Where does newly printed money go?

John W. Schoen Senior Producer • Profile • E-mail

Chris in North Carolina has been wondering: when the government prints up new money, where does it go? Rod in Texas wants to know: how long can the government keep spending money it doesn't have — before it has to shut down?

Can you explain what the government does when it prints money? How does it put that new money into circulation? Is all new money just replacing old money? How can money be introduced without somebody getting a lot of cash for nothing?
— Chris, Raleigh, N.C.

To start off, you have to make a distinction here between “cash” (which takes many forms, including checks, advances on your credit card and electronic transfers) and physical currency — the paper or coins used to represent cash in a financial transaction.

U.S. paper currency is technically a Federal Reserve note, printed by Bureau of Engraving and Printing. Most of the notes are printed to replace damaged currency that is taken out of circulation and destroyed. A dollar bill has a life span of less than two years, for example, while a $100 bill lasts, on average, more than seven years. There is about $750 billion in U.S. currency in circulation; the Fed estimates that most of it is outside the United States.

Within the U.S. the Federal Reserve is in charge of making sure banks keep their ATM machines stocked with enough cash to meet the public’s demand for paper notes. And that demand rises and falls over time. People need more cash at this time of year, for example, to hit all those post-holiday sales. There’s more cash in circulation on the weekends — when people go to the mall or out to restaurants and movies — than there is during the week.

If demand for cash rises, banks go the Fed and ask for more paper notes, and the amount is deducted from the banks’ “cash reserves.” All banks are required to carry a certain minimum amount of “cash” on their books - called reserves - to meet demand from depositors who want to withdraw funds. Those withdrawals can be paid with a check, electronic transfer or with paper currency. When banks have more paper money than they need, they send it back to the Fed. The amount is then added to the banks’ “cash reserves.” (In effect, the pieces of paper are replaced with electronic bits in the bank's computer system.)

The Fed also controls the size of the “money supply” — which is a bit different than the amount of currency in circulation. There are several different measures of the money supply, starting with physical currency and reserves. (Other measures add in checking and savings deposits, money market accounts, CDs and other forms of “cash.”) When the Federal Reserve decides to boost the money supply, it buys Treasury bonds on the open market. The cash it pays to the sellers of those bonds (almost all of which take the form of electronic bits) goes into the banking system. The Fed doesn’t just hand that cash over to a bank; it makes it available to a bank to lend.

Loans have the effect of creating cash: If you borrow cash from your credit card, that cash gets spent as easily as if you have cashed a paycheck.  So when the Fed encourages more lending (which it also does by cutting interest rates) it puts more money in private hands, which typically increases economic activity.

On the other hand, if the Fed thinks there’s too much “money” sloshing around (a situation that can fuel inflation) it will sell some of its Treasury bonds, taking cash away from buyers of those bonds, and mopping up some of the cash in the system in the process. It can also raise short-term interest rates, which make it more expensive for all of us to borrow. That (usually) also slows down the economy.

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