The textbook model of money creation (Fed → Banks → Economy) is obsolete. Today's reality is far more complex, and understanding it is essential for macro analysis.

The Old Model (Pre-2008):

Fed creates reserves → Banks lend reserves → Deposits multiply → Economy gets credit

This model suggested the Fed had tight control over credit creation through reserves.

The New Reality:

Fed creates reserves → Banks AND Shadow Banks AND Markets → Economy

80% of lending now involves collateral. The 'credit multiplier' works through:

• Traditional bank lending (regulated, slow)
• Shadow bank lending (less regulated, leveraged)
• Securities markets (collateral chains, rehypothecation)

Why This Matters:

1. Fed control is weaker: The Fed controls bank reserves, but shadow banks can expand or contract credit independently based on risk appetite and collateral values.

2. Collateral is king: Treasury bonds, MBS, and other high-quality assets serve as collateral that enables leverage. When collateral values fall, credit contracts regardless of Fed action.

3. Volatility matters: Low volatility (MOVE < 80) allows shadow banks to leverage up — multiplying liquidity. High volatility forces deleveraging — destroying liquidity even if Fed policy is unchanged.

4. The system is fragile: Collateral chains can break quickly (margin calls, fire sales), creating sudden liquidity crises (2008, 2019, 2020, 2022 UK).