What is Fiat Money?

This post addresses the question: What is fiat money? Once we have answered this question, we consider a much harder question – how to maintain confidence in the fiat money belief system?

What is fiat money?

Fiat means ‘let it be‘ or ‘let there be’. In the bible, God says ‘Fiat lux’ – let there be light. The Lord’s prayer says, ‘fiat voluntus tua’ – thy will be done! In a sovereign country, the Sovereign says ‘Fiat money’ – let there be money. In a democracy, the Sovereign is the state which means all of us. We say let there be money and there is!

Illustrated by Cohenbaum.

The government – elected by us – says this is money, and it is in all of our interests to believe them because fiat money is a collective good that helps us to get on with what we want to do. A feature of fiat money is that it is not linked to anything physical. In the past (see A brief history of money), we used a gold standard where the value of money was pegged to an amount of gold. However, this proved too inflexible – we do not want “what we can do” to be limited by the amount of a particular metal. Consequently, all countries abandoned the gold standard in the early ’70s and we have had ‘let it be’ money ever since. Fiat money is not linked to anything physical – it is information*, a collective memory, an IOU, a promise to deliver, nothing more.

Money creation

Fiat money is created out of nothing – as and when we need it – but with the condition that someone promises to do something. The promise allows money to be created, it is the I promise to pay on our banknotes! If you like, there is a magic money tree but it has strings attached – take its fruit and you are forever connected in a web of relationships until you have made good on your promises.

Illustrated by Cohenbaum.

Fiat money creation comes with a promise which is a demand on future economic activity. We might call this demand a debt, but unfortunately the word debt became associated with sin. Whereas, in Wycliffe’s 1389 version of the Lord’s prayer we asked God to forgive us our debts as we forgive our debtors, in later versions, the word debt was replaced by trespass or sin, and so we began to regard debt – a promise – as a sin, something negative. Given that all new fiat money is created as either government or private debt, and that a growing economy requires a growing amount of money, someone (government, businesses or individuals) has to promise something – has to take on more debt – in order for the economy to grow. Our promises or debts are the seeds of growth! Not delivering on our promises may be bad but it may still better to try and fail than not try at all. Far less attractive is a World where money creation limits what is possible – where money is a constraint. The only limit on what we can do should be human desire and ingenuity.

Nothing more than belief

If fiat money is a promise then it follows that the value of fiat money is based on the belief that we shall deliver on our promises.** In this web of promises we believe that someone will accept our promise – our money – for goods or services in the future. The teacher promises to teach the children, the roofer promises to fix the roofs, the baker promises to provide the bread. We could organise all this without money but it is so much easier to let money ensure that everyone does their ‘fair’ share. Underpinning belief in this web of promises is the idea that society will function tomorrow in the same way as it did today. Fundamentally, this a belief in the rule of law – that we shall be held accountable for our promises.

One of the most interesting but often overlooked properties of money is how it connects the present with the future. Whereas the past and the present are known, the future is unpredictable and this can create a problem. No one, neither government nor individuals can predict the future. Despite our best intentions we may not be able to deliver on our promises. If we promise too much and money is created too fast, the real economy needs time to catch up – a boom is followed by a bust. A debt crisis arises when some or many fail to deliver on their promises, and the system needs time to correct. During this debt overhang, few want to take on more debt, there are too few borrowers, less money is created, and the economy cannot grow as fast. In extreme cases – Japan since 1990, the US and EU since 2008 – this can take years or decades to correct. Either we can wait while the economy stumbles along, or the government can try to act as borrower of last resort and stimulate the economy as in Roosevelt’s New Deal. Opinion is still divided on whether this kind of fiscal stimulus really works, mainly because it depends on how it is implemented and how we respond.

Keeping the faith.

The government – elected by us – has sole responsibility for maintaining stability of the system of money. Although a part of this responsibility can be devolved to a central bank or regulators, it is the government that establishes these structures and can reform them. The finance minister or Chancellor is the high priest of the money system, and it is important that they take their responsibility seriously. A key role of the high priest is to maintain confidence in the fiat money belief system such the unit of exchange – the pound, the euro, the dollar, etc. – is not devalued. If we all believe, it works, if there are doubts, the currency may be devalued.

