How Fiat Money Is Actually Created: The Mechanics of Credit-Based Currency
Around the Block | May 28, 2026 — By William Sanchez Jr., Founder of A.W. Block
Most people think inflation is caused by the government printing money.
The image is intuitive. A central bank fires up the presses, new notes roll out, prices rise. The full picture of how fiat money is created, where it enters the economy, and who benefits from that process is far more consequential than the simplified version suggests. Understanding the mechanics changes how you think about inflation, wealth, and the purpose of hard money as an alternative.
Two Layers of Money Creation
The fiat monetary system creates money at two distinct layers. Most people only know about the first.
The first layer is the central bank. The Federal Reserve, the European Central Bank, the Bank of England, and their counterparts create base money, also called high-powered money or reserves. This is the money commercial banks hold on deposit at the central bank. It grows when the central bank purchases assets (quantitative easing) or makes loans to commercial banks.
The second layer, and by far the larger source of new money, is commercial bank lending. When a commercial bank makes a loan, it does not lend out money it has already collected. It creates a new deposit in the borrower’s account, backed by the loan obligation. The money did not exist before the loan was made. It comes into existence through the act of lending.
Ammous, in The Fiat Standard, captures this precisely: fiat mining is credit creation. Just as Bitcoin miners produce new bitcoin by expending computational work, commercial banks produce new fiat money by extending credit. The bank’s profit, the interest spread, is the mining reward.
The Fractional Reserve Multiplier
The mechanism by which commercial bank lending amplifies the money supply is called the money multiplier, and it operates through reserve requirements.
The simplified mechanism: a central bank creates $1,000 of new base money. A commercial bank receives this as a deposit. Required to hold only 10% in reserve, the bank lends out $900. That $900 is deposited at another bank, which lends out $810. That $810 is deposited elsewhere, and so on. The original $1,000 of base money generates approximately $10,000 of deposits in the banking system through this multiplication process.
In practice, reserve requirements in many countries have been reduced to zero or near-zero. Seb Bunney documents this directly in The Hidden Cost of Money: since March 2020, the Federal Reserve has held reserve requirements at zero. The constraint on commercial bank credit creation in the modern fiat system is no longer reserves. It is bank capital and demand for loans.
The practical consequence: the money supply does not expand in proportion to economic output, innovation, or real value creation. It expands in proportion to the extension of credit. Productive activity does not create new money. Debt creation does.
What This Means for the Price of Everything
When the money supply expands faster than the supply of goods and services, prices rise. This is inflation in its most basic form: too much money chasing too few goods.
Inflation does not raise all prices simultaneously or proportionally. It flows through the economy along specific channels determined by where the new money enters. This observation, first made by the eighteenth-century Irish economist Richard Cantillon and now known as the Cantillon effect, is the key to understanding who benefits from money creation and who pays for it.
New money enters the economy primarily through three channels: financial institutions (via central bank asset purchases and commercial bank lending), government borrowing (Treasury issuance), and the mortgage market (the largest single source of commercial bank credit creation in the United States). The first recipients of this new money can spend it at current prices. As the money circulates, prices adjust upward. Those who receive the new money last (wage earners, cash savers, fixed-income pensioners) face higher prices without having received any compensating increase in income.
QE as Concentrated Cantillon
Quantitative easing, the Federal Reserve’s policy of purchasing assets from banks using newly created reserves, concentrates the Cantillon effect in financial assets.
The mechanism: the Fed purchases government bonds and mortgage-backed securities from commercial banks and institutional investors. The sellers receive newly created reserves. They deploy those reserves into other financial assets. Asset prices rise: equities, real estate, corporate bonds, commodities. The asset price inflation occurs before any of this new money reaches wage earners or consumer prices.
Between 2008 and 2021, the Fed’s balance sheet expanded approximately tenfold, from roughly $900 billion to $8.9 trillion. The S&P 500 expanded roughly fivefold over the same period, from approximately 900 to over 4,700. Home prices in major metropolitan areas roughly doubled or tripled. Lawrence Lepard, in The Big Print, frames this for what it was: the largest hidden tax in modern history, paid by anyone who held savings rather than scarce assets.
The gap between Fed expansion and equity expansion is not a sign that the new money was absorbed elsewhere. It is a sign that the Cantillon effect is unequal even within the asset-holder class. A person who entered this period with $1 million in equities held approximately $5 million in nominal terms by 2021. A person who held $1 million in a savings account earned $30,000 to $50,000 in cumulative interest over the same period, while their purchasing power was eroded by 25 to 30 percent depending on how you measure inflation. This is not incidental. It is the predictable result of directing new money into financial markets first.
The Invisible Tax on Savers
The cumulative effect of monetary expansion on savings is obscured by the way we talk about inflation. When the Consumer Price Index shows 2% annual inflation, the intuitive response is that prices rose 2% and wages rose roughly the same amount, so nothing much changed.
CPI measures a specific basket of consumer goods that excludes most of the assets required to build wealth: residential real estate, equities, and financial assets. If you measure monetary inflation by the assets people need to accumulate to achieve financial security, the picture is dramatically different. Median U.S. home prices have increased 10 to 17 times in nominal terms since 1971, depending on the region. The S&P 500 has increased more than 50 times since 1980.
The person earning wages and saving cash is running against a price level for wealth-building assets that inflates far faster than official CPI would suggest. The invisible tax on savers is not primarily felt at the grocery store. It is felt in the ever-increasing price of the assets required to achieve economic security.
Ammous summarizes the dynamic: in the fiat standard, choosing to hold savings rather than debt is not conservative financial management. It is a systematic transfer of wealth from the saver to borrowers and institutions. The system is structured to punish those who produce more than they consume and save the difference.
Why Bitcoin Addresses This Mechanically
Bitcoin does not address the problems described in this article through policy or reform. It addresses them through a different protocol that makes the mechanics of fiat money creation structurally impossible.
No new Bitcoin is created through credit issuance. Commercial banks cannot mine Bitcoin by making loans. The supply is mathematically fixed and the schedule is publicly verifiable by anyone. There is no Cantillon dynamic because there is no new monetary injection for any party to receive first. The difficulty adjustment ensures that mining effort affects security, not supply.
Fiat money is a system with certain mechanics and certain consequences. Bitcoin is a system with different mechanics and different consequences. The choice between them is a choice between two different sets of incentives and outcomes.
Sources: The Fiat Standard, Ch. 1–6 (Ammous) | The Hidden Cost of Money (Bunney) | The Big Print (Lepard)
What Is A.W. Block?
A.W. Block is a digital asset estate investigation and Bitcoin advisory firm. On the estate side, we support attorneys, probate administrators, and fiduciaries with asset identification, blockchain investigation, and court-ready documentation. On the advisory side, we work with individuals and institutions on Bitcoin custody, accumulation strategy, and education.
awblock.io
Found value? Share, subscribe, and/or send sats here: bc1qrlgzu0m94wdrsnxjg8qym7jtnudelgfypmjmaa