The so-called “fiat money” (i.e., money not backed by a commodity) used by modern economies is controlled by a central bank whose overriding goal is maintaining monetary and financial stability. Only the central bank can issue new money or take it out of circulation.

Note that this is just a political arrangement that prevents the parts of a government that spend money from conjuring it out of thin air. For example, in the U.S., President Obama can’t just call Ben Bernanke and demand that the Federal Reserve issue more money to pay for the federal government’s expenditures; instead, the federal government must either collect additional taxes or borrow funds from investors, and the Federal Reserve independently gets to decide if, how, and when to issue new money (or take it out of circulation) to fulfill its dual objectives of monetary and financial stability.

Typically, central banks like the Federal Reserve issue money (or take it out of circulation) via two mechanisms:

(1) The central bank can buy and sell government bonds to expand or contract the amount of money in circulation and/or push interest rates up or down. When a central bank buys such bonds, it pays with newly issued money, thereby replacing one government obligation (bonds) with another (money) of equal present value; and when the central bank sells any government bonds it holds, the money it receives is taken out of circulation (i.e., destroyed).

(2) Certain private-sector financial firms can borrow directly from the central bank, which lends them newly issued money, thus acquiring a new financial instrument (a loan to a private-sector entity) and issuing a new obligation (money) of equal magnitude; when the loan is repaid, the central bank takes the money out of circulation, reducing government claims and obligations by the same magnitude.

The money issued by a central bank, which is held only by depositary institutions like banks, is called “reserves.” The aggregate of all bank reserves (plus all paper currency in circulation, to be precise) is called the “monetary base.”

In normal times, whenever bank reserves grow beyond required legal minimums, banks supposedly make more loans, thereby increasing the amount of money flowing through the economy and promoting economic growth. In other words, an increase in the monetary base is supposed to result in an increase in the money supply.

However, at present, for whatever reasons (and there is much debate among professional economists as to what those reasons might be), the monetary base has grown immensely[1], but banks are not making the expected additional loans, so the amount of money flowing through the economy is not growing as economists would expect in normal times.[2] “Money velocity” (a measure of the number of times money gets turned over in the economy) has collapsed.[3]

So, that’s the answer to the question, “where has all the money gone?”

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[1] You can see the incredible growth in the U.S. monetary base here: http://research.stlouisfed.org/fred2/series/BASE/

[2] You can see the incredible growth in excess reserves in the U.S. banking system here: http://research.stlouisfed.org/fred2/series/EXCRESNS?cid=123

[3] You can see the dramatic drop in U.S. money velocity here: http://research.stlouisfed.org/fred2/series/M2V?cid=32242