There are some rules that the high priest most follow in order to maintain confidence – in particular, not creating too much money too fast. But as the future is uncertain, how much is too fast is uncertain too. How should the high priest manage this? One of the most influential economists of the latter half of the twentieth century Paul Samuelson made use of the analogy between fiat money belief and religious belief, and put it like this [see John Maynard Keynes: Life, Ideas, Legacy By Mark Blaug]:

one of the functions of old-fashioned religion was to scare people by what might be regarded as myths into behaving in a way that long-run civilised life requires.”

And so it is with money – myths are thought necessary to maintain belief and ensure long-term stability. Imagine two almost identical countries called Agnotology and Ontology. In Agnotology, only the high priest understands about fiat money and the magic money tree, whereas in Ontology everyone knows.

Agnotology enjoys the stability and fiscal rectitude of the gold standard World, and the high priest can take a holiday. Meanwhile over in Ontology, there is an expectation that the high priest can solve all problems by creating more money – by taking more fruit from the tree. Aside from the moral question of truth, the more interesting question is which country will enjoy greater prosperity over the long term? Answers in the comments please.

Whether in Agnotology or Ontology, the high priest has the responsibility of regulating the rate of new money creation via monetary (new money creation by the private banking sector) and fiscal policy (new money creation by the government sector). The balance between public and private is a political choice between the collective and the individual. A collective – where risk is shared – is less volatile than individuals, consequently governments can borrow more cheaply than you or me. Public debt is cheap and if spent on stuff we want offers good value. So why not use it? The argument of the libertarian right is that governments limit freedom by making decisions on our behalf (and sometimes make bad decisions), but this is where democracy saves us – if we are no longer happy with a collectively agreed decision we can elect a new government. Democratic freedom is the best we can hope for.

In summary.

  1. Fiat money is nothing more than information – its value is based only on belief.
  2. The stability of this belief system is vitally important to all of us.
  3. Our elected representatives have primary responsibility for maintaining stability of the belief system.
  4. How they should achieve this is a matter of political expediency, however, democratic freedom requires that we are informed of the choices we are making.
  5. We should not tolerate a World where money creation limits what is possible. The only limits on what is possible must be human desire and ingenuity.

* Note that in physics, information is physical in that the creation of destruction of information costs energy.

** Note that the value of gold is based on belief also and is not that different.


  1. Sean Danaher -

    Very nice. Coincidentally in the Guardian today there is a long read How Economics Became a Religion by John Rapley

    On a religious theme I’m of a generation who studied Latin at school and the relevant version of the Lord’s prayer:

    “et dimitte nobis debita nostra sicut et nos dimittimus debitoribus nostris” uses the Latin for debt so it is an old concept.

    I do prefer the word promise to debt and it is important to wrench back the language from the neoliberal think tanks. Richard Murphy has an interesting blog on this http://www.taxresearch.org.uk/Blog/2017/07/07/changing-the-name-of-the-game/

  2. Geoff -

    An interesting read.
    Can I suggest the book Payback by Margaret Atwood be added to the resource list. It’s a learned, wide ranging history of “debt and the shadow side of wealth.” readable, philosophical and a compelling read………to be recommended.

    1. Sean Danaher -

      Thanks Geoff
      I’ve read some of her fiction including “The Handmaid’s Tale” which seems again popular in Trump’s America. Is it worth a book of the month?

      1. Geoff -

        Whilst reading and digesting Charles’ piece, Playback came to mind. It’s several years since I read it but for me it still adds much, almost a decade after it’s publication, to the issues of today.
        On a personal note I think the book adds value to the whole concept of debt, from a different perspective -I loved it. of coures it’s very different from esteemed authors such as Richard Murphy or Steve Keen but no less valuable for that.

        It might be worth reading the Guardian review, before making a decision Sean.

  3. Geoff -

    For all those who abuse our system Atwood has this to say – “How profitable is the future?” asks Scrooge. “Not very profitable,” the Spirit admits, or not yet.
    Unfortunately, there are a lot more people actively opposed to any attempts to help clean up the global mess – To many of them are making too much money out of the situation as it is.”
    ” I don’t really own anything, Scrooge thinks. Not even my body. Everything I have is borrowed. I’m not really rich at all. I’m heavily in debt. How do I even begin to pay back what I owe? Where shall I start?”

