Fiat Money, Fractional Reserve Banking, and Inflation: A Christian Analysis

In Brief:

Every nation on earth operates on fiat money — currency with no commodity backing, issued by central banks, and created through fractional reserve lending. This article explains what money is, how the modern banking system creates it from nothing, and how inflation transfers purchasing power from those who earn it to those who control the money supply. This is the foundation the rest of this series builds on.

“From a Christian perspective, one could consider the acceptance and spread of fiat money as a grave sin — a reflection of the flawed state of humanity, separated from God, and leading a misguided life. Fiat money stands for deceit, false testimony, and the insidious plundering of some by others.” — Thorsten Polleit, Mises.org, January 2025

What Money Is — and Why Scarcity Matters

Money does not have value in and of itself. Money is simply the most saleable commodity (Menger, 2009) making it the ideal medium of exchange. As such, the value of every other good or service can be expressed in units of money. In America, that unit is the U.S. dollar.

A stockpile of gold, silver, or dollars is only valuable because of what it can be exchanged for. The worth of a 401(k), for instance, lies entirely in its anticipated purchasing power at retirement — not in the numbers on a statement.

The Necessary Properties of Money

For something to function as money it must be portable, divisible, fungible, recognizable, and — critically — of limited supply. Scarcity is what prevents the unit of account from being infinitely reproduced and thus infinitely diluted.

Today, every nation in the world operates on fiat money (Tacanho, 2022). Fiat money is currency declared legal tender by government decree, backed by no physical commodity. Its value rests entirely on public confidence in the issuing government. The quantity of dollars in existence is controlled through the printing press — physical and digital — and through interest rate policy managed by the Federal Reserve.

Fiat money has an unlimited supply by design. Its quantity is governed only by changeable policy, not by the physical constraints that limited commodity money. This violates the necessary property of scarcity and creates what the Westminster Larger Catechism would recognize as a false weight and measure — a unit of account that can be quietly altered after the fact.

Fiat Money vs. Commodity Money

What Backed Money Before Fiat

Under a commodity money standard — gold, silver, or another scarce physical good — the money supply was constrained by what could be mined, refined, and minted. Every dollar represented a claim on a real, stored quantity of value. A government or bank that wanted to spend more than it had was constrained by the physical supply of the commodity.

Fiat money severed that constraint. When President Nixon closed the gold window in 1971, the last formal link between the U.S. dollar and a commodity was eliminated. Since then, the supply of dollars has been governed entirely by Federal Reserve policy — which is to say, by institutional discretion with no external anchor.

Why This Matters for Stewardship

When the interest rate and monetary policy are manipulated, the rate at which banks can create new money through fractional reserve lending changes accordingly. The money supply expands not through productive labor or real resource extraction but through policy decisions made by unelected officials at a central bank. The Christian who saves diligently in dollars is storing value in a unit that can be diluted without his knowledge or consent.

Fractional Reserve Banking: Finance Ex Nihilo

Defining a Bank

To understand fractional reserve banking, it helps to start with the basic definition. A bank — like a snowbank or a riverbank — is simply a place where something is stored or accumulated. In the context of the banking function (storage, movement, and repayment), a bank is where money is stored and from which it is moved through credit, loans, and repayment.

Demand Deposit Banking

Demand deposit banking is the foundation of the modern banking system. A depositor stores money with a bank and receives a receipt — a demand deposit or check — representing their claim to that money. Rather than withdrawing the money for each purchase, the depositor can transfer the receipt directly. Modern checking accounts operate on this principle: a check is a claim against money held on deposit.

Under full-reserve demand deposit banking, the number of claims in circulation equals the amount of money actually on deposit. If the bank makes a loan, an equal amount is unavailable for withdrawal until the loan is repaid (Lara & Murphy, 2012, pp. 75–88).

How Fractional Reserve Banking Works

Fractional reserve banking breaks this 1:1 relationship. Under a fractional reserve system, banks are permitted to issue more claims against money than money actually held on deposit (Lara & Murphy, 2012, pp. 105–116). The bank keeps only a fraction of its liabilities as reserves against the loans it issues.

In a March 21, 1960 Congressional hearing, Congressman Wright Patman (D-TX) described the mechanism plainly:

“If I deposit [$1,000] with my bank and the reserve requirements imposed by the Federal Reserve are [10%] then the bank can make a loan to John Doe of up to [$900]. Where does the [$900] come from? It does not come out of my deposit of [$1,000]; on the contrary, the bank simply credits John Doe’s account with [$900]. The bank can acquire government obligations by the same procedure, by simply creating deposits to the credit of the government. Money creating is a power of the commercial banks.” (Mullins, 1993, p. 167)

The bank charges interest on the $900 loan — interest on money it never possessed. The borrower repays with real earned dollars; the bank collected fees for lending something it created by journal entry.

Now consider what John Doe does with the $900. He deposits it at Bank C. Bank C is permitted to loan $810 to Jane Smith. The original $1,000 is still on deposit. The $900 John Doe deposited is still there. The $810 loan was created from nothing.

From a single $1,000 deposit, in just two steps, $1,710 in additional money has entered circulation. Carried out to the end, that $1,000 deposit allows $9,000 of new money to be created. “Commercial banks — that is, fractional reserve banks — create money out of thin air” (Rothbard, 2008).

The Federal Reserve’s 0% Reserve Requirement

The example above assumes a 10% reserve requirement, the historical norm since 1917. That requirement no longer exists.

On March 15, 2020, the Federal Reserve announced:

“…the Board reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions.” (Federal Reserve Board, 2020)

This 0% reserve requirement remains in effect as of this writing. There is no longer any regulatory floor on the ratio of loans to deposits at American commercial banks. The fractional reserve is, at present, no reserve at all.

