks are only forced to keep some of their deposits as reserves. Everything else can be lend away. The formula for the amount of money they create (money multiplier) is as follows:

a = physical currency/bank deposits w = reserves/deposit accounts MM = 1+a/w+a

You can interprete w as the rate of reserves. So if we simplify the equation by assuming theres no cash it becomes:

MM = 1/w

So if the reserve ratio is 0.1, the MM would be 10, meaning that the money supply will be 10 times bigger than the monetary base (cash + reserves).