>A regular bank can't magic up $1M out of thin air,
uhmm . . . historically, this is *exactly* where paper money comes from, and why they are called "banknotes"!
Banks issued paper notes promising to pay the bearer a sum of money (i.e., an amount of gold or silver) upon presentation. This was a matter of convenience, the paper being easier to haul about. This led to the practice al matter that a bank could issue more paper than it held money, as long as it was careful enough not to issue so much that too much would come in to redeem.
This isn't fundamentally difference than the practice of lending deposits back out to other borrowers (which is generally how this new money created by the banking system was disbursed, anyway).
In time, government stepped in to regulate how much a bank cold lend in this manner (reserve requirement).
Until WWII, the majority of the paper money in the US was *not* issued by the government, but by banks and some other companies (e.g., Railroads printed $2.40 bills, as $2.40 was a common fare).
Even today, some cites print a local currency, generally (universally) backed 1:1 by federal money. It circulates and shows the effects of buying locally as these local bills start showing up in cash registers. (In the same vein, the US Navy used to deal with local discontent and calls for removing bases of rowdy sailors by paying in $2 bills. Once merchants noticed just how much of their registers were full of that uncommon note, attitudes changed quickly!)
The federal government has the exclusive power to coin money--but this means coining metal; it doesn't stop states or other entities from printing paper money.
doc hawk, displaced economics professor