To properly understand a fiat money system, one should avoid being misled by concepts that have meaning only in the context of a commodity money system. Fiat money is issued by the Federal Reserve. It is produced at trivial cost relative to its face value. Its value derives from the fact that it is the only kind of money acceptable in payment of taxes and for settling private debts in court. Thus it can be viewed as credit that is widely accepted as a medium of exchange.
Banks expand the scope of fiat money by issuing credit through the act of lending.
The value of bank credit money is based on the promise that it can be converted to fiat money at par. Banks must hold sufficient reserves of fiat money to accommodate such conversion on demand. The Monetary Base T he story of money properly begins with the origin of fiat money , also known as the monetary base . This is money the Fed issues when it buys securities from the public for its own portfolio, mainly Treasury debt. It pays by simply creating a deposit at the Federal Reserve Bank for the seller s own commercial bank.