    Margret Atwood’s ” Payback”

  4. Peter May -

    “Meanwhile over in Ontology, there is an expectation that the high priest can solve all problems by creating more money – by taking more fruit from the tree. Aside from the moral question of truth, the more interesting question is which country will enjoy greater prosperity over the long term? Answers in the comments please.”
    Here goes: it is definitely Ontology – anything less and we are back to the limiting gold standard. And if Ontology spends too much and the money becomes worth less than it was, we can tax it.
    Money is a way of counting resources, which themselves are unlikely to be infinite, but to say that the method of counting is limited is just to artificially limit ourselves and give up before we’ve even tried! Ontology will be a happier more open place to live.
    And surely we have moved on from thinking the high priests have all – or even any – of the answers. Who, in Europe, seriously believes that the Pope knows it all and should be telling us what to do, never mind the local bishop.
    Nobody really thinks the Chancellor knows it all either and blessed, as he is, with the charisma of a second hand car salesman he can’t explain anything with any conviction. He can only say no.

    1. Charles Adams -

      “Ontology will be a happier more open place to live.”

      We can but try to keep putting the message out there.

  5. Peter May -

    This idea suggests another way for fiat money – particularly as the Dutch have only the Euro:


    But of course as there is only the Euro – there is a central bank which doesn’t support its members as a sovereign currency.

    So it seems to me that the so called digital cash proposal is mostly about a payment system (link above) – and also the idea of seperating that from the central bank- apart from the accounts held.

    “Digital cash would make the money system safer and simpler. It would allow people to hold their electronic money in accounts either at the central bank or indirectly at the central bank”

    I’m unsure if this is radical. Seems to me it is probably radical for the Euro but not for the rest of us!

    1. Charles Adams -

      It depends on the detail of how new money is created. In the UK, if as positive money suggest here


      “the Bank of England could use digital currency as a monetary policy tool to stimulate aggregate demand and influence the economy. If every citizen had a Digital Cash Account at the Bank of England (either directly or indirectly), then it would be a simple process for the Bank of England to make small and occasional ‘helicopter drops’ of newly created digital cash to every citizen. This could be done on a small scale (for example, just £50 per citizen) and at short notice.”

      This is quite radical. The rest seems not that different to our current system.

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  7. Dan Salmon -

    Excellent, but we need a 3rd country to go with Agnotology and Ontology: Kleptology. The high priest understands about fiat money and the magic money tree and so do all the banksters, while everyone is clueless. The banksters use this knowledge to slowly suck all the money out of the actual economy so they can hide it in offshore non-economies.

    1. Peter May -

      If that isn’t what the K stands for in UK it should be!

  8. Christopher J Squire -

    ‘fiat, n. < Latin fīat ‘let it be done’, ‘let there be made’, 3rd pers. singular present subjunctive of fierī, used as passive of facere to do, make.

    fiat-money n. U.S. money (such as an inconvertible paper currency) which is made legal tender by a ‘fiat’ of the government, without having an intrinsic or promissory value equal to its nominal value.
    1880 ‘E. Kirke’ Life J. A. Garfield 30 We shall still hear echoes of the old conflict, such as..the virtues of ‘fiat-money’.
    1888 J. Bryce Amer. Commonw. II. lvi. 369 Greenbacks, or so-called ‘fiat money’.’ (OED)

  9. Tyler -

    Right – all fair enough. Now taking your points 1-3 above, what do you think would happen if we start printing it (monetarism) as Richard Murphy and co. suggest?

    1. Tyler -

      And just to be quite clear, QE is not printing money in the typical and traditional sense, and the debt purchased through QE is not written off or cancelled, as Richard Murphy is wholly incorrect to assert.

      1. Charles Adams -

        Most economist believe in some form of Irving Fisher’s quantity theory of money, MV=PT, see

        so if you increase M (money) and the amount of activity (T) does not increase to match then you get inflation – an increase in P (price). V is pretty much a constant.

        Fiscal stimulus (which is not just printing money because you are still planning to cover the deficit through bond sales) is the argument that by increasing M you increase T rather than P.

