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LESSONS

Fiat and central banks

Fiat money is backed by law, not by an asset. Central banks and commercial banks create it, and its supply has no ceiling.

6 MIN READ
COURSE · Money 101STAGE 1 · FOUNDATIONSLESSON 3 OF 8
Treasury issues bonds, the Fed buys them with new reserves, banks lend and create deposits, and ordinary people receive the money last.
LEVEL · Beginner
IN THIS LESSON · 3 OF 8
BY THE END YOU WILL BE ABLE TO ANSWER
  • What backs the US dollar today?
  • Who creates most new money in the modern system?
  • Roughly what share of today's dollars were created after the year 2000?
  • Look up your central bank's balance sheet or M2 money supply for this year and for 2019. By what percentage did it grow? (Any figure you found.)

Then prove it: a 3-question quiz · a challenge. The lesson marks itself complete at 100%.

After this lesson you can: explain where new fiat money comes from.

Fiat is Latin for "let it be done". Fiat money is money because the government says so and demands taxes in it. It is not redeemable for gold or anything else. Every major currency has been fiat since 1971.

Who makes it

Three parties create dollars, and none of them is you:

  1. The Treasury borrows by selling bonds, which are IOUs.
  2. The Federal Reserve, the US central bank founded in 1913, can buy those bonds with reserves it creates by keystroke. This is what "quantitative easing" means.
  3. Commercial banks create deposits when they lend. A loan is new money; it did not come out of anyone's savings. Under fractional reserve banking, banks keep only a fraction of deposits on hand; since 2020 the US reserve requirement is zero.

Animated flow: the Treasury issues bonds, the Fed buys them with new reserves, banks lend and create deposits, people receive dollars last.
The birth of a dollar: bonds, reserves, loans, deposits. You are at the end of the line.

More than 80% of the dollars in existence today were created after the year 2000. There is no upper limit.

Line chart of US M2 money supply from 1971 to 2024.
No upper limit, in one line: US M2, approximate January values.

Why governments like it

Two columns: what a flexible money lets a state do, and what it costs savers.
The steering wheel and the printing press are the same lever.

Fiat gives the state a steering wheel: it can cut interest rates in a recession, fund a war or a bailout without raising taxes, and act as lender of last resort to banks. The cost is that the steering wheel is also a printing press, and every dollar created dilutes every dollar saved.

The IOU Machine: How Currency Is Created · Hidden Secrets of Money, episode 4Watch on YouTube ↗
>80%
of all US dollars were created after the year 2000
MINI CHALLENGEFind the number

Look up your central bank's balance sheet or M2 money supply for this year and for 2019. By what percentage did it grow? (Any figure you found.)

percent
CHECK YOURSELF
1/3 What backs the US dollar today?
2/3 Who creates most new money in the modern system?
3/3 Roughly what share of today's dollars were created after the year 2000?
pick an answer for each question

Next

What happens to prices when the supply of money keeps growing? Lesson 4 is on inflation, and lesson 5 on who wins and who loses from it.

SOURCES

  1. Understanding fiat currencies (River Learn)
  2. How does money printing work? (River Learn)
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