Inflation: A Feature, Not a Bug

What Inflation Actually Is

The act of securing a loan from a commercial bank directly contributes to inflation — not as a side effect, but as the mechanism by which the system operates.

“The word ‘inflation’ originally applied solely to the quantity of money. It meant that the volume of money was inflated, blown up, overextended. It is not mere pedantry to insist that the word should be used only in its original meaning. To use it to mean ‘a rise in prices’ is to deflect attention from the real cause of inflation and the real cure for it.” (Hazlitt, 1965, p. 2)

Inflation is rightly defined as “increasing the quantity of money and bank notes in circulation” (Shostak, 2025). Rising prices are not inflation — they are the observable effect of inflation. When Caesar clipped coins or alloyed them with baser metals to produce more from the same quantity of gold, he was inflating the money supply. When citizens noticed their coins were lighter, they demanded more of them for purchases. The mechanism is identical today; only the technology differs.

As the quantity of money in circulation increases, each unit purchases less — more dollars chasing the same quantity of goods. Prices rise not because goods became more valuable but because the money used to price them became less scarce.

How Inflation Steals the Labor Contract

Consider a skilled worker who has analyzed the labor market and concluded his time is worth $50 an hour. Not because the money adds to his life directly, but because of what it can purchase: two weeks of groceries, twenty gallons of gas, one month’s utilities. He enters into a contract with an employer, exchanging his labor for an agreed purchasing power denominated in dollars.

New money created through fractional reserve lending enters circulation gradually. Those who receive it first — the banks and their institutional borrowers — spend it at current prices before the broader market adjusts. In time, rising prices reflect the expanded money supply. But wages have not yet caught up. What once cost one hour of labor now costs two. The worker’s contract has been effectively renegotiated without his knowledge or consent, and his purchasing power stolen.

John Maynard Keynes understood this dynamic and considered it a feature:

“If one devalues the currency and the workers are not clever enough to realize it, they will not offer resistance against a drop in real wages, as long as nominal wage rates stay the same.” — John Maynard Keynes

This is the system as designed. Part 2 of this series examines what the Westminster Larger Catechism has to say about it.

Ready to understand how to take control of the banking function in your own family economy? Book a free call with William Fullington to learn how IBC applies to your situation.

Semper Reformanda.

What is fiat money?

Fiat money is currency declared legal tender by government decree, backed by no physical commodity such as gold or silver. Its value rests on public confidence in the issuing government rather than on any stored, scarce good. Every nation in the world currently operates on a fiat money standard. Because a fiat money supply is governed only by policy — not physical constraints — it can be expanded indefinitely, violating the scarcity property that makes money a reliable store of value.

What is fractional reserve banking?

Fractional reserve banking is a system in which banks are permitted to issue loans in excess of the deposits they actually hold. A bank receiving a $1,000 deposit does not lend from that deposit — it creates a new $900 credit entry in a borrower’s account while the original $1,000 remains on deposit. This process multiplies the money supply at each step. As Murray Rothbard summarized: “Commercial banks — that is, fractional reserve banks — create money out of thin air.” The United States currently operates under a 0% reserve requirement, meaning there is no regulatory floor on this process.

Does the United States still have a reserve requirement for banks?

No. On March 26, 2020, the Federal Reserve reduced reserve requirement ratios to zero percent for all depository institutions (Federal Reserve Board, 2020). This means American commercial banks are no longer required to hold any minimum fraction of deposits as reserves against the loans they issue. The reserve requirement that most Americans learned about in school — typically illustrated at 10% — no longer exists.

How does fractional reserve banking cause inflation?

Every loan issued by a commercial bank creates new money. When a bank credits a borrower’s account with $900 against a $1,000 deposit, $900 in new purchasing power enters the economy without any corresponding increase in goods or services. As this process repeats across millions of transactions, the total quantity of money in circulation expands. More dollars chasing the same quantity of goods causes prices to rise — which is the observable effect of inflation. Inflation is not primarily caused by supply chain disruptions or corporate pricing; it is caused by expansion of the money supply through fractional reserve lending and government spending financed by central bank credit.

References

Federal Reserve Board. (2020, March 15). Federal Reserve actions to support the flow of credit to households and businesses [Press release]. https://www.federalreserve.gov/newsevents/pressreleases/monetary20200315b.htm

Hazlitt, H. (1965). What you should know about inflation. D. Van Nostrand Company. https://mises.org/library/book/what-you-should-know-about-inflation

Lara, C., & Murphy, R. (2012). How privatized banking really works. Sheridan Books.

Menger, C. (2009). On the origins of money. Mises Institute. https://mises.org/mises-daily/nature-and-origin-money

Mullins, E. (1993). The secrets of the Federal Reserve. Bankers Research Institute.

Rothbard, M. (2008). The mystery of banking. Mises Institute. https://mises.org/library/book/mystery-banking

Shostak, F. (2025, January 27). Should inflation be defined only as price increases? Mises Institute. https://mises.org/mises-wire/should-inflation-be-defined-only-price-increases

Tacanho, M. (2022, February 5). Today’s fiat dollar standard is founded in lies. Mises Institute. https://mises.org/mises-wire/todays-fiat-dollar-standard-founded-lies

Westminster Assembly. (1647). Westminster Larger Catechism. https://thewestminsterstandard.org/westminster-larger-catechism/

William Fullington is the founder of Reformed Finance LLC and an Authorized Infinite Banking Practitioner with the Nelson Nash Institute. He is a licensed life insurance producer and retired Air Force officer who helps Christian families understand the Infinite Banking Concept, whole life insurance policy design, biblical stewardship, and the importance of controlling the banking function in their family economy.

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