        It is not clear what will happen with QE but as long as the BoE counts it as a debt, we can probably believe that they are still treating it as a debt. However, what does that mean if they may just leave it on their books for decades?

      2. Richard Yot -

        But what would actually happen if the QE debt *was* cancelled? What would the consequences be, if those bonds which have effectively been taken out of circulation simply disappeared?

        The rational answer to that would be: nothing. There would be no consequences. Which means that the money that was created to finance the bond purchases would simply become base money. Seems pretty similar to “printing money” once you look at it that way, it’s just that the route was less direct.

        And of course your argument seems to be based on the idea that QE will be reversed one day: ie that the bonds will be “paid back” out of general taxation. This would of course be immensely deflationary, and I would be amazed if any government were to do it, simply because of the harm it would do economically. What’s far more likely is that the bonds will either be rolled over forever, or quietly disappeared one day.

      3. Charles Adams -

        I agree, the indirectness is key. QE is mainly a transfer to financial institutions which does not necessarily get out into the real economy. In contrast, a fiscal stimulus goes direct.

      4. Richard Yot -

        Well of course the money from QE goes out to the real economy, it has to at some point – except for whatever portion the recipients decide to *save*.

        The theoretical idea of QE is to increase liquidity: swap illiquid bonds for liquid cash, thereby encouraging spending rather than saving. Ergo that means that most of the money will be spent rather than saved (since it does not make much sense to sell a bond for cash and just save the cash).

        The problem with QE is that it increased asset prices rather than the overall economy, since the beneficiaries simply invested the money in assets rather than other kinds of more productive (but riskier) investments, so there was asset-price inflation rather than CPI inflation. But the profits from those asset price increases would of course come into the overall economy, when those assets were sold.

        Does that mean that “printing money” is necessarily inflationary? Well *all* spending is potentially inflationary, and *all* saving is potentially deflationary. Printing money is no more inflationary than selling bonds to finance a deficit, it’s very act of spending that creates the potential for inflation.

        Money that is saved is no longer circulating in the economy, it might as well not exist. If some of that saved money is swapped for a bond (which is just something created out of thin air, just like fiat money) and recirculated, it’s no different the alternative scenario of that money *not* being swapped for a bond when saved, and instead of a bond being created from thin air by the state, some new money is. Same result, just different mechanism.

      5. Charles Adams -

        Have a look at Exhibit 6 at 15.38 minutes in this Richard Koo talk.


        Koo says that QE liquidity injection caused minimal increase in money supply and credit circulating in the real economy. Asset price inflation can also be driven by transfers from workers to capital.

  10. Richard Yot -

    @Charles Adams – I’ve watched that talk previously and found it very informative.

    QE is an injection of liquidity, cash for bonds. However it hasn’t resulted in increased bank lending because bank lending has nothing to do with liquidity. Banks simply lend to as many credit-worthy customers as they can find (that’s pretty much the point that Koo is making).

    The confusion is in the term “money supply”: the modern money supply is currently generated by banks making loans. When banks make new loans, new money is created (out of thin air again). When those loans are repaid that money is destroyed. It’s the private sector version of government deficit spending (creating new money) or taxation (destroying money).

    In the monetarist/neoliberal world we live in we rely on monetary policy to regulate demand, as opposed to fiscal policy. Essentially that means we need the private sector to create new money in the form of bank loans rather than rely on the state to spend more, and we do this by adjusting interest rates.

    But for the money supply to grow in this situation requires *more* new loans to be made than old loans be repaid at any one time. If the private sector is saving overall (repaying old loans) you get a recession. The private sector has to get into ever increasing debt in order to increase the money supply.

    So the point being, that QE can’t increase bank lending (and therefore the money supply) because it’s just an asset swap (cash for bonds), it doesn’t generate new assets. For new assets to exist some entity needs to spend more than it earns – either the private sector by borrowing more or the state by deficit spending. That’s exactly the point Koo is making: in a balance sheet recession you need fiscal policy rather than monetary policy, because the private sector has no appetite for new debt.

    1. Charles Adams -

      Completely agree with your last line here. There are times when there is a need for fiscal policy.

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